March 17, 2004: Distribution Channel Commentary (DCC) # 62

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THIS WEEKíS TOPICS

  1. WARM-UP, THEMATIC QUOTES.
  2. COMMODITY PRODUCT INFLATION CASES AND NEWS.
  3. "THE FOG OF WAR" AND OUR BUSINESS THINKING.
  4. THE DARK SIDE OF YOUR BUSINESS INFORMATION SYSTEMS.
  5. DID EINSTEIN WASTE HIS LAST 30 YEARS? WILL WE?
  6. VOLUME IS VANITY, PROFIT SANITY: NOLAND AND OWENS & MINOR.
  7. GREAT CHANNEL COST IMPROVEMENT CASE STUDIES/ARTICLE.
  8. STUDY FOR EDUCATING SMALL, DUMB CUSTOMERS WITH "NO BUYING COSTS."

1.    WARM-UP, THEMATIC QUOTES.

"Men believe that a society is disintegrating when it can no longer be pictured in familiar terms. Unhappy is a people that has run out of words to describe what is going on." Thurman Arnold

"The beginning of wisdom is to call things by their right names." Chinese Proverb

"The future is already here, most of us just donít recognize it for what it is." (off the top of my head)

2.    COMMODITY PRODUCT INFLATION CASES AND NEWS.

On Monday of this week, two commodity metal product type distributors and one lumber wholesaler approach me with questions about how to speculate on buying their respective product lines after a presentation that I had given at a software firmís annual customer conference. Because these executives were not in the same channels, we had a four-person conversation for about 30 minutes during which we reached the following conclusions:

  • None of the three had actually run into firm allocation/shortage problems, although all had seen lead times and prices go up by 20 to 50% since November.
  • All of them were passing on both the price increases at the same mark-ups to achieve more real margin dollar growth which made them feel prosperous in the short-term.
  • All of them were selling volume at a greater pace, because many of their customers were forward buying to lock in prices and secure future supply.
  • More evidence of forward buying was that they were getting firm inquiries and sales from customers that they normally had not been selling commodities to.
  • None of them could be sure how much special order, brokered volume might be double orders that could be canceled if commodity prices suddenly dropped.
  • They all agreed that they were in a bubble of sorts and that they did not want to have a lot of inventory at the top. We speculated that both prices and sales volume would drop faster than they had gone up, because the deflating, excess inventory in the entire channel would have to be worked off.
  • They all agreed that they felt economically smart and prosperous right now, but that they wouldnít know if they would be better off or worse for their speculative buying and selling until the full peak and subsequent trough had been worked through.
  • When would we know that the bubble had peaked? We were all aware that Chinaís voracious intake of commodity products was indirectly effecting delivery times and price increases in the US. So, we thought we should be vigilant about signs that the Asian commodity speculation bubble might pop.

So, whatís been going on with China inflation this past week? Here are a few news nuggets that I came across:

March 9 - Bloomberg (Rob Delaney): "Chinaís government is shipping more rice, corn and other grains to eastern cities such as Shanghai, the nationís largest commercial city, to help stem a rise in prices caused by lower output and hoarding, the government said. Chinaís rice harvest will fall to 126 million metric tons in the crop year ending Sept. 31, a 12-year low, prompting grain traders to hold out for higher pricesÖ"

March 10 - Bloomberg (Rob Delaney): "Wholesale prices that Chinese manufacturers pay for machinery, electricity and other raw materials rose 5.7 percent form a year earlier in February, the central bank said. Prices for parts used in the production of home appliances rose 12 percent, while metals prices rose by as much as 64 percentÖ Grain prices rose 22 percent in February, with the cost of rice surging 24 percent and that of wheat jumping 26 percentÖ"

March 12 - Bloomberg (Pratik Parija): "Chinese steelmakers paid on an average $45 a ton for imported iron ore in December, 74 percent more than a year earlier, the Tex Report said, citing customs department statistics."

For an excellent article on investing in commodities that China is buying and what might happen in the short-term and the long-term, check out this link: http://www.safehaven.com/showarticle.cfm?id=1366.

BUT ISNíT IFLATION IN THE US "MUTED"(Greenspan quote on 3-16)

Well, there are a few facts about our own inbound prices and lead times, and then there is the government cover-up, dis-information campaign. From the truth department:

The Institute for Supply Management's February manufacturing index eased to 61.4 from 63.6 the previous month. The January reading was the highest since December 1983. The employment index rose to 56.3 -- the highest since 1987 -- from 52.9, while the prices paid index jumped to 81.5 from 75.5 (a monthly increase of 7.9%!

And what did the US governmentís "producer price index" read for January and February? Surprise! The last two months have been withheld for the first time in modern memory. Hereís the PR release on that:

The Associated Press

3/5/2004, 4:24 p.m. ET

WASHINGTON (AP) ó The Labor Department won't release a report on February's wholesale prices next week because of difficulties with converting current categories to a new classification system, the department said Friday.

