Friday, June 24, 2016

The Future of Distribution: Q&A with Frank Hurtte

Looking ahead in Distribution

Perhaps it’s the economy, maybe it’s the weather, could be a coincidence, but a lot of folks are wondering what the future might hold for distributors. Just to give you a flavor, during the past couple of weeks I have heard the term “disintermediation” used as a looming threat from some credible sources.

The following are a number of questions forwarded to me for commentary by a writer for Electrical Wholesaling. These will be combined with the expert opinion of others in the distribution industry and published sometime in the coming months. I will share a link to the complete article when it is available, but in the meantime, here are some of my comments.

Question:
Looking ahead 5 years in the electrical distribution world, some estimate fewer than 200 distributors will exist. What are your thoughts?

First, I believe the distributor model will change. The “safe” size for a “garden variety” electrical distributor has grown much since my first introduction back in the late 70s and it continues to accelerate. Looking back, in the 70s a sub-$10M electrical distributor was quite viable, by the mid-90s the number had grown to about $20M, today the number is probably $50M but in five years anything less than $100M will feel the pressure.

Let me make a point, I don’t see small distributors dropping like flies. Instead, I see an increasing number of “baby-boomer vintage” owners running out of steam and realizing the business probably can’t be passed along without severely inhibiting the operating capitol.

Further, I see a lot of distributors with business models that have morphed into something outside the normal value-add product model. They have added engineering, fee based-services and have also imbedded themselves into their customer’s process in a way which builds their importance to both customers and manufacturers. Their model crosses over the line into what used to be viewed as the duties of manufacturer’s reps and systems integrators.

Back to the question, I believe consolidation will continue. But, I believe the 200 number is pretty low. Over the next five years, I see the number shrinking but something like 25-30%.


Question:
How will the independent distributor survive as it competes against its larger national rivals, many of whom have national contracts? Do you predict a sharp increase in M&A Activity?

First, there will be a sharp increase in M&A activity. For instance, in the past six or eight months there has been a lot of activity in the Rockwell Automation channel. I see more of this into the future, along with the issues I have already outlined.

Along the M&A activity line, I see many distributors in Automation side of the electrical business who are approaching retirement age without strong succession plans. Revisiting the old adage, “you can’t take it with you.” In the next few years, a lot of these owners will face the need to do something. The bigger and aggressively mid-sized distributors in the acquisition mode offer up an exit strategy which may be easier than a succession strategy.

Competing against much larger distributors will require a shift in business model. If a small distributor goes head-to-head with a larger competitor on product availability, price or e-commerce capability they will lose – period. However in the past, larger companies struggle to provide a customized set of services to closely match customer needs. This is particularly true in highly technical areas. I don’t see technology getting easier anytime soon, instead I see technology growing more pervasive.

Finally, some of the smaller distributors will be propped up by manufacturers because the larger guys do a sloppy job of introducing new products. Regardless of all the hoopla, the story from distributor supply partners has remained constant. The larger guys prefer to service the demand for products rather than assist in creating market demand by finding applications for new products or discovering innovative applications for existing products.

Question:
Some “traditional” industrial distributors are trending towards buying companies to complement their current business. Wesco, for example, has been widely known as an electrical distributor, recently bought a safety distributor. They are now an MRO supplier/supply chain strategist. Do you see this as temporary or a growing trend?

In the future there will be very few “pure electrical” distributors. We have already see this as distributors launched into the data-com world a little more than a decade ago. Today we see electrical distributors in the safety, motion control, automation, fluid power, power transmission and the industrial market. Over the course of time, this will accelerate.

Why is this happening? First, for solutions-based distributors, customers are demanding it. They want to buy a full solution not just the electrical components. For MRO/Logistically focused distributors, the emphasis is similar; providing a larger market basket of goods to their customer base.

In the past, distributors have launched out into adjoining lines of trade only to discover that breaking into the field was more difficult than they imagined. For most the move took five years or longer. And, during this time, they struggled to justify inventory. And the product/application expertise required to be credible in the market ate into their bottom line.

Acquiring a distributor already in the space makes more since because it creates a cash flow during the ramp up years. Further, acquiring brings existing relationships with first tier supply partners which are difficult to build from scratch. Lastly, buying someone also brings along the needed expertise to support the sales efforts and drive credibility in the market.

Question:
How important will Big Data be for distributors?

Distributors will need analytics to produce maximum results into the future. In general, the group gets failing results today. Pricing systems are poorly maintained and rarely use state of the art process (like David Bauders’ Strategic Pricing Associates) to find the proper balance between pricing sensitivity and gross margin. Sales efforts are mostly poorly analyzed as most distributors still rely on time consuming manual manipulation of data.

Further, operational issues can now be pushed to “big-data” process. For instance, many distributors still manually enter customer purchase order information into their systems wasting countless hours of highly skilled workers who could be assigned to tasks with better return.


Question:
Considering Amazon Business has focused on logistics and quick delivery, do you feel distributors may overhaul their delivery systems?

First, lots of distributors in the electrical space make customized deliveries without thinking about the type of customer. For instance, they provide free delivery to customers who aren’t really profitable. Lots of times, they roll out their delivery truck for boxes that could be sent UPS for three bucks because the sales team thinks delivery on the truck costs nothing.

