Low- to no-profit accounts are fixtures among jan/san distributors’ customer bases. In fact, they’re generally a well-documented majority. In 1906, Italian economist Vilfredo Pareto observed that 80 percent of business comes from 20 percent of customers. The 80/20 rule, or Pareto’s Law, broke down what Pareto referred to as the “trivial many and the critical few.”

Still, low- to no-profit customers can serve a valuable purpose within a distributor’s customer base. Their supply requirements give distributors buying leverage with manufacturers. Perhaps more importantly, they’re also the group that distributors rely on for future profitability.

Whether it’s a part of the high-profit 20 percent, or the low-profit 80, most every account has additional profit potential. For jan/san distributors, the challenge becomes zeroing in on the right accounts. The first step distributors must take is in-depth account analysis.

ABC and Its Offshoots
Activity-based costing (ABC) is one popular accounting method used to assign costs to the “activities” that go into servicing an account (activities are specific actions or “cost drivers,” such as delivery, stocking, etc.). Distributors can purchase and use software, or de-velop their own formulas, to attempt to pinpoint the exact and total cost of each account. It weighs the total ex-pense of an account against sales, so distributors can learn their customers’ true profitability.

ABC is just one of the many methods distributors use to gauge customer profitability. A simple Excel spreadsheet suffices for other distributors, and still more have pieced together their own, company-customized method of analyzing true costs.

Like many jan/san distributors, Gregg Kashmanian Jr.’s company uses an informal approach to ABC to identify the profitability of its customers. The less precise method of ABC allows for greater flexibility in determining where costs exist — and what services actually cost.

Rather than relying on gross margin to gauge an account’s profitability, the company’s managers look at less tangible factors such as delivery time rates, says Kashmanian, who is region president for AmSan New England, based in Chelsea, Mass.

The cost of walking up six flights of stairs to make a delivery factors into the profit equation, for example, Kashmanian says.

Intuitive software offerings have given distributors the tools they need to simplify account analysis.

“Today, our computer system has become sophisticated and expandable as far as developing reports that mirror our thinking,” says George Abiaad, president of Royal Paper Corp., Santa Fe Springs, Calif. “And they can quantify things for you to give you a true litmus test of where you’re succeeding.”

For example, computer-generated reports can provide information such as how much product to stock for a specific customer. Also, distributors can quickly access information on the warehouse space occupied by a specific product, the average order size for a particular account and the frequency of orders.

Distributors can then benchmark these “costs” against gross margin.

“All these reports say how much customization you need to develop for that customer to be worth the return,” Abiaad adds.

Bringing the cost of servicing a customer into the equation allows distributors to more accurately gauge the profitability of a customer. Distributors gain more insight into what customers net the most profit, and which need to be scrutinized to determine how to improve their profitability.

Is There Such A Thing As Over-Service?
When performing customer audits — through ABC or another method — there are a number of customer activities that should raise red flags with respect to profitability, says F. Barry Lawrence, Ph.D., associate professor and director of the supply chain systems lab for Texas A&M University in College Station. Some “costly” activities that are indicative of a low-profit customer: they require small shipments, speedy delivery and other extra services, but don’t want to pay for them, he says. Lawrence cautions that if they shop you around — your product or your price — on a regular basis, they’re usually suspect.

Lawrence emphasizes a critical rule of thumb: “Don’t offer services that are unprofitable.” This may sound like an obvious statement, but many distributors don’t realize what certain services are costing them.

Don’t carry products that customers rarely order, and when they do, the profit margin is low, Lawrence adds.

Dr. Michael Workman agrees that distributors can easily make the mistake of offering too many varied services without being adequately compensated. Workman owns Michael E. Workman & Associates, and is professor emeritus of the industrial distribution faculty at Texas A&M University.

“Distributors traditionally keep adding services on top of services in order to maintain gross margin,” Workman says. Those distributors end up with an extensive service offering, with a number of those services rarely being used. The cost to offer them remains, however. These services might include order tracking, zero minimums for delivery, extra sales functions, quoting, record keeping and managing customer inventory — all adding to total cost, Workman says.

Whose Fault Is It?
Once a distributor identifies problem accounts and how the current service arrangement with these accounts is losing money, what’s next?

“The no-brainer is always price in-creases to offset difficulty,” says Abiaad. Abiaad says a knee-jerk price hike could end up being penny-wise and pound-foolish. Instead, he adds, a distributor should first turn the tables and look at what it has done to cause the customer to be unprofitable.

The distributor should perform a self-assessment — of the company and its value proposition — to determine whether the customer’s low-profit status is a result of the distributor’s handling of the account.

