October 20, 2004: Distribution Channel Commentary (DCC) # 72

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THIS WEEK’S TOPICS

  1. THEMATIC QUOTES.
  2. SYSCO REVEALS THE SECRETS OF THEIR PROFIT POWER.
  3. WRONG MENTAL MODELS, WRONG PERFORMANCE METRICS.
  4. ARE YOU IN "COMMODITY HELL" YET? WHAT’S THE SOLUTION?
  5. COSTCO HAS BRAND POWER IN TOTAL COMMODITY/PRICE NICHE.
  6. REVERSE AUCTION SURVEYS; IT’S PEAKED, FADING AND LIMITED.
  1. THEMATIC QUOTES.
  2. INTRODUCTION: Both manufacturers and independent distribution players continue to feel the pressure of too much global capacity for excessively, equally excellent commodity products. Most feel that they are either one-step away or already in "commodity hell" in which some competitor is always offering a lower price for the same stuff. We have to "innovate" our way out of this problem, and there are a number of ways. This commentary will offer a few ideas and case studies. First, though, here are a few appropriate quotes:

    "In six years of operation (1876-1881), Edison’s laboratory generated over 400 patents and was known worldwide as an invention factory…..Edison worked hard to create the future (electrification of America) from the best pieces of the past…pursuing a strategy of technology brokering, Edison bridged old worlds and built new ones around the innovations that he saw…much of Edison’s work combined existing ideas in new ways."

    from "How Breakthroughs Happen" by Andrew Hargadon. HBS Press, 2003.

    "The future is already here, it’s just unevenly distributed (and understood)."

    William Gibson, sci-fi author of "Neuromancer."

    "Discovery is seeing what everybody else has seen, but thinking what nobody else has thought."

    Albert Szent-Gyorgyi, Nobel Prize for Chemistry, discoverer of Vitamin C

    "The very networked landscape we inhabit – the connections that make up our small worlds – prevents us from seeing the new connections that are required to think what nobody has thought…the ties that bind are also the ties that blind." Hargadon, Ibid. (Get new thinking from outside of our own distribution channels!)

    "Play good golf. Play your own game well and don’t get hung up on where the other guy’s ball is."

    Common golfing wisdom (Each of us has to find our own reinvention, improvement path too.)

  3. SYSCO REVEALS THE SECRETS OF THEIR PROFIT POWER.

Thanks to the internet, we can all view great slide show presentations that the biggest, most successful, public distributors give to rooms full of analysts and fund managers. Every six months are so, we should check out the "investor information" sections of the web sites of the super profitable giants such as Sysco (foodservice channel), WW Grainger (many channels), MSC Industrial, Fastenal, etc.

Today, lets check out two recent, overlapping slide shows that Sysco has posted at www.sysco.com. Please go to their latest slide show presentation at this URL in order to make sense of my comments that follow below: http://media.corporate-ir.net/media_files/IROL/86/86717/presentations/syy_040908gs.pdf.

Skim through the first 5 slides to get a feel for who Sysco is and how well they have been doing. You will later see a slide that shows that for the past 5 years they have been averaging over a 30% return on shareholder’s equity (ROE), growing over 15% per year, etc.

Slide #7 is entitled "Operating Pretax Performance" which shows how their individual "operating company’s" have all been increasing the PBIT percent of sales since ’99. What has been driving this improvement, while also growing organically?

Slide #10 "The evolving role of the Sysco Marketing Associate." Notice "Profitable" in "Profitable Sales Growth Initiatives." Sysco has been using customer profitability analysis to drive and pay their sales reps. They don’t get paid on "sales volume", "gross margin volume" or "gross margin percent"; they get paid on their customer’s estimated "profit before interest and taxes." I have no idea what Sysco’s specific compensation plan is, but I do know from trade publication articles that Sysco reps started pounding customers with small average order sizes to increase them a number of ways:

  • Buy more of Sysco’s unparalleled one-stop-shop assortment of goods;
  • Buy less often in greater quantities;
  • Pay extra charges;
  • Pay higher prices on miscellaneous goods; etc.

All of these measures added up to: converting unprofitable customers into profitable ones, delivering more lines, pounds and margin dollars per stop of a truck and per transaction processed. This productivity is the biggest secret to Sysco’s latest success.

Slide 13 shows another view of how Sysco seems to have found another gear to take their corporate ROE from 29.8%, a huge number, for ’99 to 38.7% for ’04 -- 9 points in 5 years!? What is the source of this new, higher, level of sustainable profit power?

