June 18, 2003 - Distribution Channel Commentary (DCC) # 29

Greetings:

If you know what these commentaries are about, go to "TOPICS" below; otherwise, read on.

  • A WEEKLY SERVICE/NOTIFICATION WITH WORD DOCUMENT ATTACHED

The Merrifield Consulting Group, Inc. (www.merrifield.com) has a weekly commentary service that is posted every week at www.merrifield.com. For those who would like e-mail notification with a word document attached to do further editing and forwarding on with our blessing please send us your e-mail address.

  • ADD OTHERS/DELETE ME

To make this free service continue to happen, we must reach more individuals who care about making independent distribution companies/channels more effective. If you know of others who might like to receive this service, please: forward this commentary on to them; encourage them to email karen@merrifield.com to have her add their email address to our list; or, send them to our web site. If you donít like this type of mail, ask her to delete you, and we actually will.

  • RE-PUBLISHING/RE-PURPOSING ANY COMMENTARY CONTENT? YES YOU MAY!

Just let us know by email what you want to do, give us some credit and point them to our web site. We now have software vendors, manufacturersí channel managers, buying groups, etc. that are either forwarding on (edited) parts or all of our commentaries on to their distributor constituents or posting them on their own web sites. We also have some experiments going on in which we are customizing DCC excerpts (along with interactive participation from constituent panels) for specific groups. Please inquire if you have further interest in this last possibility.

THIS WEEKíS TOPICS:

  1. SUMMER TIME COMMENTARY SCHEDULE
  2. "DEFLATIONíS PROFIT SQUEEZE; TRIAL OFFER
  3. PEOPLE PRODUCTIVITY RE-INVENTION; CIRCUIT CITY CASE
  4. FEES FOR SERVICE GUIDELINES SLIDE SHOW
  5. WHY CANíT WE DO THESE THINGS; HEART OF CHANGE SLIDES
  6. IS AN ECONOMIC RECOVERY REALLY GOING TO HAPPEN?
  1. SUMMER TIME COMMENTARY SCHEDULE

This issue of DCC will be the last of the regular, weekly commentaries until after Labor Day. We will post a few during the next 11 weeks and send out e-mail notification to those who have requested to be on our list. Also the format might be a bit different with some of the postings being excerpts from a book on "strategic turnarounds for distribution firms" (working title) that is underway.

    2.   "DEFLATIONíS PROFIT SQUEEZE"

In our initial DCC posting, we covered (in topic #1.2 - 1commentary.asp) ideas for dealing with the fact that the trends for people costs were rising more rapidly than the dis-inflation in manufactured goods largely because of the China effect. These ideas have been revisited and more thoroughly researched and explained by Adam Fein. This article is posted at the site of the best distribution-focused newsletter in existence, Modern Distribution Management. See Adamís must read article entitled: "Deflationís Profit Squeeze; What to Watch for and Three Ways to Fight It" at the URL below. While there, request MDMís free trial offer for thee copies of their newsletter in you are not a subscriber, then come back for my article out-takes for build-on comments. Hereís the URL: http://www.mdm.com/stories/fein3311.html

Here are some of Adamís points that jumped out at me with some add on comments:

  1. "Deflation is not yet a major threat for industrial distributors".
    Adamís trend research/graph supports this point well. And, I agree with the statement in the narrow, product-line and short-term view. I do think that the general economy is more at risk of debt liquidation deflation in the long run than most people can imagine. In my entire business career, I have never seen a time when so many smart people have argued about so many different angles of our global economyís problems and about so many different solutions. Nor has there been a time when so many experts have been so wrong with their economic forecasts as in the past 3 years. This suggests old model thinking isnít working for a new set of conditions. Who should you believe in order to make your longer-term decisions? Iím sticking with the very few experts who have made the right economic calls over the past few years. Some of those people and their latest web accessible stuff is in my last topic of this commentary.
  2. "total compensation trends in wholesale distribution are moving in the opposite direction from product prices" (see great graph for 1/91 to 3/03).
    Adam has drawn one average trend line for this graph. I might dare to break it into three parts. The first segment would be the trend from í91 to 3Q í00 which is up. There would be a flat line, however, from 3Q í00 to the present. And, what will happen for 2003 and beyond; draw your own line! Adam points out that "personnel productivity" improvement is vital. Will distributors continue to try to hold personnel costs flat with incremental cuts and freezes? Or, will they go after strategic, breakthrough opportunities to dramatically boost productivity and operating profits per (fewer) employees based on new assumption thinking? See the Circuit City case study for a brave, new personnel cost re-structuring move in topic #3 below.
  3. "the aging of the U.S. population implies a continued labor shortage".
    This has been a common, demographic forecasting claim for the past 5 to 10 years. It had extra impact when our late Ď90ís bubble economy took unemployment down below 4%. What do we know today that might challenge this conventional wisdom?

