September 6, 2006, Distribution Channel Commentary (DCC) # 89


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Labor Day has passed, our work resumes (along with occasional DCCs).  If we have a calendar, fiscal year-end, we only have three months – subtracting out time for the Nov-Dec holidays – to make our numbers and plan for next year. Although running our business by the numbers has many drawbacks, too few of us have moved to some more effective set of “balanced scorecards” and rewards along with tuning our work environments to support more real, value innovation. It’s a struggle to move from short-termitis to being more proactive about the longer view.  

Since my last DCC on 5-10-06, I keep hearing and reading more about financial engineering to make the numbers that beat last year’s for bonus bucks than I do about innovation for sustainable, better-than-industry results. As you skim through the random, what-happened-over-the-summer points below, think about how to better balance financial concerns with innovation ones.  

First, if you want to catch up on the numbers for the top 65 publicly traded distribution companies, plus all of the announcements that they made in July and August, you should at least skim through the comprehensive September newsletter put out by Starshak and Welnhofer at this link:

This is a recently new, free e-offering and well worth reviewing. If you would like to receive this newsletter for free, you can email them to have your name put on their list. S&H is the only firm that I know of that has made such a focused effort on providing financial advice to companies in the “distribution space”. If you need advice on: valuing and selling a distribution business or blocks of stock within; raising equity capital; etc. consider them. And, I get no kick-back for this endorsement! They are just sincere, nice, competent people.

BTW, according to S&H’s newsletters, the reported profits for the first two quarters of this year for big publicly trade distributors were generally great. Now that the housing bubble is starting to unravel, we will have to see how those channels that are strongly dependent upon commodities that go into housing will do going forward.

 What’s your view on housing? Soft or hard landing? If hard, can the US and global economy continue to grow through it? Here are some macro numbers to consider: the US economy is 25% of the global economy, the consumer is 70% of the US economy. Virtually all of the net worth of the bottom 80% of US households is in the value of their homes. Consumers had negative savings the past two years as they cashed out over $1T in house equity value and spent it, partially because their wages did not keep up with inflation or health care costs. High gas prices are another tax on US households. The global economy, on the other hand, has lots of momentum, so we will see. But, rain or shine, why depend just on the economic tides of our industry, why not innovate right through and above specific industry conditions? Who wants to be like and perform like the herd? Let’s do better and have more fun doing it! 

Second random point: BP shut down a big oil pipeline from Alaska’s North slope.  Management was “very disappointed” to find out that some parts of the pipeline were 80% corroded, because there had been no preventative inspection going since 1992. If you aren’t under any legal obligation to do the prevention work and you have to make your numbers, why invest in long-term solutions when you can wait for a crisis management opportunity instead?

Third, an article in USA Today (8-4-06; entitled, “What’s the real federal deficit?” points out that the federal government has two sets of books, but actually needs three. The set used for reporting to the voters says that the 2005 deficit was $318B. The actual audited statements report a deficit of $760B. But, if social program liabilities were included on a net present value estimate the deficit would have been $3.5 trillion (over 25% of last year’s total GDP). If the long-term costs for the 18,000 soldiers wounded in Iraq were included, it would be even higher. Do you think we voters will be able to keep the republic that are founding fathers gave us in 1787? Is your company really investing in the innovations necessary to keep your company from having a crisis somewhere down the road?

Fourth, a number of clients from different channels have inquired about whether “now” is the peak for distribution company valuations due to the multiples being announced for deals in a number of different channels. Some bigger deals that come to mind are: Home Depot’s acquisitions in several channels; Boeing buying Aviall; Fisher Scientific merging into Thermo Electron (see topic #2); Richard Worthy leaving one consolidator in the electrical distribution channel (Sonepar) to start a new one called US Electrical; etc. The short answer, IMHO, is that as long as the private equity fund-raising bubble lasts, high multiples will persist.


Last May I had a client inquire about what I thought the implications might be for the lab supply channel from the announced merger agreement between Fisher Scientific (FSH) and Thermo Electron Corp (TMO). From the narrow to the more general, there are a number of questions that we might ask ourselves if we are in any channel that is experiencing similar, on-going, financial consolidation activity:

a)      Initial statements by management: “the Thermo Fisher Scientific (new name) merger is all about growth and long-term shareholder value: $200MM in synergies; 18% accretive to earnings; 20% compounded annual growth in earnings per share over three years; by combining our capabilities, the new company will be uniquely positioned to provide integrated, end-to-end technical solutions.” Analysts’ initial advice: quick, all of you other channel players, sell out to some other, mines-to-market, total solution roll up; our M&A department will help you for a fee. Questions: What are the assumptions that management is making about big end-users? Will these users continue to buy ever more from ever few suppliers regardless of whether the locally-provided, total-service-value proposition continues to improve or deteriorate? Why do trees that are extrapolated to grow to the sky never get there? Why are companies with the best organic growth outsourcing activities not buying in new ones like Fisher? Isn’t merging manufacturing divisions with distribution ones moving backwards towards Henry Ford’s original mines-to-markets total supply chain integration? Can two huge, consolidated entities merge together and really manage it all better? I’ve seen astute private equity firms consolidate distribution companies in a given channel effectively. But, the size of the deals were small, relative to the well-run and managed platform business, and the deals were in the same basic business. How does this Fisher/Thermo deal really smell?

