DISTRIBUTION CHANNEL ROLL-UPS: CONS AND
Consolidating fragmented industries – like independent
distributor channels – really took off in the late ‘90s when earnings growth
Rapidly bought until size got too big and
remaining acquisitions too small.
Boosted by creative deal-accounting and
one-time, centralized cost cuts.
Enhanced by “growth rebates” (remember US
Foodservice’s $800MM overstatement fraud); and,
Eventually monetized by going public in the ever-rising
Ten years later, these big agglomerations are mostly struggling.
The public ones have low stock prices. But, more quietly, the rest of the
channel players are suffering from negative, roll-up side-effects. Why weren’t “economies
of scale” sustainable for roll-ups? What are the side effects for other players?
What are the innovative cures?
To stimulate some thinking, here is a partial list of the cause-and-effects
conditions sparked by roll-ups that have affected all channel players followed
by some solutions and questions.
NEGATIVE SIDE EFFECTS FROM CONSOLIDATING
majority of the roll-ups in distribution channels are now struggling to achieve
minimal profitability. Some of the “poof companies” of the late ‘90s went
bankrupt; others have been severely milked by two or more successive, private
equity owners. The publicized, economies-of-scale, cost savings have been more
than offset by: the costs of
bureaucracy; the deterioration in local service effectiveness; and, perhaps, the
unconscious loss of most profitable, local customers while pursuing big-volume,
contract-price ones that are profitless even with growth rebates factored in. Volume is vanity, profit is sanity.
effectiveness of the local profit center manager at roll-ups has dropped as
either cashed-out owners were left in place to relax; or, new, shorter-tenure
branch managers have focused on the new, make-the-numbers-to-serve-the-debt
culture and please the hierarchy instead of reinventing local, service-value
creation and retaining most profitable accounts at a greater rate. Is there a
consolidator that has gotten both sustainable cost economies AND upgraded the economic
effectiveness of the local service cultures that they have bought? There is a shortage of “and/both” new-way,
chains can all do reverse auctions with the factories for swing tonnage, but
the extra concessions haven’t offset the new other inefficiencies. And, “better
buying” can lead to chain-wide promotions of most back-end-profitable products,
which again distracts from focusing on creating local service value for the
best customers in the best customer segments that are peculiar to each branch. In mature markets, winning share of best
customers with best total value solutions (that may include some most
profitable products) beats pushing products to any and all accounts.
roll-ups have generally continued to capture market share volume (to win those
growth rebates!) two ways: a) through acquisitions of independents (“Indies”), who
increasingly feel they can’t compete and sell out, and b) winning regional/national
contract bids using special pricing agreements (aka: SPAs; contract pricing; credit-debit
accounts, etc.) But, what if the chains
are winning profitless, big bids while losing local share of each “customer
segment profit pool”?
offset all of the special pricing deals, manufacturers of commodities have
continued to artificially hike “list prices” to ridiculous levels which then
serve as advertisements to seek a special price. Every downstream buyer knows
that there is always a better discount price, so everyone becomes a more
aggressive, thorough price-shopper, and the number and volume of contracts with
back end rebate activity has grown rapidly.
back end rebate activity has grown into a business by itself. The costs of
- the manual rebate paperwork process; auditing for distribution cheating; not
getting rightfully earned rebates; and negotiations over year-end differences
of opinions - are collectively big and growing. Turning the dysfunctional, rebate problem into a core competency,
most chains have created special departments for: soliciting contract pricing;
processing rebates; and negotiating year-end rebate discrepancies. Indies can’t deal with these new costs which encourages
them to sell out, which, in turn, reinforces problems 1 – 3 above into a vicious
cycle. If both growth and contract
rebates stimulate perverse behaviors that in turn fuel consolidation and no
primary demand for the products, what can factories do to level the playing
field for strategically-effective contract pricing through all distributors
regardless of size?
of the surviving “Indies” have not been innovating
past these problems. Many continue, instead, to compete with the traditional, full-service,
distribution model that includes the costs for: outside sales reps; inside
sales reps to take orders; people to pick, pack and deliver goods; and trade
credit for all. Because people costs continue to rise without offsetting personnel
productivity, an increasing number of full-service accounts cost more to
serve than they pay in margin dollars. Indies that have not segmented
customers by segment and strata to re-serve and re-price/term them differently
(like banks and casinos do) will discover from activity-based-costing studies
of customer profitability that about 70 to 90% of their active account base will
be anywhere from mildly to large profit losers. Over-serving small, growing nowhere accounts at a loss may be the
single biggest reason that - across all independent distribution channels - the
“average distributor” in any channel does not make a pre-tax return on assets
equal to its cost of capital. Many, in fact, borrow money at a rate that
exceeds their internal return on the debt for a negative leverage effect.
competitors like Grainger, Fastenal, MSC Industrial, and Lowes/Home Depot have steadily
added the best moving items found in many different, full-service specialty channels.