It's the second Producer Price Index report that has been delayed by the classification changeover. January's report couldn't be released as originally scheduled on Feb. 19. "The length of that delay now means that the release of February data, originally scheduled for Friday, March 12, must also be postponed," the department's Bureau of Labor Statistics said.

New release dates have not been set. It is rare for the government to delay the release of an economic indicator.

The bureau produces the monthly PPI, which tracks the prices of goods before they reach consumers.

The release of the Consumer Price Index, also put together by BLS, is not affected by the PPI delays. The CPI measures the prices of goods and services at the consumer, or retail, level, and is the government's most closely watched gauge of inflation.

I will be curious to see:

  • How any PPI massage job can hide the truth?
  • If and when the sheep analysts on Wall Street will show any outrage over the withholding and manipulation of this critical information, because it wonít be good for the bond or stock markets.
  • When 20% or more of business executives finally get outraged at the collective dis-information coming from the government. For example: a CPI of .7%, a reported unemployment rate of 5.6%, hedonic pricing and annualized numbers being used for "tech spending growth" numbers, etc.
  • What publications will start to report what is honestly going on? The Financial Times/Economist are both weeks ahead of the US press in honest reporting, because the US press is dependent upon advertisers and readers that want "feel good" news.

Hereís an example of the timing and scope difference between the Financial Times, the New York Times editorial page (stall the economy to get Bush out) and the still muted Wall Street Journal (Republicans and supply-side economics forever);

The Economist column entitled "Heading for a Fall, by Fiat?" published on 2-26. Hereís the link if you can get to it: http://www.economist.com/displaystory.cfm?story_id=2459841.

The horsensical conclusion of this editorial was that most governments are sensationally growing and debasing their fiat currency supply to try to inflate economies past the debt loads that are still growing much faster than the underlying economies. So, maybe one day "the paper in your pocket will only be as good as a politician's promise."

The New York Times 3-17 issue has an editorial (not in the business section) on the real cost of cheap money at this link: http://www.nytimes.com/2004/03/17/opinion/17WED2.html.

Itís a low-key request for Greenspan to hike the interest rate immediately to 3% (3 to 5 is the current neutral, non-accommodative, less-inflationary, stop-growing-bubbles zone).

What should we do? It depends upon a lot of factors, but for sure donít assume that this is just another routine economic recovery that will assure "good times through the election". Iím happy, of course, to always to discuss strategic planning with anyone, itís my job. J

3.    "THE FOG OF WAR" AND OUR BUSINESS THINKING.

I heartily recommend seeing the academy-award winning documentary "The Fog of War" which is a two-hour interview with an 85 year old Robert McNamara with huge amounts of film clips and declassified phone conversations with both President Kennedy and President Johnson. Itís interesting to see:

  • An 85 year old critiquing his 45 year old self in front of a world audience. Any executive who wants to continue to grow should consider the psycho-dynamic challenge of what McNamara is doing.
  • That McNamara was not the hawk and prime mover behind the escalation of the Vietnam war that he was scapegoated to be. Phone conversations with both Kennedy and Johnson prove that he wanted to get out in both í63 and í65. But, once he personally decided to stick with the job and implement what the big boss wanted, he did his best to win it and see things more optimistically then they really were.
  • After his critical memo to Johnson in í67, which got him fired, he never publicly spoke out against the war before or after his "resignation" even as the war escalated from í67 on under Nixon. He had "damned if you do, damned if you donít" baggage.
  • How much the fog of war lessons apply to the fog of business thinking.

Hereís a link to the 11 lessons that I located somewhere on the net (I don't remember where!): ./exhibits/Fog_of_War.asp.

I would like to make a few comments on rules #-ed 6,7, and 8 from The Fog of War's Eleven Lessons. They are:

  • #6- Get the Data. (But, you have to ask for the right data in the right format. Try for example looking at the top 5 to 10 accounts and the bottom 5 to 10 accounts on a customer profitability ranking report. Follow the simple math and process that is in article 2.3 at our site (2_3.asp.) Then, resolve to do the one-page report for every branch manager in point 7 in article 2.20 at our site. (2_20.asp).
  • #7- Belief and seeing are both often wrong. We do see what we believe, and we look for more information to continue to support what we believe. What would you do if you found out that your #1 customer was actually the biggest loser you had based on profit contribution?
  • #8- Be prepared to reexamine your reasoning. If, for example, 90% of our sales volume involves selling price-sensitive commodities that our customers already do or would readily buy from competitors, then the true source of our profits is coming from profitable customers and not our product lines. What are all of the new ways to run our business if we look through the prism of simple customer profitability ranking reports? For more on this see this slide show: Identify_Customer_Niches.pdf.