b)      In the smell-test department, the investigative press did quickly find out that the Fisher board awarded themselves $3MM worth of options the day before the merger was announced (eight people x $380K each). Maybe they will make even more if they hang on to their options for the value improvement ride that they are projecting for the rest of the shareholders. The Fisher Chairman, Paul Montrone, did not disclose any new options, but his were already worth $240MM based on the closing price after the announcement, and he was leaving the company to pursue other activities. I wonder if this would allow him to immediately vest in all options and not be subject to insider seller scrutiny? The Vice-Chair, Paul Meister, apparently didn’t feel as flush with options already worth $163MM, so he was one of the eight. And, with Montrone stepping aside, he gets to be Chairman of the combined company. I wonder if he will get a raise with more options for his new, bigger responsibilities? What about the poor, non-employee members of the board? No fears there. They will be eligible for a retirement plan equal to 50% of their current fee of $60K. Nice work if you can get it. But, the clincher was that all of these board awards were “a coincidence and not related to the Thermo merger” according to a company spokesperson. If the board didn’t know about the deal a day before the deal announcement, I wonder what they did talk about that day?

c)      In the track record department, Fisher was bought by the private equity firm, Thomas Lee, back in Sept. ’97 for a white knight price of $48.25. Thomas Lee then did some rolling up; they bought and then spun off the troubled PSS World Medical when all of “upside potential” didn’t materialize. In August, 2004, Fisher merged with Apogent Technologies which was a consolidator of lab products manufacturing companies. That deal was promised to deliver great, supply chain synergies, but earnings for the combined giant have only been mediocre so far. This is not unusual. Multiple studies have proven that most big mergers fail to deliver on synergies, but they always deliver for the top managers and the boards.  

d)      In the conclusions department, I would expect:

·         More of the same financial results for Thermo Fisher as Fisher produced since ’97, at best.  They just have too much size and variety in the merger pool to manage. Roll-ups that get too big, too fast just don’t do that well. And, when suppliers merge with distributors, all of the other channel suppliers and distributors retaliate in many ways causing channel conflict drags for the integrated company. I have never seen a vertical integration in a channel, especially involving lots of moving parts, suppliers, SKUs, distributors and/or end-users, work well. Can you think of any that have worked?

·         These types of consolidations hurt the existing business models for dues-based trade associations and new-installs-based software firms that work specific channels. These consolidations are good news, however, for SAP and Oracle’s “wholesale distribution” ERP products, because the huge, especially public, consolidators have to report their numbers on a more timely and accurate basis or management is liable under Sarbanes-Oxley. This problem is compounded by the growth in rebates of all kinds, which causes final earnings to always be under a cloud. The bigs need one big, database platform system from some vendor that looks like it will be around for awhile; this leaves only two ERP vendors that I can see.

·         While consolidators may find some “economies of scale” in buying health insurance and holding some suppliers up for special prices, there is most often a deterioration in local, flexible service value capability. If I were a well-run, innovative local or regional distributor, I would hope that my best competitor would be bought out by a consolidator, because within one to two years I would be stealing their best accounts.

·         And, imagine what might happen if suppliers that aren’t owned by an integrated consolidator and independent distributors could solve the “special price, billback” problem in their channel with a “channel utility solution”, then power would go back to the suppliers, the end-users and the best, local, innovative service providers that the end-user would like to choose over the stagnate giants. More on this in topic #3.

·         This whole consolidation game will continue as long as ever-greater amounts of money roll into private equity funds. This bubble phenomenon is still running, for more on this try the research experiment below.

·         Go to, click on “news”, then in the search box type “private equity funds” and start to skim through the newspaper articles that have touched on this topic in chronological order from the most recent posting. You will find interesting stats like: the US private equity industry, which operates today on an international basis, amounted to 157 funds with $4.4B to invest in 1980 employing roughly 1500 professionals. There are today over 2900 funds with about 15,500 people with a call on $722B which they typically leverage another two times. The current new fund raising rate is on pace to smash last year’s all time record. 

