Distributors face a unique set of problems as products make their way from manufacturers to end-users, and that path is only getting more arduous. Whether a company distributes pet products, air conditioners, boat motor parts, or quilts, its profits are getting squeezed from manufacturers and customers. To keep a positive bottom line, distributors must effectively monitor operational efficiency and understand the influence on profits exerted by each customer.
The manufacturer usually has the upper hand in dealing with distributors as evidenced by the manufacturers usually requiring distributors to sign an exclusivity agreement which makes changing brands very difficult for the distributor, while a distributor’s customers have many options from which to choose. For example, in the heating, ventilating, and air conditioning (HVAC) market in Nashville, TN, 16 distributors compete for the same customers. If a customer doesn’t like a price, the customer has fifteen other options. Additionally, more building contractors have been asking for portions of the rebates they know distributors receive from the manufacturers. This proves the distributor’s customer base knows how the game is played at all levels. The two-sided attack on profitability forces distributors to operate with utmost efficiency and to constantly measure the profitability for each individual customer. The big question is, how should those factors be measured?
Efficiency must be measured in terms of costs. A distributor simply unloads boxes from the manufacturer, stores them, and then ships those boxes to customers once they are needed. Unfortunately, distributor profits are pinched from manufacturers who essentially set the price of the goods and from customers that are more knowledgeable than ever before. The only variable over which distributors have significant control is their operating costs.
Efficiency is the key to being profitable, and how a company internally measures that makes the company either a dynamic responder to market conditions or a slow-plodding dinosaur. The most reliable measure of efficiency is a Cost Per Minute (CPM) based on costs the distributor controls. This newest efficiency formula essential for distributors in this age of informed rapid response is controllable company costs divided by the number of minutes open for business. When measured on a per-minute basis, the costs can be extrapolated for a per-day or per-week analysis, which gives managers an accurate reading of the most recent activities’ profitability.
A measure such as inventory turnover still provides valuable insight regarding the efficient use of inventory, but this fails to provide any feedback regarding profitability. Given the speed of information in today’s business office, a distributor should be reviewing bottom line profitability every day, because a net profit is the ultimate goal. Using the cost per minute multiplied out for a daily analysis provides the fastest real-time results. Results this fast allow managers to expand successful promotional strategies or react very quickly to market conditions.
This CPM can also be employed to determine if customers are paying their fair share of expenses. An arrogance exists in distribution regarding how customer profitability is measured. Managers look at the gross margin in terms of a percentage or dollars and conclude that it’s good or bad. The gross margin is vitally important but needs to be considered with regard to the amount of expenses generated by the customer. Is a customer paying for itself? The Cost Per Minute approach factors into that answer for a distributor, because using a cost-per-minute method enables distributors to determine a net profit or loss for each customer. The obvious benefit of knowing a net profit or loss by customer is that this allows management to replicate or change its approach with individual customers. Since each customer presents a unique set of circumstances, the solutions should be unique to each customer.
If a customer is accurately assigned a fair portion of the company expenses, and that same amount is generated in gross margin from sales to that customer, then the customer is a breakeven participant. Obviously, a distributor wants its customers to pay their share of the expenses plus something, and that something is the profit. Knowing the costs in the Cost Per Minute formula enables a distributor to determine the amount spent generating and servicing the sales to a specific customer.
The formula for determining customer profitability is gross margin for the customer divided by controllable company costs less the quotient of sales to a customer divided by the total company sales. This gives an equitable distribution of company costs to every customer based on the investment needed to generate and service the sales to that customer. This positive, negative, or neutral ranking provides distributors the feedback to know how to analyze each customer.
Knowing if a customer is a winning, breakeven, or losing proposition has significant implications. The approach taken with the winners needs to be replicated as often as possible, the breakeven accounts probably need a slight adjustment, and the losers are candidates for the methods that worked with the winners. The most important point with regard to analyzing customer profitability is: don’t assume you know the answer until you include the costs in proportion to the sales and see the number. This determines the net profitability.
With information so readily available, managers have no excuses for not reviewing profitability on a daily basis and analyzing each customer’s effect on the company’s bottom line profitability. The Cost Per Minute formula provides the starting point for distributors to measure their performance.