Again, see this TV movie, especially if you were touched significantly by the Vietnam war.

4.    THE DARK SIDE OF YOUR BUSINESS INFORMATION SYSTEMS.

"Informational obeisance" is telling the emperor in his underwear what he wants to hear, because if you donít you will get fired or sometimes lose your head. Here are some examples:

Do you think that President Bush or any federal official in a tight, November re-election race wants:

  • To hear any bad economic news coming out of any government departments?
  • To hear any bad news about the progress in Iraq?
  • Tell voters about any necessary longer-term sacrifices (think severe government entitlement program cut backs and big tax hikes)?

Do you think big advertisers on the MSNBC news channel want to see any interviews with bearish analysts? How about the advertisers in all of the business magazines? (These first two examples were addressed in topic #2 above.)

Do you think Robert McNamara got promoted all the way to the #2 job in Ford Motor Company in 1963, because he told #1, King Henry Ford II, the unvarnished truth all of the time? Or, do you think that he was quick to relay and up-spin good news to Henry, giving him as much credit as possible while delaying and airbrushing bad news with a remedy that included firing the underlying scapegoat responsible?

What do you think McNamaraís finely-tuned political reflexes were while implementing the Vietnam war escalation wishes for both Kennedy and Johnson? Do you think he would come back from a fact-finding trip to Vietnam, step up to the microphone and the cameras to tell the press: "Based on new information, this war is a bigger mistake than I have thought all along, and it is un-winnable." (McNamaraís past and present story were touched on in topic #3 above)

Royal Dutch Shell recently announced that their energy reserves were about 20% overstated. The top officers tried to ride out the stockholder storm, but the CEO and the head of exploration have now been fired. Do you think that when a CEO tells the troops to go get X% more per year, they will use compounded optimistic assumptions in their thinking whenever and wherever possible? They did at Shell.

And when a whistle blower finds out that there is a big negative problem what happens to them and their message? Often they get fired and discredited, and if the message ever finally gets to the board of directors and to the public it can be two years later in cases like Enron and Shell.

Does it make you wonder how much "informational obeisance" is going on in your business? Do you wonder if branch managers tell you that they are doing stuff that you desire whether they are really doing it wholeheartedly back at their branch? Can branch managers have their own little dysfunctional information reality check problems going? All a manager has to do is get mad at a messenger who brings them bad news to get ever growing "informational obeisance" after that.

WHATíS THE CURE?

It starts with dealing with our own fears and then rewarding and sharing the delivery of bad news. For two articles that will improve your corporate: trust, responsiveness and effectiveness skim these at our site: 6_5.asp. 5_11.asp.

To make "open book management" really work teach all employees the ABCís of:

  • corporate profit return and reinvestment in their future (how jobs become careers).
  • the pathway to premium wages for each job niche supported by premium productivity.
  • the strategies we all need to pursue together to grow customer value, service productivity and better economic returns for all stakeholders starting with hourly employees.

The entire educational solution is within our "High Performance Distribution Ideas for All" educational system. You can buy it for peanuts with a re-seller discount, and it's unconditionally guaranteed for a month. Thereís a lot more information on it in the center of our home page.

5.    DID EINSTEIN WASTE HIS LAST 30 YEARS? WILL WE?

Thanks to Tenny Campbell, my #1 source for premium business reading material, I recently read an article out of "New Scientist" that started out this way:

"Albert Einstein died in 1955. But, arguably, he died as a scientist three decades earlier."

Without getting into a big discussion on classical physics versus quantum physics, Einstein gave a paper in Brazil on May 7, 1925 on the nature of the "photon". The paper has only recently been found and then translated into English. For the next 30 years after the paper, Einstein continued to use classical physics paradigms to try and figure out unsuccessfully how light could act both like waves and particles simultaneously. I can only imagine how many other talented physicists and resources joined him on his quest down a dead-end alley.

But, his publicizing of the duality of light also spurred on another school of physicists to discover "quantum physics" which overthrew or super-ceded all of Einsteinís thinking. In 1926 Werner Heisenberg came up with his "uncertainty principle" which is a cornerstone for quantum theory.

In 1955, the year of his death, Einstein was still defiant of the "randomness" in the quantum theory movement and stated his popular quote: "God does not play with dice". I have, interestingly, never heard this quote used in the context of quantum physics.

What are some modern day business examples of top management teams hanging on to old paradigms too long while new competitors with new assumptions and new ways of going to market eat up the old guys? Itís happening all around us. Wal-Mart first ate up mass-merchants with their quick response platform and their "everyday low cost, low price" strategy, and now they are consuming the grocery industry. Best Buy ate up Circuit City and now both are reinventing themselves again.

But, are we guilty of paradigm pliancy problems and being quietly eaten up by better business models? YES! If your pre-tax return on assets is in the bottom 90% of your industry. NO! If you are organically eating up market share from the bottom 90 to 95% of the industry while achieving an ROI of 4 to 6 times the rest.

