I was honored to lead a discussion on fee-based services at the Association for High Technology Distribution (AHTD). For those of you not familiar with the group, allow me an introduction: AHTD is the trade association for distributors, automation solution providers, and manufacturers providing a long list of technical products (things like programmable controllers, software, sensors, motion control, machine vision, and robotics) into the North American manufacturing segment. It’s a highly technical group, and literally all members provide some very expensive products and service bundles.
Historically, the members of this group have provided a wide array of both technical and logistical services to their customer base. Most openly admit salespeople are the gatekeepers for these services. Further, management oversight of service deployment ranges from “informal” to “talked about it in a sales meeting last year.” Ironically, even companies with well-developed turnkey service business (where fees are the norm,) still had little direct control over sellers deploying technical resources for non-project business.
COSTS ARE GOING UP…
Costs of newly graduated engineers track at somewhere around $60,000 — not counting travel, training, and benefits. Without exception, the group felt newly minted engineers did little for their business and required many months before they could impact the business positively. Even with the cost of service going up, only a few distributors took the time to proactively track the expenses on a per customer basis.
THE WHALE GRAPH OF CUSTOMER PROFITABILITY
According to industry experts, “More than a third of a distributor’s customers are costing you 45 percent of your profits.” I believe for the high-tech and high-touch distributors the number is higher.
Basically, the long tail of customers, representing approximately 50 percent of customers, cost more money to service than their gross margin justifies (Figure 1). Simply stated, these accounts generate negative bottom line profits. In an environment where sellers determine who receives free services, there is no throttle on the amount or type of services offered.
Commission structures, which the group agreed were based on gross margin, may actually encourage sellers to do “whatever it takes” to make the deal without regard to actual profitability.
IF THE DISTRIBUTOR DOESN’T PROVIDE THE SERVICE, WHO COULD?
Midway through the presentation, we asked the attendees to list the types of services they provide and identify who might do the services if they somehow went away. The list of services was extensive; this was no surprise. But the answers to the “Who could?” question were quite eye opening. Here is an unweighted summary:
1. Some customers could do the work internally, but might need to add additional staff.
2. Systems integrators could handle the work, but some might need training.
3. Engineering firms could do the work. Again, additional training might be required.
4. Supplier/manufacturers could provide the services. But, often the resources would need to travel from headquarters or the factory.
5. A few competitors might be able to provide the services.
The interesting point in the first four responses is this — all would be fee based. Furthermore, most are just a bit iffy. Unanimously, the distributors felt they had quicker response times and were generally better at solving the problems than the other options. Let’s do a quick review of why this situation exists.
Industry trends point to customers preferring to operate in a very lean environment. Most have consciously decided that maintaining large engineering departments and qualified technicians is not a good use of their budget. Additionally, the demographics of America’s workforce point to issues in finding, training, and retaining the right folks needed for rare emergencies. This is highlighted in a recent Plant Engineering Magazine survey of North American Manufacturers where the average plant outsources 20+ percent of their maintenance work.
For those not familiar with the system integrator business model, these are organizations where members earn their living providing engineering services in the manufacturing sector. Generally, they are called upon to assist customers who lack sufficient internal resources with automation upgrades. Most specialize in control system design. Experience indicates the majority prefer to do larger turnkey projects versus providing short duration on-site assistance. Some have candidly commented they struggle to make money on projects billing anything below $40,000 in labor.
Several of the distributors attending commented that systems integrators sometimes struggle with newly released technology. Furthermore, many specialize in a few of the major automation equipment maker’s products, which often require outside assistance from the distributor to make things work.
CONSULTING ENGINEERING FIRMS
Consulting engineers mirror the efforts of the systems integrator with the exception of typically providing a wider range of engineering-based services. Previous efforts indicate these folks are both more expensive than systems integrators and often favor larger projects.
Most of the major makers of automation equipment offer up some kind of technical service. There are two issues associated with acquiring service from these sources. First, technical expertise tends to be centralized — often housed at the factory or headquarters location. This translates into lost production time for the customer and travel expenses tied to the service. Secondly, while the technicians are well trained and capable, they frequently lack experience with integrated systems that take advantage of the best of several suppliers. Communications between the equipment of several automation manufacturers often requires this expertise.
All of these potential providers of service come with a price tag.
CAN COMPETITIVE DISTRIBUTORS PROVIDE THE SERVICE?
The final choice does provide a bit of a pause in our reasoning. Can a competitor really provide the service? The answer is, maybe. However, there are a number of issues to ponder. Let’s explore:
• The competitor may not know your customer’s installations and applications as well as your company. This translates into a steep learning curve on many of the services provided.
• The competitor may not have access to the same product lines. Again, this implies both a learning curve and a lesser quality of service.
• The competitor may not have the same quality of resources. This is very often the case with larger logistics provider types of distributors and remote outpost branches of larger chains. When downtime and productivity are involved, the customer knows the difference.
Summarizing these points leads one to believe the addition of fees to some services is both warranted and, arguably, risk free. Referring to the “whale graph” shown earlier, one must wonder what the impact of moving an account with negative profitability would be for distributors. Additionally, what might happen if a competitor accidentally acquired a negative profitability customer?
A FUNNY THING HAPPENED ON THE WAY TO THE BAR…
Immediately following our time together at the meeting, the AHTD group hosted a great ending reception. The weather was perfect, everyone was relaxed, and the message had soaked in. Then it happened, one-by-one, a half dozen distributors walked up began sharing their stories. Lots of service provided. Extensive support staff. No fees currently being charged. These stories came with a resolve to go back and make something happen.
Since I had billed the presentation as, “A License to Make Money,” I asked them what the impact to their business might be. The minimum amount mentioned was north of $60,000.
Here’s a portion of that conversation: “We have three application engineers on staff. Currently, we do absolutely zero in fee-based service, but we’re consistently busy. Sometimes, I cringe when I hear the places we go. I’ve heard of others charging for their service, but we never pulled the trigger. After thinking more, I believe I will require each of these engineers to add fees to just 10 percent of their time. That works out to something like 600 hours a year at $125 per hour with a total of $75,000 in added revenue. We’ll probably end up $60,000 ahead out of the gate.”
BEFORE WE SIGN OFF…
Quite frankly, I can’t imagine any distributor not assigning a value to their service and recouping at least a portion of the expenses tied to the service. While I personally believe 10 percent is a bit low, it is a start in the right direction. Another point to consider is the typical return for a distributor runs in the 4 percent range. So, to add the same amount of money to the bottom line would require a sale of between $1.2-1.5 million. Demonstrating fee-based services really is a license to make money.
Publication date: 5/24/2017