Key success factors distributors must master to succeed at integrated supply.

by Richard Vurva

If distributors want to succeed at integrated supply, they must first master five key success factors, according to Jeff Baden, a consultant with Frank Lynn & Associates in Chicago.

To successfully compete for integrated supply-type business, distributors must have:

    1) Low-cost logistics

    2) The ability to project a national presence

    3) Access to large amounts of capital

    4) Information management expertise

    5) The ability to generate savings in procurement, price, inventory and productivity

Baden’s opinion is based on three large-scale research initiatives conducted by Frank Lynn & Associates with end-users, distributors and manufacturers. Baden will present the results of the latest research initiative on May 7, 2000 at the spring ASMMA/I.D.A. convention in Dallas.

In an interview with Progressive Distributor, he shared his thoughts on how Industrial Distribution Association (I.D.A.) members can succeed in integrated supply relationships.

Low-cost logistics
The typical I.D.A. member has operating costs of about 19 percent of sales. Many integrated suppliers report costs of about 10 to 12 percent of sales and some report much lower operating costs.

Why do integrated supply operations have lower operating costs than traditional industrial distributors?

There are several reasons. Primarily, as relationships mature, integrated suppliers develop historical purchase data that enable higher inventory turns and lower costs. Integrated suppliers also don’t have sales representatives prospecting for new business, plus electronic automation lowers transaction costs.

Some distributors believe it’s unfair to make a direct comparison between a traditional distribution company’s cost structure and an integrator’s operating costs. They argue that local distributors provide higher levels of technical support than integrators, which understandably raises the local distributor’s cost of doing business.

“I agree with that statement,” Baden says. “But if you look at distribution channels historically, you find that economics determines the long-term winners and the losers.”

He predicts that a new service channel will emerge that could provide the technical support that local distributors traditionally provided customers. It may emerge from distributor organizations that change from a distribution to a service model, from manufacturer rep companies, from companies that presently offer repair and maintenance services to manufacturing facilities, or from an entirely new kind of technical support company that doesn’t yet exist.

“Distributors need to think about how they can use their value-added service to compete against companies that are more efficient than they are in terms of transactions and logistics,” Baden says.

A national presence
Some distributors have developed solid reputations for their integrated supply capabilities on a regional level. The Ross-Willoughby Company in the Midwest, Dixie Industrial in the Southeast and Texas Mill Supply in the Southwest are good examples.

But an increasing number of customers, such as Cummins, General Motors and Eastman Kodak, now expect their suppliers to have the ability to provide their maintenance, repair and operations supply needs on a national level. A few customers even expect international capabilities from integrated suppliers, although their number is still small.

“The ability of distributors to handle that kind of business is partially restricted by their geographic limitations,” Baden says.

How can local distributors expand their geographic reach?

Many I.D.A. members join alliances and consortia such as Affiliated Distributors, I.D. One and iPower to expand their geographic presence. The alliance model works well when end-users value the support they receive from individual member companies. It begins to break down, however, when a customer prefers doing business with a company outside the alliance or when the member companies have difficulty coordinating their systems and activities.

Distributors such as Integra Integrated Procurement Solutions, Industrial Distribution Group and Cameron and Barkley have acquired other I.D.A. companies with an eye toward building a nationwide distribution network with integrated supply capabilities.

Another strategy is simply building additional facilities. Fairmont Supply has employed this strategy to expand its integrated supply programs. Of course, this can become expensive.

So while some distributors will likely continue to succeed at integrated supply locally and regionally, in the long term they may need a national integrated supply strategy.

Access to capital
Integrated supply business doesn’t come cheap. Any company that has responded to a customer’s request for proposal (RFP) knows it takes more than the usual amount of time and money to bid on integrated supply contracts.

“It’s not uncommon for an integrated supplier to spend $50,000 worth of time to respond through several rounds of an RFP,” Baden says.

But that is only the beginning of the investment required. Once you’ve signed a deal, there are other expenses to consider.

“You have the physical storeroom itself, so you may have to purchase shelving, fences and security cameras,” he says.

There’s the cost to hire and train people to run the storeroom, the cost to identify and count on-hand inventory, the cost to install computer hardware and software and to train people how to use those technology tools. Some customers require their integrated supplier to buy back existing inventory and hold it on consignment.

