September 6, 2006,
Distribution Channel Commentary (DCC) # 89
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TOPICS:
1.
WELCOME BACK
TO WORK; WHAT HAPPENED WHILE WE WERE GONE?
2.
PRIVATE
EQUITY FUNDS STILL SUPPORT VALUATIONS; THERMO-FISHER.
3.
“PIMP MY CAR
(FORD)”; BUSINESS MODEL REINVENTION TIME?
4.
CREATE AN
INNOVATIVE CULTURE FIRST, THEN INNOVATE.
- WELCOME BACK TO WORK; WHAT HAPPENED
WHILE WE WERE GONE?
Labor Day has passed, our work resumes (along with occasional
DCCs). If we have a calendar, fiscal
year-end, we only have three months – subtracting out time for the Nov-Dec
holidays – to make our numbers and plan for next year. Although running our
business by the numbers has many drawbacks, too few of us have moved to some
more effective set of “balanced scorecards” and rewards along with tuning our
work environments to support more real, value innovation. It’s a struggle to
move from short-termitis to being more proactive about the longer view.
Since my last DCC on 5-10-06, I keep hearing and reading
more about financial engineering to make the numbers that beat last year’s for
bonus bucks than I do about innovation for sustainable, better-than-industry
results. As you skim through the random, what-happened-over-the-summer points
below, think about how to better balance financial concerns with innovation
ones.
First, if you want to catch up on the numbers for
the top 65 publicly traded distribution companies, plus all of the
announcements that they made in July and August, you should at least skim
through the comprehensive September newsletter put out by Starshak and
Welnhofer at this link: http://swandco.com/distnews/Distribution_News_September_2006.pdf.
This is a recently new, free e-offering and well worth
reviewing. If you would like to receive this newsletter for free, you can email
them to have your name put on their list. S&H is the only firm that I know
of that has made such a focused effort on providing financial advice to companies
in the “distribution space”. If you need advice on: valuing and selling a
distribution business or blocks of stock within; raising equity capital; etc.
consider them. And, I get no kick-back for this endorsement! They are just
sincere, nice, competent people.
BTW, according to S&H’s newsletters, the reported
profits for the first two quarters of this year for big publicly trade
distributors were generally great. Now that the housing bubble is starting to
unravel, we will have to see how those channels that are strongly dependent
upon commodities that go into housing will do going forward.
What’s your view on
housing? Soft or hard landing? If hard, can the US and global economy continue to
grow through it? Here are some macro numbers to consider: the US economy is 25% of the global economy, the
consumer is 70% of the US
economy. Virtually all of the net worth of the bottom 80% of US households is
in the value of their homes. Consumers had negative savings the past two years
as they cashed out over $1T in house equity value and spent it, partially
because their wages did not keep up with inflation or health care costs. High
gas prices are another tax on US households. The global economy, on the other
hand, has lots of momentum, so we will see. But, rain or shine, why depend just
on the economic tides of our industry, why not innovate right through and above
specific industry conditions? Who wants to be like and perform like the herd?
Let’s do better and have more fun doing it!
Second random point: BP shut down a big oil pipeline
from Alaska’s North slope. Management was “very disappointed” to find
out that some parts of the pipeline were 80% corroded, because there had been no
preventative inspection going since 1992. If you aren’t under any legal
obligation to do the prevention work and you have to make your numbers, why
invest in long-term solutions when you can wait for a crisis management opportunity
instead?
Third, an article in USA Today (8-4-06; http://www.usatoday.com/news/washington/2006-08-02-deficit-usat_x.htm)
entitled, “What’s the real federal deficit?” points out that the federal
government has two sets of books, but actually needs three. The set used for reporting
to the voters says that the 2005 deficit was $318B. The actual audited
statements report a deficit of $760B. But, if social program liabilities were
included on a net present value estimate the deficit would have been $3.5
trillion (over 25% of last year’s total GDP). If the long-term
costs for the 18,000 soldiers wounded in Iraq were included, it would be
even higher. Do you think we voters will be able to keep the republic that are
founding fathers gave us in 1787? Is your company really investing in the
innovations necessary to keep your company from having a crisis somewhere down
the road?
