Tuesday, June 7, 2016

Why do customers buy? Questions and Comments


I just had the opportunity to review Industrial Distribution Magazine’s annual survey.  This year they focused on distributor value and quite frankly, I am not shocked by the results.  I am, however, deeply disappointed. 

The survey question asked “Which are the primary reasons your customers do business with you?”  The respondents reported the following reasons:
  • 85.17% Relationship
  • 74.16% Product Availability
  • 68.42% Technical Support
  • 62.20% Delivery Time
  • 50.72% Price
  • 31.10% Engineering Capabilities
  • 30.62% Vendor Managed Inventory
  • 28.23% 24x7 Support
  • 3.35%    Other

This was the 69th edition of this survey; meaning the very first edition fell well before my father started in the distribution business back in the 50s.  Silly me, but somehow I imagined our industry had progressed. With a couple exceptions, the results look like something straight out of 1965.   I am disenchanted, but again, not all that surprised.

Looking further at the survey methodology, we see the survey was sent to a broad range of distributor professionals – everyone from executives and upper management to sales and customer service.  Thinking about the demographics of most distributors, this would point to a large percentage of sales types participating in the survey.  This is a point to ponder. 

The importance of relationships and trust…
Customer relationships are just as important today as they were back when our dads were making sales calls.  I have to wonder, however, if this comment wasn’t overstated.  I can recall a couple dozen hiring instances gone amiss when salespeople were hired mostly for their customer relationships.  It went something like this:  Sales manager hires sales guy with a long list of customer contacts “ready to follow” him to the new company, only it didn’t happen.  The sales dollars didn’t follow.  In fact, in most of the cases I witnessed, only something like 25-30 percent went with the seller. 

With this in mind, relationships with distributors are important.  But when the distributor uses a team selling approach, and most good ones do, building customer connections with product specialists, engineers, inside salespeople and management types, the individual salesperson relationship is not as important.

In today’s environment, I believe it could best be said, “Customers buy from companies and individuals they trust.”  Developing a strong track record of integrity matters.  If all the technology, product availability and everything else is fairly similar, most customers buy from the company they trust.   By the way, I trust Amazon and don’t know a soul working for the company.  Is this a customer relationship?

Product availability…
Does this mean you are the authorized distributor for a highly valued product line?  Many manufacturers go to market via limited and sometimes exclusive distribution. With the right interpretation, it could mean having what one distributor calls “the A-line manufacturers.” This same guy feels this attracts what he referred to as “A-line customers.” 

The other interpretation is concerning.  If product availability refers to local inventory, I see dark clouds just ahead.  Logistics are shrinking our world.  Back in my younger days, overnight shipping was either impossible or very expensive.  Now it’s cheap and mega-distributors have mastered the placement of distribution centers to get anything to anywhere the next day.  I am told plans are underway to begin shortening the delivery lag to half days in some areas.   Amazon is testing a new service called Amazon Now and they are offering two hour delivery.  If Amazon can do it, others will follow suit.

My parents’ business thrived because they had the best inventory within a 30 mile radius.  Thinking back, even small towns had distributor locations.  The adage, "the only game in town" was real.  Travel and logistics were almost laughingly different 50 years ago.  This business model is gone.  Looking forward, I see this phenomenon only continuing.  I struggle to imagine 74+ percent of distributors imagining availability as a key buying point.

Price, really are you kidding me?
According to over half of the survey respondents, customers are buying from them because of price.  In other words, they see their value as the low cost discount leader.  I wonder, if this is a response flavored by the responses of those involved in sales, does their management see things this way?  Over the course of several hundred (probably over a thousand) detailed conversations with distributor owners and top-level managers, I have never heard any of them say, “We are striving to be the low cost leader in our market.”  Instead they talk about solutions, technology and great customer service.

Reviewing the list above, one would wonder if some of the same distributors touting price as a customer attractant aren’t also investing in technical services, engineering skills, support and improved logistics.
I believe the price focus and the services focus are inherently incompatible. 

Why price is even mentioned at all?
Purchasers constantly push for price.  Distributor salespeople are told, “Your price is too high in dozens of ways.”  Friendly customers give the seller a “last look” where they are allowed to beat the price of some real or imagined competitor; the message is price got you the order.  Not-so-friendly folks mask preference for other suppliers with “your price was out of the ball park, this time.”  The message often plays over the top of technical services and sounds like this, “Your service is great, but all of our suppliers provide the same kinds of things.” 

