2021 and 2022 saw the fastest inflation in a generation. The prices of key industrial inputs, including raw materials, labor, and transportation, all rose to record levels. Distributors faced steep price increases from their vendors, and most were in a position to pass those increases on to their end customers.
Over the past 12 months, the landscape has changed. Except for labor, input costs have fallen back, declining by an average of 13 percent during 2023 (exhibit). Vendor prices have been slow to follow, and many products now cost more than they should. Meanwhile, low growth in industrial production has led to weak demand in many sectors, with vendors sitting on high levels of unsold inventory.
The widening gap between “should cost” and “does cost” puts distributors in a tricky position. Their customers know that input-cost inflation has fallen, and they are asking why prices have not.
Today’s cost environment presents a significant opportunity for distributors, however, if they have the procurement capabilities to take advantage of it. Several large distributors in different industry segments have already responded by conducting accelerated category reviews. Their aims: to close the gap between prices and should-costs, reshape their categories, and optimize total cost of ownership (TCO). Some are reducing SKU cost complexity, too, by simplifying special pricing agreements with their vendors. The savviest players are going even further, using this time to make strategic shifts: adapting their overall portfolio mix, assessing the status of preferred suppliers, and developing their private-label offerings.
Category reviews as a catalyst
For distributors, today’s category reviews fall into three basic types, with the choice depending on the maturity of the procurement function, the organization’s appetite for change, and whether the priority is immediate impact or long-term value.
Rapid-value capture reviews are designed to cut costs quickly. For commoditized categories or those with several viable alternatives, distributors will run comprehensive RFx events that aim to capture savings based on shifts in underlying commodity price indices. These events can lead to in-year savings, often through one-time bonus structures. In other categories, distributors are engaging directly with vendors to reset pricing, rebates, and terms.
TCO optimization reviews move the conversation beyond price by taking an end-to-end view of cost. In these reviews, distributors work with their vendors to optimize total cost of ownership—for example, by altering terms and conditions, introducing penalties for shipping delays, reducing lead times, or adjusting payment terms, marketing allowances, rebates, or special pricing management fees.
Portfolio reset reviews involve a holistic transformation of the category, with the aim of maximizing margins, volumes, and growth opportunities over the mid to long term. Part of this reset is evaluating the role of private label and making private label a centerpiece of the offerings, as appropriate.
Portfolio-focused category reviews also involve forging strategic partnerships with key suppliers. Such relationships can create value beyond savings—for example, by driving growth through innovation, or collaborating to achieve faster time to market for new products. Top performers have a high level of competence in the rapid identification, qualification, and development of new suppliers worldwide, and the ability to switch vendors and shape customer demand.
The best approach, or combination of approaches, to category management is different for every distributor. Key considerations include trade-offs between immediate and long-term impact, and how much of the value created is shared with end customers. To generate any value at all, however, companies need to act now. Traditionally, category reviews by distributors achieve reductions in cost of goods sold of 2 to 5 percent. This year, we have seen companies achieve savings of up to 20 percent in selected categories, leading to margin improvements of 50 to 150 basis points when executed at scale.