April 2, 2003 - Distribution Channel Commentary (DCC) # 18

April 2, 2003 - Distribution Channel Commentary (DCC) # 18


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If you are me, you read and listen a lot to try and figure out what’s happening in the world. My general take for the big picture and the longer-term is in two articles at our web site under the "articles" button (see #1.10 and its support note). The Iraq war, no matter how it plays out, and this past week’s business and economic news has only reinforced my views that this post-bubble economy is nothing like we have experienced in the past 50+ years. With the exception of China, the news coming out of all G7 economies this past week was consistently negative; everything is slowing down. What’s more, it looks like a high price for oil will continue to be a tax on industrial economies.

Looking ahead, we are moving into a month in which many public companies will report on Q1 earnings. Look for more "surprise" downward earnings announcements for three big reasons. The SEC is pressuring companies to be more honest about a) expensing under-funded pension liabilities that tend to be at old-line companies and b) employee stock option expenses at more youthful, hi-tech, NASDAQ-type companies. And, c) higher commodity input costs can’t be passed on through higher prices because

record levels of global excess capacity still remain. As fast as many organizations are trying to downsize domestic capacity (not good for on-going trends in employment and consumer confidence stats), lower-cost, knock-off capacity is growing in China for manufacturing, India for services and Wal-Mart for retailing ever more goods.

What should we do? We can fret, blame or continue to wish that a rising tide will re-appear to float our business boats, or we can look inside our firms and decide to address two golden opportunities:

  1. Pursue one set of proactive measures for the 20 to 40% of our customers that generate 150% of our profits while applying another set of measures for the 60% of our customers that generate minus 50% of our profits, especially the 5 to 15 biggest losing accounts per distribution location. Turning big losing, lead accounts into win-win gold ones provides the biggest bottom-line swing in the shortest time of anything a distributor can do.(It works for trucking companies too; see #4 below)
  2. To avoid boring regular readers, there has been lots of previous how-to coverage on profitable/unprofitable customer plays in the following DCC topics: 1.1, 3.3, 3.5, 5.2, 7.3, 9.2-3, 10.3, 12.3, 13.2, 14.3, 16.2 and 17.3. If you are a new reader, you might read the abstracts (request them from karen@merrifield.com, if you would like). The more ambitious readers might copy and paste excerpts from these topics that speak to you while adding in your own notes and questions for others at your firm to consider. Here’s a big hint for turning lead into gold accounts: the average sales rep on the account will not be able to do it. Designated champions and even "support analysts" who can do simple "total procurement cost reviews" will have to sell the account on changing its lose-lose procurement habits to win-win transactional flow with perhaps more volume to boot. But, it’s worth it!

  3. Work with all of your employees to change the environment at your company so that they will bring both their "hobby energy" (HE) and their "home economic" (HE) savvy to the job everyday in order to become part of the high performance service solution instead of part of the passive problem. DCC topics that touch on releasing "HE squared" are: 1.3, 2.4, 5.2, 7.2, 9.3, 9.4, 13.1 and 15.4.

The ideas in the aforementioned DCC topics have worked for far too few distributors. There definitely is a continuum for the ability of distribution execs to be open to, understand and pursue new solutions in the face of a different type of economic downturn. If any readers have any ideas on how to encourage more execs to re-think old, flawed, un-spoken business success assumptions so that they can then mine the gold within their businesses for the benefit of all stakeholders, please let me know.


Here is a quote from DCC 17.3 followed by an answer to the question I asked and is now underlined below:

"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. Jack’s "business engine model" took all stakeholders for a great ride for the next 12 years."

Where did Neutron Jack or anyone get the idea that being #1 or #2 in a market was critical to high performance profits? I first tuned into the concept in the mid ‘70’s by reading a strategy pamphlet series entitled "Perspectives" by Bruce Henderson, the founder of the Boston Consulting Group. The gist of his commentary was that in the biological, evolutionary fight to survive for limited food sources (profits), lots of natural monopolies have resulted in nature like one pride of lions per water hole.

