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Here's a look at how distributors can reduce costs to survive or even prosper in a downturn

THE ECONOMY HAS BEEN DIFFICULT FOR THE manufacturing sector and its suppliers. Distributors need to cut costs, both to remain profitable and to continue to be a valuable and cost-effective part of their customers' businesses.

There has been a continuous stream of layoff announcements at manufacturing facilities across the country. Payroll is a large part of a distributor's expenses, so many distributors have followed suit in an effort to cut costs.

According to Profit Planning Group president Dr. Alan Bates, payroll often makes up two-thirds of the distributor's expenses and most of the other expenses are fixed costs. In light of these facts, he says more distributors need to look at their headcount and make some adjustments.

He advises to first look at all of the company-paid employee benefits and make cuts where appropriate, but says those usually represent a relatively small cost and many distributors have already made the hard choices on this front.

"For a variety of reasons, distributors are hesitant to reduce headcount," says Bates. "Just running the numbers makes it clear that [payroll costs] put distributors in a bind."

Bates cites many reasons for the reluctance to fire or lay off employees. These include optimism that the recovery is near and that the costs associated with firing and later retraining outweigh current benefits.

"It can be very gut-wrenching at most distributorships, which are small enough that they know the employees personally," says Bates.

According to Bates, most distributors will need to make a five to seven percent reduction to bring the workforce in line with sales. It is important to make these cuts in the right way, however.

"Ask, 'Am I cutting fat or hacking away the foundation?' We often let less productive workers hang on, but this is a good excuse to get rid of them," says Bates.

When cuts are made, it implies a very negative situation, cautions Bates. Morale and positive spin are important factors.

"Share more information about where the company is going and provide more positive goals," says Bates. "You also need to sell hard to the employees why the cuts were made and what positive points it means for the company."

Sharing the burden

Jack Healey, senior vice president and CEO for Atlanta-based Industrial Distribution Group, Inc., echoes the importance of personnel in cost reduction. He points out that it is necessary to look to the future when making cuts.

"We started with the executive team and took voluntary pay reductions to set the tone for the organization," says Healey. "It is important to send the right message across the company at the outset of taking cost reduction measures. Setting the right tone has long-term impact on the company's overall health."

After the voluntary executive pay reductions, employees from top to bottom were mandated to take a one-week furlough per quarter to avoid layoffs, he says.

"Keep in mind that customer service can't be reduced, especially in tough times," says Healey. "We exempted staff only if a furlough would impede customer service."

In a number of the company's integrated supply contracts, the employees are part of the contract and not subject to furlough, he adds.

There are many other ways to reduce costs and become more profitable, however. Healey points out that he has also looked at the entire organization's operations for opportunities.

"At the same time we were reducing personnel costs, we focused on selling, general and administrative costs over the last 12 months. It has been a lot of work but we have reduced our SG&A expenses by $1 million per quarter," says Healey. "To maximize gross margins, we examined how best to purchase from our vendors to get the best terms and rebates. For this, I can't stress enough the importance of forecasting."

He says when the processes are managed efficiently and systems used effectively, orders can be made with forecast data to capitalize on the best discounts and make fewer, larger orders. In that respect, electronic data interchange (EDI) can be used to reduce invoice costs and simplify processes.

"We also looked at how we bill freight and took control of the carriers we used to reduce costs," adds Henley. "Freight is a huge expense that so many overlook."

In addition, Healey says most companies face an annual healthcare cost increase of greater than 10 percent. By changing insurers, IDG decreased those costs, he adds.

Improved internal systems have also allowed the company to increase efficiency and reduce staff in the A/R function. The company also negotiated payment terms and discounts with vendors, says Healey.

"Tax planning also plays a role," he adds. "By consolidating 45 legal entities into five, we reduced state taxes by $600,000 per year."

Cut the chain

Twenty percent of the supply chain costs are redundant, according to a National Assn. of Wholesaler-Distributors Distribution Research and Education Foundation report. The supply chain provides a tremendous opportunity to cut costs, says Tim Underhill, president of Underhill & Assoc.

"Unfortunately, these savings take time and effort to develop," he says. "Rather than layoffs, use your good people to identify and reduce supply chain costs."

Work with manufacturers not just to lower prices but to reduce channel costs, advises Underhill. Then identify redundancy and channel costs with customers as well.

"Customer supply channel costs are often overlooked," says Underhill. "Reducing those costs will also help your customers' bottom line and may lead to more business with them."

He also points Out that errors account for an incredible amount of waste. Up to one-third of gross margin dollars are wasted on errors, cites Underhill.

"Even though distributors are aware of this, most do nothing about it," says Underhill. "The solution is total quality management and continuous improvement programs."

Distributors get the most money and best profit from long-term and satisfied customers, says Dr. Don Rice, of Bryan, Texas-based Don Rice & Assoc. But sales, opportunities and even customers are lost when mistakes are made.

"The scary figure is that 25 percent of time is spent doing "rework" and correcting errors," says Rice. "In two out of every 100 lines of billing there is some error. Most of this waste is because the process isn't right."

