Commentary #20 April 16, 2003

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THIS WEEK’S TOPICS:

  1. WAR CLOUDS GIVE WAY TO ECONOMIC RECOVERY?
  2. DON’T READ THIS IF YOU HAVE TO FEND OFF ALLIGATORS J
  3. WHAT IS YOUR "MOST PROFOUND ECONOMIC INDICATOR"


  1. WAR CLOUDS GIVE WAY TO ECONOMIC RECOVERY?

Whether you buy into the rightness and timeliness of the Iraq war, the US military has done a wonderful job. Now new concerns will fill the headline news like: the cost and dangers of keeping the peace in the middle-east and rebuilding Iraq and SARS out-of-Asia. But, aren’t all of these current negative events false causes for our economic malaise? Why do the experts and the media not see the big, structural, economic problems of the global post-bubble economy plus the implications of China, India and Russia joining the free market system?

Will occupying Iraq be enough to turn-around a secular bear market and spark a sustained, normal recovery that actually creates a few new jobs here in the US? Here’s some horse-sensical data to consider:

  1. A panel of 54 "economic experts" has downsized their forecasts for US economic growth for the first quarter and the rest of the year by about 40%. On Jan 1st their average growth expectation for Q1 was 2.7%, now it is 2.1%; their Q2 forecast has also been revised downward from 3.2% to 2.1%; but, they are holding firm with 3.75% growth for the second half of the year. This is the third year in a row that things have been forecasted to pick up in the second half. What do you want to bet that we will have a 3.7% type-growth rate in the second half? If you are a bottom 90% distributor performer that is averaging a 5% pre-tax return on assets (DCC #10.1), shouldn’t you be reinventing your core strategy regardless of whether our malaise continues or not?
  2. Goldman Sachs released a report on the history of forecasting accuracy which showed that never have the expert forecasts been so wrong (to the positive side) for so long (the last three years). This suggests that the forecasters’ assumptions and their data-based models seem to be out of sync with some new structural problems within the global economic system for which they haven’t correctly adjusted. My summary view of what’s different and what to do about it are both in article 1.10 and its support note at http://www.merrifield.com. And, if you would like to check out a short article on what the "Economic Cycle Research Institute" has to say about this trend toward worse forecasting go to their 4-5 article entitled, "Forecasts at Turning Points":
  3. http://www.businesscycle.com/showstory.php?storyID=518

  4. CEOs and consumers apparently don’t feel as bullish as the forecasting experts. Two surveys by the Business Roundtable (the 500 biggest company crowd) and the National Federation of Independent Businesses (little guys like most distributors) showed that 10% and 6% respectively were planning to hire more people in ‘03; while 45 to 50% were planning layoffs and the balance were staying the same. Check out the NFIB home page and the survey results at: http://www.nfib.com/PDFs/sbet/SBET-33103.pdf.
  5. The big guys with 75% capacity utilization (dipping to 74.5% this past week) were planning negligible capital expenditure for expansion in the US. Perhaps some direct investments are going into China and India, but that won’t help the US economy anytime soon. (More on this in e below)

  6. Consumer confidence and spending can bounce around these days depending upon war news and which big items are significantly discounted along with zero percent financing, but generally their balance sheets are leveraged to the max and their monthly cash flow is more than 100% accounted for. Here are some recent stats: according to Cambridge Consumer Credit Index: 6% of credit card holders are currently making no monthly payments and 40% are making minimum monthly payments. Why would anyone pay 18% annual finance charges? Maybe because they have already maxed out on the refi-capacity in their house and their home line-of-credit? How can we have a recovery when there isn’t any pent-up demand with consumers or corporations? Can we have the biggest economic bubble in history with a short mild-recession while total debt for our society continues to grow much faster than the underlying economy? Won’t consumer confidence crumple if the 2+ year unemployment and underemployment trend continues? The leading indicators – announced layoffs, want ads and foreign investment plans- suggest to me that the unemployment trend will continue.(?) Read on.
  7. Jobs seem to be the new leading export commodity for the US economy. We lost over 400,000 in the first two months of this year while China’s factory production rose 17% in January over a year ago. A specific case in point might be Stanley Works, the largest US maker of tools; they announced on 4-9 that they will lay off (another) 1000 workers, close four plants and five warehouses. What do you bet they have been doing capital expenditure investments in China that is creating jobs over there? Can you see how US companies can report great productivity improvements per worker here as they harvest their businesses? Can you see how they will still continue to suffer earnings hits for pension cost commitments, because they have a constant number of pensioners with fixed and rising (healthcare costs) no matter how many people they lay off?
  8. Here’s another related news tidbit. Deloitte Consulting published a survey on 4-9 that found that 100 of the world’s top financial companies plan to transfer $350 billion of their cost bases abroad over the next five years. Nearly half of this money will go to India.

