Wholesalers on pull replenishment, an oxymoron?

ETretail.com, November 3, 2014, Mumbai

I am often asked how I make a living out of implementing theoretical concepts detailed in textbooks. (The textbooks, of course, are The Goal and It’s not Luck, both business novels by the renowned physicist turned management guru Dr Eli Goldratt.) How are the ‘theories’ presented in these books that are studied in classrooms applicable in real settings, wonder the MBA degree holders who’ve read them as part of curriculum. How do the concepts hold up in a complicated, messy environment of unpredictable competition, conflicts between channel partners, pressure of internal targets, economic uncertainty and fickle consumers?

As an answer, I lay the complete logic before these sceptics, walk them through the Current Reality. Most seem convinced of the soundness of the solution itself but not of its efficacy at bringing results. A few months after this chat, one such sceptic called me for an urgent consult. You see, he had not received the results he expected.

Despite stocking the regional warehouse with high (higher than normal) levels of inventory, stockouts persisted leading to sale loss. Soon, the company had to switch back to the forecast based system, he rued.

I put on my detective’s hat and asked him a few pointed questions. The mystery unravelled without much resistance.

Going by the books, the company had calculated the stock buffers keeping in mind the production lead-time, market demand and the variability of the two. While I did not doubt the accuracy of the calculation, I noticed that much of the company’s sale – 50% – was being recorded in the last week of the month! Yes, it was a ubiquitous case of month-end skew or the dreaded hockey stick syndrome

If the buffer levels were arrived at looking at the average sales and its variability, and not considering the month-end spike, the buffers would be nowhere near adequate. If the buffers were arrived at with an eye on the maximum sale expected, the inventory would be mountainous; the bean counters and the warehouse managers would not allow it.

Yes, we could work out a buffer level that would be adequate throughout the month and, ensure fast, frequent supplies in the last week. But that’s not the point, is it? Tackling the peak in this manner would be a temporary solution. We need to decipher the peak and track down the reason for why it occurs despite actual end consumer consumption staying even throughout the month.

Most distribution-dependent companies in the country operate through distributors who supply to retailers in their catchment area. Do these distributors cover all the retailers in the country? The short answer is no. There are over six million retailers in the country. Yes, there are more retailers in this country than the number of people in some nations. (Read Dr Goldratt’s article titled ‘Comfort Zones’ in his book The Choice for his take on the topic).

Distributors cannot reach out to all the retailers in the country. I know of a few companies which have an army of about 7,500 distributors but still cannot cover all the retailers. These companies then look to wholesalers to get to the small and remote retailers.

Essentially, wholesalers are the link between organised distribution and fragmented retail. Co-existing with distributors, they serve those retailers who are out of the company’s coverage area. Their modus operandi: buy in bulk, deal in limited range, operate on wafer-thin margins and focus on inventory rotation. Inventory rotation and keeping the cash registers ringing are crucial to this strategy, more so because the margins are extremely thin.

So, why do wholesalers buy in bulk? Isn’t it strange that these dealers who supply small quantities to small retailers buy and hold large quantities of stock?

The answer is connected to the modus operandi. The wholesaler thrives on high inventory turns or ROI. Also, he sees price as the key variable influencing sales. So he drives a hard bargain and gets a huge discount on his bulk purchases. This discount is passed on to the market in a bid to achieve high sales. These bulk purchases are made in the last week of the month when he is likely to be showered with freebies/incentives by desperate sales teams stretching for targets. The next week, which is the first week of the new month, the wholesaler is flush with goods but all out of cash; he can’t go shopping for a few days. He waits for the last week of the month. Thanks to this pattern, companies are left holding the metaphoric hockey stick month after month.

Companies that are overly reliant on wholesalers have no way of escaping the trend. I know of one FMCG company which sells only 20% of its stock to retailers; 80% of its stock is channelised to the market through wholesalers. As much as 60% of the entire month’s stock is sold on the last day of the month!

So how do such companies transit to a consumption-based replenishment system without losing out on the sales that the bulk buyers bring in? The first step is to break the bulk buying habit of a few large wholesalers. At the same time, the companies have to minimise the loss they might incur while curbing purchases of wholesalers. One way to do this would be to offer the discounts not on single purchases but on the cumulative secondary sales the wholesalers report. Higher the sale, higher the discount. The wholesalers stand to gain even if their sales are not remarkably high. This would not only break the month-end skew but also pave the way for replenishment to actual sales. There you have it, a win-win solution!

Of course, this is just the beginning, the first step. Moving forward, companies have to aggressively increase direct retail coverage, cast their nets wider and wider. Most of Vector’s clients are already on this path, gaining control over the market, enjoying price stability, too. The wholesalers are still very much part of the picture and they operate on pull replenishment. How’s that for an oxymoron?

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