Fourth, a number of clients from different channels
have inquired about whether “now” is the peak for distribution company
valuations due to the multiples being announced for deals in a number of different
channels. Some bigger deals that come to mind are: Home Depot’s acquisitions in
several channels; Boeing buying Aviall; Fisher Scientific merging into Thermo
Electron (see topic #2); Richard Worthy leaving one consolidator in the
electrical distribution channel (Sonepar) to start a new one called US
Electrical; etc. The short answer, IMHO, is that as long as the private
equity fund-raising bubble lasts, high multiples will persist.
- PRIVATE EQUITY FUNDS STILL SUPPORT
VALUATIONS; THERMO-FISHER.
Last May I had a client inquire about what I thought the
implications might be for the lab supply channel from the announced merger
agreement between Fisher Scientific (FSH) and Thermo Electron Corp (TMO). From
the narrow to the more general, there are a number of questions that we might
ask ourselves if we are in any channel that is experiencing similar, on-going,
financial consolidation activity:
a) Initial
statements by management: “the Thermo Fisher Scientific (new name) merger
is all about growth and long-term shareholder value: $200MM in synergies; 18%
accretive to earnings; 20% compounded annual growth in earnings per share over
three years; by combining our
capabilities, the new company will be uniquely positioned to provide
integrated, end-to-end technical solutions.” Analysts’ initial advice:
quick, all of you other channel players, sell out to some other,
mines-to-market, total solution roll up; our M&A department will help you
for a fee. Questions: What are the
assumptions that management is
making about big end-users? Will these users continue to buy ever more from
ever few suppliers regardless of whether the locally-provided, total-service-value
proposition continues to improve or deteriorate? Why do trees that are
extrapolated to grow to the sky never get there? Why are companies with the
best organic growth outsourcing activities not buying in new ones like
Fisher? Isn’t merging manufacturing divisions with distribution ones moving
backwards towards Henry Ford’s original mines-to-markets total supply chain
integration? Can two huge, consolidated entities merge together and really
manage it all better? I’ve seen astute private equity firms consolidate
distribution companies in a given channel effectively. But, the size of the
deals were small, relative to the well-run and managed platform business, and
the deals were in the same basic business. How does this Fisher/Thermo deal really
smell?
b) In
the smell-test department, the investigative press did quickly find out
that the Fisher board awarded themselves $3MM worth of options the day before
the merger was announced (eight people x $380K each). Maybe they will make even
more if they hang on to their options for the value improvement ride that they
are projecting for the rest of the shareholders. The Fisher Chairman, Paul
Montrone, did not disclose any new options, but his were already worth $240MM
based on the closing price after the announcement, and he was leaving the
company to pursue other activities. I wonder if this would allow him to immediately
vest in all options and not be subject to insider seller scrutiny? The
Vice-Chair, Paul Meister, apparently didn’t feel as flush with options already
worth $163MM, so he was one of the eight. And, with Montrone stepping aside, he
gets to be Chairman of the combined company. I wonder if he will get a raise
with more options for his new, bigger responsibilities? What about the poor, non-employee
members of the board? No fears there. They will be eligible for a retirement
plan equal to 50% of their current fee of $60K. Nice work if you can get it. But,
the clincher was that all of these board awards were “a coincidence and not
related to the Thermo merger” according to a company spokesperson. If the board
didn’t know about the deal a day before the deal announcement, I wonder what
they did talk about that day?
c) In
the track record department, Fisher was bought by the private equity firm,
Thomas Lee, back in Sept. ’97 for a white knight price of $48.25. Thomas Lee then
did some rolling up; they bought and then spun off the troubled PSS World
Medical when all of “upside potential” didn’t materialize. In August, 2004,
Fisher merged with Apogent Technologies which was a consolidator of lab
products manufacturing companies. That deal was promised to deliver great,
supply chain synergies, but earnings for the combined giant have only been mediocre
so far. This is not unusual. Multiple studies have proven that most big mergers
fail to deliver on synergies, but they always deliver for the top managers and
the boards.
d) In
the conclusions department, I would expect:
·
More of the same financial results for Thermo
Fisher as Fisher produced since ’97, at best.
They just have too much size and variety in the merger pool to manage.
