April 9, 2003 - Distribution Channel Commentary (DCC) # 19

















April 9, 2003 - Distribution Channel Commentary (DCC) # 19

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THIS WEEK’S TOPICS:

  1. BAGHDAD VICTORY! NOW WHAT?
  2. NCAA BASKETBALL: LESSONS FROM THE ZAGS AND CATS
  3. INSIGHTS FROM BUSINESS MAGS’ 2002 RANKING ISSUES
  4. WHY MANUFACTURERS ALWAYS(?) FAIL AT FORWARD INTEGRATION INTO DISTRIBUTION CHANNELS
  5. BUSINESS INTELLIGENCE FAILURES AND FUTURE PROMISE
  6. SUPPLIER-DISTRIBUTOR BEST PRACTICES SURVEY RESULTS


  1. BAGHDAD VICTORY! NOW WHAT?

We have all been pre-occupied by the Iraq war to some extent for too long. The stock markets have turned into national mood rings fueled by war news and the speculative trading of 6000 hedge funds. But, according to surveys, 92% of US businesses surveyed have claimed that, so far, the war has had no effect on their operations or decisions over the past few months.

As I type this early Wednesday morning, April 9th it appears that the Battle of Baghdad is substantially and gratefully over. It would seem likely that the rest of Iraq’s cities will fall to Coalition occupation very quickly. Now the hard financial and economic story begins. What will the costs be for: the battle; the on-going maintenance of peace; the reconstruction of Iraq; and the solidification of the rest of the middle-East? How will these add to our current twin deficits? Our nation’s foreign trade deficit is running at a third-world, 5% rate of our GNP and our Federal government spending deficit has accelerated past 3% of our GNP and climbing? What will this mean for the economy? The US dollar bubble? And, for our stock markets?

No one really knows these answers for sure. Here are some interesting views though:

  1. The Congressional Budget Office’s latest 10 year forecast for government spending has gone from a $5.6 trillion surplus two years ago to a $1.2 trillion deficit without the full Bush tax stimulus program and $1.8 trillion with the full package.
  2. Goldman Sachs did a similar study and came up with a likely case scenario for cumulative budget deficits for the next 10 years to be a negative $4.2 trillion. I tend to trust their estimate more than the US government’s.
  3. Every year there is a new estimate for the discounted cash flow, net present value for the Federal government’s unfunded Medicare and social security liabilities for the next 75 years. This year that total was best case $23 trillion, worst case 26T. But, they are not assuming any new breakthroughs in medical capabilities and wellness practices that could, of course, increase both life expectancies and new services covered by Medicare.
  4. Back to the present and the cost of policing the world starting with the mid-east, what will that cost? How fast will more oil and lower priced oil become available? What will bigger deficits mean to the value of the US dollar and the net well being of our economy, our companies and our families? A URL for a good article from the Asian Times entitled "A Casualty of War: The Dollar" does a nice job of showing how vulnerable we are on all of these issues. I also like their bigger picture, Asians are financing this perspective. Here is the URL:
  5. http://www.atimes.com/atimes/Middle_East/ED08Ak01.html

  6. As for the markets and the US economy, I think we have already had the war rally. Once the euphoria of Saddam’s fall has past, the markets will focus on the fact that the global economy is probably in a recession. Earnings downgrade announcements for first quarter results are outrunning upgrades by a 3 to 1 margin so far. The same old post-bubble economy structural problems that were in the making since 1982 are still there, and good jobs and capital expenditure investments are still going to China. Plus, we now have to come up with a financing plan for our global police and re-construction work that has just started and a dollar rescue plan by (?) mid 2004. For my views on the post-bubble structural problems see: http://www.manufacturing.net/ind/index.asp?layout=article&articleid=CA286966 and the support notes at http://min.isisit.com/merrifield/articles/1_10notes.asp

2. NCAA BASKETBALL: LESSONS FROM THE ZAGS AND CATS

I watch very little TV and when I do it tends to be snatches of ESPN SportsCenter in hotel rooms while on the road. I have had, however, the accidental good fortune of watching two, different-flavored, ultimate college basketball games in my life. The first game was one that I never thought could be topped. It happened back in 1992 in the early evening on a Saturday in a small Southern town. I had done an all-day, management team session for a regional distribution chain, and couldn’t get a plane back home until Sunday morning. So, I watched what the management team wanted to watch: the Duke-Kentucky game for the Eastern Regional Final Championship game in that year’s NCAA basketball tournament.

