Overreaching for Mass Retailers

Serving these giant accounts may be profitable But will the gains outweigh losses in other channels? Be prepared to make big changes in manufacturing, logistics, sales, and customer service The thought of winning a contract to supply a mass retailer is enough to make a sales manager salivate. Toys R Us accounted for a fifth of the US toy market in 1996, The Home Depot sold more home improvement products than all hardware stores combined, and a quarter of the underwear purchased by Americans came from Wal-Mart. Exhibits 1, 2, and 3 give an indication of the strength of mass retailers in the United States, and how they have come to dominate many product categories. Landing an account with one of these mass retailers can double or even triple a supplier's annual sales. But rapid revenue growth is not always accompanied by a surge in profits. The strain of coping with high volumes and the service needs of powerful customers can put tremendous pressure on suppliers' profit margins if they attempt to conduct business as usual. Some manufacturers that supply mass retailers even find that although their sales rise faster than those of other manufacturers, their earnings growth is slower [ILLUSTRATION FOR EXHIBIT 4 OMITTED]. Even giants such as Procter & Gamble, Unilever, and Kraft, which have considerable bargaining clout, have felt the squeeze and are searching for new ways to serve their largest customers profitably. Channel conflict poses problems too. The rapid sales growth that many mass retailers have enjoyed has often been at the expense of more traditional outlets. Among discount stores, for example, the top three - Wal-Mart, Kmart, and Target - now account for 69 percent of US sales [ILLUSTRATION FOR EXHIBIT 5 OMITTED]. But traditional channels have not disappeared: in many industries, they still account for 50 to 75 percent of US sales, and often join forces in cooperatives to increase their bargaining power. These are sales a supplier might lose if it starts selling to a mass retailer. Indeed, some disgruntled traditional customers have dropped suppliers that do business with the big discount chains. And what of the brand? Selling a brand to a leading mass retailer can do wonders for awareness (an estimated 23 percent of the US population shops in Wal-Mart on an average day). But in categories where image is important, such as apparel, electronics, and cosmetics, being associated with certain mass retailers might create the impression of a discounted brand. A mass retailer account is thus not automatically a plum prize. The large revenue increase can rapidly boost a supplier's profits, but in most cases these profits will materialize only if suppliers can find ways to adapt their business systems to earn attractive margins and at the same time minimize channel conflict. Assessing the profitability of mass retailers' accounts Suppliers' first task should be to evaluate the profitability of their mass retailer accounts. This can be difficult because most company accounting systems allocate overheads proportionally on an account, volume, or sales basis, rather than deciding exactly which costs should be allocated to which customers. As a result, the true cost of sales for different customers is masked. When costs are allocated properly, suppliers can find that mass retailer accounts that looked attractive are actually losing money. Conversely, some mass retailer accounts are more profitable than suppliers imagine. An effective yardstick is the pocket margin - the margin pocketed by the supplier after all costs associated with an account have been subtracted. It has three key components: the pocket price,(*) direct manufacturing costs, and the operating costs associated with serving the account. Exhibit 6 indicates the extent to which these components can raise or lower the pocket margins on a mass retailer's account. Pocket price. Mass retailers often receive large discounts on suppliers' list prices because they purchase in volume. …