Putting the Wholesaler in the Driver s Seat. Best practices from the retail industry to improve profitability and gain competitive advantage

Transcription

1 Putting the Wholesaler in the Driver s Seat Best practices from the retail industry to improve profitability and gain competitive advantage

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3 Wholesalers are more than supply chain intermediaries controlling the flow of goods between manufacturers and their customers. They are value chain partners, providing purchasing power and market access to their customers, credit management to manufacturers, and a competitive supply chain to both. Wholesalers are also buyers, which is a critical performance driver of the wholesale industry. As buyers, wholesalers can emulate best practices from the retail industry to boost profitability and gain competitive advantage. 1 Throughout this paper, earnings refers to earnings before interest and taxes (EBIT). Wholesalers typically consider their roles in the supply chain as intermediaries. They think they have little influence over purchasing conditions as prices are either set by the strength of a manufacturer s brand, or by the market (if the product is a commodity). Because wholesalers typically use a cost-plus approach to setting prices, they focus primarily on improving their cost-to-serve performance and their bottom lines. The wholesale industry is typically characterized by an extremely high share of cost of goods sold around 70 percent and profitability in a range from 3 to 5 percent. Profits, therefore, are sensitive to variations in purchasing conditions. All things being equal, a 1 percent improvement in purchase price can lead to a 14 percent improvement in earnings. 1 In short, purchasing has a huge impact on wholesalers overall profits, provided that pricing models are adjusted and strictly controlled to keep the related benefits within their bottom lines (see figure 1 on page 2). Despite their size, wholesalers sometimes endure less favorable purchasing conditions than one-time-only and smaller customers. The best prices are typically offered in the project business where large customers request competitive bidding directly from suppliers. This lack of sourcing competitiveness may represent a major threat for the wholesaler business model encouraging larger customers to bypass the wholesaler and go directly to the manufacturer to demand better prices. For wholesalers, the answer to this increasingly challenging situation is to adopt a retailer approach to buying leveraging their commercial value to manufacturers while also strengthening their price negotiation skills to increase purchasing power and profits. A.T. Kearney putting the wholesaler in the driver s seat 1

4 Figure 1 Purchasing has a large impact on wholesalers overall profits % of selling price 100% 70% Sales COGS* Cost-toserve Cost structure Example: Construction material wholesaler 25% 1% decrease in purchase price led to a 14% increase in EBIT* 5% EBIT *EBIT is earnings before interest and taxes; COGS is cost of goods sold Note: Cost structure changes with the dynamics of the business (for example, volumes, consumer prices, fixed costs absorption and store openings) Source: A.T. Kearney analysis Wholesale and Retail: The Similarities The wholesale business and the retail business have several things in common. They both have to deal with the high cost of goods sold, low margins and a combination of both strong brands and commodity products. But this is where many of the similarities end. Unlike wholesalers, retailers have learned to deal with these challenges by developing powerful category management and leading-edge purchasing practices. Specifically, retailers: Develop private label brands to provide an alternative to strong A-brand suppliers and to differentiate their products from other retailers. Apply tendering and open book practices with private label and commodity suppliers (such as fresh categories) based on a thorough understanding of value chain dynamics. Source private labels globally by leveraging volume across countries and through buying consortia with other non-competing retailers. Employ sophisticated negotiation techniques with A-brand suppliers. These negotiations are based on a deep understanding of each supplier s contribution to retailer performance, and comparisons to the commercial support retailers provide to each supplier; comparisons are made with regard to share of sales, sales growth with a retailer compared to the market, promotions, shelf space, and supplier s brand visibility in catalogs and websites, among other things. These practices have helped leading retailers such as Colruyt and Tesco increase operating margins up to 6 to 7 percent from an average of 3 to 4 percent. In our experience working with wholesalers, those that employ these same practices can also increase their margins by several percentage points. The following discusses the ways in which wholesalers can emulate the practices of their retailer counterparts to boost profits and competitive advantage. Develop Private Labels to Increase Value Retailers began developing private labels not only in response to A-brand pressure but also to differentiate from other retailers. Over time, they improved the quality of their private labels and developed a multi-tier private-label strategy to cover all consumer needs while also securing customer loyalty by offering unique products. Today, retailers private labels range from lowcost entry-price products, and me-too products (equivalent to brand products but cheaper), to premium products such as those that are bioand eco-friendly. In most European countries, private label penetration is between 20 and 40 percent in value. 2 putting the wholesaler in the driver s seat A.T. Kearney

