Why isn't Direct-to-Site Always Profitable for Merchants?

Mark Oliver, H+H MD, reports on how merchants may not always capture the value they add when providing this service to builders

As direct-to-site business does not require the merchant to hold stock or transport product to site, it has a lower cost to serve than the core, ex-yard business. As such, one would expect the margins to be lower for the same return on capital and risk. But not necessarily as low as they end up being as a result of the aggressive competition between merchants to secure direct to site business. Are merchants possibly underselling some of the value they offer within the overall supply chain?

As a heavy-side supplier, H+H is quite experienced in direct to site sales.  We understand that because aircrete is one of the first things that a builder needs in the construction process, merchants often view getting the aircrete sale as a route to selling other products where historically they have made higher margins.

In some sectors loss-leaders are an accepted practice – for example supermarkets may discount staple products, such as milk and bread to attract customers. But this only works if you can be absolutely sure that you will make up the profit you have given away on other product groups.  If you don’t make money on everything you sell, then in the long run, your business may not be sustainable. Merchants should be able to make a reasonable return on every product or package of products they sell. Not everybody sees it that way of course - some accept a balance where there are lower yields on some products and higher ones on other items. And if net profitability by customer can be measured, taking into account all discounts, rebates, cost of credit and all other costs to serve, and all of their customers generate a profit then it may not be a concern. But that is a big if.

During the downturn we have experienced many merchant customers engaging in, or some might argue having to respond to, aggressive market behaviour and dropping margins on their direct to site business. The resulting margins on some products are extremely low compared with the value that merchants add in terms of customer and order management and processing, payment terms and credit risk.

Many suppliers recognise that merchant direct to site margins are wafer thin and give their merchants price support to address this,  but too often that support is competed away and passed on to builders. Of course suppliers have a responsibility. They should promote the value of their products and work with merchants to establish logical pricing structures that assist merchants to make a margin. And, if a merchant has put in a lot of work to create a sales lead, for example to specify aircrete over another solution, then I would like to see that merchant capture the value in a margin for that job.

Increasing margins

For the past five years the surplus of supply versus demand has created a buyer’s market. Huge price pressure on both merchants and manufacturers, combined with cost inflation on manufacturers, has driven a reduction in production capacity as well as a reduction in the number of suppliers. Between 2008 and 2011 the number of building products and materials producers has dropped 10%, equivalent to 1,500 firms, and a further decrease is expected when the 2012 figures are released in the coming weeks.

Now that the market is getting a little busier and demand approaches the new lower levels of supply capacity, the prices of many products will rise quite materially to recover the pent up cost inflation that has not been passed on for several years.  These rising supplier prices will give merchants the opportunity to increase their own selling prices and, in the process, the opportunity to grow or rebuild their direct to site margins by competing on service and relationship rather than on price.