·         Until the private equity bubble pops – perhaps with a recession and a stock market decline – the excess supply of money for too few good acquisitions should keep a floor under currently high valuations for companies that might want to sell to either a strategic or financial buyer.  


As I go to press with this DCC, I see in this morning’s (9-6) news that Bill Ford has fired himself from being CEO of Ford and brought in a guy from Boeing just three days after the news reported Mr. Ford’s memo to his 300,000 employees that the company needed a “new business model”. I think Ford Motor needs a lot more than just a new business model, it may need about 7 or 8 types of innovations out of “Doblin’s 10” (?) in Ford’s total solution.


“Innovation management”(IM) needs to change at most companies in mature industries from an incremental, reactive, accidental art to a systematic, more ambitious science. One of the thought leaders on IM is Larry Keeley, the co-founder of Doblin which is based in Chicago. I recently went through one of Larry’s slide show presentations that he gave in June in which he elaborated on Doblin’s ten types of innovation. To review Doblin’s 10 types of innovation – one of which is “business model” – go to this link:

Doblin has reviewed many successful corporate breakthroughs and checked off how many of the ten innovations were rolled into the breakthrough solution. For example, Dell’s total proposition was made possible by innovating in 7 of the 10 categories; the Apple iPod in 7; and Starbuck’s in 8 out of 10. Makes me think Ford needs about 7 or 8 out of ten including: the family giving up voting control of the company and perhaps a trip through bankruptcy – sooner rather than later – to get out of ruinous contracts with unions, suppliers and dealers backed by tough franchise laws in every state.

What was compelling to me in Larry’s latest slide show regarding the 10 innovations was the correlation of types of innovations with returns. More than half of all innovations efforts involved changing at least  two of  the ten innovation categories – “product performance” and “product systems” – yet all of these efforts produced negligible returns. “Less than 2% of all total innovation efforts produced over 90% of the value”, and those efforts starred the three least used innovation levers – “business model, networking and customer experience”.

So what should we be planning for 2007? If we want to outperform our industry averages, we can’t push the same old innovation (product?) levers harder. We have to rethink our “business model” by rethinking how we “network” with our channel partners on supply chain cost reduction and value creation solutions to boost the value “experience” of the few accounts per distribution location that really matter .

·         Manufacturers figure out how to get out of the less than truckload distribution activity business; distributors buy those items that turn less than 12 times a year from master

wholesale functionaries on a vendor managed inventory basis, because you can’t forecast demand accurately past 2 to 4 weeks without having both excess stock and lower fill-rates. Why do you think Wal-Mart runs all big volume items through their DCs and not directly to the stores, it has to do with turns, earns and fill-rate economics. And, while we’re on supply chain ideas, how might special price/billback deals work through master distribution facilities? (See the last section below)

·         All channel parties need to segment customers by size and net-present-value profitability in order to raise prices and terms for moribund losers in order to super-focus on the 5% of all customers that will generate 80% of the future profit growth. Weed to feed; prune to grow; we must free up resources from losing elements of the business to reinvest them into innovative opportunities within the best parts of our business. And, most distributors are lucky if they can sell two out of the four modes of channel selling – outside sales, telemarketing, catalog, and cash-n-carry/wholetail. If you are (unconsciously) active in three of four of these segments, pick your best two and harvest the others.

·         In channels where distributors originally went to market with outside sales people pushing products, think about reducing your sales force to half its size to focus on the 10% of accounts that have economics that can still support outside selling. Then, change the reps role and skill sets to being demand-replenishment systems consultants first and reactive product pushers second. This all assumes that close to 90% of today’s sales are on commodity products to large, repeat customers that are under pressure to buy all of their stuff at the lowest total procurement cost. If you have, however, exclusive, profitable, manufacturing franchises, by all means push products the way the supplier wants.

·         If all of these ideas seem sketchy, confusing and scary, remember that whatever you do proactively in 2007 will provide negligible returns at best if it seems tried-and-true and not scary. Running with the industry herd and making lost of small, reactive, incremental, me-too adaptations to how you do things is necessary for survival, but it won’t create any sustainable, industry-beating, value returns for you. If you want more elaboration on how some or all of these ideas might apply to you, I’d be happy to visit with you starting with an initial, “free bite of the apple” phone call.


Every channel that has commodity products sold through independent intermediaries has a  paperwork reconciliation problem with awarding special prices to some end-users that involve the intermediary fulfilling orders at losses and then billing the manufacturer back for the loss plus some fulfillment margin. In different channels, the terminology varies, but the process is similar. In both the PC and electrical distribution channels, the problem has been described as a growing, out-of-control, consuming “cancer”. That sounds serious.

Some of the remedies for symptom relief are:

·         Progressive distributors and/or their software vendors have developed in-house “ship-and-debit” software solutions to track all of the billback rebates.

