November 6, 2006 - Distribution Channel Commentary (DCC) # 93

November 7, 2006 - Distribution Channel Commentary (DCC) # 93

 

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TOPICS:

 

1.      Credit bubble fuels buyout bubble which supports your company valuation.

2.      Wal-Mart cuts prices; will “special pricing agreements” increase in ’07?

3.      Lowes going to “net pricing”, will HD follow? Why? What do they foresee?

4.      Time Magazine to publish on Friday for fewer, better customers; so what?

5.      Do “5-5-5 reports” for each branch; rate employees “A,B,C”; weed to feed.

6.      Hospital hand-washing perceptions and stats for over-the-hill sales forces.

 

Thematic Quote for the day:

 

“When I was seven years old, my grandfather, Karl Wallenda, put me on a wire two feet off the ground. He taught me all the elementary skills: how to hold my body so that I remained stiff and rigid; how to place my feet on the wire with my big toe on the wire and my heel to the inside; how to hold the pole with my elbows close to my body. But the most important thing that my grandfather taught me was that I needed to focus my attention on a point at the other end of the wire. I need a point to concentrate on to keep me balanced.”  - Tino Wallenda (He Found Me)

 

Comment:  As we run our businesses, don’t we have to maintain our balance on a daily, short-sighted basis. But, do we solve those daily problems in a way that will also move us towards our longer-term vision – “the end of the wire”? A bi-focal management mantra for service companies is: “people, service, profits” (PSP). The theory is that if people work together to give superior service value for the right customers with the brightest futures, won’t profits follow? If so, then we must measure and manage people and service metrics everyday. Do we? How? When? Who?

 

1.      Credit bubble fuels buyout bubble which supports your company valuation.

 

As I start to write this commentary on Monday night (11-6) before Election Day 2006, I note that both the British and US stock market averages were up strongly today on a flurry of buyout announcements and rumors. The private equity world is still raising ever greater amounts of investment funds that are being matched with ever increasing amounts of less-expensive “collateralized loan obligations” which are in turn being insured against default by currently plunging-in-cost “credit default swaps”. What’s going on in the world of “structured finance” is beyond the scope of this commentary, but suffice it to say an exploding wave of buying power is pursuing ever fewer attractive buy-out candidates. So, high valuations for any sellers will continue until the entire perpetual-motion, money machine blows up.  

 

When and how will it blow up? These questions are akin to asking when will the next big earthquake hit San Francisco, which – according to averages – is so far past due not too many people think about it.

 

The current deal-powered stock market advances around the world remind me of the markets just before “Black Monday”, October 19, 1987 when the DJIA dropped for no specific reason by 20% in one day. Back then, all big public companies feared that raiders would offer to buy their company with 100% financed junk bonds issued by Michael Milkin’s firm, Drexel, Burnham, then sell them off in pieces. Daily take-over announcements bulled the entire market to every higher valuations. Coincidentally, exactly 19 years later, on Thursday, October 19, 2006, the DJIA closed above 12,000 points for the first time ever.

 

Some questions on selling, or not selling, the company:

·          If you think that you should sell your business in the next 1 to 5 years, should you do it now to get a maximum multiple on maximum earnings that have probably been airbrushed by inflation factors like Hughes Supply did to Home Depot?

·          Should you hang on, risk a market blow-off, and a long trough before today’s valuations might come back? If so, how would you run the business in the interim? Would you renew it and take it to the next level? Or, harvest it and hope to sell it before the company dies?

·          Or, why ever sell it? Why not create an organization that continues to grow and thrive whether family members happen to be running it or not? This last scenario doesn’t happen very often, but it doesn’t mean that the methods for doing it aren’t out there within the body of management science.

 

If any of you are asking any of these questions, I would be glad to offer my two cents of advice.

 

2.      Wal-Mart cuts prices; will “special pricing agreements” increase in ’07?

 

Wal-Mart Stores, Inc., which just turned in softer-than-expected same-store sales growth for October and forecast flat results for November, said it was cutting prices on nearly a hundred electronics products, including high-definition TVs, digital cameras and cell phones. It's the second price cut by the world's largest retailer ahead of the key holiday shopping season; last month WMT lowered prices on more than 100 toys and games. (They also lowered prices on generic drugs – see #3 below for more.)

 

WMT is most sensitive to the economics of the bottom 50%+ (and climbing?) of family budgets that have had an increasingly tough year with: higher average energy costs, higher health insurance costs, higher home equity and mortgage ARM interest costs, declining home values and flat incomes.

 

If the US economy should go into a housing-bust led recession in ’07, don’t you think that manufacturers of price-sensitive commodities will be trying to lock up volume contracts with the 5% of the big end-users that consume about 30-35% of the total volume demand? If so, there could be an increase in “special pricing agreements” that involve billback rebates for distributors. These types of deals are an after-the-fact mess for channel partners, and they tend to favor big consolidation distributors. If there are any distributors or manufacturers out there that would like to turn this messy activity into a strategic, surgical opportunity for first movers, then I have some novel suggestions involving the use of a third-party, web service software solution provider.