These natural monopolies in nature last as long as the environment doesn’t significantly change or some new, more powerful competitor or mutant doesn’t evolve on to the scene and upset the balance of the game. In free market capitalism, longer-lasting monopolies are rare, however, for several reasons:

  1. Suppliers, customers and consumer law will conspire to prevent monopoly exploitation by only one provider. Where monopolies do exist, such as most US government services, they become high-cost, poor performers of what they are supposed to do, because they are missing competition. Competitors force us to stay efficient and effective at continually innovating in an outward, customer-friendly, value-enhancing way for one customer niche at a time. Government monopolies try to be all things to all niches (voters) while being consumed with internal personal and departmental concerns at the trade-off cost of being less flexible and effective for all customers.
  2. Entrepreneurs, more importantly, don’t have to wait for slow changing evolutionary accidents to open new competitive opportunities, they can proactively innovate to take revolutionary steps to upset the balance of the business ecosystem. If a successful rule-changing company reinvents the existing game of business enough, a new product-solution life cycle can begin.

In a new life cycle game, the first mover’s customer demand and business profit potential will attract competitive, me-too capacity that will eventually compete away premium profit potential in the competitive space and trigger a consolidation of the competitors. The #1 best performer with best economies of scale for a defined scope of customer demand will stay very viable. The #2 player in the same niche can often do all right, especially with some extra help from suppliers and customers who don’t want to be dependent on a monopoly supplier. And, the rest of the players should probably exit for different, new, better-opportunity niches; sell; or liquidate.

How does the #1 or #2 rule apply to distributors? Can’t three or more companies make good profits in one marketplace? In many distribution channels in bigger cities aren’t there far more than three similar distributors? Some thoughts on these good questions:

  1. Most distributors aren’t making "good profits". According to Al Bates’ Profit Planning Group reports for 40 different distribution channels, 90% of all distributors averaged a 5% pre-tax return on total assets in 2001. The shareholders of these companies would do better to: liquidate; put their equity in muni bonds; and have either 100% free time or get a less stressful job to have more total income with less total investment risk. They could also free their other stakeholders to get a better long-term performance ride from better performing distributors in their space.
  2. Or, they could (re)define their historic #1, best customer niche(s), to then reinvent their total value proposition to do more with their core. This core revival will require re-deploying resource commitments from the losing customers, products and suppliers to the winners which would require some up-front assumption changes. The idea that you can grow sales volume and profitability more effectively as a by-product of total service re-invention tuned to the best, right customers that are then retained and penetrated better versus pushing product price specials to all old customers (losing ones too) and new customers is a tough, channel-culture rule to break.

  3. All of a given category of distributors within a given city shouldn’t be any more similar than: all of the retail outlets that sell Crest toothpaste; athletic physiques for Olympic track people; or, ‘big cats" in Africa. In these other examples, the competitors have structures and competitive spaces that are in tune with their strategies. Product-volume driven distributors try unwittingly to be too many things to many different niches of customers, so they are mediocre value providers and price-takers for all customer niches that they don’t really see are different.

To illustrate this product-oriented, blind spot for trying to be too many things to too many people, here’s an experience I had once with a room full of electrical distributors. A question came up about WW Grainger adding a few more electrical products to their catalog and their c-stores and the disloyal manufacturer that had decided to sell these products through WWG. I then tried the following Socratic process:

  • "How many of you think you compete with WW Grainger?" Most hands went up.
  • "What percent of your total sales volume overlaps with WWG’s?" Single digit percentages.
  • "How many of your best (core) customers would consider calling WWG first for the same stuff?" Zero.
  • "In your personal lives what percent of your annual, household consumables do you buy from C-stores versus other retail outlets?" Single digit answers; majority from full-service grocery store.
  • "Do the full-line, full-service grocery stores that you shop at and your closest, best C-store compete head to head for your business or just for an occasional incremental item or two?" Negligible overlap.
  • "If you have to have both a grocery store and C-store supplier on an annual basis, what percent of your household spending does the current #1 supplier in each of those purchasing segments get?" The grocery store got 70 to 90%; the C-store (when neighborhood need arose) 80%+
  • "For the fixed cost of space and inventory to have competitive one-stop-shop, fresh, in-stock fill-rates for these two shopping niches, what happens to the ability to fine-tune the right product selection, item fill rates and eventually total annual turns if one competitor has 50 to 80% of the local niche volume?" Ans. They all go up for the dominant guy and down for the competition until they go away..