Cutting to the finish, the Kentucky Wildcats led the Duke Blue Devils 103-102 with 2.1 seconds remaining in overtime. But Christian Laetner's 17-foot turnaround jumper, probably one of the most memorable shots in NCAA history finish, gave the Blue Devils the trip to the Final Four and eventually the national title. Both teams played their hearts out and matched incredible play making and shooting down the stretch and throughout the overtime to the final shot. How could any future game ever surpass let alone hope to match this game? Well, it happened again this year.

On Saturday evening, March 22nd, it was "déjà vu all over again" (a Yogi-ism) plus something more. I had a W. Coast presentation that required spending the night over, so I again watched what turned out to be my only near-complete game (second half +) of this year’s edition of the NCAA basketball tournament. It happened to be a Western regional contest between #9 seeded Gonzaga and the #1 seeded Arizona Wildcats (popular mascot!). The Zags fell to the Wildcats 96-95 in a double overtime finish that could have gone either way three different times. The play was comparable to the Kentucky-Duke game minus a miracle-ending, winning shot, but this game had a sweeter post-game flavor. In the ’92 game, the sportsmanship was below average. It wasn’t bad, it just had an edge. And, in fairness to both Kentucky and Duke die-hard fans, the context was different. The stakes and expectations were higher. Both were top seeds and favorites to win it all; the game was to get into the final four. We also weren’t at war in ’92 which might have put things into a better perspective for this year’s tournament players.

At the end of the Cats-Zags thriller, both teams were upbeat and sincerely congratulatory towards one another. The Zags showed no regrets, no tears, just joy in having played their hearts out and perhaps thankful that the Cats had made them play the best game of their individual and collective lives; they left the court with great honor and glory even in defeat. The Wildcats couldn’t have been more gracious and were no doubt humbled, but relieved winners. They too seem to show an appreciation for the game that the Zags had forced them to play. Isn’t this what great competitors are supposed to do for each other?

HOW DOES THIS RELATE TO YOUR BUSINESS? I think a lot of US manufacturers and distributors are currently in a very tough economic game. For most distributors’ their value-add is their service, their products are commodities that competitive distributors offer too. The quality, consistency and flexibility of a distributor’s total service value proposition is totally dependent, in turn, upon the quality, commitment, flexibility and coordination of their employee team.

If we all love to watch games like the Zags-Cats contest and soak up the statistical story along the way, why can’t we keep score, play hard, do ever better and have fun in the game of business? Don’t all businesses need their players working together in a motivated, excellent way? Isn’t that what a team of company players would prefer to do? Well then, why don’t 97% of privately held distributors withhold the scoring statistics of the game from their players? They don’t:

  1. Share general financial numbers with employees and let them know how they are doing as far as:
  2. a. gross margin$/employee on an annual basis (value-added/employee is what supports premium compensation for jobs done).

    b. Profit after tax/employee reinvested to grow the company and the employees’ future.

  3. Know or share basic service metrics that are tuned to target customer niches so that employees can know how well they are taking care of the customers that in turn take care of them by staying loyal and buying more.
  4. Tell the employees who the top 5 most profitable customers are along with the top 5 most important target accounts so that anyone can step up to give an extra service effort for these customers if given the chance.