 

3.      Lowes going to “net pricing”, will HD follow? Why? What do they foresee?

 

Just received two new reports from Jason Whitmer (jwhitmer@cleveland-research.com). One is their latest on Home Depot and Lowes; the other is their “monthly consumer insights”. These guys are anthropologists who go out and get first-hand, grass-roots intelligence on the companies that they follow for investors. The reports are free upon request to Jay via his email address above. Here are some out takes from each report:

 

From the Home Center Report:

“Recent discussions we have had with vendors suggest the homecenters are taking a more aggressive position in negotiations regarding 2007 pricing. Specifically, we understand LOW has communicated to most of its vendors that it will be moving to net pricing in 2007, and rumblings suggest HD will follow. This is a change from the “gross pricing” used presently (followed by an in-depth study of the current pricing and rebate scheme)…… LOW will replace the outside service labor in its stores with more of its own labor…. For certain, this move will create some incremental margin for LOW (at the expense of its suppliers). The move to in-house service may improve customer service in the stores, but there is risk that in-store merchandising could be compromised (if LOW doesn’t adequately staff this position)…. We have also heard some rumblings HD is going to bring in-house more of the in-store merchandising it had historically outsourced. At this point, it does not appear HD will go nearly as far as LOW; HD may in-source around half of its outside service versus LOW bringing in around 90%.”     

 

(DBM Questions: Does this move by Lowes seem to be a way of avoiding layoffs by pushing them on to the in-store merchandising firms? How long a housing downturn are they forecasting? What do they see in their sales deterioration that we aren’t seeing yet?)

 

From the “Consumer Insight Report”

$4 Generic Anecdotes at WMT (from the WMT perspective first)

·          “We are absolutely swamped and our volumes are up 50% week over week. We are asking customers to return next day to pick up.”

·          “The increase in scripts has been substantial. On transfers from CVS and WAG, we are being put on hold permanently, they won’t pick back up. I would guess that is a sign they are getting calls non-stop about transferring scripts.”

·          “We are running like crazy to keep up, traffic has been crazy.”

·          “Our wait times are now over 1 hour, which is 3x our normal wait times. We are hiring more help as a result. Transfers are mostly CVS and WAG but really all Rx, independent guys as well.”

·          “We are severely understaffed and I am growing increasingly overwhelmed. We are pushing people back 24 hours to meet demand. Wait times have tripled in most cases.”

Pharmacist Anecdotes from Tampa: CVS/WAG

·          “I really don’t think they gain any real market share from us. The WMT here is so busy, there’s only 1 in the nearby area compared to 3 WAG, 2 CVS, and us – too much of a hassle to make a big deal over a few bucks. The lines and the traffic will just not make it worth people’s while, and they are always under-staffed over there, never picking up the phone. It’s a nightmare.”

·          “Sure there’s been an impact but it’s not anything to get worried about. At the end of the week, we’ll end up being down about 60 scripts from what we had last week, and I’d say only 21-22 of that number could be attributed to switches over to WMT. That would make it 2.1% of the scripts I average per week. And this is during the first week of this, the absolute most hyped-up, over-the-top PR about what a great deal this is. Folks are definitely switching but the impact is nothing to worry about right now.

·          “Yeah people are moving their scripts over there but it’s not over the top, I’d say right now about 5 per day have gone since this started over the weekend (5 per day during these weekdays, not much happened over the weekend).”

·          “Nothing is going on, we’ve literally had 15 calls this week about it, and only 4 have transferred scripts over. This doesn’t look like it’s gonna amount to much for WMT.”     

 

(DBM QUESTIONS: WMT folks think there is a huge switch going on while the competition thinks its no big deal: are both sides just seeing what they want to see practicing some human delusion and denial? Don’t retired people who consume the most drugs have lots of extra time, but no extra (fixed-income) money? Once the customers get past switching their scripts, driving a bit further (to also buy other less expensive stuff while they are at WMT than the high-priced drugstores) and WMT gets lines back down to 20 minutes will the switching geezers tell their friends? As the population ages and consumes even more drugs, how will this trend affect the “full-service” drugstores with all of their high-priced alternative goods in the front of the store?

 

4.      Time Magazine to publish on Friday? To capture fewer, better customers? So?

 

Did you notice on August 17th that Time magazine announced that it will shift its Monday publishing schedule to Friday, with a mid-week close beginning this January? Why change an old formula and have to compete with the Economist and The Week (started up in 2001 now with 439,000 readers)?

 

Speculation is that Time wants to go after the fewer, but more educated and higher spending readers who have regular work-week jobs with their best time to read (and they can read) on the weekends. Advertisers pay a lot more to reach those eyeballs, than the stay-at-homes that buy mags on Monday to read between the errands of the week.  Over the past 30 years, however, the stay-at-homes have been joining the workforce in increasing numbers and perhaps the rest are getting their general news in alternative ways. At any rate, Time must be considering losing a magnitude of 20%+ of their circulation count to increase their advertising by even more. The strategy seems to be: downsize the volume and activity costs; upgrade the content; refocus on the best; and make more money. Time management egos have two give ups: circulation count bragging rights, but isn’t volume vanity and profit sanity? And, who wants to admit that they have been guilty for 30+ years of not reading and changing with the trends?   

