Increasing Industrial Distribution Profitability by Segmenting Customers, Suppliers and Products-Part 3 Segmentation continued

After the basics are agreed on, it is time to determine what metrics should be used that will provide the greatest benefit in the least time, using the fewest resources, and minimizing any risk. That is a lot to ask and may not be accomplished every time, but it should be the goal.

Given the previously mentioned groups, it is important to determine the metrics that will help improve operations in terms of customers, products,and suppliers. There are no single right answers, but there are some common themes that are seen among companies that use the concepts.

“Contribution to gross margin” is a common measure. It requires simple Activity Based Costing (ABC) methods. The company must be able to measure the actual cost to process an order, complete a purchase, provide customer support, and perform other regular operations. After this is defined, it is possible to look at the gross sales by any of the three major categories and determine a ranking of customers, products,and suppliers.

Ranking is important to the workings of segmentation. Many distributors first learned about segmentation when setting up early inventory systems. There was A, B, C, and D inventory.  In many cases, the ranking was based on “turns.” This then drove the calculations for how much inventory to maintain and how often to order.

In its simplest form, the rankings discussed in this paper provide a foundation for understanding the principles, but they do not necessarily define specific opportunities for any given company. Management needs to work with their trusted advisors to identify the appropriate metrics, segmentation, and differentiation to obtain the greatest benefit.

One of the first lessons of segmentation is that not all groups need to be treated the same. Companies can offer rewards, discounts, greater sales emphasis, perks, and more business to those parties who, by their actions, become more important to the operation. For this discussion, there are three definitions that are required.

1. A good customer is one that generates a profit.

2. A good product is one that generates a positive contribution to gross margin.

3. A good supplier is one who through their actions helps the enterprise succeed.

For example, customers who are part of a segment defined as: “the top 20 percent,” do not have to and should not be treated the same as a small volume customer whose contribution falls in the lowest 10 percent of customers and is probably negative.

Anything that can be done to correct the latter’s status is worthwhile. If they cannot be moved into profitability, then they may need to be “fired” unless there is some overriding reason to allow the status quo to continue. To many, this appears to be unfair. Salespeople will want all of their customers to be treated as if they were in the top group due to “competitive” pressure.

Vendors expect every distributor to work hard to promote their products and will expect equal treatment for all of their lines. Of course that is not good business, but many companies are unable to differentiate their action at a sufficient level. It is the ability to treat one group significantly better than another, which will create the competition to become part of that group. It is what allows resources to be directed to the greatest good for the company.

If we continue with the previously noted example, companies in that top 20 percent may be treated to special pricing, special promotions, special events, and extra services. A large volume customer who is not treated as such will complain to their salesperson that as a big customer they deserve the same or better treatment. It will take training and discipline so that the sales force will understand the ramifi cations of less profi table customers and work with them to increase their margins (or other measures) so they are part of the top group.  As the culture changes, there will be positive competition to get all of one’s major accounts into the “platinum” group.

This competition is good. It will focus the sales people on what makes a good customer. It is not just volume, although that has a major impact. It includes all the ways a customer uses limited resources when dealing with the company. Some of the common metrics include average days to pay, number of returns, special services, extra training, and all other benefits that reduce the contribution to gross margin. As soon as the sales force understands the drivers, they will do what is necessary to take care of the customers who count the most.

It is also necessary to understand that in a multicultural, multinational environment not all segmentations need be or should be the same across international borders. Individual customs, mores, and regulations work against a single standard segmentation process no matter how logical or desired. Understanding geographic, political, and cultural differences is essential for segmentation to deliver the potential that is possible.

Due to these known differences, the discussion that follows should be understood to work within an homogeneous cultural area. Where possible, it should be extended to cover as much territory as feasible. However, do not dismiss cultural differences. They are critical to success in many areas of the world.

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