It may take weeks to sift through the customer’s inventory and data.

“While all of this is happening, the integrated supplier is not realizing a full stream of revenue, because it is burning off existing inventory in the plant,” he says.

Some integrators charge a management fee or service fee to cover up-front costs, but most integrated supply deals are still cost-plus arrangements where the integrator is paid based on a percentage of product sales.

“The point is, if you want to do integrated supply business, make sure that you have access to capital to cover the added expenses it will require,” he says.

Information management expertise
New research just completed by Frank Lynn & Associates indicates that when customers switch integrated suppliers, or when they stop doing integrated supply altogether, a major reason for the change was because the integrator was unable to adequately integrate its systems to the end-user’s systems.

To be successful, integrated suppliers must interface with a variety of enterprise resource planning systems used by customers, such as SAP, Baan, PeopleSoft and others, not to mention proprietary systems.

Integrated supply requires a higher level of information management support than what is needed in a traditional distribution business. Systems management sophistication, workflow process redesign, on-site inventory management and electronic transacting are examples of the sophisticated capabilities that integrators must build into their business model.

In addition, many customers are exploring how to utilize the Internet to further streamline their MRO acquisition processes.

For example, Dana Corporation announced its intention to utilize the Ariba B2B e-commerce platform to purchase up to $5 million of MRO supplies via the Internet. Cargill Inc. signed an agreement with J.D. Edwards and Ariba to consolidate and streamline procurement processes from requisition to payment on a global scale. The move to electronic commerce likely will have a dramatic effect on integrated supply. Distributors must have the capability to respond.

“In order to be competitive, integrated suppliers either will have to develop, acquire or be acquired by, or do a joint venture with some company that has Internet commerce capabilities,” Baden says. “Several leading-edge thinkers are pursuing this strategy. For example, supplyFORCE.com, which was created in 1999 by Affiliated Distributors, joins the integrated supply capabilities of A-D Northeast and an e-commerce functionality that is being homegrown.”

Ability to generate savings
Finally, successful integrated suppliers must be able to demonstrate savings to end-user customers in four areas: procurement, price, inventory and productivity.

1) Customers expect integrated suppliers to have a more efficient system than they do for receiving, managing, issuing and paying for MRO materials.

If you consider that 40 to 50 percent of all items purchased by customers are spot buys, one question becomes, how does the integrator do that more efficiently than the end-user?

Integrated suppliers must have the automation tools, the relationships with suppliers and the business processes to procure products more efficiently than customers can alone.

“I would argue that if you’re an integrated supplier, this ability is a core competency,” Baden says.

2) From a practical standpoint, price is probably the least important of the four areas where integrated suppliers need to demonstrate savings. From the standpoint of dealing with the politics of relationships with end-users, however, it’s often the most important. Customers expect their integrated supplier to get better pricing. In order to do so, they must standardize brands and consolidate vendors.

3) Customers expect integrated suppliers to take over inventory management responsibility, freeing the customer to focus on its core competencies. Integrated suppliers must run the storeroom, institute controls and systems for ordering supplies, and maintain the proper amount of on-hand inventory to avoid delays and back-orders, while simultaneously reducing excess inventory and waste.

4) Generating productivity savings is probably the most important long-term function of integrated suppliers, yet it has received the least amount of attention. What kind of productivity savings are customers looking for? They want their integrated supplier to show them — or bring in an expert to show them — how a new carbide cutting tool can manufacture motor shafts within a tighter tolerance, thereby reducing production reject rates. They want to know how introducing a new lubricant can extend the lifetime of a compressor, or how a new welding technique can make welders more efficient.

Still want to be an integrator?
The market is far from saturated, so there will continue to be opportunities for distributors to do integrated supply business.

Frank Lynn & Associates estimates that about 18 percent of the $45 billion in MRO product sales to large U.S. manufacturing companies flows through integrated supply agreements. A study by Texas A&M University says end-users expect to triple the number of integrated supply contracts in which they are involved within five years.

Whether I.D.A. members are currently involved in integrated supply or just getting started, they must examine their business strategy to determine if they have mastered the five factors outlined here to succeed at integrated supply.

This article originally appeared in the April 2000 ASMMA/I.D.A. spring convention issue of Progressive Distributor. Copyright 2000.

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