By Mike Marks, Managing Partner, Indian River Consulting Group
The industry is now transitioning to another phase. The part that is over included the shock, the need for quick reactions to protect people, and actions needed to make it through to the other side. Some didn’t make it and now everyone is trying to figure out what is next.
The goalposts will keep moving throughout the summer
Those that study supply chains know that after a shock like this we’ll be whipsawed before we get back into the flow. Those that are ready will take share from those that aren’t. Recovery in the utility, industrial and construction markets is going to be spotty with some industries coming back quickly and others lagging. Geography matters a lot, as does the outlook for your customer’s customers’.
Those on the wrong end of the return to growth will need to either raise prices or cut costs, or both. Everyone in the value chain is faced with the same challenge, including manufacturers, distributors and customers. These events will feel like a series of small shocks throughout the summer and fall. Some price increases will not stick, some cost reductions will not be enough, and businesses that are undercapitalized with weak balance sheets will continue to fail. Many will negotiate extended terms before they file. As customers find their way through their own challenges, many will end up changing primary distributors and even some brands. There is an old saying in the Army: “You don’t have to like it, you just have to do it!”
We are already seeing some early moves that could be questioned on both the price increase side and the cost reduction side. Remember that this industry started with arguments between George Westinghouse and Tom Edison. We were the Amazon and Google of the day during the Spanish Flu, which had 50 million fatalities, according to the CDC. As a critical industry, we are still here, and we will be here for a long time. Those companies that make it through this pandemic will have earned or changed their reputation, for better or worse, based on their actions through this period.
Those firms driven by strategy rather than short-term earnings will consider the long run when making price and cost decisions. Winners will initiate rather than simply react. The share-gaining firm will execute a realistic plan for the balance of this year where transitioning to the new normal will be a resourced priority. The losers are those rushing to get back to where they were in January. Some companies in this industry still ‘secretly’ think they can make their original 2020 revenue objective. Denial is more than a river in Egypt.
Thinking About Price Increases
If done properly, the downstream value chain partners, whether they are distributors or customers, recognize the need for price increases. While they would rather not have it, they understand when their upstream partner truly needs it and that it is critical that they survive.
- A good price increase announcement is not full of corporate doublespeak; rather it is personally genuine and presents a truthful case.
- It isn’t done too early as a “just-in-case my profit is affected,” because if you do that, you are telling channel partners that, “It is all about me and you guys figure it out on your own.”
- Many increases will be legitimate due to productivity declines from required social distancing and ongoing reinfections. No one knows if these extra costs will be here long term, so smart distributors and manufacturers will acknowledge the uncertainty and the goal of rescinding them when possible.
- Prospective notice is always provided and wherever possible alternatives are provided that could obviate the need for an increase. Put boundaries on minimum order size, order frequency, direct digital links or other factors that reduce the need for the increase. The advance notice period must allow for shipments of products that are backordered.
Thinking About Cost Reductions
One could make a case that a cost reduction is simply an alternative to a price increase. We all know the math and the need to produce a profit with a positive cash flow. That said, it is worth discussing a few elements that have impact on a firm’s reputation over the long run.
A distributor has three options when faced with a price increase from a manufacturer: pass it along, absorb it and cut costs, or absorb it and dilute profit.
A cost reduction in the form of a layoff or furlough means that fewer people are doing the same work, so things will fall through the cracks and service levels will decline. Because of this, a cost reduction is often also a cost transfer to both the upstream and downstream channel partners. Mistakes and transfer of responsibilities can increase the costs incurred by both. These are often material as many executives overestimate the amount of available discretionary energy in their workforce. It is important to recognize that this discretionary energy is a finite resource. When it is used up good people leave and a downward spiral begins as customer find other alternatives.
It is usually harder for distributors to pass on price increases than it is to do a cost reduction. In a distributor’s business model, a high percentage of their cost structure is variable. A manufacturer has few variable costs, and because so much is fixed, they will find it relatively easier to do a price increase.
A distributor that is stressed will first go to their strategic suppliers and ask for some support. They will simultaneously try to develop a plan to set some customer price increases. Most will want to wait until they believe that the increase will stick – along with their key customers. If they can’t wiggle out, then a cost reduction is next.
- When pay cuts or furloughs are used, does the team understand the criteria for when they go back to normal? Employee uncertainty reduces productivity and often the best people are the ones who leave.
- Does the organization have confidence in their leadership and their new normal sales plan? Many distributors are well down the road on their own sales transformation efforts. They are well ahead of many of the large manufacturers.
- A manufacturer with a realistic plan will know which distributors to support.
How does this all fit together?
- Decide whether your firm is playing a short game or a long game.
- Once decided, be genuine and consistent in your behaviors and how you choose to make exceptions.
- Decide what you want your upstream and downstream channel partners to say about you when you are not around. Just behave to make it so.
Manufacturers and distributors need to recognize that any disruption of this scale lowers switching costs between channel partners. With a bit of humility, companies can gain share from those that are overconfident, complacent, or arrogant.
With some trust and honesty, the contractor that can’t handle the price increase will come back to the distributor with the problem and potentially pitch some other ways to stay together. This combination of trust and honesty has significant economic value to the channel.
This same trust and honesty can turn cost reductions into channel partner discussions on how to work together to lower the cost to serve, the cost to acquire and the cost to use. What if these collaborations became part of the new normal?
In simple terms, this starts at the top with the right values. Time will tell, as this is going to be a bumpy ride.
Mike Marks is the Managing Partner of Indian River Consulting Group. He and his firm are well known in our industry and he is also a Research Fellow with the NAW Institute of Distribution Excellence. He can be reached at email@example.com. You can learn more about the firm at www.ircg.com.