March 24, 2004: Distribution Channel Commentary (DCC) # 63

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THIS WEEK’S TOPICS

  1. THEMATIC QUOTES FOR THE WEEK.
  2. INSPIRATIONAL TURNAROUND STORIES FOR 90%+ OF US WHO NEED THEM.
  3. 21 GUN SALUTE TO "REINVENTING PROFIT POWER."
  4. REDISTRIBUTION ACTIVITY IS UNDER: APPRECIATED, USED AND MEASURED.
  5. COMMODITY, PRODUCT-LINE INFLATION UPDATE.
  6. ECONOMIC OPTOMIST OR PESSIMIST? BUSH OR KERRY? RECORD POLL POLARITIES SUGGEST WHAT SCENARIOS TO PLAN FOR.
  7. INTERESTING DISTRIBUTION SOFTWARE EVALUATION SITE.
  1. QUOTES FOR THE WEEK.

"It’s like a Greek tragedy. Everybody plays his part, everybody does what’s right by his own life, and the total just doesn’t work." Andy Grove (Retired Chairman of Intel)

"It’s not enough to do your best; you must know what to do, and then do your best." W Edwards Deming

"Today value-added is almost everything. If you don’t add value, you can’t get and keep customers. I’m not saying personal relationships aren’t important anymore. They just aren’t enough. Customers want to know what you’re doing – or intend to do – for their business." Norman Brodsky (Ed.-at-large, Inc Magazine.)

"It’s being engaged that makes a difference; individuals lose, teams win." Bronson Van Wyck (B-school section agent)

    2.    INSPIRATIONAL TURNAROUND STORIES FOR 90%+ OF US WHO NEED THEM.

The bottom 90% + of distributors and most mature-industry companies could make better returns by liquidating and investing in municipal bonds, because they are selling commodity products and undifferentiated, "good service" on a last-look, meet-the-price basis. There are general guidelines that apply to curing all such under-performing companies. This commentary series has been laced with stories and how-to methods for turning around mature industry companies’ performances that support those turnaround guidelines. Check out the index of topics for all past commentaries at this link: List%20of%20topics%20in%20commentaries.asp.

(The first DCC topics on turnaround tactics that I happened to notice, starting from DCC #1, were #s 5.2 and 7.2)

Here’s a quick review of some general stages of a turnaround in a chronological order:

  • In the pre-turnaround, action-contemplation stage, we have to stop assuming that our current survival is equal to long-term viability with an eventual, good, liquid exit valuation possibility. The bottom 90%+ - on a pre-tax return on total asset number, in most mature industries - are slowly dying; they just don’t know it.
  • Before we get better, we will have to: unlearn existing bad habits; confess our flawed, unspoken, "success" assumptions; and agree on how to free up some operational slack by weeding losing customers, products and employees that don’t fit into where we could improve to.
  • There are five stages to the turn-around process: 1) downsize the losing elements of our business to free up the slack to. . . . 2) up-grade what is best and most promising. . . . . then by 3) re-focusing on our more profitable core of customers, one niche at a time. . . . we can 4) revive/re-invent our value proposition to be a distinctive #1 total value. . . . finally 5) be able to consider pursuing new best customer niches or other types of "adjacencies". Trying to diversify away from a losing core will always fail.

Here are, IMHO, a few inspirational turn-around case stories gleaned from this past week’s fire hose of news flow.

#1: INDUSTRIAL DISTRIBUTION GROUP, the publicly traded (IDG), Atlanta-based, roll-up of small, industrial supply companies made the 3-22 issue of Barron’s. (pg. 29, Sizing up Small Caps; "Mighty Mites". Here’s the link for on-line subscribers, it may work for non subscribers too: http://online.wsj.com/barrons/article/0,,SB107974177201860746,00.html?mod=b_this_weeks_magazine_main).

This poof-company went public in ’97 at $17/share, soon peaked at $23, hit $1+ three years ago, and closed 3-22 at $7.35 with a current book value of $6.16.

IDG’s turn-around story is still underway. The turn-around CEO, Andrew Shearer, arrived in August ‘01and has pursued the first four stages cited above – downsize, upgrade, refocus and revive.

