• Fee or Free It's Time to Rethink the Equation

    June 1, 2012
    Way back in my dad's day, distribution was pretty simple. You had a set of customers, local inventory, you provided products when needed and occasionally

    Way back in my dad's day, distribution was pretty simple. You had a set of customers, local inventory, you provided products when needed and occasionally helped a new guy get in business by providing some “relaxed” credit terms. But along the way, a few things have changed.

    I believe things made a radical shift during the early 1980s. The explosive growth of UPS, Federal Express and other logistics providers put the squeeze on distributors by lessening the value of local inventory. The economic push of a recession, inflation and shifts in business trends forced businesses to reconsider their very existence. Those who survived rethought their selling strategies.

    Value-added selling went from being an obscure book to being a way of life. As distributors from coast to coast jumped on the bandwagon, the menu of services available to our customers grew. For the next couple of decades, the services that distributors provide have exploded. Running the gauntlet from inventory management and “keep full” programs to technical support and troubleshooting assistance, distributors offer their labor and expertise: for free.

    When offered up gratis, absolutely no one has an issue with our services. Customers, supply partners and even our own sales team are delighted that we offer a package of value overflowing with services. But just mention a fee associated with those services and watch the fireworks go off.

    But one point is constant — a recession changes the fabric and fashion of business. Reread my comments regarding the economic storm of the 1980s that brought on the whole value-add concept. Our latter-day Great Recession is no different. Customers furthered the ongoing trend of “skinnying down” their work force. For proof, one need only take a quick peek at the unemployment numbers. Don't be misled; this 9 percent-plus is not just a large lot of low-skill line-labor; engineers, maintenance workers, technicians and master mechanics languish in the unemployment role as well. This affects everyone in the selling profession.

    For knowledge-based distributors, it's a double whammy. Not only have customers cut their work force to the bone, supply-side partners have yet to put resources in place to match the current upswing. Customers who once depended on the phone support lines of vendor partners discover longer hold times and difficulty getting anything other than the simplest questions answered. The result: more post-sale support is falling on the local distributor.

    Now the cold, hard facts — according to activity-based costing analysis of hundreds of distributor organizations, more than 50 percent of our customers are unprofitable. Let me explain: Half of our customers require more support than their gross margin dollars cover. This comes as the result of many issues; the short list includes:

    • Too many small orders — Rather than consolidate, the customer places numerous small orders, each requiring their own invoice and supporting documentation.

    • High return rate — The customer buys two of everything and returns half of every order, and processing returns is expensive to the distributor.

    • Hassle factor — Slow pay, distance and other issues that suck our resources like that handsome count from Transylvania.

    • High level of support required — The customer lacks the expertise to properly apply products. Every sale, large or small, requires a number of interactions with salespeople, specialists and other staff.

    You need to address the support issue. Are these accounts somehow siphoning profits by demanding and receiving the same high level of support as your four-star customers? Remember, the great customers (gold, platinum, super-duper, premium … hopefully you have already identified them to your troops) happily pay for your service in margin dollars. But this is only half of the story on charging for support.

    Product Trends Drive a Need for Paid Support

    Whether you sell building automation, air handling systems, air purity systems, environmentally friendly coolant or any noncommodity line — the relative cost of the product is trending downward as complexity drifts upward. If you don't sell something that requires application, measurements, configuration, set up or troubleshooting, raise your hand. I thought so; our work with knowledge-based distributors across all product fields demonstrates increased complexity. Weirdly, each generation of product translates to more complexity and a lower price. This shift in functionality cost is a great deal for our customers.

    Page 2 of 3

    In the old days, the gross margin dollars (for higher priced and less complex products) covered our costs and provided a fair return. In our zeal to be the good guys and sell on value, we instituted a lot of extra services, above and beyond service of days gone by. For many, this was the mantle of a new breed of distributor, service was our competitive differentiator, and we wore it proudly. Too much of a good thing poisons the well. We failed to realize giving away massive amounts of services without some control cuts into profits faster than price chopping.

    As products get cheaper on a per-feature basis (some call it cost of functionality), something has to give. Just as I wave the flag for a scientific David Bauders' Strategic Pricing Associatesstyle pricing process to eliminate uncontrolled margin erosion, I urge you to consider service giveaway control.

    I know what you're thinking; we can't charge for services because:

    • Our insurance will skyrocket — If your insurance provider is keeping you away from a paid service model, consider this. If your salespeople are providing advice or suggesting solutions (and they are), you may already be at risk. Even the very common activity of suggesting a “functional equivalent” substitute may have liability implications.

