Category management’s next horizon: How distributors can outperform

Like top retailers, the most profitable distributors have detailed end-to-end views of category performance. This helps them manage complexity and supply constraints, keep costs down, and meet customers’ needs while driving profitable growth. But few truly understand how to extract full value from their assortments.

These distributors are now looking to the next horizon of category management excellence. By reimagining the role of the category manager, resetting category strategy, and linking this strategy to core value levers, they will keep gaining ground in today’s world of shifting buying patterns and rising demand and inflation.

The gap continues to grow between outperformers and the rest of the industry, which has made little progress in margins despite nearly a decade of revenue growth (Exhibit 1). Our analysis of 140 publicly traded global distributors shows that even a 1 percent improvement in the cost of goods sold increases EBITDA by an average of more than 18 percent. Yet we see many distributors barely scratch the surface of great category management. Most category teams tend to operate as centralized buying organizations, reacting to sales, suppliers’ strategic priorities, and customer demands rather than shaping the industry and their assortment requirements.

What is holding the distribution industry back, and how can it reach the next horizon of exceptional category management?

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What’s holding distributors back

Distribution companies have historically played a major role across value chains, offering thousands, if not millions, of products to customers through elaborate catalogs. The depth, breadth, and availability of products will continue to be differentiators and top buying factors for most customers across the industry. But elevating category management in distribution is becoming far more important for four main reasons:

• The growing complexity of customer requirements. Customers will keep expecting more, including more seamless omnichannel experiences, greater product and price transparency, customized recommendations, more value-added offerings, and faster deliveries. Understanding the role of brand, as well as the right product positioning and placement across customer portfolios, is critical to knowing where and how to win within and across categories.
• The ever-expanding depth and breadth of product assortments. Most distributors find it difficult to manage the growing volume of products, increasing price complexity, and multifaceted supplier terms. Those without strong supplier relationships and flexible supply chains have struggled to keep up during the pandemic. Many lack deep insight-driven category strategies that could help them weather the storms of product shortages, supplier price increases, and disruptive competition.
• An unprecedented inflationary environment driving uncertainty. High inflation, coupled with labor shortages and rising freight costs, is putting intense new pressures on distributors. But with a deeper understanding of end-to-end product categories, a distributor can make targeted changes in assortments and prices and identify more favorable product substitutes to grow market share and maintain, or even expand, margins.
• A talent gap and rising expectations for category managers. Many distributors simply don’t have the capabilities or tools they need to uncover the most valuable category and assortment insights. Most category managers still rely on just a handful of levers, such as basic contract terms and price-increase avoidance, to work toward a narrow set of outcomes.

Nonetheless, progress is possible. While most distributors struggle to manage rising complexity, a few industry leaders are applying lessons learned in retail and other industries to transform their approaches to category management, to gain share, and to bolster profits.

The three pillars of category management excellence

Based on our experience working with distributors across industries, category management excellence stands on three main pillars: reimagining the role of the category manager, resetting category strategy, and linking strategy to core value levers.

Reimagining the role of the category manager

To win, distributors first need to reimagine the role of category managers. The best category owners maintain a P&L mindset, including a comprehensive understanding of product offerings, pricing and channels, and cost drivers such as payable terms, marketing funds, channel fees, and supply chain performance incentives (Exhibit 2). Their primary goal is to develop a growth-centered product portfolio while expanding margins.

Category managers today need to be much more than buyers familiar with the industry; they should be proven leaders who are both analytically and commercially savvy and who take a customer-centered view of what products or services will address customer pain points and create competitive advantages. They should build category strategies, including assortment and pricing perspectives, based on customers’ needs and willingness to pay rather than on what sales and suppliers are pushing.

They should maintain an understanding of what the attributes of their core products are, where they can best position products to drive growth, and what products may be interchangeable. Best-in-class category managers also need a comprehensive view of the business, including inventory and working-capital requirements, and must understand how to link critical supplier requirements, such as on-time delivery and payment terms in negotiations, to best position the assortment and portfolio for broad-based success.

