The current model of wholesale distribution—in which the distributor buys products from suppliers and then makes these products available to customers—has remained unchanged for 50 years. Lately, the end result is that the pre-tax profit earned by most distributors has been decreasing drastically, to the point that distributors must start selling services as well as products in order to offset the downward spiral.

The biggest challenge that distributors face in this move to selling services is their organization's culture. Traditionally, the products have identified the distributors and their business. The shift from a strictly product-based business to one that includes services will test the distributor's ability to change its culture. A fundamental aspect in this transition is the distributor's ability to anticipate customer and supplier needs.

Ultimately, the distributor must expand its capabilities to create and assess the value for his customers, and potentially his suppliers. He can do this by developing, and then implementing, a long-term, sustainable value-and-demand supply chain proposition.

The Industrial Distribution Program of Texas A&M University conducted a nine-month-long study on fee-based services in the wholesale distribution industry. This study explored industry practices within the context of fee-based services, with the purpose of exploring the effects on distributors' profitability, customer loyalty, and issues associated with shifting from a product-centric selling business to the fee-based services model.

The study also explored how distributors can develop processes to initiate fee-based services. These aspects were studied through analysis and documentation of current fee-based services in three vertical channels: electrical, building materials and pharmaceuticals.

Wholesale distribution channels are facing historically declining pre-tax profit rates, while the costs involved in operating the business continue to increase. These are the realities in the traditional product-based business. And managing the traditional business so that it yields an adequate return on investment for the distributor's stakeholders is continuing to be more difficult. There are many opportunities for wholesale distributors to wring more pre-tax profit out of the firm by improving operational efficiency and effectiveness, but this is not an indefinite source of improving profit.

There's been considerable discussion about unbundling services, then charging customers for the services that they had been getting as part of the purchase price of the product. It's understandable that it comes as a difficult proposition for distributors to ask customers to pay for services that they had been getting for ''free.''

In order to initiate, develop, and expand fee-based services in the industry, distributors need to study and observe their customers' businesses closely. Since most services are closely tied to products, distributors can study the pre-use, use, and post-use of their products, and the value brought to their customers at each stage. The main challenge for distributors will be to understand and identify value-added service opportunities in those activities surrounding the product.

Wholesale distributors that are thinking about adding fee-based services to their business must first decide if this new endeavor is, or should be, a part of their overall strategy. This is important because, if it is part of that strategy, it will take up a considerable portion of organizational energy. In order to decide, a thorough analysis of the issues associated with fee-based services should be conducted.

These issues commonly include: the distributor's ability to assess customer needs; the changing role of the sales force towards customer-centric selling; the difference in marketing fee-based services, with a focus on a market of one; matching service-business opportunities with existing resources; and the role of employees in the success of a fee-based services business.

Once the decision is made to pursue fee-based services, the distributor should conduct a self-assessment that includes an analysis of his internal core competencies, and answer the question of whether the distributor's internal capabilities (business processes and resources) match the requirements to deliver service to the customer. But even more importantly, do they think the customer will value these services? Only after all these details are finalized, will a company be ready to proceed with the process of designing and implementing a fee-based service business unit.

The distributor's customers are engaged in a set of activities that represent their core business process. For example, an appliance manufacturer concentrates on building appliances; a hospital is in the business of healing the sick; and a homebuilder constructs homes. These businesses are highly skilled at their core business. What challenges them are the other activities and functions that surround their core business. This is the area of opportunity for the wholesale distributor.

The non-core functions that these firms must accomplish in order to support their core business—material supply, inventory management, material handling, waste disposal, transportation, etc.—are activities in which they are not as skilled. Consequently, the cost to perform these functions is usually quite high. Wholesale distributors must develop an understanding of their customers' business processes so they are in a position to identify fee-based service opportunities within these processes.

Once these processes are well understood, the distribution firm should examine its internal core competencies in order to map existing assets—human, systems, equipment and facilities—to those identified opportunities. If the core competencies do not exist, or if they are insufficiently developed to meet the customer's need, then it must be determined if investment in the capability can return sufficient dividends to justify the expenditure.

Some distributor characteristics that have successfully shifted into a fee-based service offering include: in-house supply management expertise; extensive product knowledge; resources to manage large maintenance projects; the ability to provide technical advice and service at multiple locations through local resources; a national customer base; a large inventory of products from various suppliers; centralized purchasing and accounting; incentive programs that increase productivity and encourage entrepreneurship; on-site support personnel; and customer training.

