• May 14, 2003 - Distribution Channel Commentary (DCC) # 24
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    The stock market is suppose to reflect common foresight six+ months into the future, so after churning sideways to up for the past three weeks, does it see a second half recovery that the experts have been forecasting for three years? First, a few of many possible caveats:

    1. The Japanese stock market had a number of big, impressive bear market rallies since ’89 when their stock market bubble finally popped, but on average it is now at a 20 year low. Is our market in the throes of its own bear market sucker rally orchestrated by the hedge fund traders that have been dominating the markets volatility over the past year?
    2. If the economy were starting to warm up, both long-term interest rates and the US dollar would be going up, not down; what are these strange counter-trends telling us?
    3. Recoveries can’t happen in the US economy if there isn’t pent-up consumer demand for autos and houses that can be fueled by personal balance sheet savings and better employment-wage prospects, but, the exact opposite conditions exist. Massive increases in the money supply to keep interest rates low over the past few years have fueled both the auto and housing buying bubbles putting consumers in a record personal debt situation. Meanwhile, jobs are leaving for China, India and other new global economy players faster than we can create new ones based on new technologies.

    In sum, the big post-bubble structural problems that our economy faces, as detailed in our "post-bubble economy" article ( 1_10.asp) and support notes (#1.10- 1_10notes.asp ) are still in place. Borrowing more at all levels of our economy to spend our way to prosperity can’t work. I continue to advise all distribution firms to rethink their strategies around the productivity plays that are derived from customer-centric, profitability ranking reports and high performance service principles that put all employees’ hearts, minds and wallets into the game.


    I would like to add one more set of personal economic observations. Over the past two weeks, Maestro Greenspan pulled off an interesting series of moves. First, the Fed orchestrated a massive increase in the M3, broad money supply growth rate of $55B in one week buying back old bonds out to 10 years (usually they buy just short term t-bills). Then, he stated that the Fed would not change the short-term interest rates, but stood ready to do so because of renewed concerns about deflation. This two-step move knocked 10 year bond yields down a huge 26 basis points to new lows. Since mortgage rates are based on the 10-year bond rate, they have now dropped to new all time lows. This is just in time to try to gin up the Spring selling season for the housing bubble. And, the timing was perfect for offsetting the US Government’s record sale of $58B in bonds that was not a pretty-demand affair. In a sense, the Fed created enough new money out of thin air to finance the government’s new bonds by debasing our fiat currency.

    This orchestrated set of moves was not lost on smart money managers outside of the US; they dumped our deteriorating dollar. The dollar tanked 2% in one week against all currencies, including the Argentina peso, the Brazilian Real, etc. The 72% of all other central bank reserves in US dollars sat tight for political reasons; if your home currency goes up against the dollar, then you can’t ship as much to the US, your economy slows and manufacturing jobs can be lost. Euroland, for example, will lose about 1% GNP growth for each 20% appreciation increment for the Euro against the dollar. There has been a 26% upward valuation for the Euro over the past 15 months or so, and the momentum of the shift could go as high as 40%.

    What will this do to Germany which is probably in a recession right now with record unemployment north of 10% and heavy exports to the US? Some of their big banks and insurance companies are a breath away from defaulting with portfolios of financial derivatives, loans and stocks that are tied into the well being of the German economy. If one of their banks tanks, they have no central bank to bail it out; they gave up that power to European Central Bank (ECB) which is suppose to have one monolithic set of policies for countries that are in all kinds of different economic conditions. Ditto for all of these conditions in Japan.

    Why do you think the Maestro, who is always trying to spin out of his past mistakes, talked about the danger of financial derivatives being concentrated in too few big banks this past week? What does he see and fear? His inflating of the money supply to finance more government and consumer debt for houses and autos is killing the dollar when both Japan and Germany can not deal with it. Watch out for financial tornado alerts with global implications from outside our country.

    There is one way out for all of the G-7 countries. That is for all to inflate money supply, lower interest rates and debase currencies together, then all of the mis-spent debt that sits on all of these economies can be paid back in much cheaper dollars. The savers, investors in paper assets and lenders will all then take the big haircut, and 95% of the voters in the US who are debtors will get a big break. If you are a saver, an investor in paper assets- stocks, bonds, money markets - or a lender, what has happened to your purchasing power this past year after inflation, taxes and a 26% currency depreciation versus the Euro? If you are getting a 5% return on a muni bond in a 1-2% inflation, dollar world that’s OK, but what if you had been in Euro’s and saved a 26% haircut? Interesting times ahead!


