March 12, 2003 - Distribution Channel Commentary (DCC) # 15 Merrifield Consulting Group

March 12, 2003 - Distribution Channel Commentary (DCC) # 15



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This past week had a lot of grim economic news with the “Iraq war uncertainty” just being a side show with no financial strategy behind it. In no particular priority order, here were a few things that caught my eye:

a.       Economists were predicting a loss of 10,000 jobs for February in the US, the total came in at 308,000. It looks like the "soft spot” in our economy that Sir Greenspan has been talking about for a few months is softer than the experts seem to be able to see. The job market’s future doesn’t look any better. Want Ads are at all time lows. The Challenger report for announced layoffs in the months to come is climbing. Lots of US manufacturers are still investing into China factory capacity at an accelerating rate that will eventually lead to more jobs there and fewer here. This would normally be an OK “creative destruction” process, but this time the scale, scope and speed of what China is doing is overwhelming our national capacity to create new jobs in spite of best effort new hires by the government’s Transportation Security Agency and the mortgage origination industry. And, those who are being laid-off have record levels of debt for their refi’d homes, plus 0-0-0 auto payments.

b.       It looks like both housing and autos are finally stalling out which might end the string of new, world records for consumer debt that US consumers have just broken again for January. Auto sales fell off a cliff in spite of higher incentives per car than ever before. For those of you in building supply channels that feed stuff into home construction and improvement, Sir Greenie stated this past week (between the lines) that: there is a housing bubble; it’s not his fault; and watching the bubble movie in reverse isn’t going to be pretty. For a best interpretation of what Greenspan was really saying and for a hint of what is to come, go to and type in this article title in quotes: “Analysis: Greenspan’s second bubble.” It was a March 4th UPI article, so you will have to go to one of the general sites that pop up and dig down to the date to find it.  

c.        The SEC has asked public companies to give investors more realistic accountings of pension liability deficits (3-6). The future announcements of earnings being down, because of pension shortfalls that expand faster than stock markets fall, will be similar to the ever expanding state deficit announcements we have been hearing over the past nine months. Of course companies don’t want to make these earnings hit announcements because it will drive the stock market down which will increase pension liabilities. 50% of all pension money is still invested in stocks. Can you see the vicious cycle brewing?

d.       The stock market is really trying to have a “post-war” rally, but the buying power for stocks has dried up. Meanwhile, Japan’s market hit a 20-year low 12 years after the peak of their stock market bubble high. These bear markets can last a long time if the government tries to pump money supply, lower interest rates and deficit spend enormously as Japan has done and the US currently is doing. All of these measures haven’t worked in Japan, and they won’t work in the US because the bubble damage was done from 1982 to the present and beyond. Borrowing to spend more and drive debt levels higher isn’t the solution. P.S.: Europe exchanges are at new 7 year lows with the German exchange off 70% from its high. This meltdown is a global event.

e.       Finally when the bombs drop, the petrodollars will go on strike and not be re-cycled into dollars and dollar-denominated US treasuries. Just for starters, Iran now wants all contracts denominated and paid for in Euros. How will we finance current and climbing federal deficits + the battle + the endless nation building in the Middle East that is to follow? 45% of treasuries are currently being bought by foreigners who may have noticed that the US dollar has already dropped 20% against the Euro in the past year. They are going to go on strike to some degree unless we offer them higher interest rates and assurances that we won’t keep debasing our currency by pumping up the money supply to keep short term interest rates in a negative return area. This war doesn’t have a financial plan that will ultimately be friendly to people around the planet who have saved, invested and directly or indirectly lent money. Your after-tax, after inflation negative returns on money market funds in a depreciating currency should already be telling you this. But, the futures markets for short-term treasuries is currently forecasting that the Fed will lower interest rates again, if not this month then in May.


Enough grim news, the good news is that 90%+ of distributors that are averaging 5% in pre-tax return on total assets aren’t making the 15%+ ROTA that the top 10% are; or, the 20%+ of the top 3% (DCC 10.1). If you happen to not be in the top 3% and envy their numbers, then you can choose to stop doing what you have been doing harder and try some high performance management ideas. Two quick sources for ideas: our “e-booklet” (a 45 page word document) that we will email to you upon request; and, our 30-day guaranteed video, “High Performance Distribution Ideas for All”, a turn-around, revival solution in a box.