    Let’s do the math for China and India. Together they have 33% of the world’s population who are highly-educated, English-speaking and dying to work for far less than US workers. Both countries have zero to negligible regulatory and social-political overhead costs. With the cold war ending in 1989 (fall of the Berlin Wall) the birth of the Internet and shared common data bases, it has taken these countries (throw Russian into the mix too) a few years to become hospitable for free market capitalism. Now they are in the acceleration part of the life-cycle. This adds up to a mega-trend that will be rocking our world for 5 to 10 years to come. Can we reinvent ourselves, our businesses and our new technologies in order to create new sources of jobs and wealth faster than these giants eat up our old sources of margin, wages and profit power? Will consumer confidence and the borrow-more-to-spend trend keep up in the face of rising unemployment and under-employment?

  9. And finally, what are you assuming for the longer-term valuation of your company? Will the roll-up offers
    from the late ‘90s come back anytime soon? Is the Dow currently rallying back on the track to "Dow 36,000"? Last week the S and P average closed at a valuation of 31x the last 12 months earnings with an average dividend yield of 1.8%. No bull market has ever started from such extremely high valuations. Warren Buffet isn’t buying this market, are you? (DCC #14.5) In private markets, company valuations are still dropping. A former dot.com era flier, BowStreet, moved from Portsmouth, NH to Boston to get better rent and access to more talent along with another downsizing of staff. The company in its prime raised $140mm in venture capital putting fantastical values on the company. They recently did, however, a 5000-for-1 reverse stock consolidation. This left a group of employees who had been encouraged to exercise their options at pennies a share a couple of years ago with a new paper loss along with a pink slip.

Maybe everyone who is tied into the long-term value appreciation of a wholesale distribution business should stop hoping for higher multiples and focus instead on generating real, free, cash flow with real dividend paying potential. How do we do that? We have to define and achieve a sustainable competitive advantage built on the right customers and suppliers that will in turn create sustainable profit power? Sales volume, more or less, will then be a by-product of retaining and penetrating the best, right customers for our strategy. How can we get "MORE FROM OUR CORE BY ‘04"? Buy our unconditionally guaranteed video, "High Performance Distribution Ideas for All". Read "what executives are saying about it at www.merrifield.com. And, read the rest of today’s commentaries including the 8 annotated slides hotlinked in #2 below!

2. DON’T READ THIS IF YOU HAVE TIME TO FEND OFF ALLIGATORS J

A manufacturer who has developed a great, heavily subsidized service to improve his distributors’ bottom lines was lamenting to me recently about how he couldn’t get any of his better distributors to subscribe to his offer. "They don’t seem to have time to read, talk or think about anything new." And, I thought it was a great offer!

During the past week, I also had a distributor friend ask me for a "simpler" solution than what I have been writing and speaking about. He kiddingly, said: "You know, the old silver bullet that really works". After discussions with both the savvy, frustrated supplier and the harried distributor customer, we reached these conclusions:

  1. The average distributor: has made one to three rounds of cuts or freezes in costs and payrolls; isn’t making enough money; is worried about business volume contraction; is feeling poor due to valuation drops for their company, their investments, their retirement fund(s). THEY ARE WORKING 110% HARD and feeling burdened with every employee's expectations upon them to make things better not worse.
  2. Distributors have accumulated a lot of losing: sales activity, dead items in the warehouse and employees who would not pass the "if I could hire this person all over again knowing what I know now, would I hire them test?" But, they don’t have the ready tools, time or total team comprehension, commitment and coordination to tackle accumulating, systemic mistakes, when….
  3. Personnel capacity (including the wouldn’t hire again ones) is stretched to the max just taking care of daily activity with not enough time to take care of all of yesterday’s mistakes and today’s surprises. (And, the good ones are being over-worked (exploited) and might consider leaving if anyone else was hiring.)
  4. There are even hidden, potential viscous cycles in this activity trap which we won’t go into. Let it suffice to assume that for most distributors there just isn’t any slack resources for proactive measures, no extra time, talent, cash, confidence, etc. to invest.
  5. In conclusion, the old saying applies: "When you are up to your keister in alligators, it is hard to remember to focus on draining the swamp where they are breeding" (perhaps at an accelerating pace!).