By stripping out most of the people-service costs, selling at higher margins
and outsourcing trade credit to the credit card companies the “alternate channels” have grown faster and more profitably serving
all of the full-service distributors’ active accounts for spot, downtime-is-money
buys when a customer is within a convenient drive time of a store.
Indies in many channels have also been losing MRO business sold to local
manufacturers as the production has moved to Asia
or closed. Factories that are divisions of national companies have trended
toward awarding multi-plant contracts to the consolidators with national
distribution footprints and better contract-pricing management. This category
of lost sales is yet another spur for Indies
to sell out, which fuels the consolidation story started back in point #3
10. In an
effort to buy better, most Indies, in a number of channels, have joined buying
groups or co-ops that offer group purchasing power with suppliers as well as
sourcing and marketing lower-priced, higher-margin, private-label lines
increasingly from Asia against the wishes of domestic factory “partners”.
11. The race
to outsource private-label goods from China was, however, a one-time,
ten-year, cost-arbitrage game that has run its course. The initial “high-margins”
have been competed away leaving all distributors with two, redundant lines –
brand names and private labels – both typically made in Asia
with little to no profit left in them. Because the Asian clone products sell
for every-day, much lower prices, the brand name suppliers’ list prices stimulate
requests for contract pricing deals, and suppliers have been rapidly reducing channel
support programs. Brand name producers
must either restructure to be every-day-lower-price competitive, or
meaningfully reinvent product categories or supply chain economics that wrap
12. As the Asian
import game has matured, the local distribution center (DC) that is plugged
into the best total supply chain with mixed container hubs in Asia and master distribution center (MDC) hubs with
the highest volume flow-through into the most frequently scheduled pool lane
truck deliveries in the US will beat competitors. Buying containers less
frequently on a direct basis may have lower factory prices, but the hidden
costs of uneven, local inventory on items within a line are greater. The
ultimate priorities at the local DC should be in descending order: highest
everyday fill-rates; best turn-earn; and then lowest land cost. Best local
fill-rate economics are, in turn, a function of being able to re-order as
frequently as possible. Wal-Mart stores, for example, maintain 99% fill-rates
by replenishing all commodity items from its MDCs daily! What group of importing suppliers or distributors will figure out how
to partner to build the lowest, total-cost supply chain that will beat all of
the one-off, supply chains for single factories and importing chains?
13. In some
channels, there exist (master) wholesalers that only sell re-sellers. But, will
they be able to figure out how to reinvent/sell themselves as the cost+,
sole-supplier (MDC) solution for all A through D items as wholesalers in the grocery,
drug and hardware channels did starting in the early ‘80s? And, will Indies
still persist in trying to buy A and B items/lines direct - whenever possible -
for a better “price” (or, bigger margin percent) not realizing the hidden-cost hit
that they take for lower turn-earn and fill-rate metrics. If
Wal-Mart, Grainger, Fastenal, MSC Industrial, etc. all thrive by using internal,
two-step distribution, why can’t wholesalers and Indies
“re-configure out” this opportunity together?
14. Indies and chains do not use, for the most part, the four,
significant, supply-chain IT applications that emerged over the past 25 years:
a. Paperless, continuous
replenishment between two (MDC to dealer) or more supply chain steps which was pioneered
by Wal-Mart from ’83 to ‘88;
b. Barcode utilization throughout;
c. Quick swipe credit card readers
for counter business; and,
d. Effective e-catalog
functionality for regular customer replenishment and special-ordering of cross-docked-at-the-distributor
service items and case-quantity commodities from MDCs.
15. Why haven’t
the distribution software “solution providers” that grew up within specific
channels since the early ‘80s done a better job of incorporating these supply
chain applications? Many software firms have also been consolidated by private
equity firms that have discovered that there are dis-economies for supporting
many similar, distribution-channel software solutions for a mature, consolidating
pool of customers. The solution to too many moribund platforms is to: boost maintenance
fees significantly (to service debt) and threatened to pull the plug on all
platforms except for the chosen, next-generation unified solution. But, even
the unified platform has 25-year-old, design roots that often require the four supply
chain applications in #14 to be tacked on in sub-optimally performing ways. Here
are some comments from a few Indie clients on their next generation, unified
“Takes 20 clicks to enter one line item at the counter
(forget 4-second, $2, debit-card-swipe action at Starbucks).”
“The e-catalog is slow as molasses.”
“Any support requests are all now declared “custom
work” for big fees and slow response times.
One client did admit that he and
his fellow users had worked with the IT system/vendor for the past 25 years to
lock in an incredibly fine-tuned, old business model that can’t easily be changed
for a world in which end-users now want e-friendly, demand replenishment solutions.
SOLUTIONS FOR THESE PROBLEMS?