    To make my global economic ramblings above relevant to distribution. Here’s an interesting case study. A client of mine is a very patient, able, distribution-channel consolidator having made some well-timed industry acquisitions over the past 20+ years. They were quite dismayed a few years ago when valuations for nice companies hit a high of 14 times "EBITD" (earnings before interest, taxes and depreciation) as big, now-dumb-looking money from Europe jumped into the game.

    But, times have changed! With both the US dollar and economy tanking, the Europeans have shut their wallets. Here are the macro numbers:

    From 1990-1995 the average net inflow of European money into US deals was $10B.

    In 2000, the net inflow into US investments peaked at $194 B!

    In 2001, the net inflow was $184B.

    In 2002, $3.5B

    And so far in 2003, there is a net liquidation and out flow of money yet to be precisely determined.

    What happens to valuations when the big acquisition money that drove up valuations flows the other way, and deals that have operationally soured come back on the market? If supply is up, demand is down along with operating profits, shouldn’t valuations as a percent of net tangible assets go way down? It depends upon whether would be acquirers are looking in the rear-view window and thinking that the other buyers are still there and this isn’t a post-bubble, global economy with a second half recovery on the way.

    What’s my client thinking? They regret that they got caught up in high-valuation rationalization 18 months ago when they made a geographic-expansion acquisition and paid 20% over book value. They still have, however, a strong balance sheet and are making money in a channel in which a lot of competitors aren’t.

    Today they have a chance to acquire a bigger, far more cost synergistic deal. I’m suggesting that they look at the new downward trends and pay a lot less. If some other fool wants to think it is still '00-'01 and pay a big premium for a cobbled together roll-up that is now losing money with internal management turmoil, let them. We are always going to have competitors, better that they be debt-strapped with losing operations and their management team stretched way too thin. We will see what happens. In the meantime, I will predict that you will see:

    1. a lot of companies that were bought too fast for too high a price from '97 through '01 will be back on the market; or,
    2. in the throes of dramatic internal turnaround efforts. And,
    3. acquisition valuations in hard terms will continue to drop. You might hear of reported deals at book price for save-face, no write-off purposes, but the seller will be financing the deal with low-cost, subordinated debt. 


    As an informational junkie, I’m always looking for ways to connect different dots of information into meaningful insights. A trap I try to avoid, of course, is not becoming guilty of seeing only the daily, micro news that supports a wrong-headed, big picture model that I might have. Lots of people haven’t liked my post-bubble economy views that I have been writing about since July ’01, but some have grudgingly started to admit that there might be something to it.

    A sub-set of the post-bubble thinking is that high-wage, high-overhead jobs (due to: unions, big city costs, bankrupt city and state cost tax increases, big corporate legacy pension costs, EPA, OSHA, tort liabilities, diversity subsidies, etc.) are all being exported to China (for manufacturing) and India (for back office services) faster than we can invent new jobs from new technology driven solutions. So, unemployment will continue to rise and pension promises will continue to be broken at a time when the average consumer has too much debt and is about 5 paychecks away from defaulting.

    Here are a few articles (points of data) from the past week that tie into this big picture that might be particularly interesting to distributors to industry:

    1. "Industry official: U.S. Manufacturing will never be the same"- http://milwaukee.bizjournals.com/milwaukee/stories/2003/05/12/story6.html . The gist of this article is that low-skill manufacturing jobs are never coming back. Only high-skill jobs in very flexible factories have a chance, but we don’t have the high skilled people to go into these opportunities. And, domestically there is a lot of incentive competition amongst the states for these few remaining job opportunities.
    2. "Hostile-to-business laws ruining state" -http://www.dailynews.com/Stories/0,1413,200~24781~1382862,00.html . This one is written by a California business consultant who points out that California was recently ranked by the Wall Street Journal as the worst place to have a business out of all 50 states and that was before California legislators have proposed:

    a. Penalties for all business owners who don’t offer medical benefits to pay into a state-run fund that would in turn provide the benefits.