·         A third party web service provider, Trackmax at, has provided big relief for many foodservice distributors and now a handful of industrial paper/jan-san distributors.

·         Some vendors work with larger intermediaries to do one-off paper automation solutions involving EDI transaction sets for rebates (844, 849). IBM and Tech Data, for example, have done this in the PC channel.

·         In all channels, there is a cry from intermediaries to stop the special pricing combined with artificially high standard pricing and go to everyday low prices.

But, how often does the following scenario happen? An independent, local distributor has a good-buddy, local, big account that consumes enough commodity products to deserve special price(s). But, the small distributor can’t get access to the same low special prices that a big chain can even after the independent joins a buying group. The local account is forced to buy the better pricing from the chain even though they prefer the local guy’s service and want to keep the business locally. The chain keeps growing its volume organically, at least on price-sensitive bids and through acquisitions, which enables the chain to keep threatening suppliers with switching big volume to the other vendors or Asian-made private labels unless they get extra, special pricing. The independent figures its time to sell out, and the cycle repeats. The only winner in this scenario is the consolidating chain.

What if a group of manufacturers formed a “utility” which would allow:

·         Any distributor to bird-dog and submit a special price account situation through the utility (a bottom-up process).

·         A supplier could quickly review and award special pricing to the best-fitting end-users AND NOT JUST TO THE initiating distributor. The end-user could get multiple bids on contracts from competing distributors. But, all distributors would have access to the same special price. The end-user then gets to buy from whatever supplier they choose.

·         Rebates could only be awarded if the winning distributor enters all special pricing billing activity by account and affected SKUs through the utility. This would allow suppliers to track, real-time their special-priced, product flow through specific distributors to specific end-users involving special prices.

·         Suppliers would then integrate their legacy system into one central utility to be able to pay rebates quickly, accurately in a paperless manner.

·         I could go on, but this will hopefully get you thinking. In a world with too much supply of equally, excellent commodity products, special pricing for the right, strategic end-users isn’t going away. Automating different patches of the supply chains pain for ship-and-debit activity isn’t a total solution, nor does it solve the dysfunctional aspects of forcing distribution channels to consolidate. Who would like to re-empower the manufacturers, the right end-users and whomever their best local supply distributor might be? Call me to discuss this further.


I have written four articles on “innovation management” (, articles #ed 1.11 through 1.14) and have done some experimental, slide show presentations on the topic. But, truth be told, a company can’t take IM to the next level if the company doesn’t first move towards having an “innovative culture” which is, for most, another, what-does-that-mean phrase.

What are some specific ideas and practices that we can think about and experiment with to start moving towards a more innovative company environment? Here are a few:

a) How can we first rethink measurement systems and rewards to be more “balanced” instead of over-weighting “management by financial numbers”? We have to overcome the concern that proactive, innovative activity will be “expensed” today to the detriment of the current profits in order to make lots more profits in the years to come.

b) To do any proactive activity, we have to first free up resources – time, talent, and treasure – to invest in longer-term innovative ideas. But, most firms are so lean and mean that employees are “too busy” triaging yesterday’s operational necessities. So, we must get really excited about how we want to do what we do best, even better to build the courage to then weed what we do poorly and unprofitably in order to redirect corporate resources.

c) When we do new stuff, there are no best practices and roadmap to copy – at least for our specific type of business – we must blaze our own trail to the new world we imagine. This means “failing forward” or making, fast, prototypical steps that create good, learning mistakes. We want to maximize learning and progress for the lowest, tuitional cost. The costs go up with the size of the projects, so CEOs should be making the biggest, most expensive, “good mistakes”, admitting them and sharing what has been learned. It comes with the position and is a sometimes difficult ego challenge.

d) Ideas must come from combining known solutions from other industries (e.g. other distribution channels) for common problems. In other words, having roundtable sessions with non-competing executives in the same industry is interesting, but not sufficient for breakthrough ideas that will outperform the industry.

e) To get evermore employee participation in one or more of the steps in the innovation pipeline process, we have to give people encouragement and recognition for: not rushing to answers, but living the questions for awhile; not criticizing others’ new ideas, but for at least letting them live for a bit if not building on them; and not being scared of making “good mistakes” when failing forward. It would also help, going forward, to try to hire more courageous, inquisitive, personally changing and growing people.  

I could go on. If you are interested in thinking more about changing your company’s environment to make it more supportive of innovative efforts, here are some things to read:

A case story article on how Quill Corporation (a mail-order, catalog distributor; division of Staples) did its innovative journey at this link:

Some of my own stuff on “pushing the wheel of learning” and “making good mistakes” at:

Steps to breakthrough results:

Thoughts on waking up our corporate luck:

That’s all for this effort. Happy innovating!