Einstein seems to me to have been a very smart, hard working and well-intentioned scientist. Lots of top managers running mature-industry companies have the same admirable qualities. But, if we donít have enough "PARADIGM PLIANCY", are we leading our company down the tubes? For a head check I have prepared an interesting document covered in the next topic.

6.    VOLUME IS VANITY, PROFIT SANITY: NOLAND AND OWENS & MINOR.

On March 8th Noland Company based in Newport News, VA. reported profits were up 30% for 2003 over 2002 while sales were down 3%. One of the reasons for the drop in sales with the increase in profits was the termination of some unprofitable integrated supply contracts.

Noland is just one of a number of big, publicly traded distribution companies that have reported downsizing, but upgrading the profitability of their integrated supply activity. This is a normal part of the life cycle of integrated supply deals which has all been played out before in the hospital supply distribution channel. This same channel is the best place to see what the living edge of integrated supply involves, and the star to watch is Owens & Minor based out of Richmond, Virginia (stock symbol OMI). It is the last, pure-play, national, independent, hospital supply distributor, the others have been merged into drug, "health" distributors: Cardinal, Mckesson, and Amerisource Bergen.

Whatís OMIís story? The company was founded as a wholesale drug company in 1882. They started buying into the hospital supply channel as some point, but made a total commitment to it in Ď92 when they sold Mother, the drug distribution business, and shortly thereafter bought another huge regional chain called Stuart Medical.

HMOís, starting in California around 1990, became a huge driving force for the consolidation of hospitals into big chains of "integrated health providers" which in turn consolidated the distribution channel by awarding monster consolidated, integrated supply contracts to the chains with area coverage capability. While simultaneously digesting Stuart, OMI was scooping up these huge, initially profitless, contracts. Then they went to work on:

  • Getting total supply chain costs out.
  • Co-creating ever more efficient systems with their customers.
  • Introducing more economical private label products.
  • Measuring and getting paid for their true delivered total procurement cost value for the customers which is effectively done today through a web service for the customers dubbed "Wisdom".

Today OMI is running at $4.2B in sales out of 41 distribution centers, but look at their trend numbers since the 92-93 new beginning. For í95, the company did just under $3B in sales and had a slight loss for the year. Since then sales have grown at a 5%+ per year rate while profits have increased 10 fold. OMIís operating income as a percent of sales has climbed steadily from zero to todayís 2.7%.

To give you an idea of how good their operating income margin is, their latest ROI was 14.6% versus the industryís average of 7.3% and the S&Pís average of 11.3%. Their operating profit/employee is $18,000 versus the industryís $15K and the S&Pís $16K.

To understand how OMI best sells their value to customers to keep and expand their sales, read an article on their "Wisdom" system that the customers use and pay for. Hereís a Fortune piece link: http://www.owens-minor.com/pdf/Fortune082000.pdf.

Here is a link to a great slide show presented by OMIís CIO, David Guzman, in 12-03. http://www.richtech.com/events/guzman.ppt.

THE BOTTOM-LINE?

Get paid for your measured service value that comes from co-creating, win-win replenishment systems that measurably lower the customerís "total procurement cost". For more on this objective, see our article #4.9 at this link: 4_9.asp.

7.    GREAT CHANNEL COST IMPROVEMENT CASE STUDIES/ARTICLE.

In the spirit of creating inter-dependent economic benefit between channel partners, check out Tom Galeís great article with three case study examples at the link at the end paragraph. The case on a "freight recovery" program may seem like a company centric profit improvement program, but I think it can be reframed as an incentive for both suppliers and customers to work with distributors to create larger, healthy average order sizes. This in turn will lower freight and transactional costs for both parties as a by-product of better organized, disciplined replenishment systems and buy-sell coordination.

Sometimes we need a negative incentive to do the right thing. In modules 3.10 and 3.11 of our "High Performance . . ." training system, there is coverage on two types of incentive plans for the outside sales reps that will align them with selling win-win replenishment programs. Hereís the link to Tom Galeís great article: http://www.mdm.com/stories/partners.html.

8.    STUDY FOR EDUCATING SMALL, DUMB CUSTOMERS WITH "NO BUYING COSTS."

When you try to sell customers on how they are killing themselves with transactional costs when they order too many small orders, what do you say when they reply: "but, my paper processing costs are for free, I do it all myself anyway". If you are looking for a credibility study to back up your claims, then check out the "executive summary page" (page 7 of about 45) of a National Independent Business Federation study on small business paper processing costs at this link: http://www.nfib.com/PDFs/sbpoll/sbpoll12_2003.pdf.

 

THATíS ALL FOR THIS WEEK! BRUCE

Bruce@merrifield.com

919/933-7474