5 Wholesalers, by comparison, have yet to exploit the true potential of a private label strategy, which still accounts for just 5 to 10 percent of total sales in non-commodity products. This is primarily because wholesalers lack the capabilities to develop and source private label products, and because they are concerned about how A-brand suppliers might react to their entry in the market. Wholesalers have a great deal to gain from private labels. A private label strategy can help improve margins, develop unique product offerings and build a credible alternative to A-brand suppliers. However, the success of a private label initiative depends on the robustness of the implementation. Defining a private-label strategy typically begins with answers to three questions: What is the wholesaler s credibility as a manufacturer in a specific category? Which categories are best suited for private labels from a market, supply base, supply chain and financial point of view? Which private label structure (low-cost, me-too or premium) is best for each category? Figure 2 illustrates a framework for prioritizing private label development per category. Key to defining the strategy is understanding customer buying behavior especially, knowing when and why they are willing to switch from A-branded products to private label alternatives. The starting point is to gain a thorough understanding of supply market dynamics. Wholesalers must be able to identify a potential supplier base, evaluate category innovation intensiveness, and perform a detailed cost-structure analysis, including determining the key sources of cost advantage such as labor, raw materials, volume, and location. Armed with the assessment, the wholesaler can then define the optimal role the private label will play in the value chain, and the innovation strategy using new specifications instead of sourcing off-the-shelf products. Private labels can also help leverage the full value chain, for instance, by buying raw materials or intermediates Figure 2 Categories are prioritized to balance potential benefits with ease of implementation Evaluate potential impact Direct Calculate potential margin increase Indirect Assess supplier negotiations Review current dynamics Gauge potential OEM sales Evaluate degree of direct retail sales Calculate project pricing Determine wholesaler importance to supplier Source: A.T. Kearney analysis High Priority 2 Priority 1 Potential impact Low Difficult Easy Ease of implementation Illustrative Evaluate ease of implementation Technical complexity Determine wholesaler s capabilities Evaluate supplier base experience Market pull Assess brand dominance Gauge supplier s end-user activity Estimate degree of private label already in the market Calculate degree of product commoditization Evaluate price sensitivity Consider if wholesalers customers are end-users of products Risk Determine possible negative impact on supplier relationship with key branded suppliers A.T. Kearney putting the wholesaler in the driver s seat 3

6 products instead of finished goods and using contract manufacturing or in-house manufacturing. When sourcing private labels, wholesalers can take a page from the retail playbook combining volumes across countries, and coordinating specifications to leverage scale through global tenders. Other retail best practices include forming buying consortia with wholesalers in different countries to increase purchasing power, and developing an open-book relationship with suppliers to ensure price transparency. A private label strategy can help improve margins, develop unique product offerings and build a credible alternative to A-brand suppliers. Adopt a Global Approach for Commodities Sourcing commodity products, such as copper and plastic pipes, is another matter. By their very nature, commodities have little differentiation and therefore brand value. A large share of their cost structure is in raw materials where markets can be extremely volatile. Sourcing them requires leveraging volumes across regions through global tenders using suppliers from countries with significant cost advantages (for instance, those with lower labor costs, proximity to cheap raw materials and markets for goods with a high share of transportation cost). Strict logistics tracking and tight risk management of commodity market volatility are also key when sourcing commodity products. Wholesalers can estimate the should-cost of a commodity product by understanding the product s cost structure and the evolution of the main cost elements. These insights also provide a way to identify supply regions with the best cost advantages and to reach agreement with suppliers about adopting a pricing mechanism to cope with price volatility of key components of the product (usually energy and raw materials). In addition, it is essential to monitor the evolution of key raw material prices over time since suppliers tend to pass on higher raw material prices to their customers but rarely reduce their prices when commodity prices decline, unless encouraged to do so. Figure 3 provides an example of such a scenario. Employ Fact-Based Negotiation Strategies Retailers know how the game works. Suppliers of strong brand products emphasize the customers pull for their products and therefore the necessity for retailers to carry them at any cost. Over the years, retailers have developed more sophisticated approaches to retain control of their assortment decisions. In particular, they negotiate more effectively with brand suppliers by applying differentiated, factbased negotiation strategies based on the transparency of the combined costs and benefits of their commercial relationship. Applying these techniques has helped retailers significantly increase their profitability. Wholesalers can learn from these retail negotiation tactics. For one thing, retailers do not simply 4 putting the wholesaler in the driver s seat A.T. Kearney

