March 26, 2003 - Distribution Channel Commentary (DCC) # 17

March 26, 2003 - Distribution Channel Commentary (DCC) # 17


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Whether we like the terms and goals of the Iraq war or not, our countryís young adults are now involved and need our support. Their only way home is through Baghdad. Hereís hoping for the best possible scenario of a quick capitulation by the 10% of the Iraqi population that has been exploiting and brutalizing the other 90% and a peaceful, rebuilding of a pluralistic Iraq amidst the chaos of the mid-east.

There are, of course, good odds that one of a number of other worse occupational scenarios will unfold after the battle of Baghdad is completed within "a matter of weeks" (Rumsfeld). Iraq could shape up to become the most expensive mother of all tar babies in just a few short months. Regardless of what best to worst scenario plays out, our US economy is in no shape to finance any of them. For more on my thinking that bigger government deficits meeting more reluctant foreign bond buyers will drive up long-term rates that will lance the US housing bubble see DCC#15.1.

In the meantime, donít be fooled by the volatile US stock markets. Last week we had a big down day followed by the fastest increase in the averages since 1982; this week started off with another huge down day. This casino action is the result of a trillion dollars of hedge fund money trying to generate movement up or down while being on the right side of being long, then short. The hedgies could be, in turn, being manipulated by the "plunge protection team" within the Bush administration.(Google that phrase in quotes; it will be awhile before the main media start reporting on it.) In the short run, the markets are an emotional barometer, but in the long run they are careful weighing machines. Watch the 200-day or even the 40-week (280-day) trailing average charts for the market averages to know what the primary trend is. So far, it appears to be a 3+ year old, global bear market with years yet to run. (Due to government intervention, the Japanese post-bubble economy exchange re-valuation process has been prolonged and is still setting new lows 13 years later.)

The Wall Street casino action does not change any of the problems of the post-bubble economy covered in past commentaries and in our articles posted at Besides the structural problems left over from a 20-year, globally synchronized, boom-bust bubble economy, we have the China manufacturing phenomenon accelerating. We visited the China story in depth in DCC #1.2 (11-12-02). The gist of that commentary is that the breadth, depth, speed and likely longevity of Chinaís liquidation assault on high-cost (pay, pension, union) manufacturing jobs in G-7 countries is unprecedented. It is hitting our economy at just the wrong time. Instead of wishing China would ease off, the commentary suggested distributors accept the reality and embrace it by re-weighting their allegiances to those suppliers that had the best outsourcing strategies for China production.

Here are a few update points to our previous commentary. First, check out the graph for machine tool consumption at the American Machine Tool Distributor Associationís excellence web site. Go to , click on "statistics" and look at the graph at the top. Why should anyone but AMTDA members care about the declining 12-month trailing trend for machine tools? Because! Machine tools are a leading indicator for capital expenditure in industrial America, and there isnít any! In the meantime, Chinaís consumption of machine tools has been growing at better than 20% compounded annually since at least 1999.

Whatís my horse-sensical forecast for the AMTDAís chart that appears to be forming a new, level, (false?) bottom from which a capital expenditure revival might occur in general for the US in 2003? I donít see it for this year. For starters, I think the US auto industry and its supply chain are both starting to decline significantly for a number of reasons:

  1. Two years of severe, escalating, financial discounting has pulled future sales of autos into the past 18 months leaving the monthly payment American consumer saddled with big, "interest-free", lease payments for the next 5 years. And, in spite of new, bigger discounts, cars arenít selling. Fordís recent 17% reduction in production plans supports these assumptions.
  2. GM and especially Ford have leveraged themselves to the moon to finance the artificially high sales levels, pushing about $18 billion of future losses into their finance subsidiaries. The losses will be recognized over the next five years as interest on debt will not be offset by interest coming in on 0% car loans. This expense shifting to the future allowed both companies to report "profits" in í02. Another profit booster came from including fictional excess gains in their pension fund investments by using a 10-year, trailing average return procedure while actual current under-funding of their pension funds are plunging. For the real bottom line, long-term, one analyst recently conjectured that Ford would be bankrupt now if not for its brand nameís effect on financial markets.
  3. ( - 17k - Mar 23, 2003)

  4. Consumer confidence numbers continue to decline as unemployment numbers continue to climb. Jobs are evaporating, automating and emigrating to China (and now service jobs to India) far faster than our economy can (re) create new ones. Consumer retrenchment or tighter lending standards for the most foolish, monthly payment consumers could hurt investment flows further. (I wonder, by the way, how much longer consumer credit companies will continue to expand their sub-prime lending while simultaneously writing off ever greater percentages of past due collection problems?)

