December 3, 2003: Distribution Channel Commentary (DCC) # 49

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THIS WEEK’S TOPICS

  1. "HOW BREAKTHROUGHS HAPPEN"
  2. CHINA KNOCK-OFF MATH FOR A FULL-SERVICE DISTRIBUTOR CASE
  3. MY NC STATE E-COMMERCE PRESENTATION IS ON THE WEB
  4. "E-PROCUREMENT" HITS "SLOPE OF ENLIGHTENMENT"
  5. D&K HEALTHCARE BEATS THE BIG DRUG DISTRIBUTORS ON INTERNET SERVICE
  6. CASE STUDY ARTICLE: DISTRIBUTOR SALES REPS SEEING THE "TPC", PROFITABLE RELATIONSHIP" LIGHT (a recently published article)
  7. A GOOD STRATEGY ANALYSIS ON SYSCO, THE #1 FOODSERVICE DISTRIBUTOR
  1. "HOW BREAKTHROUGHS HAPPEN"

"How Breakthroughs Happen" is a book that I am currently reading by Andrew Hargadon that was released this past June. I would encourage those who are working hard at selling products for a mark-up and not making enough profits to read the review material for this book at Amazon.com. As you skim through that information, think about where profit improving innovative ideas might come from.

From his exhaustive, long-term research, Hargadon has discovered that innovations do not result from flashes of brilliance by lone inventors or organizations. In fact, innovation is really about creatively recombining ideas, people, and objects from past technologies (from a broad array of diverse sources) in ways that spark new technological revolutions. (Edison, it turns out, was a ‘technology broker" and a terrific promoter who lead a team that recombined a number of discoveries to come up with a better light bulb and an electric grid system to support it. A chap in England invented the first bulb 30 years earlier.)

If Hargadon had attended a distributor buying group meeting or a trade association convention, he would probably tell us to bag or dramatically change the roundtables and the industry leader panel discussions. These exchanges would involve trading fine-tuning ideas for the main unchallenged ways that we all would continue to operate. He might encourage us, instead, to think outside the box by inviting guests from best performing players in other non-competitive channels to tell us about how they think about similar challenges in their different boxes.

Outside of industry gatherings, we should endeavor to do team exchange visitations with different channel companies not to just benchmark narrow operational capabilities (e.g. how they use bar coding in their warehouse). But, to question their main strategic assumptions and related processes for how they: target customer segments, rethink and change service offerings, and then sell and get paid for their unique value propositions. We should try to initiate multiple, new and deep connections to these other thinking boxes.

Who is the best performing distributor in another channel that is ideally in your city that might share similar, customer, value-added challenge thinking and solutions? Why not call them up and sell them on field trip exchanges? You might even offer to pay them to host an open kimono field trip visit for a small team of your people. It could be a huge educational value, and you would start to do, in Hargadon’s words, "bridge gaps", form "new networks" and "become your own technology recombiner".

This newsletter tries to offer best, generic, "technologies" that I see and work with in many different distribution channels. But it is a poor substitute for the learning that could on with team exchange visits with our best, different distributors with the right agenda. After checking out the book, if not reading it, let me know if I can further help the innovation capability at your company or help to set up team visit exchanges.

  1. CHINA KNOCK-OFF MATH IMPLICATIONS FOR FULL-SERVICE DISTRIBUTORS

Regular readers know that I am following the trends for the exporting of manufacturing to China and the creation of super, low-cost supply chain commodity items very closely. Both inter-related trends will have profound implications on distributor economics and pricing models. For more on these trends see the following references:

Here’s a link to a newly posted annotated slide with about 200 words at our site that is a quick read: ./exhibits/Profitability_of_Products.pdf.

Here also is a recent DCC topic that touches on the China/supply channel product trend coupled with a new case study story. (All past commentaries plus an index of all their topics can be found behind a link in the upper right hand corner of our homepage at www.merrifield.com.)

The DCC reference is: # 48.2 "Supply-Chain, private-label commodities will kill markup models". (48commentary.asp.) Here is the case study problem. A large distribution client of mine has a perfect China knock-off product that could steal a lot of volume from a big-brand name, top 100 best moving item that they currently sell for $2.00 per unit at a 20% margin out of their warehouses. The new product will sell at $1.00 a unit at only a margin of 15% at best, because Wal-Mart and other big box stores will be selling the same item for $.95 or less on introductory promotions.

Here are some questions the CEO has?