Roll-ups that get too big, too fast just don’t do that well. And, when
suppliers merge with distributors, all of the other channel suppliers and
distributors retaliate in many ways causing channel conflict drags for the
integrated company. I have never seen a vertical integration in a channel,
especially involving lots of moving parts, suppliers, SKUs, distributors and/or
end-users, work well. Can you think of any that have worked?
·
These types of consolidations hurt the
existing business models for dues-based
trade associations and new-installs-based
software firms that work specific channels. These consolidations are good
news, however, for SAP and Oracle’s “wholesale distribution” ERP products,
because the huge, especially public, consolidators have to report their numbers
on a more timely and accurate basis or management is liable under
Sarbanes-Oxley. This problem is compounded by the growth in rebates of all
kinds, which causes final earnings to always be under a cloud. The bigs need
one big, database platform system from some vendor that looks like it will be
around for awhile; this leaves only two ERP vendors that I can see.
·
While consolidators may find some “economies of
scale” in buying health insurance and holding some suppliers up for special
prices, there is most often a deterioration in local, flexible service value
capability. If I were a well-run, innovative local or regional distributor,
I would hope that my best competitor would be bought out by a consolidator,
because within one to two years I would be stealing their best accounts.
·
And, imagine what might happen if suppliers that
aren’t owned by an integrated consolidator and independent distributors could solve the “special price, billback”
problem in their channel with a “channel utility solution”, then power
would go back to the suppliers, the end-users and the best, local, innovative
service providers that the end-user would like to choose over the stagnate
giants. More on this in topic #3.
·
This whole consolidation game will continue as long
as ever-greater amounts of money roll into private equity funds. This bubble
phenomenon is still running, for more on this try the research experiment
below.
·
Go to google.com, click on “news”, then in the
search box type “private equity funds” and start to skim through the newspaper
articles that have touched on this topic in chronological order from the most
recent posting. You will find interesting stats like: the US private
equity industry, which operates today on an international basis, amounted to 157
funds with $4.4B to invest in 1980 employing roughly 1500 professionals. There
are today over 2900 funds with about 15,500 people with a call on $722B which
they typically leverage another two times. The current new fund raising rate is
on pace to smash last year’s all time record.
·
Until the private equity bubble pops – perhaps
with a recession and a stock market decline – the excess supply of money for
too few good acquisitions should keep a floor under currently high
valuations for companies that might want to sell to either a strategic or
financial buyer.
- “PIMP MY CAR (FORD)”; BUSINESS MODEL
REINVENTION TIME?
As I go to press with this DCC, I see in this morning’s
(9-6) news that Bill Ford has fired himself from being CEO of Ford and brought
in a guy from Boeing just three days after the news reported Mr. Ford’s memo to
his 300,000 employees that the company needed a “new business model”. I think
Ford Motor needs a lot more than just a new business model, it may need about 7
or 8 types of innovations out of “Doblin’s 10” (?) in Ford’s total solution.
“DOBLIN’S TEN TYPES OF INNOVATIONS”
“Innovation management”(IM) needs to change at most
companies in mature industries from an incremental, reactive, accidental art to
a systematic, more ambitious science. One of the thought leaders on IM is Larry
Keeley, the co-founder of Doblin which is based in Chicago. I recently went through one of
Larry’s slide show presentations that he gave in June in which he elaborated on
Doblin’s ten types of innovation. To review Doblin’s 10 types of innovation –
one of which is “business model” – go to this link: http://www.doblin.com/IdeasIndexFlashFS.htm
Doblin has reviewed many successful corporate breakthroughs
and checked off how many of the ten innovations were rolled into the
breakthrough solution. For example, Dell’s total proposition was made possible
by innovating in 7 of the 10 categories; the Apple iPod in 7; and Starbuck’s in
8 out of 10. Makes me think Ford needs about 7 or 8 out of ten including: the
family giving up voting control of the company and perhaps a trip through
bankruptcy – sooner rather than later – to get out of ruinous contracts with unions,
suppliers and dealers backed by tough franchise laws in every state.
What was compelling to me in Larry’s latest slide show regarding
the 10 innovations was the correlation of types of innovations with returns. More
than half of all innovations efforts involved changing at least two of the ten innovation categories – “product
performance” and “product systems” – yet all of these efforts produced
negligible returns. “Less than 2% of all total innovation
efforts produced over 90% of the value”, and those efforts starred the three least used innovation levers –
“business model, networking and customer experience”.