5 to 10 years ago who foresaw:

      --how rapidly China was going to move up the manufacturing food chain to cause 36 straight months and counting of factory layoffs in the U.S? The growth rate of Chinaís manufacturing exports to the US are still accelerating; we arenít to the inflection point (or mid-point) of the life cycle of this phenomenon when year-to-year growth rates start to decelerate.

      --that with common databases, the internet and collapsing global telephone costs that all software programming, call centers and back office support jobs would be vulnerable to exit the U.S. at a now accelerating rate with India leading the way?

      --that China and India with 40% of the worldís population, which is dramatically unemployed or under-employed, would be willing to work so hard at - school, their English and their jobs for lots less - than people want to here in the US.

      --that the global averaging out of total costs to do skilled jobs would be so dramatic and just beginning?


Simply put, anyone who is hiring today is finding out that they can get better talent for less money than many of the people who are currently on their payroll. This new development, in my opinion, isnít going to change anytime soon.

    d.  "Strategies for the squeeze: go free to fee".

    Services for a fee? Adam is right again. Distributors have to get better paid for what they are doing one way or another, and one way is to "evaluate fee-for-service models". This, unfortunately, is more difficult for distributors than just raising prices or enforcing the current terms that they already have in place. How do you say to a customer Ė "Iím going to increase what you pay to me in a more complicated way than what we currently are doing"? Most distributors canít even get tougher on pricing and terms with customers that they know they are losing money on for fear of losing some incremental volume and margin dollars. To help in a how-to, distribution specific way, we will post by Friday, an annotated slide show entitled "Fees for Services". For more, see topic #4 below.

    e.  "Dump your debtÖcash is king during periods of deflation".

This again is conventionally good wisdom if you think about what worked during the great depression when all currencies were tethered to gold or what Japanese consumers have been doing for the past 13 years of their deflationary lives. This time around, however, the Fed is unilaterally forcing a "cash is trash" fiat currency policy on the rest of the planet. (For more on this topic see #6 and the good read references therein.)

(Japan has recently joined the currency devaluation game, big time! One week ago the Bank of Japan (BOJ) announced that they had bought for the first time, with money out of thin air, $9 billion in non-performing, commercial loans from banks and stated that they are prepared to do more. They also announced to savers of cash that they are strongly leaning toward charging a tax on all deposits of 2 to 5% by next April, while simultaneously issuing new currency to go after the money in the mattresses. When citizens come to convert their currency into the new bills, they will have to pay the tax. The BOJ would like to see the yen drop against the dollar by 20 to 30%. Scary stuff, huh.)

So, "dump debt". To keep things simple, yes, for most people. For the calculated risk takers, note that the global purchasing power value of dollar debt has eroded significantly in the past year and is likely to continue to do so. If you are sure that your cash-flow can service outstanding debt through toughest times scenarios and if you can hedge positively against the dollarís debasement, have some debt. (For example, if you had borrowed against your building a year ago, then invested it in Euroís or gold and finally paid off the debt today, you would have a 20% gain.) We have to get out of our dollar world and start to think about conserving purchasing power in currency-debasement, adjusted terms.

Enough on Adamís important article, letís move on to even more dramatic news.

      3.   PEOPLE PRODUCTIVITY RE-INVENTION; CIRCUIT CITY CASE

How the mighty have fallen! Circuit City (CC) is one of the 11 "good to great" companies chosen out of the publicly traded universe that was spotlighted by the currently number one selling hardcover business book, "Good to Great" by Jim Collins. CCís stock price went up 18.2 times more then the general stock market averages from 1982 to 1997! No company sold more VHS machines, etc. from Japan during that period; they executed the big box, home electronics strategy first and better than anyone, then attempted to do it again with CarMax for used cars.