I could carry on about both "the art and science" of defining #1 best niches for local distribution locations and how to then pursue them. I will leave you with these scientific steps or decision-making tools that still leave a lot of "art" to the job of defining and pursuing more from your core.

  • Rank your customers by estimated Profit before interest and taxes (E-booklet 11-14)
  • Identify an homogenous sub-group of customers within the top 10 most profitable customers
  • Sub-divide this group further by two further dimensions:

A, B,C,D strata based on potential volume to support different modes of selling – outside sales coverage, telesales, catalog and cash-n-carry.

How the customers buy: personal loyalty; best total procurement cost; and pure price

  • Now define your #1 niche by: traditional customer segment; by size/volume strata; by purchasing values; and by the 5 most profitable customers that personify this niche.
  • Go visit the most profitable and another 5 best target accounts that fall within the same sub-group to ask them: why they buy from you and others; why they have shifted volume chunks between suppliers in the past; and what do all competitors do that frustrate them the most. Listen for ways to re-tune, re-think and re-allocate services more for the very best, less for the small volume loser accounts.
  • Now make some big decisions. Can you become a number one dominant supplier to this niche of customers by capturing 50 to 85% share of this niche? (Not 100%, because you don’t want those in the niche who are pure price buyers or who are extinction in motion; only the ones which will be profitable now and in the future and will buy best total service value.) And, if you re-think what the total investment in one-stop shop assortment of items and re-tuned service will be, can you get enough volume to make the turn-earn and total economics of a local distribution capability go? This critical mass economic thinking is akin to a grocery store chain deciding if a marketplace population base, its growth rate and the quality of the existing food sellers in the space will allow the firm to wedge in a jumbo, big or small store format. And, how long will it take to get to break even and high performance economics?
  • If the answers are "yes", team sell the best core accounts and the target gazelles relentlessly (DCC#7.3, 9.3). If the answer is "no", then re-think the marketplace and find another niche of customers with which you can be #1 at and get to critical mass economics. Then, all of your locations will become free cash flow machines like Neutron Jack’s SBU’s became in the ‘80s.

A client emailed in a question asking for my definition of a "commonwealth capitalist" which I had casually used in some past DCC. The short answer is that it would be any individual who is a stakeholder in your business who can see that they must often sub-optimize their short-term, personal needs and goals to make sure that the needs of the company and its channel partners are met. This will, in turn, insure that each individual who is associated with the company will actually maximize their wealth in the long run. They exhibit long-term, big-picture, enlightened self-interested behavior.

If an employee sees the company that they are working for as a "commonwealth" entity, then they will want the company to make big profits to reinvest into more assets to support more growth to support more jobs and job promotions. This cycle turns their job into a prideful career.

They want the customers to get the best total service and value so that they will: stay with the company, buy more, pay more for a better total value and tell their friends to do business with us too. They will stay late and do heroic actions for the target customers who will generate a disproportionate amount of the employee’s future income. They will not get caught up in personal or departmental politics at the expense of sub-optimal performance of the service systems that run through departments to take care of customers.