So what should we be planning for 2007? If we want to outperform
our industry averages, we can’t push the same old innovation (product?) levers
harder. We have to rethink our “business model” by rethinking how we “network”
with our channel partners on supply chain cost reduction and value creation
solutions to boost the value “experience” of the few accounts per distribution
location that really matter .
·
Manufacturers figure out how to get out of
the less than truckload distribution activity business; distributors buy
those items that turn less than 12 times a year from master
wholesale functionaries on a
vendor managed inventory basis, because you can’t forecast demand accurately
past 2 to 4 weeks without having both excess stock and lower fill-rates. Why
do you think Wal-Mart runs all big volume items through their DCs and not
directly to the stores, it has to do with turns, earns and fill-rate
economics. And, while we’re on supply chain ideas, how might special
price/billback deals work through master distribution facilities? (See the last
section below)
·
All channel parties need to segment customers by
size and net-present-value profitability in order to raise prices and terms for
moribund losers in order to super-focus on the 5% of all customers that will
generate 80% of the future profit growth. Weed to feed; prune to grow; we must
free up resources from losing elements of the business to reinvest them into
innovative opportunities within the best parts of our business. And, most
distributors are lucky if they can sell two out of the four modes of channel
selling – outside sales, telemarketing, catalog, and cash-n-carry/wholetail. If
you are (unconsciously) active in three of four of these segments, pick your
best two and harvest the others.
·
In channels where distributors originally went
to market with outside sales people pushing products, think about reducing your
sales force to half its size to focus on the 10% of accounts that have economics
that can still support outside selling. Then, change the reps role and skill
sets to being demand-replenishment systems consultants first and reactive
product pushers second. This all assumes that close to 90% of today’s sales are
on commodity products to large, repeat customers that are under pressure to buy
all of their stuff at the lowest total procurement cost. If you have, however,
exclusive, profitable, manufacturing franchises, by all means push products the
way the supplier wants.
·
If all of these ideas seem sketchy, confusing
and scary, remember that whatever you
do proactively in 2007 will provide negligible returns at best if it seems
tried-and-true and not scary. Running with the industry herd and making lost of
small, reactive, incremental, me-too adaptations to how you do things is
necessary for survival, but it won’t create any sustainable, industry-beating, value
returns for you. If you want more elaboration on how some or all of
these ideas might apply to you, I’d be happy to visit with you starting with an
initial, “free bite of the apple” phone call.
SPECIAL PRICING/BILLBACK
“CANCER”
Every channel that has commodity
products sold through independent intermediaries has a paperwork reconciliation problem with
awarding special prices to some end-users that involve the intermediary
fulfilling orders at losses and then billing the manufacturer back for the loss
plus some fulfillment margin. In different channels, the terminology varies,
but the process is similar. In both the PC and electrical distribution
channels, the problem has been described as a growing, out-of-control,
consuming “cancer”. That sounds serious.
Some of the remedies for symptom
relief are:
·
Progressive distributors and/or their software
vendors have developed in-house “ship-and-debit” software solutions to track
all of the billback rebates.
·
A third party web service provider, Trackmax at
Trackmax.com, has provided big relief for many foodservice distributors and now
a handful of industrial paper/jan-san distributors.
·
Some vendors work with larger intermediaries to
do one-off paper automation solutions involving EDI transaction sets for
rebates (844, 849). IBM and Tech Data, for example, have done this in the PC
channel.
·
In all channels, there is a cry from intermediaries
to stop the special pricing combined with artificially high standard pricing
and go to everyday low prices.
But, how often does the following scenario happen? An
independent, local distributor has a good-buddy, local, big account that consumes
enough commodity products to deserve special price(s). But, the small
distributor can’t get access to the same low special prices that a big chain can
even after the independent joins a buying group. The local account is forced to
buy the better pricing from the chain even though they prefer the local guy’s
service and want to keep the business locally. The chain keeps growing its
volume organically, at least on price-sensitive bids and through acquisitions, which
enables the chain to keep threatening suppliers with switching big volume to
the other vendors or Asian-made private labels unless they get extra, special
pricing. The independent figures its time to sell out, and the cycle repeats.
The only winner in this scenario is the consolidating chain.