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Category managers should not be siloed. Working from a central position, they should serve as core integrators of the business—collaborating with the sales, purchasing, supply chain, and finance departments to drive penetration and profitable growth. They need to extend their influence across functions, informing stocking considerations and helping to shape sales behaviors. And they need to have a 360-degree view of the business and bring the sales organization on the journey, understanding all the key considerations of assortment changes and product substitutions while establishing portfolios that continue to meet customer expectations.

Resetting the category strategy

To be effective, a category manager must become the chief strategy officer for his or her category. The multistep process requires a deep understanding of each customer and segment, beginning with the role the distributor’s offering plays for the target customer and how that role aligns with the distributor’s goals.

The best category managers know that not all category strategies are the same. They understand product positioning and tailor their approaches based on this awareness. For example, a product can be a “destination,” critical to a customer’s portfolio and to the distributor, or “complementary,” merely adding value to another offering. The category strategy depends on the product positioning (Exhibit 3).

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For example, a destination product strategy may help the distributor become a one-stop shop with a broad, differentiated assortment mix. Pricing will deliver high margins and high value in multiple tiers. The brand strategy may also be multitiered based on customer requirements and could position the distributor as a market leader with a distinctive and differentiated category offering. Understanding the role of the product helps the distributor decide how much to invest in sales, training, and private-label offerings, as well as how many brands or SKU types to offer to support growth.

As the bar rises on category strategy development, the most successful category managers have the skills to take a data-backed and insight-driven approach to compete more effectively. They use internal product, sales, and margin data alongside external competitor and market research to gain deeper insights. And as chief strategy officers, they sustain profitable growth across categories.

Linking strategy to core value levers

Among leading distributors, the category management function is a profit center designed to grow revenues and margins. Category managers at these distributors consistently use a suite of levers to drive margin expansion as it relates to the category strategy. We have found that five of these levers, coupled with advanced analytics to uncover deeper insights, deliver outsize impact (Exhibit 4):

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1. Optimizing the assortment mix. In the past decade, OEMs have tried to differentiate themselves and offer customers more options by manufacturing mountains of products with different designs but similar functionalities, such as hammers in more than a dozen colors, significantly raising complexity and costs for distributors. Industry leaders are now tackling this complexity using customer-centered research to understand what drives buying behaviors, what products—inside or outside their current product mix—drive demand, and which innovative products, including those with low sales today, will become more relevant in the long term to provide a truly distinctive offering and drive profitable growth.

   We’re seeing the most innovative distributors make surgical but substantial assortment reductions and regularly reimagine assortment mix to stay aligned with customers’ needs. A leading food and beverage distributor, for example, was facing intense pricing pressure from traditional and nontraditional competitors. The merchandising team took a category- and customer-centered view, resetting strategies based on in-house and third-party data and other market insights. They worked with sales and analytics to better understand their market position and gain a deeper understanding of customer requirements to deliver a simpler assortment at lower cost while increasing variety and value. The steps they took included product assortment rationalization, expansion in some areas, and better integration of continuous customer insights to guide pricing, brand development, and assortment selection. These efforts drove 10 percent gross margin improvements across most categories while dramatically lowering complexity with an enterprise-wide SKU reduction of 50 percent.

2. Elevating the role of private labels. Few distributors get full value from private-label offerings or penetration. While some leaders have converted 60 or even 70 percent of their product portfolios to high-margin private-label substitutes, many still struggle to shift more than 20 percent. Those who do harness private-label offerings wisely can enter new categories, expand margins without raising prices, and create competitive advantages and pricing protection by offering unique products that can’t be shopped around. The biggest hurdles for most organizations include customers’ preferences for familiar branded products and the inability of distributed and undertrained sales teams to explain the value of private-label offerings. Meeting those challenges can raise gross margins by double-digit percentages and can improve overall EBITDA by more than 100 basis points. Private-label integration, done well, is a powerful tool for any distributor.