HERE ARE MY BEST, SIMPLE SOLUTIONS IDEAS FOR ALL ALLIGATOR WRESTLERS:

The best, fastest, first-step that I know of for: increasing a distributor’s profits, often increasing volume, and decreasing transactional activity costs to free up a bit of operational slack is to turn the LEAD ACCOUNTS INTO GOLD application which is one of the seven plays that comes out of doing a simple profitability ranking report. But, after that one application, 90%+ of all distributors will need to use some of their new found slack to do a better job of describing their true strategy ("maps") which is also enormously aided by the customer profitability ranking method. For more, on lead to gold, read DCC #12.3 (case study, especially points 6 and 7; AND, #20 DCC 04-16-03 slides (THE 8 ANNOTATED SLIDES

P.S. If you can’t do the simple "PBIT" (profit before interest and taxes) ranking reports that I describe, then compute the average "gross margin $s per transaction" for each account and sales territory and ideally rank by that number. High averages are profitable, lowest ones are unprofitable.

For any big turnaround to progress beyond the lead-into-gold play, a team of at least key employees must gain a comprehensive understanding and commitment to tackling systemic inefficiencies. The short case study story (in an email I received) that follows illustrates this point.

"Hi Bruce,

I attended a class of yours at last years _______ Software User conference (early May ’02). At that time, I purchased your "High Performance Distribution Ideas for All" video kit for our company. Because our software lets us run off the "PBIT ranking reports" for customers and sales territories, we did that right away. The results were startling to me and all of our managers, so I told everyone to do the tapes on their own time to find out what to do about the big winners, the big losers, the little losers, etc. Nothing happened. Most of the team watched a few of the modules at best and went back to normal activities. Approximately 45 days ago (mid-February ’03), we started viewing the tapes every Friday morning between 6:00-7:30 AM with the complete management team present.

Now, we are not only gaining a tremendous amount of information, everyone looks forward to the weekly gathering dubbed "The Bruce Meeting". We are currently watching the modules where you discuss TPC (Modules 4.11-13). One of our team members asked how you would handle the "I don't want to put all of my eggs in one supplier’s basket" objection from some of our customers.

The entire team would greatly appreciate any help you can offer to this question. We look forward to your response.

From: A Building Supply Channel Executive"

COMMENTS ON THE LETTER:

First: to answer the "all in one basket" question, I suggested that he read article # 4.6 at our web site entitled "Is Relationship Marketing Appropriate for Your Firm? It has been a very popular and widely published (in trade journals most people have never heard of) article, here is the direct link for it:

Second: I have seen a number of cases in which distribution execs have looked at newly printed "PBIT ranking reports" for the first time and not said much or started to quibble about "how this can’t be right, (the underlying economic assumptions are wrong)". Few actually bother to ask about the economic assumptions behind the report, they just dismiss the analysis on the intuitive assumption that all of their past work can’t have been as misguided as the report suggests: data free rebuttals. They all then continue doing what they have always done. All big paradigm shifts in history were initially ignored in exactly the same way. For example, Darwin’s idea of evolution instead of the Bible’s creation story; Galileo’s conclusion that the Earth orbited the sun; etc.

Third: On their own, most people "don’t have the time" (or the will) to practice good health habits even though they intellectually understand why they should, but they can do it with the collective will and enthusiasm of training partners and a coach. In this case, the CEO is the coach. The team has made the time out of their personal lives and their sleep time (not their too-busy work day) by meeting before work at 6 to 7:30 AM.

