Saturday, March 12, 2011

of Margins, Profits and Collaboration

A manufacturer needs a retail store to sell its products. And, a retail store needs a good agile manufacturer. While this is common knowledge, supply chain practice tends to suggest otherwise. Look at this article in Economic Times:

The Electronic retailers want the manufacturers to raise the margins by 4% from the current 8 -10%. The manufacturers say that the organised retailers give them a lower throughput than the smaller mom and pop stores and hence they can't increase the margins for modern trade.

Gross margin is defined as the buying cost subtracted from the selling price. For all practical purpose, this number is very different from profits. A high margin product can be a net loss product and a super low margin product can be a profitable item.

There is the issue of overheads here. Traders who work on volume products on low margins strive to keep overheads low. This way they can ensure good profits even with gross margins of around 2 - 5% only. For some MNCs on the other hand, profits are not even 10% of the gross margins. MNCs have an expensive bureaucracy to support and pay salaries to. Point that I am trying to make is that increasing margins is not the only way to make more profits.

A vendor who is unreliable would need lot of followups. This follow up is done by a buyer, and this buyer gets her salary from the buying organisation. So, a low cost vendor might actually be a loss making proposition. A bad quality product or a wrong shipment can surely be returned to a vendor. The vendor may also give a 100% credit note against the returns. But, the time lost in creating this return journey is a cost to the buyer. Similarly, a customer who demands frequent deliveries or who keeps changing order commitments is surely more expensive than a customer who lifts material in higher quantity, has lesser frequency of replenishment and also who give stable orders.

Instead of haggling on margins, the electronic manufacturers and the retailers could sit together and analyse these very cost drivers. In a truly modern sense, the modern trade must give up the aggressive postures and come to the negotiating table. Together with the manufacturers, maybe they could work out arrangements of last mile delivery to the consumers homes or offer special after sales service deals.

Same for manufacturing companies. An electronics company has significantly greater efforts in selling to smaller stores than large format chain retailers. Pan country buying decisions are probably made from one office for large format retailers. For smaller mom and pop stores, every small store would need a sales executive from the manufacturing firm visiting every week. The savings in sales effort costs would easily more than make up for the lower throughout in the organised retail.

The key would be for one party to demonstrate maturity and initiate the process. This is not a zero sum game where one firm has to lose for the other to win. There are numerous cost drivers besides the basic price. There can be a truly win win solution here. It is not a fight of the retailer versus the manufacturer. It is actually a relay race where both players have to work together to capture and satisfy the end customer.