In our 01-29-03 DCC (#9, topic 1) I discussed the declines of both Home Depot and McD’s due to obsessing on numbers and growth instead of service quality that makes growth with profits happen. There has since been more instructive media coverage on these two case studies.


On February 26th Home Depot announced historical financial news results; both its quarterly sales and profits for the quarter ending 01-31 dropped for the first time in history. Sales were off 2% from the same quarter a year earlier, profits were down 3.4% and same store sales were down 6%. The day before Lowe’s had announced their quarterly results: sales were up 16%; profits were up 46%; and same store sales were up 4%. This 10-point difference in same store sales is one of the best illustrations I have ever seen in the head-to-head power of service retention economics. Lowe’s has better fill rates and service, so they don’t drive away as many customers to Home Depot as HD is driving to Lowe’s. The average for the two firms is –1% same store growth which is consistent with the slow down in both consumer spending and housing. This further illustrates that it is possible to grow quite profitably in a contracting industry at the expense of a competitor that is focusing on financial strategies like: “buying lower, consolidating suppliers, and centralized spend management.”


Let’s dig deeper into the differences of the two in both performance and longer-term momentum. This was the 7th quarter in a row in which Lowe’s has beaten Depot in same store sales numbers. In spite of what Home Depot execs might say, this performance difference was built in and out years ago and won’t be easy for Depot to change. What’s my assessment beyond the DCC 9.1 comments?


Lowe’s was started in 1946 and grew impressively as an employee and service centric outfit with retail stores all over the Carolinas. Home Depot started up in 1978 by pioneering the big box strategy for the “home improvement” category unlike traditional specialty stores: hardware, lumber, etc. Depot’s original culture was great pay, great people, great service which was further fueled by stock appreciation and promotions for all due to rapid opening of new stores in new prime locations in new big cities. Once the big cities were saturated with Depot stores, both the attractive promotions and easy growth slowed down. The hyper-growth culture and stock appreciation game was over. So, the two founders diversified their holdings. Bernie retired and Arthur bought the Atlanta Falcons and went into civic-leader, social stuff in Atlanta. Depot brought in a cost cutting manufacturing CEO from GE (Nardelli) who centralized buying, consolidated suppliers and unwittingly hurt local store fill rates and cut costs further by using more part-time employees in the stores.(More in DCC 9.1)


Lowe’s, in the meantime, has always been a slow, but steady innovator. They decided in 1989 to stop the small store, rural strategy and to compete with Depot in the big box game. At first they opened stores in rural areas focusing on items that were distribution-center friendly (TOOLS!) and using independent distributors to feed their stores the lumber-type stuff on a just-in-time basis. Depot, on the other hand, had always tried to maximize store direct purchases and crack suppliers’ heads on price rather than collaborative, integrated process improvement like Lowe’s.


Then, in 1994 Lowe’s felt that they had evolved a better big box model than Depots with brighter lighting, better looking décor and signage and more emphasis on home decorating that appealed much more to woman than the tough guy, dim-lit format of Depot. They went into the big cities head to head with Depot stores and measurably took away a good 20% of a Depot store volume pretty quickly. Then, it appears from the latest numbers, that they gradually and steadily have won defectors from Depot with their superior, consistent service edge.


Lowe’s is about half the total size of Depot today with half the number of stores. They may be able to keep eating away at Depot and be a growth story and growth culture for some time. What is Depot going to do? On 2-26 Arthur Blank took time out from his other life to announce with Nardelli that they plan to:

a.       Balance an efficiency drive with a commitment to great customer service.(Arthur had a back to our original service culture basics speech.)

b.       Launch a $250 MM store remodeling plan (copy and one up Lowe’s? Can they tack on all of the improvements or do the stores have to be reconstituted?)

c.        Increase training for workers to improve customer service. (What if part-time folks aren’t the same raw material and aptitude as life-long, associate recruits; and, will the 75% of the new store managers and regional VPs who replaced the original culture crew go along with it? A new generation of political, suck-up, number-crunching bureaucrats might not change as easily as Nardelli thinks.)