Fourth: Most radically new ideas have to be reviewed, discussed, comfort-zoned and revisited in a number of inter-related, inter-connected ways before we are willing to pursue them. Often this is because maintaining the present state of things is such a bad alternative. If the first steps are "cheap, easy experiments with little downside", why not? In this case, the first steps are a few Friday sessions to see if interest could become self-fueling, which it apparently was. The video modules provide both the content and the methodology for getting on and staying on a transition path process towards transformational change implementation..

Fifth: This CEO took a very unusual, proactive step; he bought the video and ran the PBIT ranking reports for a "shock and awe" experience. (Only about 5% of the CEO’s at the same user’s conference have bought the tapes so far. Are the rest too busy and in a 100% no spending mode? What’s interesting is that the cost of the video is peanuts (and returnable for 30 days) in comparison to the collective hourly value of the management team’s time for just one management meeting. (In fact, maybe watching and discussing video modules at normal management meetings is a good way to get a much better return on the invested time most distributors are unconsciously paying for their current meetings.) Perhaps thinking about going from "good to great" isn’t about the investment cost, but human emotions and inertia. We don’t want to admit we have been working hard, but ineffectively. Isn’t it easier to hope that the economy and our company results will just get better in the second half of one of these years to come?.

Finally, here is the simplest, shortest (8) slide(s) show that I can think of to get better results; it’s entitled: "Getting From Surviving to High Performance". Here’s the link:#20 DCC 04-16-03 slides.pdf>

3. WHAT IS YOUR "MOST PROFOUND ECONOMIC INDICATOR"

For regular readers of this commentary series or visitors to my web site, you may have gathered that I have heavily endorsed the book "Good to Great" (G2G) by Jim Collins. For people unfamiliar with the book and the author, read the reviews at Amazon.com. It was published 18 months ago and is just now experiencing the sharpest sales rate of its lifecycle (currently the #4 overall best selling book at Amazon with 143 reviews averaging 4.5 out of 5 stars).

If you missed my two articles that adapted G2G’s 7 principles and specifically its concept of "profound economic indicators", you might want to skim these two articles at out site:
"Good Wholesalers to Great Ones"(#2.14) 2_14.asp
"E=MC2 Measurements for Distributors" (#2.16) 2_16.asp

For a fresh dose of inspiration, I recently came across two articles that touched on the "profound economic indicator" guideline for achieving greatness. But first, what’s the concept?

Jim Collins and his research staff noticed that at all 11 of the companies that they discovered as "good to great" ones, each had an unusual measure (two or few) for success that was a very deep an elementally connected to their strategy. Walgreen’s, for example, had come up with a way to measure PBIT/customer/visit at their most convenient store sites and design.

I recently came across another example of this profound measurement concept that is unrelated to the G2G study; it is Harrah’s Entertainment Inc (a low roller, casino chain story). They invested in a very fancy "yield management" measurement system to retain customers at a better rate than the industry and pursue increasing their gaming win per room ratio by 15%, a huge number for their industry. Harrah’s has gone from a has-been to increasing sales 5x in 5 years and profits even faster. For the latest quick reads on both Harrah’s story and Collins check out these short, inspiring articles:

  1. "In the Hot Seat" (column featuring Gary Loveman, CEO of Harrah’s) in Fast Company’s Feb. ’03 issue, here’s the URL: http://www.fastcompany.com/magazine/67/inthehotseat.html
  2. "The $1000 per Minute Man" (on Collins) in Forbes 4-28-03 issue, p.68. You can go to forbes.com, click on the current issue and then the article, but then you have to fill out an online registration form.

How do we relate the profound measurement ideas to wholesale distribution? In my E=MC2 article, I identified two measurements which will get 100% of employees focused on what I believe is the quickest way to strategic alignment:

    1. gross margin $ per year/employee; and,
    2. PBIT/customer per strata (assuming you sub-divide a customer segment into 4 strata that must: be sold, serviced, priced and termed differently for each to be profitable.

These measurements by themselves will not suggest, however, all of the turnaround, revival plays that an organization should pursue to raise these key measure and company profits dramatically. (Our video does!) Nor, will these measurements give you the sustained motivational energy that a company will need to become and stay a high performer. (See the slide show hotlinked at the end of #2 above for more on the total strategy map system that you will need.)