For downsizing and upgrading, here are a few stats:

  • The company’s sales peaked at $546MM with a profit before tax (PBT) loss of ($12.7MM) for FY ending 12-00.
  • For FY ’03 sales came in 12% lower at $483MM as unprofitable customers were re-priced to either become winners for IDG or losers with some other competitor that is into losing incremental volume for vanity’s sake. Assets and people were downsized in parallel to both lower sales and small order activity, so the PBT for ’03 climbed to $4.4MM for a net swing/change of + $17.1MM at the PBT line in 30 months time. This turn-around has happened, more impressively, as the manufacturers IDG sells have gone through a depression marked by 42 straight-months, and counting, of net layoffs!
  • Total Assets were $230MM for ’00 versus $133MM for ’03, so sales to assets turns has improved from 2.3 in ’00 to 3.6 at year end ’03.
  • Total Debt has dropped from $65.8MM in ’00 to $36MM in ’03 at lower, re-financed rates. (Why borrow to finance receivables and inventory to support losing sales volume from losing customers?)

Some re-focus and re-vive stats were reported by Barron’s also:

  • (Profitable) Integrated supply contracts for which IDG uses proprietary software and runs in-plant store rooms for the customers now account for 51% of the company’s total sales, up from 44.6% in ’02. They seem to have "revived" their core by capturing and retaining customer niche share faster than it may be immigrating to Asia.
  • The fund manager who told Barron’s readers to buy IDG at $3 per share in 10/03 is forecasting more than a double in profits for IDG this year and double in the stock price. Sounds like IDG’s credibility as a fast-improving – customer, supplier, employer and investment vehicle – are all improving which is vital when trying to sell, achieve and share inter-dependent channel cost savings ideas.

During this turn-around, what must Mr. Shearer have said to the entrenched managers and sales reps who might have said or thought back in the fall of ‘01:

  • You can’t shrink sales, we will lose manufacturer rebates which are our biggest source of profits!
  • You can’t shrink sales, we have lots of fixed costs, so our losses will grow!
  • We don’t have any losing customers, they are all contributing margin contribution dollars to our fixed costs!
  • You can’t raise customer contract prices and terms, they won’t like it and will all leave for competitors that are already offering them better deals!

Anyone who thought or stated these things were apparently using flawed, unspoken-assumption thinking, because the PBT swing was huge in the midst of a deteriorating sales channel. And, all of the stakeholders that are still with IDG have a much more promising future today than they did in August ’01.

Who will be on the turn-around leadership team at your company? Imagine how much faster and better Mr. Shearer could have orchestrated his turn around with multiple copies of our "High Performance Distribution Ideas for All" transformational system? Many of you still can!J

#2: "AUTO MEGADEALERS: RUNNING OUT OF GAS?" is the title of an article in the 3-29 issue of Business Week. Here’s the link: http://www.businessweek.com/magazine/content/04_13/b3876111_mz020.htm.

For those who don’t want to read the entire sad story about six, publicly-traded, roll-up companies in the auto dealer channel (AutoNation is the largest), here are a few choice quotes:

  • "It’s getting tougher to keep growing fast by making big acquisitions. At the same time they haven't’ figured out how to perform any better than the mom-and-pop dealerships they bought. Indeed, most have lower net margins than the independents. And many make only 5% to 6% return on assets, while paying between 6% and 10% on the money they borrowed to buy more dealerships."
  • (Ford vetoed a chain’s bid to buy a dealership noting that) "the chain has lower profit margins and weaker customer-satisfaction ratings than other dealers."
  • "The chains save money by reducing advertising costs, consolidating their back-office work, and paying lower interest rates on inventory from the manufacturers. But the savings aren’t enough to offset the cost of extra management layers or the regulatory expenses of being a public company.

What do you think happens to local management effectiveness when you buy out a 20+ year, veteran, owner operator who’s name, face, voice and/or reputation is tied to lots of local advertising where they guy has lived his entire life? What do you bet that the new "profit-center" managers gets lots of new by-the-numbers reports and turn over every 2 to 4 years? The local service and resource investment dis-economies must be quite large to significantly offset the savings that big chains do achieve.

How should most distribution chains re-think how they hire, train, pay, and keep profit center managers at one location for longer periods of time? Why don’t chains have economies of wisdom for developing and supporting more totally effective profit center managers than the local independents? Do you think most chains even ask these questions to begin with? Or, if they do, do most assume that they can’t achieve a longer-term, breakthrough solution for the channel that they are in? Perhaps 5% of the chains have done it!