Slide 17: "Technology investments drive distribution efficiencies" I think the title of this slide is misleading; technology tools aren’t a strategy, the strategy drives what tools you choose and how you use them. Don’t think anyone can buy the same tools that Sysco has and use them with different strategic mental models and assumptions and get comparable results.

To look at their vast customer portfolio through the customer profitability ranking report lens, Sysco has no doubt made many changes, including their reps new selling and incentive focus – no more buy this product promotions to load up customers to steal today’s sales from the future. They are instead selling more old items to old customers on a larger average order size, systematic basis. These strategic changes have in turn lifted the metrics that you see in this slide that have in turn lifted: annual gross margin per employee; branch profitability; and total ROE for the company.

Sysco is following the same value creation path of "ABC Supply." ABC’s story is told in two documents at our web site. Exhibit 25 at: ./exhibits/CASESTUDYRethinkProfitPower.asp. And, article # 2.22 at: 2_22.asp.

In article #2.22, ABC Supply added three master wholesalers as suppliers to be able to add more items to their local, one-stop-shop assortment for their #1 target niche of customers. In the two Sysco slide shows reviewed in this section, you will see that Sysco will be investing close to $1 billion into a network of about 8 regional master distribution facilities. I infer that this will be to: lower total system transportation costs, lower their 150 DC’s inventory investment while improving their fill-rate service and order size economics. The "master distribution space" should be bigger in just about every distribution channel regardless of who provides it.

The rest of this first slide show should be self-explanatory, especially when you understand that the source of their improved profit power is to more perfectly achieve and then sell one-stop-shop economic capability to their food operator accounts.

A June ’04 slide presentation complements the one above, here is the link to the second show: http://media.corporate-ir.net/media_files/nys/syy/presentations/syy_deutsche040607b.pdf.

As you skim through this show, look at slide #6 entitled "Sysco – A Model for Success." These are general common sense, best practice kinds of statements that don’t hint at maximizing one-stop-shop sell/buy economics instead of pushing products on promotion by reps that are compensated on margin dollars whether an account is transactionally profitable or not.

Slide 11: "Sysco Brand Growth." The fact that roughly 40% of Sysco’s sales are of their private label goods is a bit of a profit mirage, especially for people outside foodservice. In the foodservice channel, almost every distributor has a buying group, private label line that they sell. How and why the manufacturers let private labels take over the channel is a bit of a sad mystery to me. Does Sysco, because of their huge volume, squeeze out some extra margin dollars above and beyond what the other giant chains get from the same suppliers – maybe. Do customers love the Sysco brand and pay more for it? Or, do they put up with it. I think the latter. I still think Sysco’s focus on customer profitability and rethinking what and how they sell customers around that is a bigger source of profit power. And, the entire issue of how to rethink branding and the role of private label branding by distributors is a topic that will be revisited often in the commentaries, because I have a lot to say on the subject, just not today.

Slide 12: "Deeper Question." This is a good slide. ABC Supply found that by going back and rethinking how they could better and more deeply serve their most profitable customers they were then able to grow the group over 50% in the next 18months or so. And, the sales reps had reported at the outset that: "We are already getting all of the business!"

Slide 13: "How Sysco Stacks Up. . ." What a testimonial to the amount of money you can make in a mature, consolidating, commodity, price-sensitive, distribution channel, IF you have the right profit power improving strategy. Just think, you can read ABC Supply ‘s story and more on our web site to get on the right strategic value regeneration path for each of your DC’s. But, to change everyone’s mental models, pay incentives and skill sets to be able to then implement the customer profitability driven strategy isn’t easy. Our video, "High Performance Distribution Ideas for All" is, however, the catalytic solution for making a company’s transformation happen. There’s lots of promotional info on the video in the center of our home page, and we have kits in stock when you are ready.

Slide 26: "Customer Analytics." This a cool slide that blends truck scheduling software with customer profitability information so that branch and sales management can also think in terms of target selling to customers along a route to build the profitability per route through more "zip density delivery."

  1. WRONG MENTAL MODELS, WRONG PERFORMANCE METRICS.

Its time for 3rd quarter earnings reports on Wall Street. With accounting games, industry cycles and un-funded pension liabilities, "earnings per share" is the wrong mental model for investing for wealth. Warren Buffet has always looked at free cash flow return to investors over a long time horizon discounted to a present value. If he can buy $1 of total return for $.50, then he does and goes to the ball game or a bridge tournament.

What are our mental models for how we run our business to create long term value for all stakeholder groups? How do we reflect these mental models in the "performance metrics" that we use to guide our employees in their daily activities? Do we have the right North Star(s) to orient everyone with?