This entire competitive race reminds me of the one between Wal-Mart versus K-Mart. They both started up in 1962 when fair trade laws were struck down by the Supreme Court allowing brand name goods to be discounted. Wal-Mart went after little towns with a strong employee/service culture using a 2-step, eventual “quick response” (QR) distribution capability and initially grew much more slowly than K-Mart. The big K raced to open big boxes in big cities and took direct store delivery. But, when Wal-Mart eventually went into the big cities with their QR capability and superior service culture, they killed the Big K. K-Mart tried to imitate Wal-Mart’s advantages, but they couldn’t tack them on to what they had organically grown. If you have a cat and it needs to bark, you can’t modify the cat; you have to get a dog.


How do these case examples relate to distribution branch location dynamics? Here are a few thoughts:

1.       Lowe’s big boxes targeted customers more carefully and effectively than Depot; they are lady-friendly. What is each distribution branch’s #1 historic niche? How can each branch re-tune their focus on this niche for better, sustainable competitive advantage over local competition. (See video modules 3.1-12)

2.       Lowe’s has always put high, consistent fill-rates ahead of buying lower; the total economics are superior. Lowe’s replenishment systems, local purchasing and relations with suppliers all reflect the fill-rate objective. Depot went for low-price from suppliers to improve margins; a simplistic, financial management objective. If a branch can maintain a 5%+ fill-rate advantage for a target niche of customers over the next best service competitor, that edge and time will contribute heavily to a general, profitable same location growth differential over competitors that pursue the same niche. (For more on why fill-rates, as an organizing force, provide superior total profit growth economics see DCC 8.3 and video modules 4.1 to 4.3).

3.       Home Depot will not improve their service culture, metrics or results without first stabilizing, improving and re-culturizing their store managers. Excellent service is a daily discipline that happens at a (decentralized) location, because a local, hands-on leader believes in it and is making it happen in a way that attracts and keeps above average employees. There is a direct correlation with growth, profits, returns and service quality (one niche at a time) at a distribution branch location. But, the service quality will rise and fall, in turn, with the service quality coaching ability and longevity of the branch manager. Big distribution chains that think that they can break up a branch manager’s functions into operational/departmental specialists that report to their regional specialty counter-parts will never win the local service retention game.


Enough on this battle of big boxes for now. But, stay tuned, I’m forecasting that Lowe’s, like Wal-Mart eating away at K-Mart, will continue to win this battle for some time to come and that there will be more lessons for us to learn as we watch the contest. My sense is that Home Depot isn’t as damaged and poorly run as K-Mart was in 1988 and both Lowe’s and Depot will have a tough time weathering the unwinding of the housing bubble that has peaked here in the US. Now what’s new with Mickey D’s?



In DCC 9.1, I discussed how financial management coupled with volume is vanity had overcome McD’s historical service excellence and bottom-up, innovative and committed franchisee culture. Business Week’s March 4th issue followed up with an extensive analysis of what’s wrong at McD’s and what they should do to fix it. It’s an excellent article worth reading, here is the URL:


The article confirmed a few of my suspicions. The parent organization stopped measuring service metrics at locations in the early ‘90’s and allowed franchisees to cut back on training. McD’s average service metrics have since gone down while defections to the best fast food service operators have gone up. And yet, they are planning to open up another 1,230 locations worldwide in 2003 on top of their 30,000 locations. There are times when a company has to stop growing through managed numbers to right-size, get back to service basics to start growing organically through service retention to provide better quality returns for all stakeholders instead of imploding from empire extension metrics.


Plenty of distribution chains are guilty of wanting to acquire and expand today when they need to rank all locations and downsize, upgrade, refocus, revive and revitalize what they have, not just with locations, but within the customer portfolio of most locations. Volume is vanity, profit is sanity and positive cash-flow to pay down debt during deflationary liquidation downturns is most important of all!




Speaking of death by managed top-line growth at all costs, I made some observations on how US Foodservice’s rebate games had torpedoed its parent company’s future (Ahold of the Netherlands) in my 3-5 DCC (14.2). Do you think that USF’s rebate rot is only the tip of an iceberg. First, within the foodservice industry, there has been an adverse stock market reaction, perhaps as much over-reaction as wisdom. Ahold and Fleming (who partnered with K-mart supercenters) are being investigated by the SEC, and their stocks dropped by 60% from a few weeks ago. This past week, however, the stocks of Sysco(syy), the country’s largest foodservice distributor, and Performance Food Group(pfgc) dropped faster than the S and P index by 10%+. The suspicion is that just like Enron’s games forced all of the other power companies to play number enhancing games, this may also be going on in the food distribution channels where rebates are huge and most creative.