As usual I could go on, but how do you get all people to trust that if they sacrifice their immediate personal and departmental (unions are big here) needs, then:

  1. The extra effort will be focused on a strategy that will actually work and generate more wealth for all stakeholders to share.
  2. They will get their fair share of the extra wealth that is created; it won’t be skimmed off disproportionately by the management and shareholders.
  3. All other employees will make the same sacrifices and personal investments every day in order for all to have a better future. A few responsible peoples’ extra efforts will otherwise be diluted down to ineffectiveness, and others will be getting a partially subsidized ride today. This futility of individual action concern must be answered.
  4. I can’t answer these questions in today’s DCC, but our video, "High Performance Distribution Ideas for All" does provide the educational enlightenment plus the pragmatic solutions to the questions raised above.


If you are a subscriber to Forbes or want to go through the rigamarole of signing into their web site at http:www.forbes.com, then check out the article in their 4-14 issue entitled "The Big Tune-Up". It’s a short article on how Bill Zollars became CEO of Yellow Transportation (YT) three years ago and has orchestrated a masterful service turn around. For quick background, YT is the current #1 share trucking company in the $24B-a-year LTL market for shipments that are too small to fill up a whole trailer but too big for parcel giants UPS and FedEx. YT got big by historically buying out regional trucking companies through the mid ‘90s when they finally were big, national and losing money.(Sounds like some of the distribution channel roll-up companies of the ‘90s.)

The article doesn’t first give you the recipes for a service company turnaround and then tell the story in a parallel fashion, but I will. First, re-read the conclusion steps in note 2 above. Then check out the annotated slide show link starring the "service profit/retention model" that is at the end of DCC #15 on our site (we will have a "slide show" button and direct links to the slide shows someday). As a shortcut, know that the bumper sticker slogan version of the model is "people, service, profits"(FedEx’s motto). Then, here are the steps that Zollers took:

  1. He surveyed the best customers about what they didn’t like and what they wanted. This helped him to define what the service metrics and developmental direction for an "augmented (service) product" might be. That is, start with being brilliant on service basics, then move to special services for special customers often for unbundled fees or premium price services (think UPS and FedEx charging more for next day than slow boat).
  2. He found out that the error rate was 40% for all shipments and decided what a hidden gold mine the business must be. (Kind of like finding out that 50% or more of your customers are break even to big losers and thinking about doing better with the 20% that generate 120 to 150% of profits).
  3. He realized that faster shipments through hubs is always desirable for shipping customers. (Duh)
  4. Driver turnover and inefficiencies contributed to both #2 and #3.
  5. So, he traveled the country for 18 months giving his new service vision speech at countless terminals.(Our video can do this for distribution chains for a lot less, repeatedly, forever.)
  6. He doted on his drivers ("the people" part of the service retention model) so that driver productivity rose by 20% by 2000 and reduction in man hours lost from job injuries dropped 29%. Then, "the service" metrics part started to improve.
  7. Errors were reduced from 40% to less than 4% which also lowers costs by doing it right the first time.
  8. Shipment times cross-country through hubs were reduced by 30%.
  9. He empowered reps to deal with problems immediately and soothe customers with free shipping on the next order to the total tune of $300,000 per year. One customer was quoted as saying: "Yellow workers go the extra mile, no one else does"
  10. Concurrently with the service improvement drive, YT started to visit with both losing customers and those who weren’t prepared for pick ups or deliveries costing YT lost productivity. They either renegotiated the terms and work with us habits/systems, or, they priced them away to the competition.
  11. When you start wining more share from most profitable accounts while sending losers to the competition, you hit volume-driven, price selling competitors adversely in both places. Take winners give them losers.
  12. Consolidated Freightways went bankrupt last fall, and I’ll bet YT’s take the best, give the worst strategy had a lot to do with Consolidated’s demise. I have certainly put distribution competitors out of business with this strategy.
  13. When Consolidated tanked, YT only picked up one sixth of their business which I suspect fit into YT’s niche of customers who are willing to pay more to get a lot better total trucking productivity cost. You don’t want the rest of the customers who aren’t buying what you are selling.
  14. YT has been growing sales in a declining/contracting industry and their profits even faster. For 2003, Zollars is promising to double earnings to $65M on 7% sales growth with an operating profit margin of 7%.