If the 97% did let the employees know these things and what’s in it for them, then, the employees’ interest, energy, cooperation, pride and results could all take off. Watching a great game is fun. Being on a winning team everyday is a lot better. Why don’t the 97% of the firms getting mediocre to poor financial results, give the employees and the company a chance to do a lot better? Our video, "High Performance Distribution Ideas for All" dedicates 12 modules to: educating all employees about the ABCs of corporate finance; where labor rates come from; and, what they have to do to be part of the higher wage, better future, total company performance solution. (More info on the video at our site.)

3. INSIGHTS FROM BUSINESS MAGS’ 2002 RANKING ISSUES

In late March of every year the major business magazines – Forbes, Business Week and Fortune – come out with their annual, public company, performance-ranking issues using the previous year’s numbers. Well, the 2002 ones have now all arrived at my house. These issues are unusually thick because lots of data tables provide more pages of cheaply generated "editorial content". The content then allows lots more pages of advertising to be included. And all of the ranked and featured companies are hit for ads. So, you can see why the other two magazines knocked off Fortune’s "500" idea that they started in 1955.

What value do readers get from these issues? I don’t know in general, but I do know that I have mixed feelings about their value. I always skim through them like I do all other issues. A lot of the data is interesting, but not actionable. Some of the general themes and conclusions are old news. But, there are always a few interesting things that I notice. For what it might be worth, here are some of my observations from this year’s crop.

  1. The original emphasis on these rankings was "who’s the biggest". I think this preoccupation with quantity over quality is a dis-service to the business community. There are naturally too many ego-driven, volume is vanity executives in business to start with. These rankings tend to lionize the importance of being big and having profitless "market share" due to over focusing on product-driven, volume strategies. I wish there was more emphasis on "profit is sanity" and which companies have developed long-term, sustainable profit power for the benefit of all of their stakeholders.
  2. Over time these reports have done a better job of at least putting in columns for 10-year total return to investors and longer-term average return on equity ratios, but those measurements are still after thought reporting tacked on to who’s the biggest.
  3. The yearly rankings by individual companies don’t, after all, tell you very much. For sales, GM and Exxon have been at the top of the list since ’55, and now Wal-Mart will be there for the next 10 years at least; so what? For annual rankings by profits or return on equity, one-time merger or accounting events explain why the very top and bottom companies are where they are.
  4. The industry sector averages do a better job of illustrating general themes. "Diversified wholesalers" are industry segment #67 in this year’s Fortune report. There are 15 companies with total sales of $39.8 billion and total profit of $336 million -a very slim .8% PAT ratio – where are the economies of scale? And, W.W. Grainger’s profit of $212 million was 63% of all of the profits for the group. What is WWG’s unassailable niche(s) and source of sustainable strategic profit power capability? These reviews will never tell you. Because of size matters cut off levels, the Fortune’s rankings didn’t include MSC Industrial Direct Co. which has a higher profit margin than WWG. MSC (NYSE symbol MSM) only did $830 million in 2002, but they made $44.8 million in profit, a 5.4% rate that exceeds all 15 companies in Fortune’s segment #67.
  5. Fortune’s Industry segment #68, "electronic and office equipment wholesalers" (Ingram Micro, Arrow, etc.) has 15 companies which totaled $86.5 billion in sales and ($1.5 billion) in cumulative losses. These industry segment totals do help you identify which industries are floating everyone up or down, which we already knew if we are in them, and not much else.
  6. All three magazines try to put a spotlight on a few companies that are notable for either long-term, exceptional results and superficially try to explain why; or they spotlight companies in trouble and share their turnaround prescriptions. These articles can be interesting, but if you want real reasons why companies do well or badly check out the two books that Jim Collins authored ("Built to Last" in ‘92 and more recently "Good to Great").
  7. This year both Fortune and indirectly Business Week correctly, in my opinion, put the spotlight on Cardinal Health based in the Columbus, Ohio area (Dublin) and run very ably for 32 years by its founder, Bob Walter. The Fortune article is not very insightful about why and how Cardinal has been so super successful for so long, but everyone should still read this short piece to at least put Mr. Walter’s story and style on your radar screen. Here is the URL:

    http://www.fortune.com/fortune/fortune500/articles/0,15114,437549,00.html

    Business Week’s indirect coverage of Cardinal is through a drum-up business review for Mercer Management Consulting book by three of their partners. The book is entitled, "How to Grow When Markets Don’t", a timely enough title. There is a more complete review of both the book and its views on Cardinal in Fast Company’s latest issue. I recommend this review/article with the following caveats. The key concepts the authors push are compelling and are potentially correct in a theoretical sense. But, the channel conflicts of getting out of your core space and forward integrating towards the final customer with innovative products and services to boot are quite real. Executing innovative moves in new business spaces that you haven’t been in is doubly risky. And, most businesses must first reinvent their core businesses first. No business should diversify into other games when they can’t perform the best at their old one. Here is the URL for the Fast Company article:

    http://www.fastcompany.com/magazine/69/growth.html

  8. Sometimes these annual performance magazine issues, in an effort to be different, run some ratios that are, for me, helpful benchmarks. I noticed such an opportunity in this year’s Forbes issue regarding "Productivity per employee". In distribution businesses, a key North Star ratio for my high performance personnel methods is "gross margin/employee". A CEO should also keep an eye on "after-tax profits reinvested/employee" as an indicator of how much is being reinvested into the company to support future growth opportunities for all stakeholders. Key standards that I have always aspired to for a high-performance, high growth company have been: 20% pre-tax return on total assets; 2 times the channel average for "GM$/employee; and $5k in profits re-invested per employee per year.

On page 165 in the 4-14-03 issue of Forbes, there is a little box with personnel productivity numbers for 10 companies from different industries. The 5-year, average profits per employee ratios that were closest to a distributor’s business model were: Autozone at 6.8k; Lowe’s at 11.8k; and Target at 4.8k.

4. WHY MANUFACTURERS ALWAYS(?) FAIL AT FORWARD INTEGRATION INTO DISTRIBUTION CHANNELS

The book review mentioned in #3.6 above also covers how John Deere has brilliantly forward integrated into the irrigation distribution channel. In the article/book they refer to the new division as the "John Deere Landscape"(JDL) division. I haven’t read the detailed coverage of this foray into a distribution channel, but from the article reviews it doesn’t smell very good to me. Here’s why:

  1. Deere quickly bought up a few consolidator chains within the irrigation channel in the last few years. I am assuming that they pay some fast operators ’99 –’00 valuations for these deals.
  2. The article/book touts the big innovation as having the parent organization offer through the JDL division "low-cost credit" through the JDL contractor customers to the final customer for financing "landscaping projects". It sounds like GE credit corporations strategy for every piece of equipment GE divisions made over the past 15+ years, but sale-lease back deals on jet aircraft engines plus the rest of the plane to major carriers was a huge, great ride. I don’t think GE’s $26 billion in leases for aircraft being parked in the dessert by bankrupt carriers is looking so promising going forward. Now, how about contractors selling and extending financing for commercial landscaping jobs in this post-bubble economy. It looks like buy high, sell low through flaky third party people into a tough industry with big credit default problems to follow.
  3. And, what about running the distribution companies in lots of cities over the long-haul and getting a decent return on the big price paid for them? Manufacturers have tried to forward integrate into many different channels over the past 40 years with overwhelming poor, operational return results for several key reasons:
    1. The factories push volume so hard that the downstream distribution companies shift to big volume, low-margin contracts that yield breakeven financial results at best. Selling the parent company’s full product line wins over putting the best one-stop-shop assortment of local stock for target customer niches comprised of many suppliers that may have some marginal overlap in product line offerings.
    2. The manufacturing parents impose a political, career path and incentive structure on to the distribution division which militates against attracting and keeping good and effective branch managers at the distribution locations, so service quality gradually erodes and costs and inventory rise for the job that isn’t delivered.
    3. Because the factory sales force can take the captive distribution division’s business for granted, they spend more time wooing and dealing with independent distribution companies that compete with the captive distribution division. There are two types of channel conflict pushback. Suppliers that are mostly complementary to the forward-integrator may still shift their energies to the independent distributors, and the independents only buy opportunistically from the forward-integrator, because they don’t want to help the parent of their competitor.
    4. When buying into a distribution channel works for a manufacturer it is because there is a super-tough division executive who can both shield the captive distribution division from all of the handicaps and run an excellent operational show. Then, some new CEO comes into the parent organization and notices that 20-50%+ of the distribution divisions volume is with overlapping competitive supplier lines, and the independent distributors are under-buying from the company, because of the channel conflict problem, so they sell it; often to the executive team.