  • Should he proactively sell the item to old and new customers and to trade the current 40 cents of margin per unit to make 15 cents? His customers normally buy a number of line items per shipment, and his costs per transaction won’t change. Won’t this margin erosion directly hit his bottom line?
  • He will not generate any more demand with his mature, regular customers with the knock-off product. Can he sell the knock-off item initially to only new customers or re-distributors in alternative channels that he doesn’t normally compete with to win new incremental business? How fast will the cheaper product leak back into his mature customer base? These scenarios will vary dramatically with the product and the channel.
  • Wal-Mart will put the knock-offs in their stores and steal more volume from higher-cost, higher-service channels than they might lose in margin erosion on the brand name item that will be right next to their knock-off store brand name side-by-side on the shelf. They don’t have, however, the high, extra cost structure of order fulfillment and delivery to cover. What will our case study friend’s customers say when they run into the same knock-off product from the same Chinese source at Wal-Mart where it is apt to be selling at an introductory promotional price of $.89 per unit?
  • Fast forward to the future and assume that 50% of this distributor’s volume has switched to the cheaper knock off. What percent of customers will now be unprofitable, because their margin dollars per transaction have dropped below their average cost per transaction? Should the company raise minimum sales orders (again!) or start charging un-bundled fees for order placement and/or shipping costs for what segments of customers?
  • If the margin dollars deflate out of any distributors best items, it will expose the slow items for being the losers that they are. How can manufacturers persuade independent distribution channels to stock and promote new items that might not become top performers if the distributors aren’t making money on a line as is and have too many of yesterday’s new items not turning and earning in their warehouses?

If anyone out there wants some "technology broker, recombination ideas" for solving the - sell niche items through independent distribution channel problem – contact me.

3.     MY NC STATE E-COMMERCE (EC) PRESENTATION IS ON THE WEB

From May ’94 through 2000, I spent an enormous amount of time studying and working with companies on how the emerging world of "electronic commerce" would change channels of distribution. During that period I wrote a lot of articles on EC topics (sections 7 and 8 under "articles") and a best selling book published by NAW. After the huge "hype wave" was over and EC had gone into the deep freeze or "chasm", I went back to the "high performance service management" work and path that I had started with in the early ‘80’s. I knew that it would take a few years of on-going development before total solution EC apps would reappear on most distribution-channel executives’ radar screens.

In the meantime, all of the universities that started up e-commerce studies in ’99 to ’00 have continued to do their thing along with all of the dot-com survivors that have been living off huge surpluses of funds that they raised in the last few years of the hype period. The big ERP software vendors (SAP, PeopleSoft, Oracle, etc.) have been working with the "Global 3500 companies" (with sales over $1B) that are far-sighted, patient and deep-pocketed to evolve total e-solutions that will really work. I think now that some EC apps that could really make a difference to distributors, for better or worse, are finally getting traction.

I was recently delighted to have the opportunity to dust off some of my old material from 2000, then update and repurpose it for a presentation I did on Nov. 19th to some 50+ e-commerce students at NC State University (NCSU). The campus is about a 30-minute drive from my house. My topic was:

"E-Commerce, Changing Channels of Distribution and Good Jobs"

At NCSU, THE EC professor is Michael Rappa. His story and on-going sizeable and free contribution to the world of EC can be found at this link: http://www.digitalenterprise.org. or at http://ecommerce.ncsu.edu/seminar/merrifield.htm.

Among his many activities, Michael schedules guest lecturers to come address the EC students (both under-grad and grad). He then posts both the slides and sometimes the live videotaped show on his site. So, you can check out the 21 slides I used (click on Chart)and/or watch the video of my pyrotechnic show using "streaming" and "big bandwidth" if you have it (along with the time) at this link: http://digitalenterprise.org/seminar/merrifield.html.

I have to warn you that when I checked the link this morning, the stuff was still not loaded. So, you may have to try again next week. In the meantime, I have added a few hundred words of annotated notes to two of the 21 slides that I think are most important for experienced distribution execs. Those slides are introduced with a link in topic #4 below!

     4.    "E-PROCUREMENT" HITS THE "SLOPE OF ENLIGHTENMENT"

A good strategic planning tool for when to get serious about using new technology "solutions" is Gartner Group’s "Hype Wave" model. This is a commercial adaptation for forecasting when a technology will have crossed the "chasm" between its initial, not-fully-developed appearance and hype to a commercially mature, total solution. Both the "crossing of the chasm" and the "hype wave" are described in two picture slides with a couple of hundred words of my comments at this link: E-Procurement_SloopofEnlightenment.pdf

