Profit Improvement Report: The Race to Provide Services Nobody Really Wants
By Dr. Albert D. Bates
President, Profit Planning Group
Distributors in virtually every line of trade have worked hard to increase their service profile through the years. As one obvious example, the time between receipt of a customer's order and delivery has shrunk dramatically. The list of other, equally significant, service enhancements is lengthy.
Today, distributors continue to look for additional ways to enhance "service" in order to lock in their customers. The problem is that all of these new and better services increase payroll costs with no guarantee of actually locking in the revenue. If they don't, distributors will suffer from payroll expense creep.
This report examines the nature of the service revenue/service cost issue. It will do so from two important perspectives:
- The Revenue/Payroll Relationship—A analysis of how sales and payroll growth interact to drive profit in the firm.
- A Profitable Service Profile—Some specific suggestions for ensuring that service enhancements actually lead to profit improvement.
The Revenue/Payroll Relationship
Throughout the distribution industry, including NAHAD members, payroll is the overwhelming expense factor. This can be seen clearly in Exhibit 1 which presents the current performance of the typical NAHAD member based upon the latest IPR Report of financial performance.
As can be seen in the first column of numbers, the typical firm generates $8,000,000 in sales, operates on a gross margin of 38.0% of sales and produces a bottom line profit of 4.5% of sales or $360,000. Of most significance, payroll is 21.9% of sales or 65.3% of the total expense load for the firm.
In some instances distributors may feel they are forced to enhance their service profile in the face of new offering by competitors. In other instances, firms are seeking to establish their own competitive advantage. In either instance, the key profitability issue is how much of a sales increase can be generated, if any, in relationship to the payroll cost associated with providing the additional service.
The last two columns of numbers in Exhibit 1 present the potential good and bad results associated with an increase in payroll expense. In both columns it is assumed that the increase in costs is associated with an additional service. Further, in both columns payroll costs are assumed to increase by exactly 3.0%.
The middle column of numbers represents a situation where the increased payroll costs are offset by a 5.0% increase in sales. In short, the firm has developed a service-enhancement profile. Total profit increases by 27.6% and the bottom line rises to 5.5% of sales.
The final column, in very sharp contrast, reflects a situation where payroll costs increase due to the additional services offered, but revenue is stagnant. This might represent a situation where all of the competitors increase services at the same time resulting in no measurable change in market share.
The economic impact is dramatic. Profit declines by $52,500 or 14.6%, even though the increase in payroll was only 3.0%. In short, service expansion programs must generate the revenue to cover their costs and produce enough additional revenue to drive higher profit.
Research in distribution suggests that in many instances service expansions are less likely to reflect second-column economics in Exhibit 1 than third-column ones. Simply put, the value of the additional services may not be there.
A Profitable Service Profile
In building a service profile that drives sales growth faster than payroll growth there are two opposing strategies that can be followed. First, add or strengthen truly profitable services. Second, minimize or eliminate unprofitable ones. As simple as this may sound, it actually has somewhat counter-intuitive implications in terms of the potential changes in the service profile.
Service Strengthening—Research conducted by the Profit Planning Group indicates that with very few exceptions, customers do not desire any additional services from distributors. Instead, they would like some existing service components strengthened. In particular they want better performance with regard to inventory.
The inventory needs expressed were two-fold. First and foremost they desired an improved in-stock position. Second, they desired a broader assortment to facilitate the ability to engage in one-stop shopping.
To a real extent this is a serious condemnation of distributor performance. The most essential role of distribution is product availability. Failure to perform adequately in this arena is simply unacceptable. The pressures associated with cash flow are an excuse for inventory inadequacy, but not a valid reason.
The economics of improving service through better inventory performance are extremely compelling. Additional inventory investment comes with a carrying cost implication. However, in today's environment of low interest rates, carrying costs are dramatically reduced from previous periods.
On the positive side, a higher fill rate is one of the few services enhancements that automatically generates higher sales volume. Every lost sale, whether caused by being out of stock or anything else, is a pure loss of volume. Eliminating lost sales reverses the economics of the third column in Exhibit 1.
Service Elimination—While it is heresy to suggest, but there may be some services that everybody in the firm thinks are wonderful, but customers find to be without benefit. This is often a surprisingly fertile field for profit enhancement.
In service elimination a reasonable motto would be to "copy the banks, not the airlines." Banks no longer return checks with the monthly statement. Most customers find having less to throw away to be an actual benefit. ATM machines have largely, but not completely, replaced tellers. Self-service means better service for the preponderance of customers.
Airlines, in sharp contrast, have started charging extra for meals, blankets, checked bags and just about everything else. Customers go along with the add-on charges because they have to. Even if fares are lower, there is a continual bitterness about the service reductions.
The best way to determine if a service elimination decision is a bank action or an airline action is to ask customers. Often the feedback is enlightening. When the firm discovers it has been able to brilliantly providing a service that nobody really cares about, it is an eye-opener.
All distributors sell products. The best ones also provide an array of services that customers value. The challenge is to identify exactly which services are truly important to customers and which ones are not.
The valued services must be provided with absolute precision. The ones that are non essential should be bid adieu.
About the Author:
Dr. Albert D. Bates is founder and president of Profit Planning Group. His latest book, Triple Your Profit!, is available at: www.tripleyourprofitbook.com, as well as Amazon and Barnes & Noble.
©2012 Profit Planning Group. NAHAD has unlimited duplication rights for this manuscript. Further, members may duplicate this report for their internal use in any way desired. Duplication by any other organization in any manner is strictly prohibited.
A Managerial Sidebar: So What Do Customers Really Want?
Surveys on what customers expect from distributors have been conducted periodically for more than twenty years. They have been duplicated in almost every line of trade imaginable. They all produce the same result.
What customers really want is for distributors to provide services that make their lives easier. In order of importance, those services are:
- High Fill Rate (Service Level)
- Wide Assortment of Products
- Fast Delivery
- Accuracy in Order Filling
- Competitive Prices
The ability to provide great service on the first four items dramatically reduces the reliance of the firm on pricing. However, if the firm offers nothing but parity on those first four items, price becomes the overriding competitive issue.
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