www.quantumprofitmanagement.com Quantum Profit Management
The Advantages of Segmentation

Bruce Merrifield, President — Merrifield Consulting

•competitive strategy •customer service •customer demographics •distribution management best practices •market segmentation •profit strategy •distribution industry trends •new opportunities for distribution industry •cost-to-serve math •cost-to-serve in distribution •segmentation

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In this video interview, Randy MacLean and Bruce Merrifield discuss the benefits of segmentation and how this approach can help distributors achieve far greater levels of profitability.

In the beginning, distributors only used one business model. They would buy a lot of inventory from a bunch of manufacturers which they would then sell in one place. The goal in those days was landing exclusive deals with manufacturers so you could offer customers things your competition couldn't. And, because the industry was product promotion-oriented, distributors would sell to everybody and give customers whatever they wanted.

"Distributors were focused on volume and gross profit," Bruce explained. "They hadn't discovered cost-to-serve (CTS) yet so they weren't always sure if they were making money."

"When a distributor first starts looking into CTS and using ranking reports, they're usually shocked by the results," Bruce continued. "Without the benefit of CTS, they had been relying on margin to judge whether a sale was profitable and, because margin is only one side of the equation, those guesses were often wrong."

The category with the lowest margin may turn out to be a distributor's most profitable segment because of its high volume with a low CTS. Meanwhile, their house accounts and counter sales – which have the highest margins and are usually considered a big money-maker – often turn out to be highly unprofitable.

"Think of segmentation as creating a P&L for each niche in your business," Bruce said. "When you do that, you find that some areas are enormously profitable while others are enormously unprofitable."

In the early days of segmentation, companies would try to group customers by zip code or size rather than the way they do business, their infrastructure, or based on their NBC. These distributors also made the mistake of trying to apply the same business model to all situations. This frequently led to a mismatch where the service model wasn't a good fit for the margin dollars that the customers were generating.

"Depending on your CTS, you can make a lot of money with just a 5% margin in some cases and yet lose a lot of money with a 25% margin in others," Randy said. "A brokerage account where you negotiate really big deals where the product is shipped directly to the customer obviously has a very small CTS. You could make a lot of money with just a 5% margin."

"How you offer your service can make a difference as well," Randy continued. "There are certain value-added services which can create an entry barrier when competitors don't think of offering them. For instance, instead of selling wire to customers who use it for harnesses you might offer to put the harnesses together yourself and then sell just sell those harnesses to the customers. In this scenario, you're not only making a profit on the wire, but you also on the labor involved in making the harnesses."

"If you have a lot of small customers, those obviously need a different model as well," Randy said. "You can't afford to pay a commission on them in many cases. You could also implement minimum orders and give them less favorable delivery options."

Different business models are an absolute necessity in the wholesale distribution industry. The company that tries to apply the same business model to everything will see most of its business under-perform. If you don't have multiple business models in place already, you should consider breaking your customers into segments to see where there may be places that would benefit from a different approach.

For more information about Bruce Merrifield, visit: www.merrifieldact2.com

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