Merrifield Consulting Group

August 19, 2017


















TIME FOR REINVENTING THE JAN-SAN CHANNEL

Article 2.28

 

DISTRIBUTION CHANNEL ROLL-UPS: CONS AND CURES

 

Consolidating fragmented industries – like independent distributor channels – really took off in the late ‘90s when earnings growth could be:

·        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 stock market.

 

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 THE PAST

 

1.      A 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.

2.      The 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, integrative thinking!     

3.      The 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.  

4.      The 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”?

5.      To 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.   

6.      The 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?

7.      Most 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.  

8.      Alternative-channel 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.

9.      The 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 above.

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 their products.  

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.[1] 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 solutions:

·        “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:  

  1. Segmenting 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)
  2. Downsizing, 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.”
  3. Spinning-out 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.[2]  
  4. 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 service-value opportunities.
  5. 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 benefits increase.
  6. Then, 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.[3]
  7. Opening 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 basis[4].
  8. See 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.[5]

 

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 disputes;

·        Level the playing field between chains and Indies to reduce the consolidation pressures in channels.[6]

·        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.:   

a.       Does our particular channel have a lot of structural, consolidation problems starting with profitability and contract-pricing rebates?

b.      Are alternate channels eating into traditional-channel volume?

c.       Do manufacturers find it increasingly difficult to push new, niche items through the channel?

d.      How 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?

f.        What are cheap experiments that we might try?

g.       How can I learn more about the solution ideas in this article?[7]

h.       Should 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?

i.         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 bruce@merrifield.com? Yes, please!.

 

 

 

 

©Merrifield Consulting Group, Inc., Article 2.28, June, 2008



[1] For more on “fill-rate economics” see: http://www.merrifield.com/articles/ISSAFill-rate_annotated_show.pdf.

[2] “wholetail” is meant to convey a business strategy that is between full-service distribution and normal retail location models. For example, Fastenal, Grainger and MSC Industrial have stores that are in “light commercial” locations and pricing that averages somewhere between wholesale and retail.

[3] I’m working with a software solution firm that is enabling solution steps 3-5. Inquire if interested.

[4] Fastenal has moved from replenishing stores 2 to 3 times per week to daily, third-shift deliveries to virtually move all inventory in MDCs to 85% of its stores.

[5] Contact me for a tour!

[6] Dot Foods is a pure master wholesaler in the foodservice channel that accommodates all information needs for both factories and buying groups. Trackmax.com is a software-as-a-service company born in the foodservice channel that could be redeployed as a Switzerland-type, third party service for contract pricing and rebates in any physical goods channel.