As we move from the warm weather of summer and fall into winter, we naturally shift our behaviors and activities. Calling on an often-repeated piece from the Bible, there is a time to reap and a time to sow. Distributors face a similar situation with economic seasons. Reports of economic slowdowns ripple through our industry. While few of us are applying the term recession to our conditions, things are changing. We face many important decisions: Do we move forward as if nothing is happening, do we batten down the hatches and go into full cost control mode, or do we take careful stock of conditions and plan for a future upturn?
We can’t predict the odds of a recession, but something is happening. Distributors are facing some certain changes in next year’s reality. For now, let’s leave the general economy to others and explore the local weather.
Distributors and some of their customers are reporting record-high inventories. Based on supply chain issues, many distributors and their customers placed orders in anticipation of continued delivery issues. In late summer and early fall, manufacturers were able to catch up with the demand and condense delivery cycles. This meant orders that the customer and distributor anticipated in early winter and even in 2024 were shipped to the distributor.
This presents the obvious issue of increased interest costs that affect the distributor’s line of credit. But there are other important points to consider. For most distributors, a larger inventory translates into a less efficient warehouse. Order picking times are increased, and products are more likely to be misplaced, lost or damaged during warehousing time.
Larger inventories also create purchasing issues. Customer service is strained as purchasing people struggle to create orders that qualify for factory-paid freight. Incoming freight on new orders must be monitored carefully. Assuming quick-moving stock items will soon be cycled through, what is the plan for the slower moving items?
Sadly, some distributors are falling from grace with their suppliers because the number of new orders drops significantly as they burn through inventory. One set of distributors we interviewed indicated the impact on their orders for some important manufacturers would be down by an average of 12-20% since much of their annual business is already in place due to supply chain problems.
- Communicate current inventory levels to your suppliers so they better understand the situation and their local sales teams can properly explain what appears to be a slowdown in sales to their management.
- Improve warehousing practices. The threat of lost, misplaced or damaged products only adds to the misery of higher-than-normal inventory numbers.
- Closely monitor incoming freight costs. The purchasing department’s inability to bundle orders for prepaid freight drives up costs.
- Establish a plan for steering customers to products that are currently in stock.
- Expect smaller end-of-year growth incentives.
Distributors indicate manufacturers are not interested in taking returns of surplus inventory. A few have even canceled long-standing programs that allow distributors to get rid of a prescribed percentage of their sales on an annual basis. The next section will shed some light on the situation.
Manufacturers are facing tough times. Most manufacturers are experiencing a general slowdown. Many are running their factories at lower than optimal levels. Companies with European roots have been hit with the double whammy of a broad downturn in both their home country and North America. When this happens, it is not uncommon for their American operations to be placed under far more strict financial scrutiny.
Conversations with several manufacturers revealed production facilities have reduced workers to 32-hour weeks. Some of the big names have surfaced on thelayoff.com. Most of the companies listed appear to be making small layoffs, but a few have posted numbers as high as 500 with rumors of more coming.
For distributors, it is important to understand the business model for manufacturing. Manufacturers live in a world of fixed costs. This is in sharp contrast to distribution where our costs are largely variable. They invest in factories; we invest in people. To illustrate, nearly 60% of our gross margin dollars are people costs.
When their factory utilization drops below a certain point, usually between 65-75%, their profitability wanes. Similarly, when factory utilization goes over 90%, they experience issues with overtime and unplanned downtimes which also drive profitability downward. Many of them have dropped below the ideal percentage.
Why should distributors be concerned about manufacturer issues? Low factory utilization pushes manufacturers to become more aggressive in their efforts to get new business. This drives three specific actions:
- Suppliers search for new channel partners. Expect more partnerships with big-box stores and internet-based distributors—think Automation Direct, DigiKey, PlumbingSupply, etc.
- Suppliers are considering plans for direct sales. Many feel direct business allows for more aggressive action with high-potential accounts.
- Management instructs their sales team to “not lose orders due to price.” This attitude often creates a price war that damages distributor margins.
Price wars damage distributor margin levels. While all three choices listed above impact distributors, the most universal issues come via this vicarious use of price as a calling card. Even if your supplier has not yet visited you with the “don’t lose orders based on price” message, there is an excellent chance their competitors will discuss the topic with other distributors. Introducing prices to customers who are struggling with profitability themselves tempts customers to revisit prices of other things. This mentality bleeds from one product type to another across vast sectors of the market.
- Maintain a list of ongoing opportunities. It’s not just opportunities ready to fall/convert/close for your own business, but every opportunity. This even includes opportunities where you have low levels of certainty about getting the order, i.e. your competitor’s business.
- Each salesperson should identify which opportunities could be price sensitive. If they don’t do a good job tracking opportunities because they “hate paperwork, are too busy selling or don’t believe in CRM systems,” now is a good time to convince them. This will be war—going to market without data is akin to marching off without bullets.
- If your supply partner delivers the “no price is too low” message to your organization, a good list of target opportunities will increase your ability to “pick off” business that might otherwise go to the competition. These conversions will increase your market share and provide sales growth.
- Double down on your CRM efforts. A review of existing business and near-term opportunities for price sensitivity reinforces the need for good data in your CRM system.
Reinforce your pricing process. I recommend that you shore up your prices by taking all direct negotiating power away from your sellers. Some readers will view this statement as pure heresy, but there are good reasons.
Spend time talking about price sensitivity from the customer’s vantage point. Be prepared to make necessary price adjustments if competitive pressure warrants the move.
Don’t make common pricing errors like these:
- Many customers will attempt to weasel discounts. Purchasing Departments are “boning up” on asking for lower prices. Not every situation is truly price-driven.
- This takes the pressure off new sellers who are not accustomed to the price dance.
- Talking to a manager slows down the process and gives the seller a little more time to gather facts.
- Never discount a manufacturer’s products across every product in the catalog. Customers look for discounted prices on a few items which they buy in quantity and often. Best practices call for negotiated prices on just these targeted few while the rest are left at standard price. Doing such allows your organization to make added margins when unusual items are purchased.
- Setting a long-term pricing agreement without defined plans for handling price increases, returns and other details that could rob future gross margins.
- Not asking for something in return for price concessions. Customers receiving discounts should be asked to expedite payment terms, agree to fee-based warranty support or pay a greater share of the freight and other logistics costs.
The people shortage will continue. If you have hired anyone lately, you are probably keenly aware quality people are in short supply. Skilled people, those with technical and application skills, are critically difficult to bring on board. This presents two sets of issues:
- People costs at distributors will continue to rise.
- Customers will need the expertise and services provided by distributors more now than ever before.
Quickly looking at this situation, this personnel shortage situation creates both challenges and opportunities.
The challenge for distributors is to develop plans for improving the efficiency of our systems. How might our warehouse people be more efficient, inside sales/customer service people process more orders and new employees be ramped to a profitable stage more quickly? The opportunity comes by way of fee-based services. Across distributorland, highly trained customer-facing people are being asked to assist customers with important tasks. Customers are looking for resources and in many instances searching desperately for a quality organization to outsource some of their work. Nothing cements the bond between customer and distributor like the latter becoming fully embedded and tied to the customer via some essential service.
Be prepared for certain changes in our immediate economies. No one can accurately predict the economic future of our country—recession or not. We can accurately predict the issues facing our industry over the next year or so. Be prepared to handle the changes in our small, but crucial slice of the larger economy.