If we have the wrong metrics, do you think reporting those metrics using "business intelligence software" in a more consolidated "dashboard" way is going to help us run our business any better? I don’t think so.

  • What do you think?
  • What do you measure religiously?
  • Does it have anything to do with customer profitability and estimates share of customer business and the profitable share of a customer niche?
  • Do you measure fill-rates and fill-rate economics for your business like Sysco does?
  1. ARE YOU IN "COMMODITY HELL" YET? WHAT’S THE SOLUTION?

In the introduction to the quotes in topic #1, I touched on the "commodity hell" problem. A common answer to this problem is something like: "we have to reinvent our value proposition." I think the best ways to do this in the area of independent distribution channels are:

  • Try the value creation path that ABC supply pursued that was sparked by doing simple customer profitability ranking reports. Sysco is just a large-scale testimonial for that process.
  • Borrow ideas that already work in other distribution channels. This means that we have to either get out of our corporate and industry trade association boxes and collective mental model thinking to see what true innovators are doing elsewhere or find a technology broker who does do that. By example, I think manufacturers in every channel should take a long look at trying to adapt what CoLinx has done in the bearings/power transmission channel. (For more on that consortium of manufacturers go to www.colinx.com, and read article #2.25 at this URL: 2_25.asp)
  • The Sysco story above also endorses the fact that the "master distribution center" space within each channel should be much larger than it currently is to optimize total freight, total inventory investment and local service and fill-rate economics for both distributor and end-user.

Here also are a few inspirational reads on "innovation." All of them touch on the theme of: don’t invent something new from scratch, but rather be the first in your micro-world to recombine ideas that are already out there.

An article in a recent "innovation" special issue of Business Week entitled "Building An Idea Factory." Here’s the link: http://www.businessweek.com/magazine/content/04_41/b3903462.htm

An excerpt from a fascinating, inspirational book entitled "They Made America" by Harold Evans. http://www.twbookmark.com/books/38/0316277665/chapter_excerpt19610.html

An excerpt from "How Breakthroughs Happen" by Andrew Hargadon. http://www.gsm.ucdavis.edu/innovator/fall2003/TechBrokersReinventInnovation.pdf

  1. COSTCO HAS BRAND POWER IN A TOTAL COMMODITY FOR PRICE NICHE.

If you would like more inspiration that you can get premium results for all stakeholders in a selling-commodities-for-price world, here is the latest inspirational article on Costco. This company is not only beating Sam’s, which through Wal-Mart has 6 times the buying power; it has a brand-name loyalty that has developed from their consistent high-performance practices that in turn deliver a consistently better total service/value experience. http://www.usatoday.com/money/industries/retail/2004-09-23-costco_x.htm.

  1. REVERSE AUCTION SURVEYS; IT’S PEAKED, FADING AND LIMITED.

Whenever the subject of turning products into commodities comes up, one sub topic is reverse e-auctions. Lots of distributors have participated in or heard about electronic auctions. Freemarkets.com is a service provider for this buying process. When these auctions were first tried by big buyers, the instant price savings were measured and celebrated, but no one hung around to measure how all of the other elements of total procurement cost started rising in total more than the price savings. These auctions over the past 5 years have been one big lesson in learning once again - "bargain price, bargain service"- where in the long run the customer makes a negative economic tradeoff.

Well, below are two links to some good survey feedback on how these auctions are going. My take is that they will end up being a small part of the buying universe. They will work best for government monopoly services that are legally obliged to get three or more bids and take the lowest one, especially on huge bulk buys that are not service sensitive, like coal for the municipal power plant.

Here are the links: From the pages of Industrial Distribution magazine: http://www.manufacturing.net/ind/index.asp?layout=articlePrint&articleID=CA457364

From the pages of TED (The Electrical Distributor) magazine, and the wonderful columns of Joe Salimando. http://www.tedmag.com/default.asp?pagenumber=619 Go to the section sub-titled "Death to Reverse Auctions." And while you are there check out the sub-section at the end entitled: "Grainger Gets Customers Purchasing Transaction from $100 to 5. This is another case of a successful giant selling purchasing systems economics and buy one-stop-shop from us. When will the average distributor get out of the grip of pushing products to market via sales reps paid on margin dollars and focus a lot more on selling win-win, demand replenishment relationships to best customers that have a future? For more on this them, see the case-study based article #4.9 at our home page at this URL: 4_9.asp.

 

That’s all for this commentary. If you need a distribution channel "technology broker" to help you with your "stale strategy", contact me.

 

 

Bruce

Bruce@merrifield.com