Most businesses have heard of the benefits of vendor consolidation, but few have considered the benefits of customer consolidation. The approach is to reduce the customer base in order to reduce the company’s sales transaction costs. The mechanism that makes this possible is to use multiple distribution channels to market, or multiple sales agents. This is often a goal of companies whose costs on sales transactions are simply too high, whose manufacturing is fractured by infrequent customer orders and cyclical demand, or whose customer volumes are too small to service. Imagine the costs of selling 3 units to 100 different customers, as opposed to selling 300 units to a single customer. Obviously the second transaction has lower costs and is therefore easier to manage. So, how can companies benefit from customer consolidation through multiple distribution channels?
Consolidation Through Distribution
Before delving into the process of customer consolidation, it’s perhaps best to identify the how and why of such an approach. While there are several pros and cons of dealing with distributors, the pros often outweigh the cons when it comes to consolidating a company's customer base.
First, companies are able to amalgamate low volumes sold to multiple customers, into one large volume shipped to a single distributor. That distributor is then responsible for selling and servicing the territory’s customer base.
Second, companies are able to reduce their product’s “COGS” (cost of goods sold) by reducing their manufacturing costs, their inventory holding costs, their receivable financing costs and their per-unit freight costs on outgoing shipments (if they include freight in price). This is because they ship a larger volume to one location.
Third, companies are able to divert resources to other segments of their market, segments that likely hold larger volumes and better opportunities.
How Does Customer Consolidation Work?
By no means is the following example all there is to customer consolidation. However, the idea is to show just how costly it is for companies to support small volume transactions across multiple customers, as opposed to high volume transactions to a singe distributor. Using a distributor immediately reduces the sales transactions costs by reducing your company’s costs to hold inventory and your per-unit costs of freight on outgoing shipments.
If you’re a manufacturer, these costs are reduced even further as you are able to amalgamate production volumes and reduce costs through increased production throughput. Finally, there are soft costs pertaining to invoicing and receivables collection, soft costs that help to reduce your company’s cost of capital. In essence, you chase one account for payment – instead of multiple, smaller ones who all have different payment habits.
The following is a summary of the six steps needed to decide upon customer consolidation.
An example of the Impact of Fractured Volumes
Scenario #1 – Servicing Multiple Customers: A company currently has a product line whose COGS are $5,000.00 for each unit manufactured. The company has a yearly interest rate on its business credit line of 4.5%. Its daily interest rate to finance its receivables is 4.5% divided by 365 (days in a year), which is 0.0123%. Every day customers don’t pay their invoices, it costs the company $0.62 cents in financing costs. The average number of days it takes customers to pay their invoices is 45 days, which means the company’s average receivable financing costs is $27.74 for each unit sold. It takes the company 1 month to sell the product. Its inventory holding costs are therefore 3% of $5,000.00, or $150.00 for each unit held before it's sold. Finally, the cost to ship a single unit to a customer is $100.75.
The following table outlines all these costs above for all 10 of the customers found in this particular territory.
Example of above table: Customer #1 purchased 2 units. The company’s shipping costs are $100.75 x 2 units ($201.50). The company’s average holding costs are $150 x 2 units ($300.00) and its average receivable financing costs are $27.74 x 2 units ($55.48).
Scenario #2 – Moving to a Distribution Channel: Instead of servicing 10 smaller customers with multiple volumes, high shipping costs, high inventory holding costs and high receivable financing costs, the company instead decides to go through a single distributor. This means the company will ship 41 units all at once to one source. They’ll reduce their per-unit freight costs because they’ll ship a larger volume.
In addition, they’ll reduce their inventory holding costs because they won’t have to hold 41 units, hoping to anticipate or capture the cyclical demand of 10 customers. Finally, they’ll reduce their receivable financing costs as they’ll be working with one account, and not 10.
The company's freight costs go down to $87.50 from shipping larger volumes. Their holding costs are cut in half to $75.00 as they don’t have to hold as much inventory for as long a period. Finally, their customer pays in 30 days, as opposed to 45 which helps to reduce the company’s financing costs on receivables. The yellow highlighted section includes the summary of the savings in shipping costs, holding costs and financing costs once the company consolidates its customer base. The total savings is $3,997.36
Granted, this is a fictitious example and again, trying to consolidate a company’s customer base is an involved process and one not to be taken lightly. When companies pursue customer consolidation with multiple distribution channels, they must always take into consideration the distributor’s approach to pricing and sales.
Instead of the company quoting its customers directly, they are instead relying upon a distributor to market and sell their products. Unfortunately, several distributors are known as “me-too” suppliers – those who represent multiple competitors and use one company’s high price to secure the order for another company. In essence, they play favorites in terms of whom they represent.
If you’ve made it this far, and are contemplating moving forward with customer consolidation, then just make sure you’ve outlined all your savings and have weighed those savings against the risks associated with selling through a distributor.
The above video explains the benefits of vendor consolidation. In this case, consolidating a company's vendor base improves the company's supply chain by reducing purchasing costs. You can access the video by going to the following article: What is Vendor Consolidation? Strategies to Reduce Inventory Holding Costs
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