The differentiation between competitors lies in the ability to tailor warehouse operations, transportation methods, and information systems to the needs of the customer. This differentiation decreases the likelihood of replication from competing firms, solidifying the foundation for a long-term bond with the customer.

In addition, distributors must shift the focus from a transaction form of business to a consulting form of selling. The most challenging aspect of this process is to calculate the benefits in monetary terms for the customer.

Also, unlike a product company that does mass marketing to appeal to a very broad audience of customers, in the services business, one must target a market of one.

Another change that must occur is in management techniques. When distributors begin offering fee-based services, they must implement a new method for checks and balances that involve a higher degree of management structure. These adjustments ensure success in a distributor's move towards building a service-based business.

There are different pricing methodologies that should be considered before launching a fee-based service business: markup-based pricing and customer-based pricing.

Since many distributors have not entered this business, and as there are not many success stories to learn from, skepticism abounds as to which pricing approach to adopt. It is not unusual for a distributor to approach cautiously, and be reserved in their level of engagement in a fee-based service business.

During the course of the study, we saw that companies that prefer low financial re-organization usually prefer markup-based pricing. They typically perform work as needed, and charge an hourly rate for labor and a markup on parts and materials.

A company entering this market for the first time usually starts with markup-based pricing. Such a method is usually an exploratory phase to gauge customer response and the distributor's ability to make money. At this stage, the focus is to ensure fixed return on investement. In this environment, there is higher competition, thus price negotiations drive down the margins further. The probability of diminishing returns is much higher because of the existence of alternatives for the buyer.

The method of customer-based pricing is a more advanced stage of pricing. Charges for time-and-materials service are usually higher because service providers have no guarantee of consistent repeat business. Local service competitors with lower overhead and labor costs usually exert some downward price pressures also. Similar cost-based pricing methods start with a standard markup for generic services. Then, prices are adjusted for proprietary (or other hard-to-get) aspects, or upgrading to premier levels dealing with service delivery and quality.

The ''price'' is derived from the value it creates for the customer. The focus here is not on generating profit, but on saving costs. Distributors using this method justify the price based on its impact on a customer's expenses. Many customers understand their own requirements, but don't know what fulfilling those requirements is worth to them. This creates an opportunity for distributors to demonstrate the value of what they provide, and help customers make smarter choices.

Each wholesale distributor should evaluate which pricing model fits best, so that it is attractive to the customer and provides an adequate return on investment for the stakeholders. Understand that each distributor's case is unique. Every business's ability to make a profit on a fee-based services business is dependent on its ability to deliver what is promised at a lower cost with the highest quality possible.

In more advanced stages of customer engagement, the service transaction moves to a more consultative nature, with the focus moving away from 'generating profits' to 'saving costs' for the customer. The major difference here is the scope of partnership, where the distributor proves its utility to the customer through demonstrated cost savings. These services are specialized, in the sense that they draw on the competitive edge of a distributor's competence, distinguishing itself from other service providers. The nature of a service involves specialized needs, and the actual price will depend on the cost savings realized by the customer.

The prospect of including fee-based services in a business portfolio is an exciting opportunity for the wholesale distribution industry. It offers the distributor the ability to completely change its value proposition to its customers and to more fully integrate itself in the customer's business processes. This degree of integration provides the wholesale distributor and the customers he serves the potential to more fully integrate the supply chain, serving the entire industry by creating new revenue and value streams.

Any approach to fee-based services requires that distributors develop a more active role with suppliers and customers. Of course, the ideal situation occurs when distinctiveness exists, or when the investment in new services is sure to yield greater results. But it should be anticipated that the fee-based services offered by a wholesale distributor, at least in the early stages, would probably be those that competitors can readily duplicate. Even though this competitive pressure may be discouraging in the early going, the wholesale distributor that maintains its conviction, and continually looks for new service offerings, will prevail.

Distributors face many challenges when evaluating pricing strategies. When considering pricing strategies, they need to find the right balance of simplicity and sophistication. Pricing levels should be set at the start with future gains in mind.

The future of wholesale distribution is bright. The role of the wholesale distributor can be made more secure by adopting this fee-based business model. It is undeniable that wholesale distributors face the unrelenting challenge to continue profitability. The opportunity to build a fee-based services business may provide some lasting relief for those who choose to pursue it.