Whatís the latest? For the first quarter ending May 31st, CC reported a net loss of $43.9 MM compared with a profit of $28MM a year ago. Sales fell 8.7% from 2.12B to 1.93B with comparable store sales off 10%.

Whatís the bigger trend? Ten years ago CCís annual sales were $3.27B, twice that of Best Buyís. For the past full year, Best Buyís were $19.6B and CCís were $9.5B. It appears that CC didnít adjust their (un-spoken) assumptions for how to succeed that worked up until í92, but seen to have fizzled as of late. CC started out with what are now considered smaller stores (compared to Best Buyís) with knowledgeable commissioned sales reps, because people hadnít yet bought their first VHS machines. In the early Ď80ís the prices for VHSís were high, they broke and needed repair and should you buy VHS or BetaMax? Best Buy came along later and opened bigger stores, with more SKUs and help yourself selling signs with very few sales clerks. Perhaps they reasoned that it was working for Wal-Mart and also that home electronic products had become repeat, lower priced, unbreakable products.

CC promoted sales reps into management during the fast growing Ď80s, so the sales culture became institutionalized. Sales reps were encouraged to become "independent business operators" with "unlimited earning power" and shoot for the Presidentís Club with its annual resort trip prize right up until February 5th of this year. On "bloody Wednesday", CC fired all 3,900 sales reps (20% of the entire work force) and hired 2100 mostly new people within strict salary caps of $14 to 18 per hour. The rationale: the sales reps were making too much money in a time when economizing was needed, and educational selling didnít fit the times.

Swapping out one job classification for a lower cost different one is totally legal. None of the ex-sales reps has a lawsuit angle; no one was discriminated against, they were all fired. They were all welcome to re-apply for the new job and wage and some did. Want to know more, read an in-depth article in the Wall Street Journal (6-11, on-line issue at this URL if you can access it:

http://online.wsj.com/article/0,,SB105527782366172400-search,00.html?collection=wsjie%2F30day&vql_string=circuit+city%3Cin%3E%28article%2Dbody%29

What do you think about this case example of downsizing personnel costs? Are there any parallels to outside sales forces at some distribution companies? Not surprisingly, I have a few thoughts and another distribution case study for you to consider:

  1. Normally this type of story doesnít get published, but Circuit City was trying to let investors know that they were doing serious stuff before they announced their poor numbers for the first quarter yesterday.
  2. This seems to be dramatic medicine way too late. If Best Buy is succeeding with huge stores and lots of inventory at big power malls, what will CC do about their smaller stores with less inventory in non-power malls? In other words, what is the strategically superior model that CC is trying to migrate too? Right now they seem to be a "hopeful" mutant that may not fit any environment, a fish trying to walk on land.
  3. Distributors obviously donít have the huge retail franchise value for better or worse that is tied up in store locations, size, inventory mix, brand names, advertising economies, etc, But, is there a downsize, upgrade, refocus fewer, better sales reps on better accounts opportunity; for most distributors - yes.
  4. If you are on this hook, read our article (#ed 2.19) entitled "Rethinking Distributor Profitability" at this URL: 2_19.asp. Please scroll all the way to the bottom of the support notes that are tacked on to the article to the table with 9 columns. Look at column 8 and see that on a customer profitability basis only 6 out 13 territories in this case study (ABC Bakery Supply) are net profitable. Scroll back up to section III of the support notes to find a scheme for "downsizing, upgrading the sales force". The point is that most distributors have too many outside sales reps calling on too many B, C and D accounts. If the average distributor could reduce their sales forces by 50% or more to have only the best call on the best A accounts with one or more telesales folks working the B-C group, then sales would actually go up while total marketing costs would drop.
  5. CC is guilty of perpetuating the past. Most distributors are in the consolidation, low-cost, fulfillment stage of their industry life-cycle. Their sales reps should be only calling on A accounts one or more times per month to sell total procurement cost, routinization/system ideas built on the benefits of basic service excellence and extra-services as needed for fees 90%+ of the time. Is it OK to spend 10% or less of the time selling old and new products? Sure, but that is not what is happening?
  6. When is it time to re-think our un-spoken success assumptions and our decaying business modelís effectiveness? Is it time when we are going down the tubes and have to make drastic moves like CC appears to be doing? Or, is it all of the time on an anticipatory, test-cheaply basis? For more on this see what is in the slide show covered in topic 5 below.