What about the rest of corporate Americaís investment plans? Isnít the 3-year collapse in info-tech investment at least due for a dead cat bounce or revival? The stats donít look promising to me. With manufacturing capacity at 75%, no "pricing power", balance sheets and pension funds that need to be re-liquefied or restructured and no growth in general demand, why invest in more capacity. Capital investment has always lagged a revival in demand and that isnít happening and doesnít promise to. The Fed canít lower interest rates or pump up the money supply anymore than it is doing, and there is no pent-up demand for cars and houses, because that is what has carried the economy for the past 3 years. I also assume that a big chunk of free cash flow from manufacturing businesses is being directly invested in China instead of the US. And, for IT spending, Information Week magazineís IT Director confidence survey just hit a new low since the big decline started over 2.5 years ago:


With our post-bubble economy still at stall speed (1% growth for Q1 & 2 í03?), 90%+ of all distributors that are currently earning minimal survival returns or less (DCC #10.1) need to fundamentally rethink their strategies. Hereís a closing question to pose to your organization: "How can we create a sustainable, competitive service advantage for one niche of customers at a time through our people?" This question, in turn, has several implications that raise more questions:

  1. Service advantage - Unless we have an exclusive franchise that is an annuity, we wonít get any sustainable advantages from our me-too supplier franchises, so "total service value" in the customerís mind, not ours, is the default area for finding and achieving a competitive advantage.
  2. One niche at a time - not all customers are the same. We serve different categories of customers. They come in A, B, C and D sizes which will support more to fewer services bundled into pricing and terms on a respective basis. Some buy on friendship, most buy on lowest total procurement/highest total value (whatever that is), and very few actually buy on pure price. The three sets of variables Ė customer categories x size x buying values Ė create a number of different niches (some theoretical) for which different targeted and tuned service prescriptions, prices and terms are appropriate. Because where we make our money is our historic strategy, what is our number one, most profitable, historic niche?
  3. Through our (front-line) people - Unlike retailers where the power of location and physical layout are big advantages (disadvantages), distributors have enormous service value (re) invention flexibility that must all be achieved and sustained through front-liner service execution people. How do they all know who the most important, (potentially) profitable customers are for whom to do the heroic extra effort? Why should they stay late and do odd things to help such customers? Whatís in it for them?

"The Electrical Distributor" magazine (TED) does a nice job of rounding up its industryís channel news every few weeks and posting it on its web site. Because the electrical channel(s) is so huge and reaches so many different end-user segments, skimming TEDís news gives me a good feel for whatís going on in many distribution channels. In their March 18th roundup, they did a nice job of summarizing what WW Grainger is doing on:

  1. Sourcing more of their private label goods from China; and,
  2. Strategically focusing more marketing resources towards government and hospital customers (I infer that they realize that manufacturing America is contracting, so they are re-weighting their energies toward markets that will continue to grow. Governments will continue to grow? Sad, but true.)
  3. Hereís the URL:

    This Grainger news reminded me of two other distribution clients who have, in the past year, not only by-passed their normal suppliers to source goods in China, but have also set up independent importing companies to sell their private label lines to other (primarily non-competing) distributors. Can you imagine new channels for new Chinese suppliers emerging? A somewhat similar pattern occurred for Japanese consumer electronic manufacturers trying to get national distribution in the Ď70s. In those days, the traditional distribution channels were locked up and franchised by the US consumer electronics manufacturers, so the big boxes took on the no-name brands and guaranteed the performance of the goods. The traditional channels were wiped out, along with many of the manufacturers, while Circuit City became one of the great growth, stock investment stories of the past 25 years.

