Earlier this month I was asked to lead a discussion on the future of distribution. In this case, we focused in on the future of members of the Fluid Power Distributors Association (FPDA). Since many of our readers are not FPDA members, allow me to provide a bit of background. The members of FPDA tend to be deeply involved in providing customer solutions. In many ways they epitomize the knowledge-based distributor. Their products are complex, sellers understand product technology and application nuances, customers lean on the distributors to provide technical support and most offer up additional fee based services.
Referring to the infographic below and the evolution of the distributor model, FPDA distributors are the poster perfect picture of the Knowledge-based distributor. Deep product expertise, product specialists, customer centric engineering and solution selling is their mode of operation.
While the argument for Amazon-like eCommerce may make great sense for the distributors falling into the “Logistics” side of the distribution industry, similar investment on the Knowledge-based side of the evolutionary line is likely to be poorly spent.
A quick survey of those attending the meeting revealed the following statistics:• 38 percent of attendees’ companies did zero eCommerce• 50 percent did less than 5% of their business via eCommerce• Only 12 percent of attendees indicated eCommerce represented between 11-20% of their sales
Thinking about available resources like time, effort and money, knowledge-based distributors investing in eCommerce do so at the expense/neglect of other potentially more rewarding investment opportunities. The pressing question is where should a knowledge-based distributor invest?
This question can be broken into four segments:• What customers are best matched for the offering of products, service and knowledge provided by the distributor?• How can the distributor better their ability to drive solutions to this group of customers?• How might the distributor scale up their ability to provide the solutions?And the most important question of all….• How can the distributor ensure they will be paid for the value they provide?
With all of this in mind, let’s dwell on the critical topic of getting paid for the value provided.
For this breed of distributor it’s not about value-added sales, instead the crux of the equation is value-metric selling. Simply put, knowledge-based distributors provide value far above the logistically based guy whose “value-add claim to fame” comes by way of timely deliveries, consolidated invoicing and the occasional cross reference to a more conveniently purchased part. Instead, knowledge-based distributors provide the stuff needed to help the customer develop better manufacturing processes, reduce costly downtime, reduce rejects and drive profitability.
Strangely, only a few of the sellers in this high value world really understand the true worth of their actions. Research indicates, their sellers go the other way, undervaluing what they do. Instead of measuring the financial impact of their ideas in terms of impact to the customer’s business, they shrug off the economic benefit as part of their “service”; often struggling to justify a percent or two greater margin than the person who provides just products without much needed technical support. This puts the group in a dangerous position.
As knowledge-based distributors move into the future, their reliance on technical advice, engineering support and turnkey engineered solutions as a competitive advantage deepens. Demographic shifts point to escalation of human side and other associated costs for the distributor. Without an understanding of the customer value they create, the distributors will see profitability sag.
Knowledge-based distributors need a different kind of training. The selling advantage goes to the distributor salesperson who can explain the value of their proposed solution in real customer-centric terms. It’s no longer acceptable to pepper the conversation in technical jargon and call it good. Improved cycle times, communication speed, scan rates and other data may be factors for selecting components. But when a solution is being discussed, the conversation must focus on advantage to the customer. Going further, customer advantages are best described in financial terms. For instance, the product feature of improved cycle times, translates into 10 percent more parts generated and that newly created production generates $500,000 additional revenue to the customer.
While training focused on understanding customer economic value is critical, it must also be understood that rarely are solutions outlined in black and white. To better understand the situation, let’s explore a hypothetical interaction with the customer.
Acme Manufacturing has an issue with a new machine design. They would like to employ a robotic arm to properly locate parts. The distributor proposes a solution capable of reaching into the machine grabbing the part and properly aligning the part thus eliminating a great deal of human interaction and reducing scrap. It’s a nice marriage of technology and customer need. The economics justify the work and the purchase is given the green light. However, midway through the design stage, the customer asks for a new feature. Instead of only one positioning action, the robot will require an extra move in order to add a date stamp to the part.
On the surface, the hardware required to complete the job remains about the same. But additional engineering is required to make a software adjustment. And the distributor seller is faced with a dilemma; eat the software cost, avoid conflict and keep the customer happy or negotiate a new price with the customer.
A study of distributors conducted earlier this year, points to a deficit in distributor negotiation skills. Looking more closely, we have sales teams who constantly negotiate solution and system pricing yet have very little formal expertise in the practice.
