In a recent INDUSTRIAL DISTRIBUTION feature, we noted that many buying organizations are moving away from focusing too much on the piece price of goods and toward giving contracts for the least overall cost to the organization. Purchasing is becoming automated, leaving more time free for buying professionals to delve deep into secondary and hidden costs associated with their supply chains.

Still, a wide variety of distributors – retail, wholesale, industrial and consumer – continue to battle price pressures daily. They find that price matters most to many customers, regardless of surveys to the contrary. In an endless cycle of information overload, distributors and their customers claim it's too time consuming and expensive to sift through mountains of sales data to determine fact from fiction.

Reducing prices cannot guarantee customer satisfaction and will probably harm more relationships than it helps, says Mort Harris, president of Replenex^®, Inc., based in Eden Prairie, Minn. Some are necessary. Prices and price-cutting problems are an important part of the problem that distributors face in the competitive world marketplace, Harris says. Distributors are ill-advised if they ignore the urgent need to invest in becoming a global buyer and seller of MRO goods and services.

At an NAW meeting in January, one speaker mentioned that a laborer in China makes $1,000 a year and does roughly the amount of work for which a laborer in the United States would get $50,000, Harris says.

"That scenario isn't going to change. The distributor who does not adapt to it will become extinct," he admonishes.

The only way to battle dropping prices for goods is to be focused on the end user and prove the value that distributors deliver every day. Distributors who improve their service delivery systems and prove their value will continue to be an important part of the supply chain in the future. Those who believe they can continue to do business using 20^th -century methods will fail, he says.

It will take an investment of time and money, Harris adds. Small and mid-sized distributors that gross less than $10 million and make up 75 percent of membership in the Industrial Distribution Assn., will either join the changing, technological, global commerce environment or be left behind.

The need to change is universal; distributors of every size and scope are affected, Harris says. Larger distributors are generally more aware of the urgency of finding ways to join global competition. Adding computer systems and personnel, and buying other businesses, are two ways to become leveraged for the next decade.

"There is no perceived value in the distributor by the customer unless [the distributor] can prove it," he says. "Therefore, fee-for-services is nothing more than a documentation of a value you provide of absolute cost reduction for the customer."

Replenex, formerly Minnesota Industrial Tools, Inc., was named to reflect the ubiquitous nature of supplying MRO goods and services globally, he says. His management team realized the company had to automate its processes and form alliances with other distributors to get the desired result: a company that competes on any playing field via the right price and the best service.

"When we created a strategic direction for Replenex, we decided to buy five companies in five years. We no longer do business only in Minnesota, but in the world. That's what the new name reflects," Harris says.

Manufacturers and distributors can talk about a cutting tool price versus its competitor, but the only important value in the customer's eyes is lowest total cost of ownership, Harris says. Since prices will continue to be a problem in the future, how the distributor deals with the actual, proven cost to the customer will determine his viability as a seller.

The pricing problem

There are ways to better manage prices and attract customers through your overall value, says one distribution expert. Gene Roman is a distribution systems analyst and founder of Systems Design, Inc., which provides software solutions to distributors. A speaker and trainer, Roman preaches simplification of systems to cut costs and gain market share. He says that cutting price will not create loyal customers or suitable profits.

One principle that Roman espouses in his book, Reengineering the Distributor in the 21 st Century, is velocity pricing. The process includes classifying products by category and class, the most commoditized products on the top of the list and the most specialized, custom products at the bottom. Commodities, those items that everyone shops strictly by price, top the list. Products from one manufacturer could fall anywhere along the line, depending on their popularity.

Velocity pricing protects margins on current sales and increases margins on new products as they are added down the line. The principle is simple: distributors want commodity business to keep customers coming back; they want special business for the higher margins those items promise. By raising the margin he will make on a product as a coefficient of the item's rarity, the distributor can increase his overall margin substantially.

If an item is special, or rare but happens to be on the shelf, most customers looking for it will order with little regard for the cost, if it is within reason, Roman says. Convenience items or those with few inventory turns, must be worth having on the shelf. He suggests classifying items "A" through "E," "A" products being those most tightly price shopped.

Classifying inventory is a key. The process is done by perceived commodity value, not by how many times it turns in any particular inventory. If potential customers view the item as commoditized and ordered by price alone, the distributor must consider it an "A," or most commoditized item, whether or not it turns many times.

On the other hand, products or lines kept for customers or not strictly price shopped –"D" or "E" items — should be raised substantially in margin. They must "earn their turn," Roman says.

"Generally, when someone can't find an item and you have it, they order it; they don't quibble very much on price. So your 30- or 40-percent markup is justified," he says.

"You may have to drop a half-point on some of your most common items, but you can raise many specials a point or more," Roman says.

Matrix pricing, in which each product brand or line has a fixed margin, is far easier but much less accurate in the world of supply and demand, Roman says. The distributor will never make the potential margin using that system because, as a rule, customers price shop only those items about which they are aware of competition.

If a plumbing house sells ½-in. copper fittings, they must sell them as "A" products because everyone sells them and customers buy strictly by price.

The velocity system must be automated and flexible, so every employee who might sell an item is aware of the velocity of the line, he adds. That adds upfront work in implementing the system, but software allows easy maintenance of the structure as a whole. Velocity pricing breaks down if an inside salesperson takes an order and sells the product on the old matrix price schedule, Roman warns.

"However, this is one of the few ways to significantly increase margin," he says. "You can't do it through turns and you certainly can't do it through price cutting. In a declining margin environment, you can't try things like improving collections by five days, to improve the bottom line."

"Velocity pricing gives the buyer the impression that you are the price leader because, when he buys, he gets the best price from you," Roman says. "However, if he doesn't need the products or you don't have what he needs, the price is irrelevant. He isn't buying."