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Establishing E-Commerce Territories

Parts department profit margins may be at risk.

In order to understand the need for the lift truck industry to mandate, develop and enforce e-commerce territories, it’s important to consider what the industry will look like in the future.

Competition Forces Increased Pressures On Profit Margins
We live in a world powered by competition. Our economy is fueled by the competitive spirit. The ability of the consumer to purchase the best product at the lowest cost is the engine that powers capitalism, and competition forces the innovation of products that can be made readily available to the buying public.

However, there are some instances in which this competitive spirit can have a negative impact on the material handling industry. When there is an abundance of available product, the product can lose value and become a commodity. The buyer can find discernment of a product’s true value difficult. The purchasing decision is then based on need and price points.

The lift truck industry witnessed the devastating effects of a commodity market in the late 1970s and early 1980s, as multiple manufacturers flooded the equipment market with high-quality, low-cost lift trucks. Although overall product quality increased, the resulting “price war” caused gross profit margins to spiral downward. As we all know, the lift truck industry has never fully recovered its lost profit margins.

Protect your Parts Department’s Profit Margins
The danger in today’s lift truck market is that it is again teetering on the shift to a commodity market. However, this time it won’t be equipment margins that suffer. The revenue stream in jeopardy lies within parts sales. The gross margin enjoyed by most parts departments has not experienced significant change for more than 20 years. The question facing our industry today is what would happen to our overall profit margins if our parts department’s gross profit margins were to experience a sudden decline of several points?

As we can see in the following Parts Profit Models, the effect of a declining gross profit margin can be alarming. Drawing a composite of data from our customer base, Exhibit 1, Today’s Profit Model, depicts Distributor A’s parts department. His parts sales are $2,000,000 annually. A 35% gross profit margin generates $700,000, resulting in a net profit of $154,000. If the end-user suddenly considered parts as a commodity, we could safely estimate a reduction in gross profit margins of 25%.

E-Commerce Exhibit 1The reader should note that in the information technology sector, we saw a commodity shift in server and workstation sales directly related to the use of E-commerce. Hardware profit margins commonly dropped to between 3% and 10%.

In Exhibit 2, the Commodity Profit Model, we can see the financial effect of lost gross margin. Overall gross profit drops to $433,333, a 38% loss in revenue. Assuming a distributor could lower his employment levels by $266,666 to compensate for the loss, the distributor’s net profit is 0. In today’s light economy, this loss would greatly affect the operating viability of many lift truck organizations.

E-Commerce Exhibit 2I won’t even approach the subsequent collapse of the service department’s profitability. As the buyer decides that he can effectively service a fleet for less by sourcing best priced parts, the service department’s profitability will experience a rapid erosion.

Won’t happen? I say it can happen and already has happened in other industries. Here’s why…Any enterprising manufacturer or distributor can deploy a universal website with an E-commerce engine. Marketed worldwide, this site could be readily accessible to the potential buyer. The success of this endeavor is assured by the omnipresence of the website to the buyer, and of course the discounted parts that are offered for online purchasing.

If your end-user suddenly considered parts as a commodity, you could safely estimate a reduction in gross profit margins of 25%.

The natural progression dictates that the competitive marketplace will adjust accordingly. A distributor lowers his parts profit margins and, of course, has to sell more volume to compensate for the loss. This increased activity threatens other distributors’ viability as businesses, and the “price war” spiral begins.

What To Do
How can the lift truck industry combat this future problem? There are several options that may or may not work for you. Even if the option will work in the short-term, we must plan for long-term profitability.

Sell More Guaranteed Maintenance Contracts. Keep in mind, though, that fleet customers will demand to see a supply list and cost for every part used to service their equipment, eliminating any opportunity to build profits into the contract.

Sell Value. Every strong sales and marketing team should, of course, sell value. The question becomes how does one attach a value to purchasing an air filter from your particular service department? Selling value requires both sales talent and an investment of time. Does the level of investment match the dollar generated by the particular item that is sold?

