March 31, 2004: Distribution Channel Commentary (DCC) # 64

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THIS WEEKíS TOPICS

    1.    GROWTH-REBATE ROT NEWS AND PERSISTANCE; WHATíS THE CURE?

    Earlier this month (3-5) Ahold Corporation of the Netherlands, the parent of US FoodService, announced that they were considering suing Jim Miller, the architect and former CEO of the $17 B distribution giant, for his role in reporting of over $1 B in false profits that was uncovered just over a year ago.

    Ahold also announced that Mr. Miller had already filed suit against the corporation to get his $10MM in deferred benefits that the company supposedly agreed to when he was forced to resign last May. What an on-going tale of woe!

    For regular readers, you know that I have weighed in on the bigger, dark side of vendor, growth rebates: how they burn out channels, spark independents to sell to roll-ups, etc. You can find more on this general subject in DCC topics # ed: 14.2, 15.3, 18.5, 25.3, and 26.1.

    The ill effects of racing to get big for rebate dollars in the Ď90ís, as well as other mythical net economies of scale, continued to surface this past week. On March 25th, Zackís, the stock rating service (at www.zacks.com), rated 5 companies as strong sells, two of the five were big roll-up distributors: Performance Food Group (PFGC) and Ikon Office Solutions (IKN). PFG is another foodservice distribution consolidator that is currently doing about $5.5B in sales, but has seen significant reduction in earnings year over year.

    IKON is the old copier (and other office equipment) distribution division of the giant, profitless Unisource WorldWide. When acquisition earnings magic and a good printing paper shortage started to exposed Unisource for the mismanaged mess that it was, the company spun-off IKON. The Unisource parent was then merged into a retail gas distributor that made no sense, then the compounded mess was taken over by Georgia Pacific. This new division for GP caused so much debt and pain it was quickly spun-out in a deal in which Bain Capital bought only a minority interest, but operating control. At any rate, IKON, today, is losing money on over $5B in annual sales.

    Now that year-to-year growth and rebates canít be bought by the growth-rebate gamesters of the Ď90ís, what should they do about fading profits combined with all of their debt (if they are private) or goodwill (if they are public)? I think they need to get back to basic service brilliance at the branch level focused on one customer niche at a time. Do you think that these big chains that have focused on financial engineering and economies of cost cutting can solve their even bigger dis-economies of local service value and customer niche focus?

    Weíll have to see. In last weekís DCC topic # 63.2 we learned how Industrial Distribution Group (IDG) seems to be making some headway with back to basics guided by customer profitability ranking reports and how Tyco is making a valiant culture change effort for their 25,000 managers. Both companies are making more profit by selling less volume, because they are shaping up or out the unprofitable customers that either arenít well matched to their value proposition or that nobody can make money on. (Let your competitors take those type of accounts, then they can get some "volume is vanity" action to get into the money on rebates to help defray the bigger losses they will have by serving such accounts.)

    What are some additional curative measures?

    • Stop trying to manage and push sales volume growth in a mature market with too much capacity by selling low to try to buy a bit lower. The entrenched competitors just match the price and keep the business until they decide to pass because the losses on the account have gotten so great they canít bear them any more.
    • At each branch use KISS customer profitability ranking reports and plays to identify the most profitable core customers and niche(s) buried within the customer portfolio. (For 10 annotated slides on how to do this go to: Identify_Customer_Niches.pdf).
    • By re-focusing, re-defining and re-serving core niches and best customers in those niches we can grow both sales and profits by retaining, further penetrating and growing with the best growth customers. Then, we can win manufacturer growth rebates as a happy by-product of our focused, customer-service retention strategy, not by ramming and jamming more product-centric promotion and price deals.
    • Once we achieve a best total procurement cost service proposition for a target customer niche, we can start practicing smart, oligopolistic value selling. Whatís that? Because there has been so much consolidation in so many distribution channels, it isnít uncommon to find two head-to-head competitors in a given marketplace sharing up to 80% of any targeted customer niche. When two players control a huge share, it doesnít pay for either one to try to win incremental share by shaving any price or economic terms. Of course, humans do have egos and often two parties will battle to their mutual demise for the glory of it all. If one entrenched party refrains from matching a price and sells equal to or better total procurement cost and no switching costs to the other competitor, things can turn around quickly. Why erode margins another few points to pick up no new, net share?