#3: TYCO INTERNATIONAL keeps their turnaround story going. In the March 21st issue of the New York Times, I learned that Tyco’s new, turnaround CEO, Ed Breen (former President of Motorola) who stepped in 7-25-02 has done a lot (link at the end of the blog). Besides the normal cost cutting moves, the ones that intrigued me were:

  • He has replaced the entire board and 220 out of 250 top executives (88%). The company has 25,000 ‘managers’ in total.
  • The company has written a multi-paged ethics policy and hired more than 100 internal auditors to enforce it.
  • Bonuses have been shifted from "big for those who can drive the numbers up anyway at all" to a balanced scorecard system which paid $90MM less in the ’03 budget. "Executives squawked, but there is a restored sense of corporate pride."
  • Tyco plans to sell more than 50 businesses with sales of about $2.1B (to downsize, upgrade, refocus and revive?). Many of these are in the fire and security unit which are marginally profitable and rely on "franchising" which Breen wants to move away from to focus on business with direct sales connections to customers.

The article further suggests that Tyco is not out of the woods with about $1.25B in lawsuit payments to make and $16.8B in debt to reduce.

My conclusions:

  • When you have a greed-contaminated culture that has grown up with a dysfunctional, unbalanced incentive system, it may be easier to change managers than it is to try to change managers’ thinking and habits.
  • Trying to win back the trust from all of the employees takes a lot of ethics training and leading by example. What is the most effective and efficient training methodology for getting all distribution employees to start moving together in a new, more promising way? (See our article on this at: 3_12.asp.
  • Could manufacturers that sell through distributors be quite frustrated with any attempts at getting any new, improved total product solution proposition through to the end user? Tyco doesn’t seem to want to mess around with trying to get any reinvented value propositions through independent distribution channels.

Here’s the article link: http://www.nytimes.com/2004/03/22/business/22tyco.html?ei=5062&en=11830d5c055b7630&ex=1080536400&partner=GOOGLE&pagewanted=print&position= .

    3.    A 21 GUN SALUTE TO "REINVENTING PROFIT POWER."

Because most mature-industry businesses have hit the profit growth wall sometime in the past 3 to 10 years, the idea merchants have been feeling our pain and writing business books (about 1500/month) on how to reinvent our profitability. To see what type of spider-web map would grow out of the topic "profit growth", I went to Amazon, typed in the search terms and started to follow the "other book" links from the original ones that showed up. I compiled a 34-page document that is copy-and-paste content from Amazon for 21, best-rated books that all center on "reinventing our profit growth". The link to this document on my site is at the end of this blog.

Here is what I’m hoping you will do: skim the 2-page table of contents and then do the same for the books. You will find some Amazon promo copy plus one or two reader reviews that tell a lot more about the book’s main ideas and were rated as "very helpful" by other readers.

What are the benefits to you?

  • You will be able to find and review the 21 best books a lot faster than I did.
  • You may get enough value from the notes to not have to buy and read the rest of the book.
  • I have organized them in a chronological order: a) get paradigm pliant to b) revive our core to then c) pick the right new vectors or adjacencies for growth with better profit models and d) change management skills.

Enough! Here’s the link to the document: ./exhibits/AMAZON_Book_Reviews.pdf.

    4.     REDISTRIBUTION ACTIVITY IS UNDER: APPRECIATED, USED AND MEASURED

Here are some case stories about "re-distribution" opportunities:

#1: A manufacturer of durable goods did some simple customer profitability analysis work that incorporated transactional (shipping) costs for which his marketing people were not measured or compensated. He was shocked to find out that some of his biggest losing customers were national chains. The chains had cut "truckload pricing, no freight" deals, and then all of their locations had been placing lots of small orders to be shipped directly to all of the locations. "Too few" chains according to my client had hub DC’s that ordered larger, profitable orders. Then, he had a lot of small distributor accounts that got "buying group" pricing, but were at least paying LTL freight. About 80% of these accounts were profitable before buying group rebates were subtracted out. After subtracting out buying group rebates, only about 20% were marginally profitable.