Secondly, very few distributors understand what their delivery system costs. Add vehicle cost, fuel cost, driver salaries to all the other variables and you can rack up dollars faster than you expect.

Finally, the local distributor’s biggest differentiator comes with delivering products which are both heavy and lower cost. Amazon might out do us on the 10 ounce sensor that costs 100 bucks, but they can’t handle the bundle of conduit that weighs 500 pounds and sells for 200 dollars. Distributors need to be smart on this. If they find themselves delivering only the heavy (and bulky stuff) without considerable quantities of the lightweight goodies, they are probably losing money.

I see progressive distributors placing a value on deliveries and sometimes charging for big stuff. I see distributors getting better at using all the options available including some of the same advanced logistics as Amazon.

Question:
How will all these changes affect the supply chain and the distributor/customer/manufacturer relationship?

We have to understand the Electrical Wholesaling industry is not a way of life, it’s a business model. As soon as manufacturers determine they can go to market more effectively and efficiently through some other model, they will shift their focus. Regardless of their commitment to distribution, loyalty and all the rest, if reaching customers works better some other way, they’ll be all over it. They have to in order to survive.

We have already seen this process in the lighting industry. With LED technology, the lighting market is changing. The lamp companies don’t necessarily need a distributor to sell something that lasts for twenty years. The replacement lamp business will come to a close in the next ten years if not the next five.

Manufacturers will be forced to demand POS data in order to better understand the flow of their products to market and who buys the stuff after it lands on the distributor’s dock. It’s a premise of modern manufacturing.

Manufactures will insist on better analytics from their distributors. In some instances, supply partners will require additional staffing in the form of product specialists, application engineers and professional marketers to drive new product/technology introductions to the market.

Question:
How does the buyer fit into all these changes? Will expectations change? The focus used to be product, price and availability. How will buyers change their patterns and what this will mean for “relationship selling?” Will relationships still matter?

Relationships – people buy from the folks they trust. Trust doesn’t necessarily belong entirely to people. For instance, I trust Hotels.com. While I am a once in a blue moon customer to the hotel, to Hotels.com, I am a constant repeat customer and am rewarded as such. I believe people trust Amazon because they rarely screw up orders and when they do they fix the issue with zero hassle. Distributors must get the service right and eliminate issues that erode trust.

Pure relationship selling still works for small contractors and other small to mid-sized privately owned companies. In this environment, a relationship with the owner/operator/manager still counts.

Trusting relationships at Fortune 1000 sized companies is fraught with danger. When the chips are down and the buyer must pick between you and keeping their job, you’re out; in a heartbeat.

For larger customers, selling will be about providing an ongoing economic advantage to the customer. This basically boils down to a few items, can the distributor:

  • eliminate people from the process? 
  • help improve productivity?
  • assist in eliminating waste?
  • drive down utility or other costs?
  • assist in meeting governmental regulations?

This is an economic sell and requires selling to different people.

In the future, upper-quartile distributors will excel at building relationships with upper management people who understand the economics of the sale. Today, very few distributors nurture this level relationship.

Question:
An electrical distributor who relies solely on the sales of electrical products may not survive. What should electrical distributors be doing to try and position themselves for growth-and survival?

Selling electrical products “only” will not kill a distributor, if they are large, they can leverage their suppliers and provide pricing which is near best in class. For small distributors, tying to electrical products “alone” is a recipe for quick financial disaster – most likely during the next major recession. For mid-size distributors, the strategy will equate to longer term stagnation. If the ownership is 50 plus, they will most likely survive till retirement; just don’t encourage the kids to get into the business.

Question:
With the blending of automation, electronics, etc. in the electrical industry, what effect do you foresee this having on the marketplace, specifically do you see new competitors or new forms of competitors on the horizon?

Will there be new competitors? You bet. For those playing in the automation space, expect lots of competitors. The automation space, especially around motion control, lies at the crossroads of fluid power, power transmission and electrical technology. We have already seen lots of conflicts in this market. More to come.

The Internet of Things (IoT) and its industrial cousin, the Industrial Internet of Things (IIoT) promises to be a boom market in the not so distant future. This attracts not only the normal cast of competitors but some biggies like Cisco and others from the IT field. I am optimistic that a few electrical distributors will be big players, but they will be fighting it out with a whole new set of competitors.

Further, the line between some distributor and systems integrator (and even contractors) is blurring. New technology players in technical spaces are turning to SI’s because they got terrible reception from the distributors they approached. In this play, the SI ties product sales to services and replaces many tasks once conducted by distributors.

Finally, there are a host of off-shore companies with plans to break into the US market. They have made the rounds of distributors and have a difficult time getting traction with established wholesalers. They get little respect because they currently don’t have the market share required to produce instant results. But, many of these organizations are big enough and powerful enough to create other alternatives. I believe some will circumvent traditional distribution and thus create new competitors in our market.

What will the future hold?
Changes lots of changes. This doesn’t cover all of the changes but it does touch on quite a few major ones. We are interested to hear from you on your prognostications for the future. What will your world look like in 2025?

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2 comments:

Anonymous said...

I find change and challenges highly overrated, however it is inevitable that we must adapt.
Thanks for the informative article.

michaljohn said...

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