In June 2003, Gartner Group released a report on "supply chain technology" in which they plotted many different "solutions" on a hype wave. The only app that has crossed the chasm and started to climb the "slope of enlightenment", which means early majority users are now buying the solution, is "e-procurement". This category of solutions is being pushed to and now bought by the Global 3500 so that they can put their entire purchasing process on the internet. Most of the early buyers are focusing these solutions on buying "indirect" or "MRO" items in a radically new way to reduce the "total cost of ownership" or "total procurement cost". Because e-procurement solutions will dramatically effect many distributors and their suppliers, I think it is time to put this solution set on the radar screen and start thinking about:

  • How suppliers of indirect goods to Global 3500 can turn a perceived negative into a positive.
  • How distributors can use these same tools to buy their goods differently and better.
  • How distributors can use these tools to provide real time information to their customers that might want to concentrate more purchasing to one distributor on particular lines in exchange for rebate incentives that either or both the manufacturers or the distributors might offer. This would co-opt the same function that a buying group for customers may be currently trying to do with less efficiency and more rivalry.

To do some background reading with big company case studies, check out these links:

  1. D&K HEALTHCARE BEATS THE BIG DRUG DISTRIBUTORS ON INTERNET SERVICE

Here’s a first for me! I was doing a little internet screening work through Google and came across a newswire reporting how D&K (NASDAK:DKHR) had been rated by "The Customer Respect Group" as having the highest score for drug wholesalers in "overall online customer respect".

Nine companies were rated which presumably included the big 3 wholesalers that control close to 90% of the pharmaceutical distribution volume – McKesson, CardinalHealth and AmeriSourceBergen – all of which have annual sales north of $40B. Even D&K as a "small regional" is publicly traded and had $2.2B in sales for 2002.

I don’t know how pharmacies and/or their customers, the consumer, use the web sites offered by the 9 drug wholesalers and how big a strategic advantage the online capability is, but I do think that it is an interesting milestone that e-commerce has evolved to the point where these kind of surveys are starting to happen.

Here’s the link along with my congratulations to the CEO, who happens to be a squash-playing acquaintance of mine in a previous lifehttp://biz.yahoo.com/bw/031124/245539_1.html.

    6.    CASE STUDY ARTICLE: DISTRIBUTOR SALES REPS SEEING THE "TPC", PROFITABLE RELATIONSHIP" LIGHT. (A recently posted article)

A self-explanatory article along with:

  • a "support notes" supplement,
  • a one-page annotated slide, and
  • an exhibit with all of the questions and assumptions used in the seminar

have been posted at www.merrifield.com at the following links.

Article: 4_9.asp

Support Notes: SupportNotes4-9packet.pdf

Slide: ./exhibits/Profitability_of_Products.pdf

Exhibit with questions: ./exhibits/Exhibit15_Assumptions.asp

I would be interested in anyone’s reactions or questions about this revolutionary, breakthrough educational story and technique.

    7.    A GOOD STRATEGY ANALYSIS ON SYSCO, THE #1 FOODSERVICE DISTRIBUTOR

In DCC #48.5 I offered up a "dumb foodservice distribution strategy" from a "big 5" consulting company with lots of cool research, but I didn’t hear back from anyone. So, I thought this time I would offer up a really good strategy piece that covers several types of big, well-known distributors starring Sysco, a "seriously successful consolidator". That phrase is almost an oxymoron considering how many consolidator, roll-up firms have crashed, including U.S. Foodservice owned by Ahold. (The other distributors covered in the piece are: Syncor (exclusive drug distribution lines); Gibraltar Steel (service center diversifies into special value-added services); and United Stationers (super-efficient supplier to office supply dealers)

The lead author, Sam Rovit, is an acquaintance of mine who really knows his distribution stuff. I agree with all that Sam and his colleagues have included in this analysis and could add more. Such as:

  • Sysco uses customer profitability software, thinking and strategy very effectively (DCC #23.4)23commentary.asp.
  • Sysco has created an unequalled, total, one-stop solution for 100% of a small restaurant’s needs that allow them to receive delivery and still be profitable to Sysco. These small accounts would normally be small order problems for 4 or 5 different distributors, but Sysco can sell them – Jan/San, foodservice equipment, office supplies, etc., all on one order with one delivery making it possible for the little guy to meet Sysco’s profitable minimum. Otherwise, these Mom-and-Pops have to go to four different will call counters/big box stores to get all of their supply needs.
  • Sysco took the initial private labeling of football commodities to many more continuous improvement levels.

At any rate, I hope you enjoy the piece and see "recombination technology" opportunities (ref. to topic 1). Here is the link: http://www.gibraltar1.com/p.32-37Rovit.pdf .

That’s all for this week,

Bruce Merrifield

Bruce@merrifield.com

919-933-7474