Understanding Your Distributor
In a blog titled, Advice for Distributor-friendly Manufacturers, I said this: Understand your distributor's business model. Distributor associations publish Profit Analysis Reports. Reviewing these allows you to better understand the Gross Margin levels needed to drive profitability. Looking for ways to reduce duplication of effort and streamline operational processes allows distributors to operate profitably when slimmer margins are required. Helping your distributors be better helps everyone.
A couple of manufacturer-type salespeople noted that their distributors were not members of distributor associations publishing a Profit Analysis Report (aka PAR report). Yet, they are still keenly interested in better understanding their distributors’ models. One asked: What would be interesting and worthwhile questions to ask to find out a distributor business model?
Before we launch into the questions, let me share a bit of background information. Some of you may find this elementary; however, I feel compelled to err on the side of safety. For instance, just last night I had the opportunity to chat with a very promising young man who had just landed a job with a leading supplier. He was struggling to understand the behavior of one of his distributors and solicited my advice. Even though my young friend had been in a distributor-centric selling role for more than five years, no one had shared some of the following fundamentals:
Background Fundamental One
The distributor business is a low return business – about two
Don’t confuse Gross Margin with profit.
Let’s say a distributor buys your product for $100 and sells it for $ 142.86 with a Gross Margin of 30 percent (we will come back this calculation in a moment). Does that mean the distributor just made $42.86? The answer is a resounding no. The $42.86 must cover the cost of facilities, utilities, inventory costs, marketing and finally people. After all those costs, the distributor is likely to make under a measly three bucks; $2.85 for those of you with a need for financial details.
Looking more deeply at our example, for many distributors, a single sale of $142 is not singularly profitable. The transaction costs of handling the order exceed the $42.86 in Gross Margin.
Distributors deal with Gross Margin.
Gross Margin is the difference between the sell price and the distributor’s cost of goods sold. Gross Margin Percentage is measured using this formula:
Gross Margin Percentage = (Sell Price-Cost of goods sold)/Sell Price
Understanding the difference between Gross Margin Percentage and Markup Percentage will endear you to your distributors. It’s a subtle thing, but very important for understanding your distributor. Markup Percentage is measured using this formula:
Mark-up = (Sell Price – Cost of goods sold)/ cost of goods sold
Returning to our example above.
The sell price for a 30 percent Gross Margin is $142.86. The sell price for a 30 percent Markup is $130. While not a massive amount of money, the difference is important for an organization operating on a two percent return.
Distributors want wallet share, Manufacturer’s want market share.
One big fundamental difference between distributors and manufacturers lies in their cost models. Manufacturers live in a world of fixed costs. Keeping their factories (a fixed asset) running at optimum capacity is a primary driver of financial success. They strive to build market share to achieve this goal. Distributors are more variably cost-driven. In the example above, we discovered that a $140 sale might not cover all the costs of processing the customer order. However, the costs tied to selling a larger bundle of products to the customer on the same order are only slightly more expensive to process.
Distributors selling their full product offering to a single customer fair far better than those selling single items to a plethora of customers. The best distributors regularly review sales by product at each customer to find opportunities to increase their wallet share – and thus their profits.
Now with Questions
As we review these, I will provide not only the question but the reason why I suggest they be asked as well as the implications for your distributor.
What do you consider your flagship product lines?
A “flagship product line” is a manufacturer the distributor feels is strategically important to their business. With flagship lines, the distributor does much to link their business with your business. Distributors support flagship lines with great vigor; often tying their marketing to the flagship line’s marketing efforts.
In some situations, the call is easy. For example, Rockwell Automation in the Electrical Space, and Parker in the Fluid Power and other lines of trade are easy enough to spot. However, with other distributors, the situation might not be as apparent. You need to understand what your distributors see as their specific flagship lines.
If you believe your line should be a flagship line and the distributor doesn’t agree, you have a problem. Perhaps you were overzealous in your appraisal of your worth to the distributor.
Armed with a better understanding of the flagship lines, a sound strategy might be to find ways your products might be sold in conjunction with or to complement the strategic lines. If you discover that your product competes with the flagship line, it might be prudent to ask when and where your products will be sold. If the answer isn’t good news, a new distributor might be in order.
What is your average Gross Margin percentage?