    For more on the reasoning behind oligopolistic pricing strategy, check out this link: http://www.revisionguru.co.uk/economics/oligopoly.htm.

    For a case study on two English bus companies that had a national duopoly and a volume-is-vanity, ego-driven war of mutual destruction, here is a link to a short article entitled: "Laurel and Hardy of the Bus Business" which may only work for on-line subscribers to the Financial Times/Economist: http://search.ft.com/s03/search/article.html?id=040319002579.

    2.    "NO INFLATION IN THE US" (?) LINKS TO GLOBAL VIEWS

    From the federal government we keep hearing that unemployment is low and "inflation" is benign. This allows the Federal Reserve to be "patient" about keeping short term rates at a negative 2% while gunning the money supply growth along with the help of all "structured finance", debt-back bond producers. Fannie Mae is the biggest; they are now taking zero-down, interest-only, adjustable rate mortgages and turning them into dollar denominated, long-term bonds. Because cash is trash with a negative return and the Fed is effectively the central bank for most of Asia that pegs their currencies to the dollar, there are now huge asset inflation bubbles all over the world.

    If you would like more on the real story to understand why big stagflation (a best scenario) or serial bubble popping is ahead, check out these articles:

    • For a little discussion on how the government keeps the CPI low and how they will most probably overhaul the delayed PPI number check out this column by Bill Fleckenstein:
    http://moneycentral.msn.com/content/P73981.asp.

    • For more from Fleckenstein on how the government makes the GDP and tech spending growth numbers a lot bigger than they really are by using "hedonic pricing" (not actual PC sales, for example, but what the same PCís would have cost in í96), check out this article: http://moneycentral.msn.com/content/P72746.asp.
    • For how China is and will continue to drive commodity prices through the roof, with growth accidents along the way that will cause plunging commodity prices check out this well written overview article by John Mauldin and place your inventory speculation bets accordingly. Some people think the first commodity price blow off could happen by May; many assume that supply will exceed demand comfortably by next year; and others think the China freight train will be manipulated right through the 2008 Olympics without a blow up. So far, the only true shortages in the US that I have heard about are for scrap steel and solar panels (see topic #4 below). Hereís the link to the China article: http://www.2000wave.com/article.asp?id=mwo032704.
    • To understand how Mr. Greenspan has reflated the entire world with investment bubbles donít look to information from our government or from domestic business news sources beholden to domestic business advertisers, read the Economist and The Financial Times regularly for articles like this one: http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1079419983726&p=1012571727304.
    • And, if all else fails in this borrow-to-spend on consumption recovery (debt dollars are substantially not going into productive investments), we have our Congress finding new ways to borrow and spend right up to this coming November election. Here is a link to a short article from the only sitting congressman who has been able to tell his constituents (and therefore the rest of us too) the real economic story and continue to get re-elected (Ron Paul of Texas): http://www.house.gov/paul/tst/tst2004/tst032904.htm.

    Because hope and wishful thinking arenít strategies, we need to assume that if the inflation lid is going to blow off the pressure-cooker and interest rates are going up, how do we lock in our current, low, short-term, variable interest rate on our line of credit loans? Iím assuming most readers have already locked in low, fixed, rates for long-term debt in their personal and business worlds. One clientís story on doing a swap follows in topic #3.

    I would like to close off this section with a letter that was mailed in to and posted by the oldest, wisest, best and best-value investment letter writer of all, Mr. Richard Russell. He writes everyday, 5 to 6 times per week. His story is at www.dowtheoryletters.com. At the close of his 3-30 posting, he included this letter from a wholesale baker on the inflation he is seeing from his suppliers, but not from his government stats. So, without permission, but with admiration for Mr. Russell, hereís the letter:

    "Dear Mr. Russell,
    I had to write this letter regarding the comments of Adrian Van Eck of last Friday. I am also extremely angry with our government for the massaging of the "numbers." I own a wholesale bakery in Nassau County, Long Island New York. Mr. Van Eck is exactly correct in his idea about the rampant inflation that is going on. Aside from the rise in local taxes, health care, and oil, I would like to tell you about the inflationary pricing that has occurred in my business during the last 10 weeks.