I won’t bore you with case studies on how manufacturers tried and ultimately failed or permanently fizzled at forward integrating into the following types of channels: paper, steel, chemicals, electrical, candy and tobacco, building products, etc. What’s interesting is how, in some of these cases, the lessons that were learned in the 60’s and 70’s were forgotten and new manufacturers are trying to do the same thing in the same channels again in the late ‘90s.

Here are a few recent additional items that I have come across regarding manufacturers doing a creative forward-integration move:

  1. Ford has huge financial and some operational problems right now that include a recent purchase of the equivalent of a Jiffy Lube type company in the UK. After the acquisition, Ford became aware of big conflicts with their independent car dealers in the UK who perceived that the lube chain was a big competitor of theirs.
  2. I found a Mercer Management Europe, slide show on the web that has sexy graphics and high concepts to illustrate why European car manufactures should forward-integrate into the car channel and re-invent what the dealers do with all kinds of new service schemes for the final consumer. It’s the same high-concept stuff you will read about in the article/book review that includes the John Deere forward integration story. Too bad it doesn’t work for the long haul. I wonder if Ford Europe drank this Mercer Management Kool Aid before buying the lube chain? Here is the URL for the slide show:

http://www.pret-a-press.de/wolfgangseeger/download/MercerAutomotive.pdf

5. BUSINESS INTELLIGENCE SOFTWARE SHORTCOMINGS AND FUTURE POTENTIAL

I have had a number of distributor execs who have bought the "High Performance.." video inquire about what they should do if their computer system will not do customer profitability ranking reports or if their "business intelligence" (BI) package will not track service process metrics. I first would refer all similar inquiries to an article of mine posted at www.merrifield.com entitled "Data Into Dollars? Not Yet!" (Note: all of our articles are now posted at our site!) The URL for the "Data" article is:

http://min.isisit.com/merrifield/articles/2_18.asp

Even if a software firm that targets distribution users within a common channel has a good fitting BI module, it can’t offer more than about 50% + of the numbers that a distributor would need to run a high performance distribution company. The BI package could, however, offer spreadsheet templates that would allow distribution locations to feed in daily service process metrics that could then be:

  1. Trend tracked and graphed.
  2. Polled, compared and re-shared back amongst all branches for internal benchmarking purposes.
  3. Used as both a catalyst and a structural discipline tool for getting all branches on a continuous improvement, service excellence path.

For now, I recommend that video users review the ideas and details in the modules on "achieving perfect service" (M 4.1-13). For those who don’t have the video, some articles at our website that touch on the perfect service steps of – defining, measuring, achieving, selling, getting paid for and leveraging (partnering with) basic service excellence- are numbered 3.1, 3.9, 3.5, 3.8, 3.2, 4.2, 2.5.