    b. The announcement that there is a state worker’s compensation crisis with presumably big insurance hikes on business to follow.

    c. Announced increases for the "Paid Family Leave Act"; etc

  • This chap is anticipating death by 1000 cuts from the legislature that is populated by career politicians that have no business experience. He notes that bigger corporations are moving their HQs leaving the small businesses that don’t have an organized, focused voice to bear the brunt of the higher costs and regulations. What’s doubly concerning about this report from California with the $36 B deficit and state employee layoffs still to come is that it is the epicenter of the housing bubble. The number of sub-prime, young, naive renters that are buying starter FHA housing with down payments from charities that get the money from the builders is epidemic.
  • 3. "Big Three Squeeze Parts Makers" from the Globe and Mail (Canada’s big national paper) (can’t give you a URL or a google search that gets you to the article; so here are some excerpts)

  • "Parts makers are being asked or told to trim prices even beyond their 3 to 5% annual donations…competitors bid on a component already being made and the existing supplier is told to match the lowest price with awarding of contracts to the lowest bidder regardless of long-term relationships or expensive capital investments made by existing suppliers". "The pressure is worse by a magnitude of 10 than it was 18 months to two years ago" said the president of one parts maker. "It’s totally ruthless under the guise of politeness." ‘The reasons for the new heat on parts makers….US market is flat.. (plant utilization capacity is at 75% and dropping due to 5% more, new, non-union capacity being built)…prices for new vehicles (net of incentive discounts) have been falling for several years in a row…health care and pension costs are rising dramatically."

    "There is a much greater sense of urgency now with the Big Three than I’ve seen in my 15+ years in the industry" stated an executive who is aiming to cut his costs by 10% in each of the next 2 years.

    "Auto-companies are using the low-cost countries such as China to beat up their North American suppliers, especially on commodity parts.

  • DBM Comment: The big three have actually shifted a magnitude of over $18 billion of losses to be realized to their finance subsidiaries over the next 5 years with zero percent financing deals to pretend to make profits on manufacturing today, all since 9/11. Their pension costs are crippling. Are they now burning up their supply chain "partners" too? Should the supply chain manufacturers harvest their businesses as fast as possible and diversify into securities or Chinese manufacturing? I’ve seen estimates that entire cars will be exported from China to North America within 5 years. What should distributors to North American supply chain manufacturers plan on and do?

    Excerpts from an e-mail from a California based fasteners distributor that echoes all of the themes above.


    Looks like your prediction for extended pain (at last September’s Western Assoc. of Fastener Distributors meeting) are coming true. The WAFD had to cancel its Spring Conference (they got 10 to 15% of their normal registration levels)….the main excuse given by members was business conditions. Either they couldn’t afford it, or they were too busy doing the payables because they had to layoff the accounting clerk. (at the end of a number of factors)..we have seen a disturbing trend of manufacturers moving to other states (from California) ..thanks Mr. Davis! If this keeps up, reasonable business owners have got to start wondering, "why bother". Particularly little guys