7 request better prices or purchasing conditions. They justify these requests with fact-based analyses systematically benchmarking supplier performance against peers on a category-by-category basis. For example, one key measure of a supplier s performance is its true contribution to a retailer s profitability, moving beyond sales and gross margins to consider all relevant costs in the overall relationship (including channels, stores and logistics). There are four major advantages to this factbased negotiations approach: Establishes the rules of the road so the buyer and brand suppliers are speaking the same language regarding profitability (and not just bonuses) and discussions are on a categoryby-category basis. Puts the buyer in the driver s seat by providing tangible facts to develop a real understanding of the current situation, set fact-based targets for performance improvements, and steer discussions with suppliers. Helps the buyer develop a roadmap with a clear destination and alternative routes, helping the buyer set priorities, tailor improvement efforts to each supplier, and determine alternative courses of action whether to develop the supplier relationship, maintain the status quo or scale back support. Levels the playing field by raising the buyer s level of confidence in its negotiating position. In helping wholesalers with their branded supplier negotiations, we have found that factbased negotiations allow wholesalers to balance the power of branded suppliers and improve their own margins by several percentage points. The following are the main steps in a factbased negotiations strategy for A-brand suppliers (see figure 4 on page 6). Figure 3 Copper price versus product price 1 Price LME copper index 130 Product price Immediate price increase after LME copper index increase 3 In 18 months, LME index decreased by 27% as product price increased by 10% Typical two-month delay between decline in LME* copper index and product price Jan Mar May 2008 Jul Sep Nov Jan. A.T. Kearney 2009 Mar May 2009 Jul. *London Metal Exchange Source: A.T. Kearney analysis putting the wholesaler in the driver s seat 5

8 Figure 4 Three main phases of a negotiation strategy Evaluate wholesaler and supplier relationship Determine negotiation scenario Develop negotiation script Market data Internal data Review market size and suppliers shares Gauge market and suppliers growth Evaluate price indices Category Category files Category files files Review performance of each supplier in the category Analyze sales, purchases, bonuses, promotions and inventory Gather data on: Annual targets Inventory levels Promotion plans (annual) Pricing strategy Decide on negotiation strategy Talk to purchasing team about: Historical relationship with the supplier Supplier hot spots 1st meeting Perormance review with supplier 2nd meeting Discussions and negotiations 3rd meeting Discussion and agreement Source: A.T. Kearney analysis 1 Based on gross margin and year-end rebates and additional costs such as inventory (capital cost) and logistics. Evaluate the wholesaler-supplier relationship. The relationship between wholesalers and suppliers can be assessed on a category-by-category basis to determine (1) how much the wholesaler supports its suppliers and (2) how much the supplier contributes to the wholesaler s performance. How much the wholesaler supports the supplier. The share of sales a wholesaler gives a specific supplier contributes to the supplier s ability to increase market share. Wholesalers can support and differentiate their suppliers in a number of ways. For example, they can make product available at different levels, such as immediate in-store delivery or one-to-two day availability by delivering from distribution centers. Wholesalers can also provide different types of sales and after-sales support, such as share of catalogs and position in showrooms, participation in promotions and loyalty strategies, recommendations from their sales force, technical support, and spare parts management. How much the supplier contributes to the wholesaler s performance. Suppliers contribution to wholesalers performance requires an assessment that combines insights from internal and external data sources. The assessment is performed at category levels evaluating sales performance in the market and with the wholesaler in terms of market share and growth. It should also establish the true profitability of each supplier for the wholesaler, comparing them to other brand suppliers and private labels in the category. 2 The return on marketing investment (sales uplift related to specific commercial investment) should also be included in comparing supplier performance. Determine negotiation scenario for each supplier. Armed with the fact-based assessment, wholesalers can evaluate a supplier s performance 6 putting the wholesaler in the driver s seat A.T. Kearney