I have done a little work with two software firms to help them begin to tune their BI packages to work with our video’s strategic productivity plays involving measuring customer profitability and the seven different plays that fall out of that one mega application. Plus, we have discussed additional measurements that will allow a company to determine how well they are retaining and further penetrating core accounts with high flow-through profit items. Here are some metrics to think about:

  1. A ranking report of customers from high to low by the total number of unique items that a customer bought from you on an annual basis. Wouldn’t the customers at the top be potentially buying a huge, semi-customized one-stop-shop array of items from you with great lowest total procurement cost benefits and high switching costs? So what?
  2. A ranking report of customers from high to low by the average line items (to the hundredth decimal point) per transaction. Wouldn’t the customers at the top tend to be the ones with very disciplined internal re-ordering systems? Or, your sales rep may be maintaining the system? The kind of people who go to the grocery store far less frequently with a detailed, systematically generated list are more profitable than customers that have emergency, stocked-out, small, one-line item orders. How do you find and help these customers increase lines per invoice as a result of better re-ordering systems?
  3. A ranking report of customers by "profit factor" which is the average GM$/transaction times the average GM% for the account. The ones at the top give you big average order sizes at pretty good margins; the bottom ones are giving you small orders at low margins and are big losers. Rank your sales reps territories by this factor; you can see an example of this in the ABC Bakery Supply case study in our e-booklet or at this URL: http://min.isisit.com/merrifield/articles/2_19cs.asp.
  4. Ranking customers by the number of special orders they place for the year along with columns for average GM$/invoice and GM%. For the ones with high enough averages to be very profitable do some extra services for them that will induce them to give you all of their special orders. (DCC #14.3; click on the March 5th issue under our "commentaries" button at our site for the two solution services)

6. SUPPLIER-DISTRIBUTOR BEST PRACTICES SURVEY RESULTS

In tough times suppliers and their distributors can go two ways. The unenlightened path is to try to minimize profit declines at the other’s expense (beggar thy neighbor). The enlightened path has two options: make yourself internally more effective and therefore valuable to your customer; and/or work together to take cost out of the buy-sell process (like Wal-Mart).

To help address the productivity of channel partners within the power transmission channel, the Power Transmission Distributors Association (PTDA) compiled a list of best practices or golden rules for their members to follow along with case studies. Here is the URL for the list followed by a few comments.

http://www.ptda.org/members/bestpracticeslist.htm

As you look over this list you might try these thought experiments on a few different grids:

  1. Put your 5 best core customers and your 5 best target customers in columns to the right and think about, then ask them, how you are doing on some or all of these issues and which ones are of A, B, and C importance/value to them.
  2. Put your top 3 to 10 most important, long-term suppliers in columns to the right of these practices and rate them on how well they do. Rate the value of these practices to you either generally or by supplier if necessary. Could this rating system serve as a productive agenda for a honcho to honcho visit on either the supplier or customer side?
  3. In PTDA’s first case study, which is reprinted at Industrial Distribution online (here is the URL: http://www.manufacturing.net/ind/index.asp?layout=article&articleid=CA286966 ), the best practice is "your people are accessible". This reminds me of an extra service I stumbled on for printing customers in my printing paper distribution days in the ‘70’s. I was then the chief operating officer of a mid-west distribution chain. While on a team-selling call a big printer PA at a core customer for one of our locations told me that we were slow with "price and availability" quotes which made, in turn, his estimators slow in bidding rush jobs from both old and new customers. We immediately got our local paper buyer out to see our top 5 printing accounts and gave them our buyers direct access number along with a guarantee that we would get them "P and As" faster than anyone. We did and our business exploded with the customers who had told us we were already getting the lion’s share of the business. The truth of the matter was, our customers were getting more rush jobs, because we both were doing a better job of quoting faster.

That’s all for this week! Hope you found something worthwhile in this commentary. If so, please tell others to check out this service at www.merrifield.com. If you have questions or comments on any of the commentary, we are always delighted to hear from you. Don’t hesitate to email me with your thoughts.

Next week, I will have some summary material on the "art and science of defining and mapping out your competitive strategy" so things like balanced scorecards and BI software can really start to work for you. I will start to put a spotlight on some high performance personnel issues and more.

Best regards,

Bruce Merrifield