I advise him on how to renegotiate the big-chain, small-order accounts. And, I suggested he consider re-directing the buying group crowd through a re-distributor that provides all of the tracking support services he might need.

#2: A manufacturer of specialty tools confessed to me at a software users’ conference that his web order entry system coupled with fast, direct shipment had worked too well. Many of his distributor sales reps were doing their own special orders for their accounts. Sales were up nicely, but order fulfillment and freight costs had climbed much faster than margin dollars to reduce profits. His company was getting killed by small orders that were being priced and freight-charged at the distribution company’s contract rates.

We had a discussion about all of the differences between the old and new way to see if we could come up with a third way that would allow for more sales and more profits. I suggested that he segment his customers and price/term them differently for the web order entry option and to consider using a re-distribution, outsourcing service capability.

#3: A producer of freight-sensitive food items called about using the services of a well-known, national, master distributor that has grown enormously over the years due to great economics and service for both manufacturers and distributors. He understood that the master distributor would give him access to a lot more small distributors, but he was balking at the cost. He reasoned that his costs for shipping straight truckloads to his best direct accounts on the opposite coast were significantly less than what the master wholesaler wanted for a "functional discount".

We talked about the total, average economics of the volume flow and not an isolated, best-case, freight cost comparison. I suggested some simple activity based costing studies plus some retain and grow fill-rate economics his distributors would get by using the master distributor’s services. I haven’t heard yet what they have decided to do.

WHO ARE SOME MASTER DISTRIBUTORS? WHY ARE THEY GROWING THEIR CHANNEL SHARE?

Some distributors belong to buying groups that in turn have set up their own coop central warehouse. The range in how efficient and well-used these type of facilities are, however, is huge. Two, best-of-class master distribution co-op capabilities are, for example, Johnstone Supply (HVAC, etc) and DoItBest Corp. (hardware, lumber, etc). Many of the members in these two co-op families buy as much as they possibly can through the co-op warehouse(s), because it makes the best total economic sense. I am aware of other co-op warehouses which are so poor in their execution and have such low-share of member purchases that they would be best off to outsource the job, including all private label goods, to the best master distributor in their channel, if such a beast exist.

In other channels there are long-time, dedicated, master distributors that have "never sold direct" to end-users. Some excellent examples are: LaGasse in the jan/san channel; United Stationers in office supply; ORS Nasco in the welding supply; and Dot Foods in the foodservice channel. Dot notably does an expanded set of outsourcing services for both buying groups and manufacturers.

In most every channel, there is an economic need/space for some type of master distribution capability. Lots of times manufacturers try to forward integrate and fill the space themselves. Here are some examples that come to mind:

  • 3M has regional warehouses that try to combine goods from multiple 3M divisions that sell into the same channels.
  • Before the roll-up blew up in 2000, Thomas and Betts created a powerful master distribution capability by buying up many independent, electrical-product manufacturers and then having all of their plant production shipped to and through two master distribution centers. Electrical distributors were eventually able to buy assorted items from about 40 different manufacturing suppliers that were eventually stocked under one roof.
  • I read recently about 3 non-competing manufacturers in one channel forming a joint venture, master distribution company to re-route production from both domestic and foreign plants. All manufacturers that outsource some production to Asia will have a similar break-down and re-mix need for their "full line".
  • I have occasionally seen large regional distributors put together a re-distribution program for small, non-competing distributors in the same channel. Often, they are selling assorted cases of commodity items from two or more suppliers for which the truck-load and LTL pricing differential works as a functional discount for all three parties – the supplier, de facto master distributor and the little distributor.

The potential redistribution space is under-used, because most channel players just don’t have a good understanding of the true total economics for all three parties. For those who would like to dig deeper into the "butterfly economics" of redistribution. Here are links to some food for thought:

In these challenging times, there is still big untapped productivity and profitability to be found between channel partners. But, all three partners – producer, redistributor and distributor/dealer – have to be able to agree on:

  • How to flow-chart what is and what could be.
  • What the total cost trade-offs are for both "before and after" including the economic benefits of having higher, everyday fill-rates that yield: larger average order size, less split orders, backorders and lost orders, better customer satisfaction and retention and better total personnel productivity.
  • Who is best equipped (core competency capability) to do which new set of activities? The dedicated, re-distribution creature with the best one-stop-shop breadth of inventory lines and the biggest, everyday throughput volume to achieve economies of both inventory turns and freight per stop.