    1. In a industry "transition" (think clipper ships to steam ships; ice harvesting to ice-making to refrigeration) those who downsize, upgrade, while strategically refocusing on their most profitable core (if they have one) to revive it (if it is long-term viable; there is still one buggy whip manufacturer in the US) will have several advantages:
      1. They can make a high return on their capital.
      2. They will have the free resource flow – cash, talent, time, credibility and bottom-up, can do spirit to innovate in new directions either within or outside of their traditional sphere of competence and channel relationships.(Think of Anheuser-Busch surviving 13 years of prohibition from 1920 to 1933. They survived by making everything from truck bodies to refrigerated cabinets and ice cream, soft drinks and yeast. Over 75% of the nation’s 1400 breweries closed their doors instead of being able to downsize and reinvent.)
      3. Current owners will have more options for exiting their business including boot-strap buyout options with or without ESOPs (DCC #23.1 23commentary.asp) by the next generation of managers, especially if private company valuations and buyers continue to decline.
    1. Most distributors have a wide enough base of customers and products that they can identify customer-centric niches in which there are some customers that do have long-term viability and even growth prospects. The trick is to identify these accounts and re-allocate your marketing efforts in direct proportion to the long-term, discounted cash flow, net present value of customers’ estimated profit streams (not volume, gross margin $ or %, but estimated profit before interest and taxes). To do this every distributor must do customer "PBIT ranking report" (profit before interest and taxes) with increased levels of activity based costing input and put some future forecast of the PBIT trend for each customer. Even quick and dirty "lifetime value" of customer analysis will put us ahead of most volume/product-pushing competitors and immediately suggest that the firm should be spending about 90% of our re-invented, proactive, total-team, marketing efforts on less than 5% of our current customer base!
  • A big, regional chain that sells a lot of MRO materials to big manufacturers across the company recently started doing some "strategic information R and D" on my "gazelle" theory that 3% of all active accounts will account for 80% of future growth over the next 5+ years. As a first slice of analysis, they took roughly the top 3% of the customers in total sales for 2002 and compared their sales to what they had done over the last few years. In three years time, these accounts had grown from 40% of the company’s total sales to 60%. Over 100% of the company’s total growth for the three years had come from 3% of their accounts, the other 97% had actually contracted.

    What will they do next?

  • a. They agreed that they team-sold all of these accounts on an as-needed, reactive basis. They had not thought of proactively and systematically team selling including local inside sales people, buyers and delivery personnel. We brainstormed how that might work and what it might do to "sell more to the core by ‘04", and they bought it.
  • b. They are going to do a profit ranking report for the top 10% of their multiple location accounts, because volume is vanity and profit is sanity. There is one account in particular that keeps making ever greater demands for special charge backs and services "OR WE’LL PUT THE ENTIRE CONTRACT OUT FOR BID". Those are signs of an abusive customer on which the company is probably losing money. Time to get the facts and negotiate accordingly.

    Manufacturing America is in a transition and it will be very tough on those who supply the companies that are (self) liquidating. Just because the Big 3 auto companies and their supply chains have been around forever doesn’t mean that they will be here in 5 years; look what happened to the big, old-line steel guys. If we are selling someone who in turn sells 50% or more of their stuff into GM or Ford, let’s stop hoping and start diversifying.

    There will always be some surviving and new manufacturing in the US, the key is to focus our time on the 10 accounts (core + target) per distribution location that really have a decent if not growing, profitable future. We can’t do it successfully, however, if we continue to try to sell to many products to too many different customers types in one undifferentiated way.


    What strategies should we pursue for tough times? Looks like I’m not the only consultant with some new strategic snake oil advice. Here is a quick overview of some of the more popular books being offered by consulting firms, independents (often academics) and the best-for-last, distribution-specific authors.


    How to Grow When Markets Don’t (2003) by Adrian Slywotsky of Mercer Management Consulting.

    This is the latest book that is getting reviewed by all of the business magazines. Amazon only has two reviews for it averaging a score of 4.0 out of 5, and it is their 1,638th best selling book for the past week. I mentioned this book in passing in DCC #19.3 and 4. The gist is to look for total, extra, extended service offerings for your existing customers. But, this pre-supposes that a company is already excelling at what they have been historically doing which isn’t the case for over 90%+ of all distributors.

    Creative Destruction; (2001) by Richard Foster, et.al. of McKinsey. Amazon has 18 reviews on this book averaging a score of 4.0, and it’s sales activity rank has slipped with age to 29,543. The gist of this book is that a company can only out-perform its peers and the stock market averages if it is a perpetual innovator. The process of creative destruction, dis-assembling what and how you do things to then re-assemble them, must become an integral part of our companies from top to bottom.

    Good stuff, true enough. But, again, the bottom 90%+ of all distribution firms can’t think and move strategically when they haven’t even been able to do their past well enough to reinvest into some new future direction.

    Profit from the Core (2001) by Chris Zook of Bain Consulting. Amazon has 25 reviews averaging 4.5, and the book’s selling rate ranks again due to age at 18,982. So it scores higher than the first two and is still selling better than the other 2001 entry. The gist is that the next wave of growth for most businesses is to get more from the core, because they have become too scattered and financial in their activity with which I couldn’t agree more. The problem with this book is that the examples are tough to relate to simple, service, transactional businesses like distributors.