I would now like to dig a little deeper in search of measurements more "profound" than the two "north star measurements" above. Regular readers (or new ones that go to our site and read articles #ed – 2.15, 2.3, 2.19 and case study for article 2.19) will find that customer profitability is strongly correlated with big annual volume at an average gross margin $/transaction well above the company’s average cost per transaction. (Companies that focus on cash-n-carry business and/or catalog sales – D and C strata accounts within a customer segment – can make good money on big volumes of smaller orders with a different business model that stars: higher margins, profit mark up on unbundled freight charges and customers doing some of the value-added services for themselves. But, the margin $/transaction must still exceed the cost/transaction to make a PBIT/transaction!)

If we scratch our heads and try the "5 whys" analysis technique (DCC #16.4) regarding larger average order sizes, here is one logic path that emerges:

  1. Why do some customers average larger order sizes?
    Answers:
    1. They are bigger and consume more;
    2. They buy more items from us that we happen to have in stock (or did they command us to stock them?). If we have lower fill rates, then we will have lower average order sizes along with more back orders, inter-branch shipments and buy out transactional activity cost for both parties. We will have higher defection rates of customers, and we won’t be able to charge firm or higher margins.
    3. They buy these items together in a disciplined, systematic way that builds to a larger order. At the other extreme, we may have some customers who use a zero-and-I-need-one-now reorder points that creates a lot of money-losing, emergency, stress-building small orders for us. They of course are suffering higher paper work, expediting and down time costs for lack of inventory on hand.
    4. They have a business model that consumes our products on a much more steady, predictable basis, than a customer that must quickly respond to a large variety of needs on a quick-response basis.
  1. Why don’t we then target: bigger customers within a niche of customers that all buy a lot of our core items that we buy well and for which we can tune to high fill rates. These target accounts should also have predictable consumption patterns with internally disciplined re-order systems that minimize both on hand inventory and out-of-stock emergency small orders?
    Answers:
    1. We never thought about customer profitability based on bigger orders for best items on a highly routinized basis even though that describes perfectly our most profitable customers.
    2. Our sales force compensation is based on any margin dollars sold to any customers, we never thought of limiting them to selling best targets on a systematic basis or giving them a modest incentive to help educated and organize the customer to buy bigger at a lower total procurement cost.
    3. Our marketing promotions have been product volume driven which encourages us to sell a little of the promotional item to all old and new accounts not just more old or new items to best old customers on an ever improving system basis.
  1. Why don’t we start ranking and measuring customers by line items per transaction, because if they have a highest total, then:
    1. We would be minimizing our total transactional service costs AND minimizing their total procurement cost; A TRUE WIN-WIN!.
    2. We would know that we have high, everyday fill rates for the accounts on top. Can we identify a sub-group of homogeneous customers that buy a common group of items which makes them also our best performing items? Are there other customers in this niche we should go after to sell a total system value proposition to?
    3. The high-rankers probably have internal, disciplined re-order systems; how did they evolve? Can we use them as case study testimonials for both our sales force and other accounts as to what is possible with system selling and buying?
    4. If you combine points a-c, wouldn’t the high rankers be getting high co-created value from us which should support last look and a little more margins and/or increase their perceived costs of switching to another supplier and having to re-create these coordinated economics? Maybe we should point out these sometimes hidden economics to them before a new PA switches for a lower price or thinks a reverse auction is equal to a better "win-win" deal?

Answer:
a. We have never done it that way.

  1. Why don’t we invest some energy in doing a little R and D with the data that is stored on our system. If we rank customers from high to low, great winning freak accounts will be at the top and freak losers will be at the bottom. Couldn’t we learn something from the black and white contrasting of the two sets of accounts?

Answers:

Dear Reader: If you are still with me, what would your answers be to this question. If you would like a few more ideas for this analytical path to measurement profundity, consider:

    1. Ranking all accounts at a location by lines/transaction. In other columns of the same report, compute, if possible, the total – sales, margin dollars, average margin$/transaction, total number of unique items bought over the period.
    2. Do rankings for each sales territory and compute an overall average lines/transaction for each territory.
    3. What might you do to help your organization sell more core items to more core customers on a more systematic basis with highest, most effective fill rates in the marketplace.
    4. How you might educate and motivate both the sales force and the customers to work together to improve the routinization economics for both parties.

If anyone out there wants to pursue this path further, just let me know!

That’s all for this week.

All the best,

Bruce Merrifield