Progressive Distributor - Do the two-step

Do the two-step

Now might be the time for industrial distributors to look more seriously at master wholesalers to help them buy better, manage inventory smarter

by Samuel Shapiro

Market consolidation continues to drive change in the industrial sector. Today, manufacturers find themselves with a handful of large distributors that account for the majority of their business and thousands of relatively small accounts that make up the rest. We are all familiar with the old 80/20 rule — 20 percent of the customers represent 80 percent of the business. That is no longer true in the industrial market. Today, for most manufacturers, fewer than 20 percent of the distributors represent more than 90 percent of the business.

The number of distributors that a manufacturer sells through depends on the nature of the product. Companies that sell products across segments, such as tools and safety supplies, sell through thousands of distributors. Manufacturers of specialty controls, hydraulics, abrasives, cutting tools, pneumatics or other categories may have several hundred to 1,000 or 2,000 distributors. In either case, if you are a distributor on the low end of the volume scale, get ready to buy from a wholesaler.

Think from the manufacturer’s perspective. They may have 100 or 200 distributors that represent 90 percent or more of their business. Plus, there may be thousands more that, unfortunately, manufacturers have neither the time nor resources to pay attention to. Electronic Partner Relationship Management (PRM) systems won’t solve the problem. It is these small distributors that manufacturers are looking to get off of their books. Managers need ways to cut costs, and the low-hanging fruit are the small accounts that management believes costs them money.

Manufacturers tend to pay attention to distributors that buy at least $250K annually. Buy more than $1 million from them and you clearly have their attention. Generally, distributors that buy $50,000 or less should get ready to be transitioned to wholesale. If you buy between $50,000 to $250,000, you are on the bubble.

Where are the wholesalers?
In many industries, a wholesale or master distribution channel exists to serve small dealers and distributors. Lumber wholesalers serve lumberyards, candy wholesalers serve convenience stores, computer wholesalers serve value-added resellers (VARs), tire wholesalers serve tire dealers. In the industrial market, a handful of distributors such as Oklahoma Rig or Production Tool Supply developed a business model designed to serve small distributors (see “A n old model revisited"). Buying groups also serve this function.

The largest distributors in the industrial marketplace, such as Grainger, MSC, Ferguson and others, have dedicated wholesale operations to serve their branches.

These trends are forcing distributors to reevaluate the way they do business. Large distributors should consider setting up wholesale divisions to serve small distributors. Don’t even think about serving small dealers with the same business model as end-users — it’s a 10 percent to 15 percent margin game instead of 15 percent to 25 percent.

Real men buy indirect
Small distributors need to get out of the “real men only buy direct mindset.” These distributors need to join a buying group or buy from wholesalers and then reconfigure their business. Let the wholesaler hold the inventory. It is the small distributor’s job to satisfy the end-user with solutions and support. Get rid of half or more of your warehouse space. Train your people. Make sure you know more about your customer’s needs than they do. You will no longer be paid for your inventory holding and large-volume purchasing capability. That is the job of a handful of inventory specialists, wholesalers that have or will emerge to fit this space.

Small distributors must get ready to work on lower margins. The manufacturer will sell to wholesalers that need margin dollars to cover their costs. Those margin points will come out of the small distributor’s hide. The small distributor will have to work on a 10 percent to 20 percent cost structure and buy from the wholesaler in order to compete. In effect, these small distributors will have to look a lot more like reps and less like distributors.

Industrial market manufacturers must learn how to deal with two-step distribution. They must realize that the pricing spread between the wholesale channel and the direct distributor channel must enable the wholesaler to make money, keep the indirect distributor competitive and make sure that the direct distributor stays direct. If these systems are not managed properly, they lead to product brokering and brand value erosion.

There are distributors out there who have made their careers by buying right and selling cheap. These brokers take advantage of manufacturer volume discounts and incentives and spread product around the market to both distributors and end-users. This is not the kind of wholesaling that we are talking about. We are talking about structured wholesale distribution with resources and support capabilities designed to serve small distributors.

Structured wholesale distribution provides inventory support, account management, marketing programs, same or next-day delivery service. Brokers beware. In order to make this work, manufacturers must clean up the special deals that make brokering possible. For some distributors, this will result in a significant price increase.

Manufacturers must also realize that distributors that buy from wholesalers can be as or more important than distributors that buy direct. These small distributors can do a great job selling new or highly technical products and services, whereas many direct-buying distributors may only purchase large quantities because they redistribute small volumes of fast-moving product to each of their branches. Manufacturers can still maintain direct relationships with small distributors even though product may flow through a third party. It is time to uncouple the logistics and support functions in the market to enable these dynamics to occur.

Add steps to subtract costs
A year ago, the business world was abuzz with Internet opportunities to revolutionize the ways companies go to market. Often, these opportunities were based on taking steps out of the supply chain to lower costs. After all, why does a manufacturer need distribution when it can sell direct over the Internet at considerably lower costs?

What we all realized was that the Internet is not a complete go-to- market solution. Even with the best Web site in the world, companies still need physical distribution, sales support, services and other supply chain functions. We learned that the Internet does not revolutionize a manufacturer’s go-to-market strategy but rather offers incremental benefits as the technology is applied to communication and transactional functions.

Instead of taking steps out of the supply chain through the Internet or any other means, industrial manufacturers will increasingly add a step to the supply chain — wholesale distribution. It seems counterintuitive doesn’t it? How could adding steps to the supply chain lower costs? In fact, for many manufacturers, adding steps to the supply chain is exactly what they need to do to both lower costs and increase sales. Distributors should get ready for this change either by leveraging their inventory support capabilities to serve small distributors or, for small distributors, by taking these costs out of their business.

Click here to read the sidebar, "An old model revisited."

Samuel Shapiro is a principal with Frank Lynn & Associates, the Chicago-based channel strategies consulting firm. He can be reached by phone at (312) 558-4821 or via e-mail at shap@franklynn.com.