A coffee distributor we’ll call ‘CoffeeMax’ operating in a major metropolitan area was fighting it out with a tough competitor, ‘HotDrinks’. The business involved selling coffee to restaurants, coffee houses and other institutions in and around the city. Although HotDrinks was profitable in other markets they were under extreme pressure to improve profits in this specific metropolitan region and had recently appointed a new manager to grow the business. Knowing this, the owner of Coffeemax came up with the following strategy.
Like other product / service businesses, the coffee distribution business is driven by two main factors, the sales price for the coffee minus the cost of the coffee, and the cost to deliver the related services. The cost of the coffee itself is almost identical for all competitors making it impossible to gain a product cost advantage. Different volumes of coffee sold to a client do allow for price reductions to high volume customers but the cost to deliver the coffee and related services represents up to 50% of the contract costs. These service costs vary greatly based on several factors; the cost of the coffee brewing equipment and its maintenance, the frequency of delivery, the size of the drop order and importantly, the customer’s distance from the warehouse.
Central to CoffeeMax’s strategy was segmenting their customers according to their proximity to the distribution center and size of drop order. HotDrinks, like many companies, segmented according to gross margins noting that high volume customers expected the deepest discounts making their gross profit margins on a percentage basis look awful.
CoffeeMax, noting that service costs were not included in gross margins, put into place a strategy to aggressively go after the high volume, close proximity accounts factoring in all the costs of delivery, service etc. HotDrinks couldn’t believe their luck as they started to win all the high gross margin contracts around the city. Unfortunately for the people at HotDrinks these high margin contracts represented small shipments and / or were located in remote areas far from the main distribution depot. In this type of business with high service costs, the high margins didn’t translate into high profits. CoffeeMax’s gross margins looked dismal on paper but their service costs were one half of their competitor’s, leaving huge profits on the bottom line.
Sometimes allowing the competitor to win in the unattractive segments can create the opportunity to gain a foothold in the market place, allowing you to stake out a superior position and making it very difficult for the competitor to re-establish themselves. By the time HotDrinks figured out which were the profitable accounts in the city, they were sewn up for the next few years as these contracts typically are bid out on a three year basis.
In any market it’s important to:
- Understand the profit drivers – they aren’t always obvious as in our story.
- Recognize that the profit drivers can be different for different segments.
- Consider that margin percentages and high gross profits don’t always translate into bottom line profits.
For CoffeeMax it was amazing how a simple market segmentation gave them a competitive advantage in a tough price driven market. Isn’t it interesting how easy strategy can be – the tough part is actually taking the time to think it out. Take the time – develop a strategy – manage your competition!