If you have energy for and under-utilized economics for redistribution opportunities and need help, let me know!

    5.    COMMODITY, PRODUCT-LINE INFLATION UPDATE.

Regular readers know that I have been watching the inflation taking off in a number of different commodity distribution channels and trying to understand the inflation’s root causes and future course to better advise channel players on what to do about it. (See the last few commentaries for more.) So, here’s what I uncovered this week.

First, on 3-18 the federal government reported a sharp rise in wholesale inflation pressure for the month of January. The mysteriously, long-delayed release of the Producer Price Index showed a jump of 0.6 percent. The increase was led by a nearly 5 percent run up in energy costs, countered by a 1.4 percent drop in food prices. The Labor Department was due to release the index a month ago, but it was delayed because of "problems that arose when the agency switched to a complex new system for classifying industries".

The agency did not comment on how they might have re-massaged the new PPI number for January to make it lower than the old system. And, no date has been set for the release of the February PPI, which was delayed for the same reason. Read on to see why both Feb. and March numbers will be going up ever faster.

Next, how’s inflation helping channel intermediaries? Here’s a just breaking story. On March 23rd the WSJ reported on how good it is for Metal Management (for on-line subscribers: http://online.wsj.com/page/0,,2_0033,00.html?mod=2_0033. For non-subscribers, here’s the scrap metal recycler’s news:

  • The price per ton of scrap has doubled in the past year.
  • They are shipping junk to China FOB Newark, NJ.
  • Their stock has gone from $6 to $40 since March ’03.

Some analysts think scrap prices and demand will peak in May. Some think it is a bubble. All sellers will, in time, find ways to find more of it and all buyers will find ways to use less of it and/or find alternative sources. Who really knows?

Third, will big customers like GM pay higher prices for the steel that is made out of expensive scrap? GM, after all, has over $60B of unfunded healthcare liabilities which are growing, and they have locked-in, long-term supply contracts. Again the March 23rd WSJ reported that GM is paying the higher prices. For subscribers, here is the link: http://online.wsj.com/article/0,,SB108000616298462518,00.html?mod=us_business_whats_news.

For non-subscribers, the gist is that GM will pay higher prices for the steel while they try to work something out in court, because with their just in time supply process everything would shut down quickly without a steady flow of the steel. It sounds like intermediaries that would go out of business if they couldn’t pass on price increases have more leverage over bigger customers who would go out of business if they can’t receive the product. I suspect that GM will soon have to raise the net pricing for their vehicles.

Fourth, is the China infrastructure growth bubble still driving global commodity prices higher? Here are some news bits from this past week:

March 16 - Bloomberg (Rob Delaney): "China demand for rice, wheat and soybeans has boosted prices of the staple grains in the country by as much as 31 percent in February, mostly in cities, the National Bureau of Statistics said... Soybean prices in China rose nearly a third in February, from a year earlier, while rice prices rose 21 percent and wheat 20 percent, the report said. Soybean oil and peanut oil have risen 24 percent, while rapeseed oil has gone up 25 percent."

March 18 - Bloomberg (Mark Shenk): "Crude oil futures closed above $38 a barrel for the first time since the 1990-91 Persian Gulf War, after the U.S. Energy Department reported a decline in nationwide gasoline inventories... 'Demand just keeps growing, especially in China and India, in spite of high prices,' said Phil Flynn, senior energy trader for Alaron Trading Corp. 'This is setting us up for a very bad summer driving season.'"

March 17 - Bloomberg (Tian Ying): "China's fixed-asset investment in towns and cities jumped 53 percent in the first two months of this year amid expectations the government would restrict new projects after its March 5 annual policy meeting."

March 17 - Reuters (Robin Paxton and Sambit Mohanty): "Record shipping costs fuelled by China's ravenous appetite for commodities have pushed up prices for metals, raw materials and farm products across Asia -- but done little to dampen demand. Spot shipping rates on most Asian routes have more than doubled in the last six months but, such is the region's appetite for commodities, buyers are absorbing the higher freight costs and passing them on to customers, industry officials said. 'Even with the exorbitant freight rates at the moment, demand has not ceased at all. If anything, it's stronger than ever,' said Simon Everett, general manager of Hong Kong-based Trans Orient Ore Supplies... Huge demand for iron ore and coking coal for China's steel sector and alumina to feed new aluminum smelting capacity, plus a rush for grain shipments from the newly harvested South American crop, are behind the huge rise in freight rates."