    1. Eggs have gone from $18 case to $39.95. More than a 100 per cent increase.

    2. Butter has gone from $56 a case to $92 a case.

    3. Cream has gone from $2.10 a quart to $2.50 a quart. And I just got a call from my dairy provider who says that on April 1st the price will go up another 80 cents a quart.

    4. Flour has gone up the least at about 5-7 percent.

    5. All soy based products and toppings went up 15-20 per cent last week.

    6. I just heard from my chocolate supplier who is only raising the minimum order, but their prices went through the roof about 15 months ago. You can check the cocoa futures for that.

    All of these numbers are documented and not pulled from the thin air.

    What is our government looking at? What happened to the idea of government helping the people? I am tired of politics as usual. Keep on trucking Mr. Russell."

    3.    LOCK IN LOW FLOATING RATES WITH "A SWAP"?

    A distribution client of mine has about $20MM in short-term, line-of-credit, bank debt that is pegged to the Libor rate. (London Inter-Bank Offer Rate. The interest rate that the banks charge each other for loans that are usually quite large and borrowed for one day to five years.)

    He recently was able to put $15MM into an interest rate swap contract in which he has locked in the rate of roughly 1.5% for five years. He realizes that if interest rates just went up to a "neutral level" between 3 and 5%, not only would his interest costs explode but the economy and his sales, profits and interest coverage ratio would decline.

    Iím not an expert on "Swaps". I donít know what the fees or the minimum size of debt is that you must lock up to make it all work. But, if wholesale inflation is coursing through the supply chains of the US, the CPI, doctored or not, will eventually rise along with the need for interest rate hikes.

    In case you might need to "be prepared" and want to know more, here are two links to documents that explain swaps. Here is a shorter answer document: http://www.nationalcity.com/content/corporate/CapitalMarkets/InterestRateRiskMgmt/documents/swap.pdf.

    For very comprehensive information try: http://www.interestrateswaps.info.

    4.    ELECTRICAL DISTRIBUTOR SEEKS GROWTH IN SOLAR TANGENT; SHOULD YOU SEEK PROFIT GROWTH DIVERSITY? HOW?

    Hereís a general problem for many distributors: where do you find new markets and product lines that can generate sustainable profit growth to replace the ones that are shrinking and/or profitless? But, conventional wisdom tells us not to seek out seemingly greener pastures if we are only mediocre performers at what we are currently doing. The success rate for public companies that try to diversify into "adjacencies" from their core business is only 25%.

    My entire "High Performance Distribution Ideas for All" theme in the commentaries has been aimed at first helping the 95% of all distribution centers that are not sufficiently good at their core activities. Amongst the other 5%, I have been working with a few on new adjacency moves.

    Hereís one partially disguised case. A large regional electrical distributor serves several contiguous states in which very generous tax subsidy legislation has been passed for both consumers and businesses to invest in solar power production that would most notably help to shave peak electric needs in the middle of the summer. In some cases, the combined Federal and state tax deals can turn a big mall operatorís roof into a profit center for no net present value investment.

    The distributor has reasoned that electrical contractors should be the logical players to do the installation of these solar solutions or at least the final hook up to the electric grid, so excess electricity production can be sold back to the utility company. But, the entire process from selling and designing to installing and gathering rebate funds could be different enough that most contractors will resist pursuing this business and/or do it badly when it is forced on them.

    How should a distributor go about collecting the right, best manufacturers of a one-stop-shop assortment of goods to supply how wide a range of job solutions? How should they train both their sales force and contractors to see, sell, go after this type of business? What extra peculiar value-added services will this new vein of business require? Is this a best tangent to pursue? What are their other opportunities?

    How could I help? I first suggested that as many of the management team as possible should read the book, Beyond the Core, by Chris Zook. Itís a well-research and well-written book on the vocabulary and strategic guidelines for pursuing adjacencies (from a strong core!). For reviews etc., go to this document and scroll down to page 12: ../exhibits/AMAZON_Book_Reviews.pdf.

    Secondly, I suggested that we not reinvent the wheel, but learn from others who had been in the channel or other channels with similar problems/solutions. A second back-up reference book for which you might skim the reviews in the same document linked just above is entitled: How Breakthroughs Happen, by Hargadon on page 12. A theme of the book is that teams of people who can "bridge" whatís going on in different, but related worlds are the ones who make new things happen.