If the distributor is satisfied that he is not to blame for the account’s lackluster profit picture — that the customer has been the benefactor of service above and beyond — then it might be time to take out the velvet hammer.

When making your case, be sure to put yourself in the customers’ position, suggests Abiaad. Attempt to understand their understanding of the situation. If you do, the customers will be more receptive to the solutions you offer.

We’re Talking About Communication
Distributors agree that effective communication is essential in resolving profitability issues with customers.

“One of the reasons there are problem customers is just communication gaps,” says Kashmanian. The nuances associated with shipping, customer service and vendor relationships can all lead to miscommunication, he says.

“Sit down with the customer and explain your cost model, then come to some agreement,” Kashmanian
says. “Being open and honest is the best bet.”

Open dialogue can lead to a favorable outcome. Bridget Shuel-Walker, president of HP Products, a distributor based in Indianapolis, says the purchasing department for one of her customers — a health-care account — committed to purchasing $900,000 of supplies on an annual basis. Later, a computer-generated report let HP know that the account was in line to purchase only $500,000 of supplies, even though the pricing structure was based on the higher figure.

“That’s how we priced our contract,” says Shuel-Walker. “Now we have to approach the customer and say, ‘We’re not going to hit this [number]. Do you want to raise the price, or do you want to get your locations compliant?’”

Prevention Is the Best Medicine
Profitability shortcomings are best addressed before they become a problem. HP Products undertakes a form of ABC on the front end — before it takes on a customer.

The company carefully documents the activities, or actions associated with servicing a particular customer in order to preview the bottom line before entering into a supply relationship.

“There are no mysteries,” says Jim Smith, executive vice president of HP Products. “If you do the homework up front, you can account for [a potential customer] and qualify them to find out if it’s a viable piece of business.”

First, ensure that the customer has the ability to pay for the products and services. HP services a number of long-term health-care facilities, often managed by independent management companies. In these instances, it’s important to establish which party will make the payment: the health-care facility owner or the management firm contracted to run the facility.

Concerted avoidance of low-profit supply situations — and problematic relationships — allows HP to avoid the hassle of addressing unwelcome situations. Many other distributors are — inevitably — not so lucky. They have customer profitability issues that need to be remedied. Some distributors are better at turning low-profit accounts around than others.

Workman has seen distributors’ ability to turn unprofitable accounts around first-hand. The distributors who do it well, he says, start by building a profile of what they do best. They identify maybe four functions they perform very well, says Workman, then say, “Here are the customers that value those functions most and will pay for them.” These customers are targeted.

The successful distributors then take into account a number of criteria: the salesperson serving the customer, the needs of building occupants, and the stability of the customer relationship. “They take their strengths and align them with the customer with the highest potential for change,” Workman says.

Using today’s account analysis methods, distributors are better able to target where the most likely profitability gains can be made. These tools are allowing distributors to examine and understand the true cost/profit nature of the customer equation.

Letting a Customer Go

In an industry focused heavily on service, few customers are ever handed their walking papers. Often, the only way a customer ever gets “fired” is by becoming a managerial nightmare.

Firing is never easy. Distributors are especially concerned about burning bridges — they don’t want to be badmouthed to other customers.

The first attempt at “firing” a customer usually involves “pricing them out.” Distributors gradually raise prices until the customer has no choice but to find a new supplier. It doesn’t always work, however. Often customers continue to place orders — emergency or otherwise — even after prices go up substantially. What then?

“We’ve had situations that we had to literally tell them that they’re better off going with another distributor who’s better equipped to handle their needs,” says Abiaad, president of Royal Paper Corp., Santa Fe Springs, Calif. His tactic? He says what one might say during a cordial breakup: “It’s not you, it’s me.”

The key is remaining calm, and simply explaining the situation. Abiaad had one customer — the owner of five hotels — whose employees were verbally abusive to his employees. To complicate matters, the hotel customer was a referral from another of Royal’s good customers.

Abiaad made a point to call the referring customer first to explain the situation. He then called the hotel owner and explained that there were a number of incidents of abuse. He wasn’t assigning blame, but he had to believe his staff’s allegations.

The owner apologized, and vowed to remedy his employees’ behavior, but nothing changed. Royal’s employees were treated unacceptably. Again, Abiaad called the hotel owner and told him the relationship wasn’t working. He then recommended some other distributors who carried the same lines the customer was buying. Abiaad’s approach worked — almost. After two years, the customer still occasionally buys from Royal, but without any more abuse — apparently, a successful split. — S.S.




POSTED ON: 9/1/2004