We have already stated buyers constantly test our price.  This creates a repeated message: price is important.  Scientists tell us when messages are repeated the message becomes believable; the thought develops an aura of truth.  When the message is repeated by many people, the directive appears as an absolute truism.  Psychologists call this the “validity effect” and distributor salespeople respond like laboratory guinea pigs.

We’re drinking our own Kool-Aid…
Through the validity effect, these sales types believe two points: 
  • Point One - We only get the sale when our price is lower than or at least equal to the lowest price from a reasonable competitor. 
  • Point Two – Because I am interacting with price-driven customers, and perhaps selling a lot of “stuff,” I know what the price should be for everything in our catalog. 

Hook these guys up to a polygraph and place their right hand on a stack of Bibles and the two points listed above show valid, but we need to think about the statements.

What is a reasonable competitor?  Pressed for information and objective data, most sellers lack the ability to carefully outline what makes their organization better than the competitor.  When I facilitate distributor sales meetings and ask for a list, I hear some pretty flimsy differentiators.  One of the most popular is “we have professional inside salespeople to assist in handling orders.”  When I ask if the competitor recruits their inside sales team down at the mission, everyone laughs.  The truth is we need to do better than “good service, great company culture and professional sales team.”  It’s management’s job to constantly reinforce specifics on why your company provide greater value.

Point Two requires the greatest scrutiny.  Most distributors sell tens of thousands of products to hundreds of customers.  This creates over a million price permutations, meaning, every customer purchasing every product carries a slightly different set of characteristics.  Let’s take a deeper look at how this impacts price.

We know large volume OEMs view products they purchase differently than the end user buying just one of these parts every few years as a repair part.  Research indicates many OEMs sell “repair parts” to their customers at levels equating to 250-400 percent gross margin.  Clearly, for some small users of the part, the price is justified because they lack the technical ability to determine precisely what part to purchase.  The OEM eliminates the risk and hassle factor associated with the part.  So we extend discounts to the OEM.  But, is every part purchased by the OEM the same?

Let’s assume the OEM is forced by customer specification to create a special one of a kind modification to their product.  Since this is their first use of the product, they require lots of technical and other support.  However, unlike their typical purchase, this will not come with large follow along orders.  Should the price be the same? 

Keeping with our OEM example, suppose the OEM needs to modify the lighting of their production floor.  In this particular instance, the OEM is acting as an end user of the product.  Should the margin be the same?  In many instances, distributor salespeople treat all of these situations the same.

Distributors trust their sales team to understand market conditions, but the sheer number of the pricing variations makes it humanly impossible.  In the face of such overwhelming obstacles to proper pricing, most distributor sellers resort to cost up pricing.  It works something like this:  OEMs get cost plus 20 percent, end users get cost plus 25 percent.  All regardless of product, type of purchase or support required.  If the competition has the business, the percentages drop.

How to address pricing…
Margin management falls squarely on the shoulders of management.  Our industry now has the tools to manage and control the pricing process.  This is not just the addition of some derivation of the 30 year old concept of matrix pricing (which has largely been a failure in our industry.)   Instead, it involves a process tying customer size, type and purchasing habits with product and vendor/supplier.  Further, salespeople are no longer allowed to make changes in pricing at will.  Instead, a management directed pricing leader is used to oversee exceptions to system pricing.

Cleveland-based Strategic Pricing Associates is the industry leader in this field.  With their systems in practice at nearly 500 distributors, they have fine-tuned the process over two decades.  Based on detailed studies of over 50 of their clients, we have observed gross margin improvement which typically turns out to be a sustainable two points.  The impact for a “smaller” distributor with $10 Million in sales runs around $200,000 in additional gross margin.  Further, a large percentage of the added gross margin falls to the bottom line.

Looking ahead for distribution…
When pricing isn’t an issue, it allows sellers more time to work on the things which really matter to the customer.  Things like improving the customer’s productivity, eliminating waste and driving more profits to the customer’s bottom line. 

Is improvement in distribution important?  Undoubtedly, finding ways to improve the overall productivity of the distributor is important, too.  Improvements in our industry’s overall operation will be important.  As an industry we are finding ways to do more with less.  We’re finding ways to handle order flow, logistics and billing more efficiently.  The gains made are critical to the long term health of distribution.  However, without taking care of the customer facing side of the business, we are destined to merely “give away” the gains.

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