     4.   FEES FOR SERVICE GUIDELINES SLIDE SHOW

    To echo some of the issues raised in both topics 2 and 3 above, I have prepared a slide show with 14 annotated slides entitled "Fees for Services? Some thoughts:" It will be posted as early as Thursday and as late as Friday on our site. There are about 2700 words of commentary, but this particular slide show has some great pictures we hope that you will at least skim through.

    5.   WHY CANíT WE DO THESE THINGS; HEART OF CHANGE SLIDES

    One theme that we have hit pretty hard through a number of commentaries is "change management".

    We have a slide show entitled "Closing the knowing-doing gap" at Knowing_Doing_Gap_slides.pdf.

    Our high performance video dedicates an entire section of modules, 5.1- 13, entitled "Concepts and Tools for the Transformational Journey".

    Another chap who has also been working away, seemingly forever, on the subject of change management is John Kotter, who started as a Harvard B-School professor in the fall of í72 with me. I just stayed for two years; heís been there for 31 working away on leadership and change management issues. I really like the support site for his latest book, "The Heart of Change". If anyone out there is a bit frustrated with getting the corporate herd to generally move in the right direction, check out his "see, feel, change model" at this site address: http://www.amcf.org/2002/AnnualMeeting/presentations/Dan%20Cohen.ppt

    6.   IS AN ECONOMIC RECOVERY REALLY GOING TO HAPPEN?

Why are both the stock and bond markets up so dramatically in the past 6 weeks? Just for starters, they canít both be right. Both are "liquidity driven rallies in which fundamentals matter less and less" according to the WSJís "Ahead of the Tape" column on June 11th. Merrill Lynch economist, David Rosenberg stated: "This is round 3 of the Bush tax cuts, weíre heading into round 13 of the Fed rate cuts, and weíre in wave 6 of the mortgage-financed boom." Does he think that these rounds wonít do any better than the previous ones?

My views havenít changed, the big structural problems that I noted in article 1.10 (1_10.asp) are still there. And, here are some views from guys that have been right for the past three years

  1. Stephen Roach, the head economist for Morgan Stanley, has taken enormous heat for the past three years because he has been a bear amidst cheerleaders warning everyone about the realities of the global post-bubble economy. He doesnít think all of the economic stimulation from the government will "get traction". He thinks consumers are so strapped that they will save their tax cuts. They wonít buy more cars and houses as they would during a normal rebound, because they never stopped buying them during the last three years. In fact, they accelerated their purchases. There is no pent-up consumer demand to stimulate, just personal balance sheets to mend and jobs to try to hang on to. There will be no big capital expenditure by corporate America, because they are still only operating at 74% of capacity, a 30-year low, with no pricing power and all of their growth forecasts have been averaging quite flat. And, the lower dollar wonít help exports because half of our exports are from Asian countries that are pegged to the dollar and Europe and Japan are in recession, so their demand for goods is dropping faster than our dollar.
  2. He posts his stuff at Morgan Stanleyís site on Mondayís and Fridayís at this URL: http://www.morganstanley.com/GEFdata/digests/20030616.html

  3. Doug Noland, author of the Prudentbear.com "Credit Bubble Bulletin". This chapís weekly analysis takes you deeper than you want to go into the balance sheet side of the global economy. But, this past week he included in his weekly report a written speech that he recently gave. I infer that this guy doesnít go out often, he sleeps with his Bloomberg and is truly a profound thinker. The URL below is worth checking out. Skim the first part of it to get to the speech and then read through it several times to understand:

Why the credit/debt bubble that is still mushrooming thanks to the Fed and the "government sponsored entities", Fannie Mae and Freddie Mac, is behind the market bubbles and the housing bubble.

Why the models used by the experts arenít working for them any more, because the way that credit/debt is now created, repackaged and sold is totally different than the way it used to be.

Why there will be a day of reckoning, because we canít keep borrowing to spend/consume our way to prosperity.

Mr. Noland posts his bulletin on Saturdays. Here is the URL to his latest with the fascinating speech:

http://www.prudentbear.com/creditbubblebulletin.asp

Well folks, thatís all for the formal commentaries until after Labor Day! We will do occasional postings with teasers for our book during the summer. So, send in your e-mail addresses for notification if you arenít already getting them. Have a happy and safe summer!

 

Bruce Merrifield

Bruce@merrifield.com

919-933-7474