What if a group of manufacturers formed a “utility” which
would allow:
·
Any distributor to bird-dog and submit a special
price account situation through the utility (a bottom-up process).
·
A supplier could quickly review and award
special pricing to the best-fitting end-users AND NOT JUST TO THE initiating
distributor. The end-user could get multiple bids on contracts from competing
distributors. But, all distributors would have access to the same special
price. The end-user then gets to buy from whatever supplier they choose.
·
Rebates could only be awarded if the winning
distributor enters all special pricing billing activity by account and affected
SKUs through the utility. This would allow suppliers to track, real-time their special-priced,
product flow through specific distributors to specific end-users involving
special prices.
·
Suppliers would then integrate their legacy
system into one central utility to be able to pay rebates quickly, accurately in
a paperless manner.
·
I could go on, but this will hopefully get you
thinking. In a world with too much supply of equally, excellent commodity
products, special pricing for the right, strategic end-users isn’t going away.
Automating different patches of the supply chains pain for ship-and-debit
activity isn’t a total solution, nor does it solve the dysfunctional aspects of
forcing distribution channels to consolidate. Who would like to re-empower the
manufacturers, the right end-users and whomever their best local supply
distributor might be? Call me to discuss this further.
- CREATE AN INNOVATIVE CULTURE FIRST,
THEN INNOVATE.
I have written four articles on “innovation management” (www.merrifield.com, articles #ed 1.11
through 1.14) and have done some experimental, slide show presentations on the
topic. But, truth be told, a company can’t take IM to the next level if the
company doesn’t first move towards having an “innovative culture” which is, for
most, another, what-does-that-mean phrase.
What are some specific ideas and practices that we can think
about and experiment with to start moving towards a more innovative company
environment? Here are a few:
a) How can we first rethink measurement systems and rewards
to be more “balanced” instead of over-weighting “management by financial
numbers”? We have to overcome the concern that proactive, innovative activity
will be “expensed” today to the detriment of the current profits in order to
make lots more profits in the years to come.
b) To do any proactive activity, we have to first free up resources
– time, talent, and treasure – to invest in longer-term innovative ideas. But,
most firms are so lean and mean that employees are “too busy” triaging
yesterday’s operational necessities. So, we must get really excited about how
we want to do what we do best, even better to build the courage to then weed
what we do poorly and unprofitably in order to redirect corporate resources.
c) When we do new stuff, there are no best practices and
roadmap to copy – at least for our specific type of business – we must blaze
our own trail to the new world we imagine. This means “failing forward” or
making, fast, prototypical steps that create good, learning mistakes. We want
to maximize learning and progress for the lowest, tuitional cost. The costs go
up with the size of the projects, so CEOs should be making the biggest, most
expensive, “good mistakes”, admitting them and sharing what has been learned.
It comes with the position and is a sometimes difficult ego challenge.
d) Ideas must come from combining known solutions from other
industries (e.g. other distribution channels) for common problems. In other
words, having roundtable sessions with non-competing executives in the same
industry is interesting, but not sufficient for breakthrough ideas that will
outperform the industry.
e) To get evermore employee participation in one or more of
the steps in the innovation pipeline process, we have to give people
encouragement and recognition for: not rushing to answers, but living the
questions for awhile; not criticizing others’ new ideas, but for at least
letting them live for a bit if not building on them; and not being scared of
making “good mistakes” when failing forward. It would also help, going forward,
to try to hire more courageous, inquisitive, personally changing and growing
people.
I could go on. If you are interested in thinking more about
changing your company’s environment to make it more supportive of innovative
efforts, here are some things to read:
A case story article on how Quill Corporation (a mail-order,
catalog distributor; division of Staples) did its innovative journey at this
link:
http://www.innovationtools.com/Articles/EnterpriseDetails.asp?a=197
Some of my own stuff on “pushing the wheel of learning” and
“making good mistakes” at: http://www.merrifield.com/exhibits/Make_Lots_of_Good_Cheap_Mistakes.pdf
Steps to breakthrough results:
http://www.merrifield.com/exhibits/Ex39.pdf
Thoughts on waking up our corporate luck:
http://www.merrifield.com/exhibits/Ex41Luck.pdf
That’s all for this effort. Happy innovating!
Bruce
bruce@merrifield.com
919/933-7474