    How will the Chinese manufacturers looking for US distribution emerge? Once US manufacturers put the Chinese into business to make goods for both the US market and the Chinese domestic market, many of these Chinese manufacturing "partners" seem to have no problem selling around their US sponsors to whomever wants to buy from them. If US manufacturers think that they can capture huge margins and profits by outsourcing manufacturing to China and not passing the savings on to the US distribution channels, they are wrong. Even with proprietary designs and patented technology, companies like Cisco are finding that goods from their China producers are being sold through new channels under cutting Ciscoís 70% plus margins on their most popular items.

    Iím not suggesting that all distributors should or need to get into the sourcing/importing business. Nor, do I condone Chinaís disregard for "intellectual property" or gray market selling. I do believe, however, that if any distributor of durable goods products does a bit of research and tunes their selective perception on to sourcing opportunities from China, you will see them. As a cheap experiment, go to, type in "china + imports + a commodity item" that you stock and follow some of the hits for 15 to 30 minutes.



I regularly check web sites that generate decent content and news for channels of distribution; here are a few articles that I recently found that you might want to check out. I have sprinkled some comments throughout:

"A Balanced Approach" by Richard Trombly, contributing editor to Industrial Distribution Online. In this one, the author surveys a few industrial distributors as well as gurus for thoughts on how to "rightsize instead of downsizing." There are a number of tactical suggestions worth reviewing. The concrete ideas are financially oriented (e.g. "examine every item in your budget"), the strategic ones are perhaps necessarily vague (e.g. "look for new opportunities").

URL: index.asp?layout=issueToc&pubdate=3%2F1%2F2003 - 40k - Mar 23, 2003

  1. As a short, amusing balance to the first article above, check out "You canít shrink your way to greatness" by Dave Anderson at Progressive Distributorís online site. His main messages:
    1. While cutting costs is vital, it is not a strategy; itís a tactic. It can be imitated and doesnít offer any sustainable competitive advantage.
    2. Strategic thinking involves innovation, because if it isnít different (and valued by the customer) its dead. And, if you canít describe it (write it down for all to read, understand to then truly believe and buy into), then you canít execute it.

He then offers a funny take off on Dakota tribal wisdom about all competitive aspects of a dead horse (strategy). The URL is: , then scroll to the bottom to click on the article. Many of Daveís other articles are at

  1. One main way to innovate, as article #2 suggests, is to try to do it through service. There is no current shortage of articles trumpeting service differentiation. I found, for example, a few on distribution-oriented web sites this past week that suggested quite vaguely to out-service your competition and delight your customers (who ever they are, what ever they fundamentally want). I also found one that asked why distributors hadnít really figured out what these (extra, un-named) services might really cost and how to get paid for them, because most werenít. Because that sums up the latest, insights (?) into "service", I thought that I would save us both time and not list them. The right theme, at least, is being broadcast on a regular basis. But, as with the Beatles good advice in "All You Need is Love", arenít we left needing a few more strategically appropriate, for us, specific ideas?
  2. For more scholarly detail on downsizing and rightsizing the outside sales force check out: "Is Distribution in Need of an Overhaul" by Scott Benfield. In it, Scott examines the problems with the "traditional geographic territory sales model" for which "researchÖpointed to a 40% overcapacity in this functionÖworth approximately 1.6% of sales." The big trend reason for the overcapacity is: "once products mature, the need for the seller diminishes drastically." If 80 to 95% of your sales volume is based on established commodity products to established customers ("old to old"), then Scottís message is worth reading at the same URL as article #2 above; scroll down to it also.

What more can I add (as reluctant as I am to comment on anything J )? These articles, as good and helpful as they are, all self-confess to some degree that best practice approaches to a business donít add up to or reveal what a unique, best strategy for any particular distribution location might be. All the articles directly or indirectly touch on the same questions with which I ended topic #1 above. Remember the first big question? "How can we create a sustainable, competitive service advantage for one niche of customers at a time through our people?"

If a local manager of a distribution location knew the answers to the questions in my topic #1 summary, then they could start to cherry-pick ideas from best practice articles and modify them to fit in with and reinforce their local, unique strategy.