March 18 - Bloomberg (Jeff Wilson): "Soybeans rose above $10 a bushel for the first time in 15 years as insufficient rain in South America dimmed prospects for crops needed to revive supplies, which have been eroded by a surge in demand for animal feed."….

Corn traded this week to 6 ½ year highs, tin to 14-year highs, copper a near 8-year high, pork bellies near 3-year high, Coffee a 3-year high, and gasoline a 1-year high. The Goldman Sachs Commodity index this week traded to the highest level since December 2, 1980. Already up almost 10% y-t-d, the CRB commodities index today traded to the highest level since May 25, 1984.

March 18 - Bloomberg (Alan Patterson): "Corning Inc., the world's largest maker of glass used in flat-panel computer and television displays, said shortages of the material may last until next year because of stronger-than-expected demand... A shortage of parts in the $37.7 billion global flat-panel market boosted prices of some displays by 45 percent..."

CONCLUSION ON CHINA: COMMODITY GOODS INFLATION WILL CONTINUE TO CLIMB, but China's growing shortages of: electric power, facilities for off-loading raw materials and trains for delivering raw material goods to their consumption point will cause a growth accident at some point. What’s more, there is a lot of speculative inventory and orders placed through out the world financed at low interest rate costs, and China’s internal inflation continues to grow.

In the longer term, there are no shortages or "high prices" in truly free markets. The late Julian Simon, the University of Maryland economist, made this key point: "natural resources are not finite in any serious way; they are created by the intellect of man, an always renewable resource." In other words, human intelligence, with the right economic incentives, can find ways to get more of any commodity or create substitute solutions to get a final task done.

But, for now, the most conservative estimates I have seen are for all of the aforementioned commodities to continue to climb until at least May.

    6.    ECONOMIC OPTOMIST OR PESSIMIST? BUSH OR KERRY? RECORD POLARITY IN OUR THINKING SUGGESTS WHAT SCENARIOS TO PLAN FOR?

Any good, strategic-thinking manager has to have their own best assumptions for how the economy might grow, what interest rates might do and how government might change fiscal and tax policies. There is currently, however, a record difference in both the disparity and the intensity of both economic and political views in the US. The majority of economists still want to believe that someday we are going to have a normal post-WW2, economic recovery, but a growing and emboldened group of economists and media commentators are starting to point out that this, borrow-and-spend recovery doesn’t have any clothes or jobs.

For a balanced review on economic (stock market) optimism/pessimism, check out this NYT article:http://www.nytimes.com/2004/03/21/business/yourmoney/21mark.html.

For one that is obnoxiously pessimistic, but does offer a good summary of historical cases of when countries have gotten carried away with "accommodative expansion of fiat currency credit units" which is clearly happening right now, especially in the US, Japan and China. Here’s the link: http://www.gold-eagle.com/editorials_04/greene032104.html.

On the political front, the nation is in the grip of an all-time record "premature partisan polarization". In a recent survey, Bush had a 94% approval rating among Republicans, but only 16% of Democrats approved of his job performance. More Republicans approved of Clinton’s performance during his impeachment trial! For a fascinating slide show on the entire Bush-Kerry pollster story go to this link: http://www.npr.org/news/specials/polls/mar2004/mar04.pdf. (Page 24 illustrates the polarization issue.)

If you have an extra 2 or 3 minutes and would like to see which of the candidates best aligns with your views, go to www.presidentmatch.com and do the survey. My alignment scores for three candidates fell between 53% and 47%. If your current gut level candidate choice does not have the best alignment score, remember that all of the questions are presumably equally weighted. Most people have vastly different weightings for some issues that would give vastly different alignment scores. But, it is still a mind-opening exercise.

    7.    INTERESTING DISTRIBUTION SOFTWARE EVALUATION SITE

If you ever think you will be in the market for a new ERP software package or different bolt-on application software solutions, check out this site that my colleague Steve Epner (and firm) put together. http://www.software4distributors.com.

That’s all for this week!

Bruce

Bruce@merrifield.com

919/933-7474