9 and commercial relationships within a category, and then use this knowledge to decide on a category negotiation strategy. For each supplier, there are three possible scenarios: Positive scenario increase sales support and supplier share in the category Status-quo scenario maintain sales support and supplier share Negative scenario reduce sales support and supplier share, increase share of private label or alternative suppliers Again, wholesalers can take best practices from the retail playbook to determine which scenario to use with which suppliers. For example, scenarios can be determined by evaluating aspects of the category marketing plan including the category s role, marketing tactics, SKU substitution possibilities between A-brand suppliers, and the private-label development plan. Figure 5 illustrates the different scenarios a wholesaler might apply within a category, and depicts the way in which categories are used to determine the appropriate negotiation strategy. Develop the negotiation script. In line with a category negotiation strategy, it is necessary to define a supplier negotiation script for each sup- Figure 5 Scenarios wholesalers can apply in category negotiations Over-seller Bubble size indicates sales in the category Negotiation strategy Supplier 3 Supplier 2 Positive scenario: more items, more promotions, more inventory space Supplier 1 Supplier s position Negative scenario: less items, less promotions, less inventory space Supplier 1 (status quo scenario) Supplier 1 Under-seller Less than category average Net margin percentage More than category average Note: Over-seller has more share at the wholesaler than in the market; under-seller has less share at the wholesaler than in the market Source: A.T. Kearney analysis A.T. Kearney putting the wholesaler in the driver s seat 7

10 plier. Scripts are developed for the initial performance review, initial discussions and negotiations, and to close the deal. A good script will have a request to improve buying conditions while also insinuating a credible threat; for instance, suggesting the very real prospect of developing private labels or relationships with other suppliers. Category managers can use the script to create Differentiated, fact-based negotiations puts wholesalers in the driver s seat. arguments and establish the conditions whereby suppliers are encouraged to either maintain or improve their performance. That said, wholesalers must be willing to pull the trigger on a threat if a supplier is not performing satisfactorily. Control Buying Gains Unlike retailers that manage prices centrally, wholesalers have far less control over their selling prices. A wholesaler s sales force, both in the field and in the store, has the freedom to discount prices as they see fit. And a typical cost-plus pricing policy tends to pass automatically all sourcing gains on to the customer. This limited control over pricing prevents wholesalers from capturing the expected bottom-line results from their sourcing programs. Developing a centralized and structured pricing strategy and processes will allow for allocating sourcing gains on a categoryby-category basis either to the bottom line or to commercial investments on specific products or customer segments. Think Like a Retailer By adopting retail buying strategies, large wholesalers can fully leverage their size to increase their operating margins, thereby gaining competitive advantage over smaller players through price and product differentiation. Gains achieved by improved buying conditions (a bottom-line impact of 2 to 3 percent) give wholesalers the necessary flexibility to address changing market conditions, and can be reinvested in the business to fuel growth or transferred directly to the bottom line. To capture these opportunities, wholesalers need to start thinking like retailers. They need to develop market intelligence, buying skills, and information systems to transform data into market insights insights they can use to increase profits. Authors Laurent Dumarest is a partner in the Brussels office and can be reached at laurent.dumarest@atkearney.com. Benoit Nachtergaele is a principal in the Brussels office and can be reached at benoit.nachtergaele@atkearney.com. Guillaume Cretenot is a consultant in the Brussels office and can be reached at guillaume.cretenot@atkearney.com. 8 putting the wholesaler in the driver s seat A.T. Kearney

11 A.T. Kearney is a global management consulting firm that uses strategic insight, tailored solutions and a collaborative working style to help clients achieve sustainable results. Since 1926, we have been trusted advisors on CEO-agenda issues to the world s leading corporations across all major industries. A.T. Kearney s offices are located in major business centers in 36 countries. For information on obtaining additional copies, permission to reprint or translate this work, and all other correspondence, please contact: AMERICAS EUROPE ASIA PACIFIC MIDDLE EAST Atlanta Boston Chicago Dallas Detroit Mexico City New York San Francisco São Paulo Toronto Washington, D.C. Amsterdam Berlin Brussels Bucharest Copenhagen Düsseldorf Frankfurt Helsinki Kiev Lisbon Ljubljana London Madrid Milan Moscow Munich Oslo Paris Prague Rome Stockholm Stuttgart Vienna Warsaw Zurich Bangkok Beijing Hong Kong Jakarta Kuala Lumpur Melbourne Mumbai New Delhi Seoul Shanghai Singapore Sydney Tokyo Abu Dhabi Dubai Manama Riyadh A.T. Kearney, Inc. Marketing & Communications 222 West Adams Street Chicago, Illinois U.S.A insight@atkearney.com Copyright 2009, A.T. Kearney, Inc. All rights reserved. No part of this work may be reproduced in any form without written permission from the copyright holder. A.T. Kearney is a registered mark of A.T. Kearney, Inc. A.T. Kearney, Inc. is an equal opportunity employer.

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