For now, think of this common problem/opportunity while skimming any best practice articles: there are two parts to most distributorsí businesses, the part that generates 150%+ of the profits and the other part that loses 50%+ of the profit. When reading/thinking about "downsizing and rightsizing" (article #1above) wouldnít it make sense to shape up or out the losing 50% to free up resource energy to reinvest in protecting and growing the 150%?

When thinking "innovate to be strategically different"(article #2 above), wouldnít it make sense to go back to your 150%+ profitable core business and make sure all employees understand what it is, what it wants, why and do it better. You could then reinvent it; protect it; and recultivate and grow it with "high flow-through, incremental margin dollars to the profit line. You surely donít want to ignore it, be distracted away from it by other, new, potential opportunities or harm it with new, top-down, financial management initiatives like Home Depot has done in the past two years (DCC #15.2).

As an aside, reinventing the core businesses is what Jack Welch did at GE in the first eight years of his 20+ year reign. He declared that every GE "strategic business unit" (SBU) had to be or become a dominant #1 or a strong, ascending #2 in their niche, or he would close or sell it. (Do you know the underlying realities/wisdom of being 1 or 2 in a distribution customer niche or exit? After eight years of being "Neutron Jack", he then had huge cash-flow from operations that allowed him to start to acquire, fix up, consolidate and/or buy back stock if it got too cheap. Jackís "business engine model" took all stakeholders on a great ride up through the late Ď90s.

Addressing another Ď90s topic, 90%+ distributors donít have the high pre-tax return on assets or the total free resource flow (cash, talent, time and track-record credibility with the best within all four stakeholder groups) to "innovate" anywhere else but in doing their historic, profitable core business a lot better. Call this the "back to the future" strategy. Reinvent the core while shaping up or out sideshow distractions in the customer and stocking product portfolios to generate high total resource flow. Then, consider adapting forward and along different vectors from core competencies into more interesting profit growth opportunities in which you firmly believe that you can become a dominant #1 or strong ascending #2 to a distracted, too broadly focused and/or coasting/harvesting #1. Be like Jack in the Ď80s to enjoy his returns for the decade(s) to follow!

If you do re-invent your core business, you will have to re-tune and improve your "augmented service product." Benfieldís article above suggests that as part of this process you will have to re-allocate and re-orient the outside sales force. Because the cost of outside selling has gotten so high, it must be allocated to fewer customers that generate, in my total math thinking, $400 to $500 in gross margin per month. And, sales reps must be re-educated to now sell what mature channel customers have been trending towards since the late Ď60ís: buying the "lowest total procurement cost"(TPC).

A former purchasing agent at Carborundum named Ralph Bolton started writing about achieving the lowest TPC through "systems contracts" in the late Ď60ís and early Ď70ís. The latest evolutionary term for routinizing selling and buying costs is "integrated supply contract." Some distribution channels have had relatively rapid transformations from sales reps who were product-pushing, order-taking, geographic territory managers to integrated system sellers. The big drug wholesalers did it in the Ď80ís; the big hospital supply distributors did it in the Ď90ís. In both cases, most of the leadership came from consolidating, innovating customers in spite of what those channel wholesalers want to selectively remember. Can you get 5 of your most profitable, cooperative customers in your number one niche to help you co-create the right amount of adoption and adaptation of these big trends to your #1 historic niche?


The Iraq war will only add to the tough time challenges that we have at home. Working harder, using the same old tried and true methods and shrinking our way to profitability will not work. All best practice advice is nice, but it doesnít tell us at a local distribution business who the 20% of our customers are that are generating 150% of our profits to cross-subsidize a lot of losing elements that keep us from making most any new initiative work. Managing financial numbers is important, but it isnít a strategy that helps us to do better and very different jobs with 150%+ profit part of our business or the 50%+ loss part.

This particular commentary touched on a lot of ideas for how a distributor might identify, define, describe and better manage their hidden customer-centric strategies. If any readers have questions about some of the phrases or concepts that I skimmed over, particularly in the last section, please free to email them to me. Or, I strongly recommend that you try out unconditionally guaranteed trial review of our video tape product, "High Performance Distribution Ideas for All."

Donít forget to tell your industry friends to check these commentaries out at and have us add their addresses to our e-mailing service. Until next week,

All the best, Bruce Merrifield (