    As a "bridging" exercise, I set up a meeting with the electrical distributorís CEO and Solar division champion and the founder and COO of Energy Outfitters, Inc. of Grantís Pass, Oregon. This company is the best, established solar power distributor that I could find. They have spent the better part of the Ď90ís becoming a viable business selling non-subsidized solar installations. Their competence, dedication, technical savvy, philosophical attitude, etc. was all very impressive. When I asked if I could plug their story, they agreed. For more on them go to www.energyoutfitters.com.

    From the meeting, we found out that:

    • Selling consumers through local installers is and will be quite different than the big commercial building market involving union electricians in most big metro areas.
    • Between the manufacturers and commercial end-users with big, new tax incentives, there isnít a network of capable (or "certified) installers, let alone a stable distribution channel.
    • GE recently bought a bankrupt solar power manufacturer in the US, but otherwise, the Japanese and German manufacturers and government energy policy/rebates are 10 years ahead of the US. There will be a solar panel shortage for 6 to 12 months because of aggressive higher tax subsidies put in place by the Green party that is now running Germany.
    • Both companies had unique strengths (and views) from which they could do some joint venture activity. Their potential competitive overlap and ambition was small compared to their cooperative upside, so bridging and partnering activity made sense.

    If you have questions about new venture growth directions, or more specifically solar power, I would be glad to see if I could be of any help. On the solar power opportunity, I think all of the trends for: worldwide supply and demand for energy; our import deficits for energy; our electric grid capability shortfalls; the declining cost for solar power, etc. all augur well for this area.

    If you would like to find out more about state and federal tax incentives for "renewable energy", check out this site: http://www.dsireusa.org.

    For more general information on the "renewable energy" scene, here our two sites to start with:

    http://www.solaraccess.com/index.jsp and http://www.ncsc.ncsu.edu.

    5.    GETTING EMPLOYEES TO "YES"! (MAYBE, NOT ALWAYS)

    I recently received two different emails from two different users of our "High Performance Distribution Ideas for All" training system.

    CASE ONE:

    Hereís an excerpt from a manager at a company that has been a long time client. They have grown from zero to $180MM since 1983 in a channel that most considered moribund back then. They also have averaged above a 5% operating income rate level the entire time.

    "Bruce,

    I have just wrapped up my second video series with another group of

    line employees at our company. In this pass, I played the role

    of the management representative that explained our philosophy and

    questioned folks' assumptions. It was fun. Unfortunately, we had several cynics

    that came in biased, successful-in-their-own minds and who defended their positions not allowing themselves to be open new perspectivesÖÖÖÖÖ"

    My general response:

    Groups of human beings will never all agree on any political-economic system which is what a business is within a "democratic capitalistic" society here in the US. Given the USí economic/political ecosystem in which we operate and given that most distributors are going to win or lose on whether front-line employees can provide consistently excellent and flexible service, whatís the best general way to go?

    I have found through 30+ years of experience that the concept of "every stakeholder gets premium economics from service excellence focused at target customer niches" works best. This doesnít mean that permanently small businesses in which owners are the hub of the wheel "hiring them cheap, etc.Ö" canít survive. Such companies just wonít grow all stakeholdersí economics and even the owners will have a tedious, tough job for what is often a shrinking economic annual take with no appreciable exit value at the end.

    When all employees are run through the first main section of the "High Performance..." educational program, Iím asking them to understand the ABCís of corporate and wage economics and to be part of the solution for improving "value-added per employee" (annual gross margin dollars divided by total full time employees) in order to get:

    • Premium total compensation for their job niche
    • Job security and growth opportunities if they wish
    • Pride in working on service process teams that deliver the best measurable service value (and productivity) to their customers who pay their wages; etc.

    They all want the benefits or privileges of a high performance company, but who wants the responsibilities? Many donít want to hear: "if you arenít part of the solutions in this program, then you will be part of the problem". There is a lot of entitlement thinking in the US today.