3. Unlocking value from better supplier engagement. Many distributors are at the mercy of the thousands of suppliers they partner with. In some sectors—such as IT, alcoholic beverages, and heating, ventilation, and air conditioning (HVAC) distribution—dynamics strongly favor suppliers, forcing distributors to play the game of maximizing rebates and value derived from any of the other cards they have been dealt while managing the long tail of vendors where distributors have equal power. In other industries, distributors can partner with suppliers to unlock significant value, especially in categories in which distributors have a competitive list of alternative vendors, products that are interchangeable, and the right incentive alignment with sales on customer engagement and cost protection.

   In our experience, many distributors can extract a lot more value from a given category with the right approach to supplier engagement. Just as a distributor segments categories and customers, it should segment suppliers, using category insights and analytics to develop a clear fact base and boost negotiation leverage. A leading distributor helped its category management organization conduct fact-based supplier negotiations by building a custom data set to identify price and product discrepancies. To prepare for supplier negotiations, category owners gained targeted insights supported by contract teardowns, historical growth trends, cleansheets, and customer surveys. They launched a formal process to attract new bids across existing suppliers and alternative suppliers with more competitive price offerings. With a more robust fact base, teams segmented suppliers more effectively and reached more favorable negotiation outcomes, improving margins on addressable spend categories by 10 to 20 percent.

4. Integrating supply chain performance. Supply chain performance is critical because product depth, breath, and availability are what distribution is all about. The category manager must play the role of integrator by aligning product positioning and portfolio strategy with supply chain performance. Especially where category strategies shift and new products or suppliers may be introduced, supply chain performance is critical to sustain buy-in and support across the sales organization. This means working closely with suppliers and inventory management to consistently meet key performance metrics—such as on-time delivery and specification requirements—and to maintain competitive cost, quality, and availability. Supply chain partners are critical in helping to set terms in supplier negotiations and in sustaining performance.

   Supply chain partners can even help execute new category strategies. A large industrial distributor was experiencing significant pricing and delivery pressures in one of its commodity categories. It had been making local purchases across multiple locations and had limited visibility on price and performance. The category owners worked with the supply chain to develop a buying approach co-led by a centralized inventory and category team. Based on new monthly forecasts across sites and commodity index tracking, they negotiated better rates with larger buys and stronger delivery terms, saving millions of dollars per year while reducing freight costs and increasing inventory turns.

5. Sales enablement and commercial activation. Even the best category strategies won’t deliver on their potential without the full alignment and enablement of the frontline sales organization. Sales reps are positioned to influence customer purchasing behavior, educate first-time and returning customers on product selection, and support the growth of new product introductions, such as private-label offerings. It is critical to bring the sales organization on the journey by helping them understand what’s in it for them and their customers. They also need to understand how they can advance the category strategy.

   Best-in-class distribution category managers are equipped and empowered to partner with sales in strategy development, support frontline sales execution, and conduct go-to-market planning. One leading distributor enlisted the entire sales organization in an end-to-end training journey linked to the broader category strategy, including creating performance management dashboards and incentives to support margin expansion. Sales teams engaged in product training across the new assortment and protected negotiated terms across categories including freight, fees, and improved costs. Greater sales awareness and alignment between cost improvement and commercial efforts ultimately protected cost savings and helped to drive incremental margin expansion.

Outperforming in a more competitive new marketplace

For distributors across industries, the stakes are rising. Customers are more demanding, assortments are ever more complex, and new digital entrants are highly disruptive—and each of these trends will continue to compress margins. But every distributor has untapped potential to catch up to retail and other industries and create significantly more value with category management.

In the next few years, the outperformers will gather and harness more customer and category insights and use analytics in new ways to get more from their product portfolios and to meet customers’ needs better than ever. The best category managers will build new capabilities and adopt the mindsets of P&L owners. With a 360-degree view of the category strategy, they will be empowered to lead across functions with the supply chain and sales departments. They will be the chief strategy officers of their categories and drive sustained profitable growth, leaving the laggards behind.