    Gary Hamel co-authored Competing for the Future with C.K. Prahalad in ’96, and then soloed with Leading the Revolution in ’02. Amazon reviews are 24 scoring 4.2 for the first and only 3.7 on 58 reviews for the latter. I liked both books; Gary has a great, compelling writing style with excellent research, examples and ideas. Both books focus on "getting to the future first" by being an innovator. The latter encourages bottom up creativity and experimentation at the fringes of the organization (think 3M scientists all looking for the next serendipitous post-it-notes). All good stuff, but again a bit wild for the average distributor who needs to define and execute their existing service operational strategy first.

    Good to Great (2001) by Jim Collins. This book, as regular readers will know, is what I think is the current class of the general business book field. You can check out my references to it in articles #ed 2.14,(2_14.asp) 2.16, ( 2_16.asp) 2.17 (2_17.asp) and in DCC #22.2 ( 22commentary.asp.) Amazon readers seem to agree. It scores 4.4 on 158 reviews and is currently ranked 15th on the best selling list. Why has it left the rest of the other 2001 entries in the dust? It doesn’t focus so much on strategy which is just pick something that you can be #1 in the world at, but rather on the grind it out execution of what you decide you have your best chance of being. Because distribution is a win with basic, consistent, service excellence execution business, this book is a better fit than the other general strategy books.

    Strategy Safari (2002) by Henry Mintzberg. This book puts all other strategy books and models into their respective taxonomy categories. Mintzberg has been writing about the history of strategy fixes and fads for years. This book proves that: there is no one truth or methodology; strategy will never be a pure, guaranteed science; and there will always be art and lots of flexible, improvisational implementation skills needed for any strategy. Only recommended for the experience business reader and student of strategy; it hovers above the rest of the books covered in this review.


    Facing the Forces of Change; 2001 by Adam Fein (www.nawpubs.org). This is the best of the "forces" studies that NAW has been sponsoring since 1981 largely because it wasn’t written by a committee at Arthur Andersen, but instead overseen and substantially written by Dr. Fein. It was the first such study that has used scenario planning of which I am a fan. If the average distributor can first figure out how to get more from their core, then they can use this book to help them better position their companies for the detailed future scenarios.

    Stand Out From the Competition (2003, brand new!) by Bill McCleave and Tom Gale. If a distributor is looking for a how to strategy book that is distribution, case study specific, this one wins over the rest by default. Although NAW publication prices seem high compared to the general books above, they are still the best total value to cost offerings. Check out the promotional info on this book at http://www.nawpubs.org/


    While you cogitate further on the strategic offerings covered in #4 above, here are some free strategic insights immediately available. We have posted two recent slide presentations under our "slide show" button at www.merrifield.com. One was to the "Independent Stationers" buying group. Because I had such a short time for the presentation entitled "Get Nicher Quick; More to the Core by ‘04", I promised them to put the slides on our site along with notes and additional references. I urge all readers to check out slide 7 of the 11 to get reacquainted with how "bowtie or butterfly economics" relate to customer profitability ranking reports for every single type of intermediary. This elemental, strategic insight slide is key to understanding why and how every distributor can begin to re-think their business. For the rest of the story see the offering in #6 below.

    The second posted slide show was my presentation for the North American Wholesale Lumber Association’s Annual Conference; it is a 60 slide show entitled "Improving Our Productivity Fast!". I would be glad to entertain any questions from readers who might choose to skim through them.


    Regular readers of this DCC series know that I have written lots of how-to ideas for how distributors can "downsize, upgrade, rethink, refocus and revive" their businesses. Rather than suggesting that new and old readers go back to 20+ previous DCC topics that relate to reinventing your core business, I have stitched them all together with more fresh content to create a general summary document of about 20 pages.

    If anyone would like a free, e-mailed copy of this document with the working title of :"REINVENTING A DISTRIBUTOR’S CORE BUSINESS". Please request a copy from karen@merrifield.com.

    I will leave you with this closing thought and question. Do you think there is a market out there for one more book on how to strategically rethink your distribution company approach to the market place? Let me know what you think.

    That’s all for this week! 

    Bruce Merrifield