Anticipating questions, allow me to address a couple of points.• Our customers see us a partners and don’t negotiate when dealing with us. This misconception is rampant in the distributor landscape. Customers certainly do negotiate as many have had formal negotiation skills training. Have you ever formalized the technical side of a solution only to be handed off to a purchasing person to finalize the details? This in itself is a negotiation tactic.• Our sellers have been doing this for years and know how to negotiate. Selling is typically about knocking down roadblocks to getting the order. Giving away a little margin, or throwing in some added engineering time is an easy way to close the deal. Further demonstrating the phenomenon, distributors who run engineering organizations report reoccurring conflicts between those required to generate profits in the technical operation and the salespeople. Truth is, the sellers are better at negotiating with their co-workers than with customers.• Since our sales team is paid on the gross margin they generate, it’s in their best interest to capture as much gross margin as possible. From a purely cerebral standpoint, this makes good sense. However, many salespeople reason that a commission on a small gross margin is better than “haggling over a few bucks” and possibly jeopardizing the order or customer relationship. Pushing further, antiquated commission policies sometimes encourage sales types to capture less than optimal margins because giving away technical support or engineered services does not reflect on the gross margin number. In this case, the salesperson gets a commission on bad business.
What do I recommend for Negotiation Training? Over the years I have had the opportunity to sample a number of negotiation skills training packages. Unfortunately, I have not been impressed. The big names push tactics over substance. Most fail to understand that our kind of selling is different. Distributor-customer relationships are living breathing and ongoing bond. Every interaction adds to (or subtracts from) the tie between companies. Tragically, most sellers attending were turned off by the whole seller wins at buyer’s expense mentality.
Thankfully, someone recognized this issue and did something to change the landscape. SPASigma sprang from the work done by David Bauders and his Strategic Pricing Associates (SPA) team. With nearly a quarter century of experience helping distributors apply scientific analytics to their pricing process, SPA has assisted nearly 500 distributors in their quest for developing fair and equitable system pricing. SPA understands the how distributor business works. SPASigma has taken a new approach to negotiation training. Along the way, they have developed a whole system of in-person seminars backed up with online retention tools to assist in changing the outlook of sellers in this field. You can access SPASigma here.
Before we go,
We started off by saying, money spent on eCommerce could be better spent in other ways. Following this path of skill development centered on understanding your value to the customer, understanding the cost of the services you bundle and negotiation for the best deal will position your company for immediate payback. Payback capable of funding the future.
We are gathering information and building a list of frequently asked questions.
I am often asked about commission structures within the Automation, Electrical Distribution Industry and other knowledge-based distributor operations (Power Transmission Distributors PTDA, Fluid Power Distributors FPDA and Industrial Distributors). Considering the frequency of the question (from potential salespeople, experienced seller, managers and others,) I feel it appropriate to post some thoughts on the practice. While this is not our typical kind of post, I wanted to create a forum for discussion.
Commissions based on Gross Margin are one of the most commonly used incentive practices on the channel side of the business. On the manufacturing side, many people are still paid based on their gross sales numbers. Often you will hear distributors refer to this practice as paying on “tonnage” because sales professionals compensated in this matter really aren’t required to worry about whether their company makes a profit or not. Distributors must produce gross margin to survive. Further, the gross margin does not flow straight to the bottom line. Instead, gross margin dollars pay for everything from the light bill, insurance and rent on to the cost of the distributor’s employees (which typically account for 60 percent of the total gross margin).
In nearly four decades of involvement in the industry (which includes service as a sales manager at a major manufacturer, C-Level executive in a regionally based distributor, President of the North American trade association dedicated to the automation channel (The Association for High Tech Distribution) and, over a decade, as a consultant to the industry,) I have seen literally hundreds of commission models. These range all the way from commissions accounting for only 10 percent of the salesman’s total compensation to structures which comprise 100 percent of the salesperson’s monetary package.
I typically recommend a compensation plan which is comprised of a base-salary and a commission. For the record, I find deep fault with both straight commission and straight base salary plans. The exact percentage must be fine-tuned based on the company and conditions in the seller’s territory.
The most common industry practices on payment of commission are:• Monthly draws on commission which are settled at the end of each year. These packages are designed to “smooth out” the monthly variations in commission amounts. Draws give the seller some consistency over the year, but often lead to conflict when the total commission for the year is not met and the seller ends up owing money from surplus commission draw.
• Commissions which are paid quarterly, semi-annually (every six months) or annually. Most companies have discovered the accounting required to provide accurate monthly commission payments are too time consuming to justify payment on a monthly basis; hence the quarterly, semi-annual or annual payments.
As stated before, well over 90 percent of commission plans are paid based on Gross Margin generated by the sale. Gross Margin is defined using the formula (Sell Price) – (Cost of Goods Sold)
This number does not include incentives to the distributor from manufacturers, buying group rebates, special buys, mark-ups on freight, special handling fees or other income generated by the sale.