      It's not the intent or purpose of this article to provide legal liability opinions. However, you should realize that a number of distributors are already charging for some of their services, and they have learned to manage the liability component.

      If you are still uncertain, I suggest a conversation with an attorney who specializes in the real nitty-gritty of application liabilities. Mark Voigtmann of Faegre Baker Daniels in Indianapolis leads a practice associated with high technology products. He works closely with many distributors and systems integrators who service our industry. Ask him about the liability.

    • We'll compete with or alienate some of our good customers — Concerns around the ramifications that fee-based services will have on your dealers, contractors, systems integrators, fabricator and engineering customers weigh heavy on most sales teams. It's a real concern and you must approach it logically.

      First and foremost, I am not recommending a wholesale move into the service industry. Rather, our conversation is about migrating some of the service you already provide for free to a fee-based model. You need to stress and discuss the services you are providing with your customers. Generally, the services you provide won't overlap.

      In many instances, fee-based distributors actually augment the service providers' business. Whether we want to admit it or not, there may be customers out there thinking, “I'll give Joe a call first to see if he will fix the problem for free.” Creating the expectation — competence costs money — improves the lot of everyone in the market.

      Be warned, there will be pushback. Your sales team will exaggerate issues. The people who don't like you will use fee-based service to justify their position. Good customers will understand and embrace your logic. Either way, as in many selling situations, communications is the name of the game.

    • Our supply partners will throw a fit — Some supply partners may sound the alarm as you launch into a fee-based service model. Most concern centers on lost selling time rather than the pure act of charging for some of your services. In my mind, charging for some services will enhance your supplier's position.

      Most manufacturers have a tough time providing customer backup on older, legacy products. This leads to frustration at the customer end, which spills over to new product purchases. Your new service model will allow you to fund greater material and human resources to support the older (and new) products.

      A fee-supported service arrangement allows greater support of those solution sales, where you combine the products of multiple supply partners into a single sale. Customers often complain the support they receive directly from the manufacturer is product silo specific, making it difficult to apply or troubleshoot the final solution.

    Page 3 of 3

    The competition will eat our lunch — I purposefully saved this point for last because I believe it is the single biggest fallacy surrounding the whole issue of fee-based services.

    We haven't been talking about a carte blanche policy change. Instead, I suggest a gentle shift, first recouping the cost of services provided to nontarget customers. If this group of customers line up to switch over to the competition, there will be little impact to the bottom line. From a purely sales strategy basis, the prospect of fee-based service will give good cause to review your customer list. Which customers:

    • Are targeted for further growth?
    • Have displayed price-only buying?
    • Produce the gross margin needed for our growth?
    • Might overextend their in-house expertise in the future?
    • Could benefit most from training?

    Reviewing the list will cause your sales team to come to grips with one of the great fundamentals of successful selling: all customers are not created equal.

    Limiting free services to small and potentially nonprofitable customers is akin to managing discount levels in a pricing process. The main pushback will come not from customers but from your sales team. Frank discussions with each seller can further reinforce the need to use company resources in the most productive manner. You must plan for some training to educate your whole company.

    Applying a fee-for-service strategy creates better service. Support people perform more professionally when they understand customers are paying for their expertise. We've seen it happen in training seminars, application support discussions and numerous other instances. Specialists, customer service people and sellers themselves are better prepared when they know their work has a real monetized value.

    Speaking of value, nothing enhances the value of something you offer more than a price. Let's say a customer has a big project, and negotiations are tough. By charging for various service activities, you establish a value. This becomes part of the whole negotiation — as in, you want us to knock 10 percent off the price; how about I throw in training that's worth 12 grand?

    Now let's fast forward the hands of time — welcome to 2014. You have been charging for select services for a couple of years. The revenue has been used to offset the cost of extra demonstration units, training materials and the cost of one of your support people, with a little left over for the home team; profit is important. Your service is improved and more professionalism and more customer value created. Newcomers to your market will need to fund all of this out-of-pocket, because they aren't following your fee-based service model. This provides you with a monstrous competitive advantage.

    The Time Has Come Today … Time!

    Our service, our facilitation, our value-adds, our above and beyond, whatever you call them are an important commodity. Don't allow doubt to creep into your mind. When you provide human support along with your product, you create value. This value is every bit as important as inventory, A/R dollars or cash in the bank. You can give it away, or you can profit from its application. Now is the time to start the process.

    Before you jump into action, a well-thought-out process with milestones, metrics, procedures and education is critical. The payback is huge.

    Frank Hurtte provides Strategic Insight for New Times. He speaks and consults on the new reality facing distribution in a post-recession world. Contact Frank at River Heights Consulting at [email protected] or at 563/514-1104.