    More specifically, at least three main strains of high performance resistance thinking will emerge from where it has been hiding. (The program doesnít make people negative, it just uncovers it.) They are:

    • Anti-Mastery. Why canít I just keep doing what Iím doing? I donít want to learn how to learn and fall on my face forward to better and new skill levels. My (unconscious) personal benchmarking process has been to be better than the weakest employee peer. It hasnít been to aspire to be like the best performers and try experiments on the living edge of continuous improvement.
    • Socialism, the politics of envy. I donít care if I/we can make better wages for my job niche, Iím still working harder, making less and having less power-fun than top managers/shareholders. They donít need to make so much at the bottom line or for their respective job niches. Everybody should get paid the same good wage for the same personal good effort. Our path pursuits, how many how many people have ever been proactive, responsible, try-new-stuff-on-the-job kinds of people? These people will never be happy in any company in the US, nor in Cuba or N. Korea, the last pure play societies that try to fulfill their utopian wishes.
    • Hierarchy behavior lock-in. Suck up, dump down. Do what you are told, nothing more or less. Plenty of managers within distribution firms hate the idea of any high performance practices, because they donít understand it. They think it will make them look stupid when they donít have the new answers to new questions. Ditto for loyal subordinates who have only known cubicle culture that is made fun of in Dilbert cartoons. Some people are either so hard-wired or so environmentally shaped that they really need to be working in some huge, unchanging, hierarchy to be happy. Those jobs, with the exception of government employees, are rapidly disappearing because every business has to change as fast as its environment or die.

    What happens statistically in a transition to a high performance culture? If the company is an average performer, perhaps 20% of the people (and more new and young people) will get excited about the message and methods. 20% will be totally shocked and will resist until they leave one way or another. And, the 80% in the middle will be quite panicked, but over time they can get with the program. Section 5 of the training program covers a lot of learning-how-to-learn and change together concepts that might be reviewed first and used to discuss past programs that fizzled out. Then, they might be applied to the ideas of becoming an open book company that is in Section Two.

    CASE TWO:

    Here is an email from the #2 guy at a small contractor supply distribution business. The "staff" is all of the employees including warehouse, counter and inside sales folks.

    "Bruce,

    We have your program and we are about half way through presenting it to our staff.

    We had a brief review, asking the staff to write a couple of paragraphs on:

    • What they have retained?
    • Why they think we are doing this?
    • What their motivation should be for buying in? etc.

    It is obvious to me that our motivation should be that the only way to get a raise is for the company

    to improve profitability and for me to have demonstrated a role in that transformation. No others seem to grasp or will admit that. They get stuck on 'this will help the boss' which means to me that they don't buy in.

    The survey responses, and the responses in the weekly discussions seem to show that your suggestions for attaining Service Brilliance are great, but they are "global" in scope - they mostly involve management strategic decisions. As an example, we all buy into treating customers as A, B, C or D, but it is a management decision as to who is what. We are having a hard time getting the staff to relate to the program and to see individual ways in which we can all improve the levels of service we offer. While they mouth the answers to weekly questions, they don't return messages or email in a timely manner, basic stuff like that.

    My take on the program so far is that it helps the staff understand and consequently buy into tough decisions that the owner must make. For instance, the suggestion to get the sales rep to cut out or hive off his lesser accounts, but pay him the same for a year while he cultivates the growth accounts. This is just getting the rep to accept change. It does not ask the rep to make changes by themselves.

    Am I wrong? Are there suggestions in there that each low level staff member can implement? Does that come later? How do I do a review to get them to reveal what they know and get them caught up? How do I get them to WANT to stay an hour late each week?"

    MY GENERAL RESPONSE:

    Considering that this company is halfway through the 53-video modules, I think that the passive response from most of the hourly employees is not unusual. The staff is right about the strategic decisions that the managers must and do make and the supportive role the rest must play. I think that if this company hangs in there, they will find that the majority of the employees will eventually warm up to the new reality, better results, etc. and start to eventually exhibit bottom-up initiatives and more fluent, enthusiastic conversation about the methods and plays in the tape.

    I actually called the company as a follow-up to the email to better understand the total context of what they are going through. As a result of implementing ideas from the educational system, their results are significantly up along with morale, and the management is excited about how much more upside they have to get.

    Thatís all for this week!

     

    Bruce

    Bruce@merrifield.com

    919/933-7474