Further, distributors do not typically pay commissions on the following:• Sales made which are not paid in full by the customer due to disputes or other issue.• Sales made which remain unpaid because of credit/collection issues by the distributor• Sales made which are turned over to collection agencies.• Sales which are paid well outside of the distributor’s terms (i.e. paid 60, 90 or more days after the normally extended terms.
Sales are not one time eventsIt is important to note, sales generated in this industry are not one time events. Instead, the distributor/customer sales cycle is a long continuing relationship where no sale is ever considered final. Distributors are called on to provide after-the-sale service for many years after payment is made and money has changed hands. The unwritten agreement with the customer can be summarized in this manner: If the distributor customer continues to grow the business relationship with the distributor, the distributor will extend follow-up services in perpetuity.
In Knowledge-based distribution commissions serve as a plan to compensate the salesperson for more than just “closing the order,” they also serve as payment for continued support. With this in mind, it is considered an industry norm to not pay commissions for salespeople who leave the company. For instance, when commissions are issued on February 15th for the quarter ending December 31st, and a salesperson resigns on February 1st, commissions are forfeited.
Conversely, it is not uncommon for distributor salespeople to benefit from the work done by their predecessor at the account. Most customers come with a level of “flow business” which once started continues on for many years. The new seller assumes the role of service champion and is rewarded with commissions on sales they had nothing to do with initially generating.
In the world of knowledge-based distribution, sellers are judged on their ability to not only close the sale but to provide the kind of service which causes the customer to buy more from their employer. Distributor salespeople are judged on their ability to grow the relationship as opposed to garnering one time orders.
As stated earlier, this post is in response to the dozen phone calls or emails we get from all levels of the distribution world each month and is by no means a full report on the state of commission (or commission rates) in our industry. Instead, we thought it appropriate to answer many of the common questions asked.
Here are a few random comments:
On Commission starting and end dates• Typically distributor salespeople in our industry benefit from the past work of others at their accounts. This comes by way of business flow which was developed prior to their assignment to the accounts under their charge. Typically, new salespeople start with some commission based on the work of others.
• When salespeople leave other resources must be assigned to their accounts to maintain the service level at the accounts developed. These resources must be continued whether they are provided by a new salesperson or through resources such as inside sales, customer service, product specialists or others. It should be noted this practice extends not only through the ranks of distributors, but also applies to many other members of the supply chain: supply-partner manufacturers, manufacturer’s rep agencies and others.
• Policies on being currently employed in order to receive commissions have remained unchanged for many years. Recently, we spoke with a gentleman who resigned his post in the late 1960s. He indicated his commission plan was very similar to those of today. When thinking about leaving his (then) current employer, he waited until the week following the issuance of commission checks. He went on to form a company of his own and has no hard feelings on the potential commission left behind.
• Do policies like this favor the person who stays in position for a long time? I believe long duration salespeople do better in the distributor world because they learn more about their accounts and build layer after layer of flow business. This is typically good for seller and employer alike.
Why don’t distributors pay commission on sales volume?• Typically, manufacturers pay a commission based on total sales volume. Some distributors call this being paid on tonnage. The average manufacturer salesperson is not privy to the internal cost of the product. Sell prices are very likely to be set by others. In addition, the margins for manufacturers is higher than distributors. Distributor salespeople often know their company’s cost of the product and are paid to capture as much gross margin as possible. For the sake of those outside the industry who may be reading this article, the typical distributor ends up with a profit before taxes and interest of between 2-4 percent. They are not working on a gigantic margin.
Different commission rates?• Is it reasonable to have a different commission rate for various products sold within the distributor organization? Yes. Here is why: The cost associated with doing business with many supply-partners (some distributors have as many as 500) varies. Some provide incoming freight, some are easy to business with and others have mounds of paperwork associated with each order. Fluctuating the commission rate based on the type of product sold is common.
• Can a distributor have different commission rates based on the sales territory? Again, the answer is yes. Size and type of customer play a role in how easy or difficult it might be to create a relationship. Geography plays a part as well. The salesperson responsible for a large urban territory might may discover the sheer number of potential customers to be larger than the more rural based territory.
Commission rate changes?• How often can commission rates be changed? Business is a fluid thing. Conditions ebb and flow. Product lines become obsolete. Economies rise then fall into recession. The one mistake either seller or employer make is to assume what works today will always work. While I am definitely not in favor of change for change sake, I do believe business conditions warrant changes in commission rates. As a rule of thumb, any commission plan which has not been tweaked for over five years is probably in need of some examination.
Finally….I am building a repository of questions, comments and background information around commission plans. I would invite your comments be they anonymous or sent via email and posted at this end.