Gross margin is the lifeblood of distributors. Sadly, many distributors fear disclosing gross margin needs to suppliers. Why? Many distributors feel doing so puts them at a disadvantage in negotiations. Simply getting a straight answer will tell you if the distributor trusts you. Nebulous answers indicate there is room for improvement in the relationship.
Tempering the questions with the following phrases can help provide additional insight.
- What kind of gross margin do you need to make money on a line like ours?
- Does your company require distributors to maintain a healthy inventory?
- Are demos costly and require constant, and expensive, maintenance?
- Do your products require a great deal of presale activity or post-sale support?
All of these can impact the need for gross margin.
Do you have accounts which are not specifically assigned to an outside salesperson?
Some distributors assign geographies to their sales teams; everything between West Overshoe and Hurtsville belongs to Joe. I have gone on record as not a fan of this “piece of dirt” approach for distributors. However, many companies still find reasons to justify the practice.
If the distributor uses the “piece of dirt” approach, you can count on many accounts being unexplored; potential business opportunities are overlooked. What’s worse, and quoting an old saw, “these distributors don’t know what they don’t know.” Salespeople gravitate to the accounts where they are currently doing business and generally have little time for prospecting. In these cases, prospecting and discovering new potential lies mostly with the manufacturer sales team.
If the distributor specifically assigns accounts to salespeople, who is responsible for the rest of the customer portfolio (commonly called house accounts)? Progressive distributors set up outbound marketing and calls to these customers to monitor activities, maintain relationships and occasionally establish new “A-list” customers. If this is the case, you should work on providing prospective products for the outbound team to attack.
If your distributor doesn’t have an approach (outbound calling), your conversation might focus on how leads you provide will be handled. Exploring this will provide insights on how you could assist the distributor in identifying new business.
Do you use Specialists (or Category Managers, Product Managers) to support sectors of your business?
Observation of many manufacturer-distributor relationships reveals a close tie with the right Specialist can often do more for the growth of your business than a tight bond with upper management. Why? The Specialists tend to spend more time with customers and lots of time making joint calls with sellers. In many organizations, Specialists assist the sales team in setting targets and executing plans for attacking a narrow slice of the distributor’s product offering.
Where (by customer segment and product groups) do you like to see growth come from in the next couple of years?
Let’s assume every distributor wants to grow. Asking this question reveals three things:
1. Has the distributor thought about growth with any kind of strategy or are they just hoping the sun, moon and stars are going to align and orders will magically fall in their lap?
2. The distributor plans to grow specific market segments.
3. The distributor plans to expand product groups to existing customers.
Understanding which category your distributor is considering allows you to understand how you might assist in the growth. And, if your distributor falls into group 1 you should consider using what leverage you have with the sellers of the distributor to channel their energies toward your product.
What percentage of your business do you drop ship to the customer vs. ship from stock?
Many distributors do a significant percentage of business which is drop-shipped to the customer. Obviously, this reduces inventory costs. However, other things also impact the distributor’s business; things like shipping and receiving costs, freight and warehouse work. Lower margin products handled this way in bulk, cut down on the cost of doing business. Understanding this allows a supplier salesperson to better understand the distributors model.
What analytical tools do you have to measure customer behavior?
Analytics provides the distributor with better information on customer buying and provides selling direction. The truth is most distributors don’t use analytics as well as they should. A few have invested in tools like MITS, SMP (Sales Management Plus) or some homegrown version.
Understanding the data available to the distributor is critical to understanding how they measure success at each account or by-product technologies. If they measure your product line’s adoption within their customers, they might be convinced to share the data; assuming they trust you.
If you gather point of sale (POS) data from your distributor, you should also provide some form of reverse POS back to the distributor to assist in their analytic effort. While every distributor’s territory is different, sharing product trends on a national basis provides your distributor with a bigger picture and allows for better mutual planning on both of your parts.
Finally, the lifeboat is over capacity
Under the heading of full disclosure, my original list extended far longer than any civilized blog post should cover. Like the captain of an overcrowded lifeboat, I had to push away from the scene without allowing every survivor to climb onboard. Some good ideas were left out in the darkened abyss treading water. One can only hope some of them might make it into another article or post.
I am asking my distributor friends to forward the questions they wish supply partners would ask and for manufacturing types to send questions they have found useful.
Send us a question and you will receive the prize of a lifetime – A Genuine Post Card from Iowa._________________________________________
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