He says distributors often complain about their people, but 85 percent of the problems are actually process problems.

Letting go

It is important to look at customers from a profitability basis. Bates suggests activity based analysis to determine the customers that are using up resources and time but not producing profitable sales. Often, 10 percent or more of your customer base is costing you more money than you are making.

"In a recession, some [distributors] try to get any sale they can," says Bates. "Walking away from business is hard. It requires guts, but some business you are better off without."

It is never a good deal to actually "fire" a customer, though, says Rice. Instead, he suggests finding the unprofitable customers and changing the way of doing business with them.

"Turn them into a good customer," says Rice. "Look for places to unbundle services to the customers who cause you grief."

For example, with a customer who places frequent small orders and asks for services for which he is unwilling to pay, Rice says to charge freight and bump up the margin to make the customer profitable.

Rice suggests sitting down with the customer and saying, "I love you, but you are killing me." He says they are often surprised.

"If they still cause you grief, just raise your margin or cut back services until they are a profitable customer or they leave on their own," he says.

Paul Robichaud, president of Robi Tool in Somerville, Mass., says it's important to take the brave step of letting go - not just the unprofitable customers, but also the vendors that are unwilling to work with you.

"When we acquired another distributor, we tried to work with the vendors to make the business more profitable," says Robichaud. "We had to let three of the top five vendors go."

He says his business now does half the volume, but at a higher profit. Vendors have to realize that distributors need to make a profit, adds Robichaud.

"Customers need to know this as well," he says. "They need to give us profitable sales if they want us to provide less profitable special items and services. If they value their own time, we can usually get them to value ours as well."

Mastering distribution

For an increasing number of distributors, the answer for supplying customers with difficult-to-move items without substantially increasing inventory is a master distributor. One such distributor is Production Tool Supply in Warren, Mich.

"It is the independent distributor's ability to provide personalized services and technical support that distinguishes them from large consolidators and national mail-order companies," says president Mark Kahn. "To succeed in this competitive environment, [distributors] must take costs out of the transaction and still maintain superior service levels and customer support,"

Kahn says PTS removes costs from the channel. For example, PTS offers customized catalogs and marketing materials, drop shipments, online order entry directly into PTS' ERP system, the webXpress e-commerce service and America's Tool Crib national marketing and identity program.

Kahn says everyone wins in this senario. Customers receive a higher level of service, distributors reduce the costs of warehousing and shipping unnecessary inventory and PTS extends its market presence without investing in nationwide branches. PTS' customers and vendors also share the advantages PTS gained by utilizing state-of-the-art-systems.

Team players

Sales have remained promising at Mosier Fluid Power of Kentucky, says president Dan McFarland. The employees face the prospect of a weak economy as a team.

"We post the numbers and communicate how we're doing," says McFarland. "[The employees] understand that if the industry isn't producing, there will be low or no bonuses."

Mosier is cutting costs by reduced travel and entertainment and attending fewer trade shows, he says. The company has, however, increased its overall marketing efforts. For instance, customer service staff have taken on a telemarketing role.

When times are slow, McFarland says he looks to use staff in new ways rather than reduce headcount. He says everyone is looking at operations to eliminate waste and increase profitability.

More efficient operations mean cost reductions

Here are some cost-cutting tips from inventory management specialist Scott Stratman of Colorado Springs, Colo.-based The Distribution Team.

1. Reduce the number of new items added to your stocking inventory. New items are the number one source of dead stock. Too often new items are added to inventory because of the excitement they bring to your product offerings. However, since there is little to no sales history, new items are a bigger risk.
   
2. Develop a strategy for new items. New items often aren't purchased with long-term strategy in mind. New item strategy is more than how to take them to market. Plan how long you will keep the items if, in fact, they do not sell as anticipated. In other words, what is your exit plan for new items?
   
3. Negotiate with vendors. Before bringing any items into stock, distributors need to negotiate return scenarios. This might be a minimal re-stocking fee, a simple return or a credit towards other items.
   
4. Identify the true cost of keeping items on hand longer than needed. It involves the carrying cost of inventory, calculated as a percent of product cost over time. Annually, it is roughly 25 to 30 percent of the product cost. Since new items take time to get moving, they add warehouse costs.
   
5. Maintain fast-moving item sales while aggressively moving the slower sellers. Aggressive identification and disposition of slow moving and dead stock items is another way to minimize costs and actually increase cash flow.
   
6. Be creative. Identify a person to work specifically on getting slow-moving items out of inventory. Package them with fast movers, reduce price or work out returns.
7. Reduce branch replenishment. In a stronger economy, distributors increased deliveries to branches. Instead of twice weekly, make it once a week.
   
8. Use customer profitability analysis to determine which products you should be keeping on hand. Keeping stock for non-profitable customers in this economy makes no sense.
   
9. Find other methods of distributing product. Consolidate freight carriers, look for lower cost providers or push vendors to drop ship product. For some customers, consider eliminating free delivery, overnight services and special packaging. Offer these services at a cost to those customers.
   

COPYRIGHT 2002 Cahners Business Information in association with The Gale Group and LookSmart.