What’s the bottom line for distributors from this story? I think there are a lot of durable goods distributors, for example, that make a 1 to 2% operating profit margin that have a 7% profit line company hiding within their numbers. Do what Mr. Zollars did at YT and get the same results. Our unconditionally guaranteed video will help you get there.


Rebate Rot:

In DCC#s 14.2 and 15.3, I started to monitor the unfolding story and lessons from the US Foodservice’s $500M in bogus earnings problem. In this past week, more information on the case has come to light. To quote a newswire:

"On Feb. 11, Deloitte and Touche asked for an emergency meeting with US Foodservice’s three top executives…that night, CEO James Miller confronted key executives...they were escorted from the building, and their offices sealed until 20 investigators from the law firm (went to work). ..Royal Ahold (the parent company) went public ..that it had overstated revenue by at least $500M over two years…US Foodservice officials said: "It appears that a small number of trusted employees worked outside our established accounting procedures and betrayed the company...there is no evidence (that anyone) stole money or took kickbacks…rather the employees appear to have been trying to improve the company’s performance, and the suppliers ...to keep and expand their sales…thus improving their commissions.

A couple of thoughts:

  1. I think the CEO, Mr. Miller, is more responsible than he has so far admitted. He sets the incentive plans for the top people including himself and must take responsibility for the climate that would induce employees to cheat. Why wouldn’t managers be satisfied with making great money, on average over the long run by running a strategically smart, high performance service firm? It begs the question of why they felt the need to make artificial profits now, knowing that at best they were borrowing them from the next year’s performance.
  2. As boring as accounting is, when there are decisions to make that involve $500M in after tax earnings over a two year time that is big enough and material enough that the CEO should be totally understanding of what is going on. Mr. Lay, CEO of Enron claimed the same thing: he didn’t know that underlings were inventing billions in fake profits. Anyone who runs a company must be involved on accounting decisions that involve big bucks. Because of these two points, I think in reading between the lines that USF is a sick company and will start sliding down.

But, the PR will spin the other way. "In Spite of Scandal, Ahold Unit Throws Party for Its Suppliers" (WSJ 3-31-03) is a good example. In this article you can read about 6000 customers, suppliers and USF sales people partying in Vegas as though "business is going along fine". We will see.

More on the rebate rot theme, another USF article in the NY Times, "At a Food Distributor, Vendors Often Pay to Play"(3-30-03; sorry can’t get a URL for you) peaks into USF’s "Points of Focus". This program is an incentive point system that includes a brochure for all suppliers and monthly statements for sales reps to see how many points they can earn for pushing the products with the most points attached. Doesn’t sound like they are selling the lowest total procurement cost system solution to their customers or creating the lowest total selling cost solutions for USF. I wonder if the sales reps even know what "TPC" is? Why doesn’t Wal-Mart do this with their suppliers (DCC#14.2)? Because it is inefficient, and longer term it leaves the companies that practice this kind of buying and selling vulnerable to those companies that figure out how to create and sell true value through a channel.

McDonald’s Revival:

I have monitored the decline and the reasons behind the decline of McEmpire in DCC#s9.1 and 15.2. This past week McD’s announced that they are putting their non-McDonald’s chains on the block: Chipotle Mexican Grill, Boston Market and Donatos Pizzeria chains. Now, can they get back to being #1 in the quality of the burgers, timeliness and cleanliness which is what grew them like a rocket in the Ray Kroc days. They may have to get rid of some of the financial management oriented suits who have been pursuing false economies of scale through more store openings and lost the ancient service religion culture that made McD’s great to begin with.

That’s enough for this week. Next week we will look at the usefulness of business magazines’ annual performance reviews (not what most might think). Lessons from the NCAA basketball tournament. The follies of manufacturers that forward integrate into channels of distribution. More on the data science of doing more with your core and who knows what else at this point.

Best Regards,

Bruce Merrifield (Bruce@merrifield.com)