Here’s what 1 to 3% of Indies,
who are true perpetual innovators, are doing:
customers by A-D levels and selling them at different prices and terms to
make sure that all customers will (soon) be profitable or will leave to
lose money for a competitor (or shift to a spin-out wholetail operation;
see #3-7 below)
upgrading and repurposing the outside sales force. Rank all active
accounts by estimated profitability as well as each sales territory; do
the current math for full-service selling. What did one Indie conclude? He
had 70% more sales call capacity than accounts that could support them. He
released over 50% of his sales force to then reassign all accounts doing
$400+ in gross margin per month to the remaining, best reps who then – true
to their talent – increased sales to existing best accounts by over 20% within
six months. The bottom line increased many fold on flat sales for the
first year, and 15% sales growth the next year. The mantra was: “Downsize, upgrade, refocus, renew; take two steps
back to leap 15 forward with high profits and honest positive cash flow.”
a wholetail store location(s) from the distribution business and encouraging
all unprofitable B-D customers to go to the store if they can’t meet the
new, higher minimum (profitable) order size for full-service (with free or
fee-based delivery) from the distribution division.
- Running the wholetail operation with software-as-a-service
(SaaS; aka “on-demand software using cloud computing”). ERP software that
has been evolving rapidly since 2000 with supply-chain applications designed
in from scratch, not tacked on. This move radically reduces the complexity
of a business, lowers total cost of IT usage and delivers breakthrough, local
- Negotiating a cost+, JIT, replenishment
contract with the best wholesaler(s) (MDC) in the area to take over as
many formerly directly-bought lines as possible for both the distribution
and the wholetail operations. By fine-tuning the replenishment contract both turn-earn and fill-rate economics
figure out how to automate the process with paperless EDI transactions,
and encourage the MDC to integrate into the on-demand software platform
for the wholetail store format.
up new, standalone wholetail stores in both smaller towns and big-city
neighborhoods that are replenished daily by a MDC , because the
breakthrough, on-demand, IT solution makes them viable between the cracks
of already existing channel outlets. Recapture
the convenience-store, emergency-spot-buy action from the alternative-channel
competitors. And, sell two types of next-day, cross-docked goods from
the MDC warehouse: a) even cases of commodities at every day low prices;
and b) specialty items. Everything
in the MDC’s inventory should be virtually salable on a next-day, pick-up
how all of the solution concepts touched on in 3-7 above are starting to
work as a prototype, wholetail operation serving janitorial supply
contractors and disposable foodservice item customers.
THE CONTRACT/REBATE PROBLEM
NEEDS A CHANNEL UTILITY
The Indie can not solve the problem of winning equal-access
to the best contract pricing, especially if the goods flow through an
independent MDC replenishment partner. Two solutions for
rebate-information-flow problems already exist, for Indies
in the foodservice channel. Either of these solutions could be repurposed to
become a channel utility – most probably run by a trusted third party infomediary
– in any channel that is choking on the “ship and rebate/debit” problem. But,
such a vision solution could only happen if two or more of the bigger, commodity-selling,
contract-price-awarding manufacturers lead the way because they want to:
Have fast, strategic, precision control for
awarding contract prices;
Have real time, accurate tracking of what goods
really flow to what end-users;
Have paperless reconciliation with minimal
Level the playing field between chains and Indies to reduce the consolidation pressures in channels.
Gain a first-mover advantage against the biggest
competitor(s) that might not initially be in the consortium and then when let
in be slow to innovate with the new tool/platform.
LIVE WITH THE RIGHT (SHOCKING)
IDEAS TO GROW INTO SOLUTIONS
Most of the “solutions” above will seem radical to many,
especially those who have not been a student of what “leading edge” ideas have
been occurring in larger-volume and/or more progressive distribution channels.
If we don’t have the vocabulary and building block concepts to see and
understand new business models, then they don’t seem, at first, possible. If
we, on the other hand, don’t change, but try harder at the past, what is our
future given all of the trends above?
If we start to ask and live with the right questions, we may
grow into them; e.g.:
our particular channel have a lot of structural, consolidation problems
starting with profitability and contract-pricing rebates?
alternate channels eating into traditional-channel volume?
manufacturers find it increasingly difficult to push new, niche items through
can we redefine these problems in a bigger context and see if there are
successful supply chain applications for these problems already in existence in
other distribution channels?
e. Is it possible to do field trips to “living
edge” prototype businesses?
What are cheap experiments that we might try?
can I learn more about the solution ideas in this article?
I forward this article to key channel managers at my biggest suppliers as well
as to other members of my buying group or Co-op to start a conversation about
dysfunctional channel practices?
Do my fellow users of now-rolled-up software solutions
share my concerns about coercive tactics to push me into a new upgrade? Are
there SaaS solutions for wholesale distributors?
Should I feel free to contact Bruce Merrifield about any of
this article’s content at firstname.lastname@example.org?
©Merrifield Consulting Group, Inc., Article 2.28, June, 2008