Sell Solutions. When selling a specific part, the buyer may not be interested in a long-term solution when purchasing a low-ticket item. In fact, there may not be a solution to sell.

Find Other Sources of Revenue. If you can find a quality product which can be seamlessly melded into your existing business, this is a viable option. Of course, this new product can eventually be considered a commodity. Developing new products each year may not be an efficient use of resources.

Find a Lower-Cost Supplier. Finding a lower-cost provid-er is a short-term solution. Eventually a competitor will locate the same or a similar provider.

Do Nothing. As one successful distributor has said, “If you take your foot off the gas, eventually the car will come to a stop.”

Force an Industry Standard for E-Commerce Sales
The lift truck industry should develop a set of E-commerce business standards. Two standards that directly apply are Group Bid Pricing and the establishment of E-commerce Territories.

In order for Group Bid Pricing to be successful, all suppliers and buyers would have to accept this strategy as an industry standard.

Group Bid Pricing
Group Bid Pricing can inhibit the erosion of gross profit margins as E-commerce becomes a standard operating procedure. Group Bid Pricing, invented and tested by economists, calls for items to be sold on the Internet via an auction method, and only in large groups. In other words, a buyer cannot simply purchase a single filter. The buyer has to request a bid on a group of items he wishes to purchase. Suppliers would then place bids to supply all the items requested by the buyer. Because the buyer simply cannot buy the lowest cost line item, the supplier can maintain an acceptable gross margin on the overall sale.

Group Bid Pricing is a new theory and in testing has been extremely successful. The difficulty is in its implementation as an industry-wide practice. In order for Group Bid Pricing to be successful, all suppliers and buyers would have to accept this strategy as an industry standard.

E-Commerce Territories
In practice, E-commerce territories are similar to the equipment territories that exist today. Manufacturers collect and manage equipment sales information, including the territory in which the product was sold. If a lift truck distributor sells a new lift truck into another distributor’s territory, a commission is paid to the distributor who “owns” the territory.

In much the same manner, E-commerce territories can be established and enforced. This process could be managed by lift truck OEMs, or by a neutral third party known as a clearing house. Manufacturers have already established specific parts territories. Unfortunately those territories may not be routinely enforced. In the new electronic age, this deficiency is only amplified by E-commerce. The ease of selling parts out of a territory (and, yes everyone does it) opens the possibility of, even unwittingly, the exploitation and abuse of the system.

E-Commerce Exhibit 3

Managing E-Commerce Territories
Because E-commerce engines have to track shipping locations for sales tax purposes, these engines are more than capable of being modified to report territorial sales to the manufacturer. The E-commerce engine can easily track sales amounts (i.e. item sold, quantity, list, cost, gross profit) by territory and report an overall summarized amount to the manufacturer. The manufacturer can pay a percentage of those sales to the distributor responsible for a specific territory. Thus, it becomes very difficult for a distributor to realize profits from selling products outside of his territory.

The real issue with establishing E-commerce territories and reporting sales volume lies in the sensitive nature of the information gathered. Most lift truck distributors are not willing to divulge customer sales information to manufacturers, for obvious reasons. The solution to this problem is for a neutral third party clearing house to manage the E-commerce facility.

The third party is responsible for maintaining the site and reporting results to all parties involved. The third party’s compensation is provided by the manufacturer or the distributor. Compensation can be based on an established fee-per-transaction or percentage of the sales volume through the site. The clearing house method provides for management of E-commerce territories while maintaining the confidentiality of all involved parties.

Manufacturers Must Partner With Their Distributors
All concepts for combating the possibility of a commodity market must be considered and evaluated. The success of any solution is dependent on the coordinated efforts between a distributor and a manufacturer. Distributors and manufacturers need to develop a forum for discussing E-commerce territories and their appropriate deployment.

The future has arrived. The time to develop rules and methods for maintaining a fair and reasonably competitive lift truck market must be established now.

Material Handling Equipment Distributors Association

Mark Mahovlich Meet the Author
Mark Mahovlich is vice president of dealer development at Minitrac Computer System Solutions in Strongsville, Ohio.

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