When distributors create a cost-to-serve (CTS) model to estimate and rank customers by net-profitability, there are typically two customer-group shocks:

  • Some big-margin-dollar customers are big losers. Their many small-dollar orders and/or line-item pick totals eat more CTS dollars (CTS$) than their gross profit dollars (GP$); and
  • 40-80 percent of all customers are considered small, placing small to average order sizes. Their CTS$ also exceed their GP$. 

Warning! You can rapidly increase small losers with a website marketing effort that wins new customers with terms that don’t insure enough GP$ per order.  

Case example: a big distribution chain popped company sales by 8 percent while customer and transaction counts doubled via online sales. So, 80 percent of its customers generated only 5 percent of the GP$ on 25 percent of all transactions. The new CTS model verdict is that the web division is a net-loser and that traditional distributor fulfillment costs exceed Amazon.

The Lollapalooza Denial Reaction 

When multiple cognitive biases reinforce one another within a group, irrational beliefs will take over. This, according to Charlie Munger, is the Lollapalooza Effect.

The model stinks. Change it to turn little losers into winners. But, if 100 percent of operational costs are in the CTS model, then costs shift to turn other accounts into losers.

So, kill the CTS model and return to the traditional, data-free, Lollapalooza belief bundle that includes: 

  • All sales and margin dollars are equally good (irrespective of related CTS);
  • All costs are fixed in the moment. We can always take one more order (or thousands) without hiring any more CTS fulfillment people or reinventing CTS like Amazon;     
  • All new sales/margin dollars grow: economies of scale, profits, and rebates;
  • Reps don’t like to see commissionable accounts as net-profit losers. Pretend they aren’t and be happy;
  • Win more customers (of any size and/or kind) to replace defections and deaths to support the four previous points;
  • Little losers will grow into big profitable accounts;
  • Little losers have higher average GP percentages, which make them (more) profitable;
  • Everyone we listen to in the industry shares these beliefs (confirmation bias?). Stick with the herd;
  • And, we’re doing OK financially. More volume will always win.  

Or, you could discuss belief blind-spots and test them against statistical analytics. What are the opportunity costs involved by being distracted by burgeoning small-order busyness? Could you grow faster and more profitably by focusing in on and creating stronger partnerships with your biggest, most profitable, fastest growing accounts? For more information, visit http://merrifieldact2.com.

Publication date: 02/11/19