Are they guilty? We will see, but in the meantime consider the role that supplier growth rebates have had in many distribution channels. Most roll-up companies or even aggressive distributors that have been growing their debt faster than their sales have been too obsessed with rebates. Think about it. The bigger you are, the more aggressively you can negotiate next year’s growth rebates with targeted commodity volume suppliers. One of the suppliers goes for the extra incentive proposal, because short-term it will help them make their year end numbers. To maximize rebates, the distributor then switches volume from other competitive suppliers as well as negotiates to add the volume of any deals from acquisitions done during the year. Before you know it, 100%+ of year end profits are coming in the form of rebates or “sheltered income” in channels in which there are a lot of landed-cost-plus contracts with customers.


The game escalates as all of the suppliers and distributors start to play to try to keep up. Then, each year- end gets more wooly because:

1.       The channel load ups at last year-end to get maximum rebates had to be worked off in the first quarter of this year, putting this year’s purchases into a big initial hole. This hole has to be made up by both supplier and distributor with even bigger and more year-end enticements to load up even more.

2.       Big distributors can only switch volume from one supplier to another or add new acquisition volume to last year’s base one time for a good earnings pop. What should a publicly traded company do to beat last year’s profits that include a one time pop? Should they do more and bigger deals at a faster rate and at higher prices with greater premiums (goodwill assets)? This works well as long as there are enough sellers in a rising market. Acquisition times are now over. Valuations are heading south with the global bear market, but sellers want yesterday’s price. Buyers, however, must offer a price that discounts a deteriorating economy. Even if buyers and sellers could agree on a price the buyers’ financing is gone. Stock deals don’t work for either side in a bear market, and deals by debt don’t work when there is already too much debt on the balance sheet with deflating asset values.

3.       As volume starts to drop in many channels due to the on-going grind of our global, synchronized, post-bubble economy, all growth rebates disappear.


The trends are not friends of the rebate game. So, how about announcing big, new, supply-chain or cost-reduction infrastructure projects. Sounds like McDonald’s and Home Depot above. Maybe. But, what is missing is talk about creating a high performance service culture that will win share profitably from competitors due to service value on the front end that attracts customers that are defecting or rebelling from the low-cost, mediocre service guys. Every day low cost, low price (with highest fill rates!) wins for only one player in retail, Wal-Mart; everyone else can’t have low-cost, so that they have to have some unique service proposition. In wholesale games, companies have to create a fair degree of customized value for the customers on the front end of their business. Even with low-cost and good fill rates, there is still more service execution brilliance for customers to attend to.


Here’s a closing prediction. The rebate rot is pervasive in any distribution channel in which there have been distributors that grew fast through acquisitions or price-cutting that grew volume and debt instead of strong reinvested profits. The fast growers dependent upon growth rebate games have run out of time. Will they be able to reinvent service excellence by re-thinking their entire culture? It can’t be added on to what they have. Many companies need to re-think their service education capabilities.      




Most hot-house tomato distribution companies that got caught up in growing their numbers, especially the public ones for Wall Street, are at different places on a spectrum between financial management and service retention economics. (For more on “service retention economics see the PDF file with the 5 annotated slides discussed in #5 below).


How could they or any distributor re-educate all of its employees to win at service retention economics? Most distributors invest very little in in-house education. How could even the smallest firms re-think their educational investments, themes and methods? Try our video, “High Performance Distribution Ideas for All." It’s a service excellence university curriculum in a box that can play at even the smallest location for the cost of the personnel time that is invested. It offers 53 bite-size “ideograms” that in turn serve as a platform and methodology that any company of any size can adapt further to their needs.




We recently had a manufacturing client who had bought our video inquire about procuring the 316 power point slides that are used in both the video’s 53 modules and the “Implementation Guide.” It was a first time request, but their ideas for how they wanted to re-purpose our slides for their distribution channel made sense to us. So, we offered to send them the slides either via email (big file!) or on a disc for $150. We would like to extend the same offer to anyone else who has already purchased our video.


As a web site experiment, we have posted five slides with annotation notes on our site in a PDF file. The slides cover the topic of how to achieve a “strategic service training breakthrough” in a distribution company. For those of you who check it out, we would appreciate your comments on whether it has any value and how we might use the annotated slide medium service in the future.



That’s all for this week!


Best regards,