 

Do most wholesale distributors have “downsize, upgrade, refocus and renew” opportunities within their business? Yes! They exist within the portfolios of both active accounts and employees. Want two strategic time management drills to do for 2007? Read #5 below.

 

5.      Do “5-5-5 reports” for each branch; rate employees “A,B,C”; weed to feed.

 

First, who are our best and worst accounts? Do simple activity-based cost ranking reports of customers by their estimated “profit before interest and tax” (PBIT) contribution. Note that the top 10% of all customers for the – company, branch or sales territory – generate about 100% of the PBIT. The top 20-40% generate about 150%. The bottom 60% or so are ever bigger losers with the bottom 1% often destroying about 20% of the PBIT.

 

Can’t believe it? Re-read the stories above about WMT taking generic drug sales share and Time magazine’s 30 year fade – are we in collective denial? Are we pursuing sales volume and too many customers with too little attention to hidden profitability or losses of those accounts now and in the future? If we don’t honestly measure and forecast future customer profitability, then can we claim to honestly understand and manage it?

 

Want to know more about this opportunity, how to analyze it and how to do it? Go to www.merrifield.com and read articles #-ed: 2.15 and 2.19. Want to ask the team some tough questions? Hit the “exhibits” button at our site and download exhibits #s: 30-33. Want to define what your “end point of the wire” is, your “best customer niches for profit maximization”? Download annotated “slide show” #10. Want to put the 15 accounts that will matter for each branch over the next 5 years on one page – do the 5-5-5 report that first appears at “point #7” in “article” #2.20. (www.merrifield.com/)

 

And, what about the cross-subsidization that goes on between best employees and worst employees? Have every branch manager sort all employees into three piles: A’s are “tigers, game-breakers, can-do artists, intrapreneurs”; B’s are “consistent crank-turning steadies”; and C’s are laggards in some way. As a discipline, assign up to 10% of the total to both the A and C piles leaving 80% in the middle B pile. Then, have the managers write a few sentences about what they will do to better feed, keep, motivate and utilize their A players in 2007 and a few sentences about what they will do to get C’s into the normal zone or get them out. (If you want more specific ideas and methods on how to do these steps stay tuned to the discussion site mentioned in topic #7 below.)

 

If you do the 5-5-5 and ABC analysis work, will actions follow? Most managers can’t do new, proactive stuff because they are as busy as they want to be. They don’t have the resources – time, talent and/or treasure – to pursue new objectives or super-focus on best opportunities. We must, therefore, first weed, prune, starve or delegate the losing or less important elements of our day and business to free the resources to pursue the best. “Just Do it” with 5-5-5 and ABC in 2007!

 

6.      Hospital hand-washing perceptions, and stats for over-the-hill sales forces.

 

In topic 5 above, when it comes time for an entire management team to super-focus on:

·          Selling more-to-core, most profitable customers;

·          Cracking best target accounts with exceptional reps on the assignment; and

·          Turning super-losing accounts into profitable ones

What will be the most common objection? Perhaps something like: “Our sales reps won’t like (stand for) these new approaches”. If so, what is the sub-text? Something like: “we have these independent agents on some sort of straight commission who don’t want to change. If we upset the biggest hitters, they might leave for a competitor and take a lot of their business with them. So, everything is pretty good now, let’s just let the sales force get older and harvest their territories and then we will sell the business to someone else who will have to figure out how to rebuild the business.”

 

Is everything pretty good right now? I know plenty of manufacturers and distributors that are having record profits thanks to the commodity inflation and housing construction bubbles, but how many continue to measure and manage the long-view “point at the end of the wire” mentioned in the kick off quote? If we don’t measure and graph what’s going on, are we in denial?

 

Here’s another example of denial (and arrogance): In one Australian medical study, doctors self-reported their hand-washing rate at 73 percent, whereas when these same doctors were observed, their actual rate was a paltry 9 percent (800% higher than reality!). Besides denial, the survey folks speculated that: “The ego can kick in after you have been in practice a while,” explains Paul Silka, an emergency-department physician who is also the hospital’s chief of staff. “You say: ‘Hey, I couldn’t be carrying the bad bugs. It’s the other hospital personnel.”

 

Try this quick, a-picture-is-worth-a-thousand-words experiment:

1.       Create a graph in which the Y (vertical) axis is the number of years that a sales rep has been working for the company and/or the industry, in case you stole them from another competitor.

2.       The X (horizontal) axis is the age of the rep.

3.       Plot all of the sales reps on this graph.

4.       Add two, dotted, vertical lines at: a) An average youngest age for when you think a rep can be focused, productive and on a career path (e.g. 22, single, renting an apartment is not likely to be as focused and career-with-this-company-minded as a 26 year-old who is married with kids and a mortgage); and, b) An age when you think that the average senior rep is starting to slow down, do 100% maintenance within their territory and perhaps unwittingly starting to harvest their account base.

5.       Add one horizontal dotted line to what will make a third, bottom side to a dotted “maximum productivity window”. This line should cross the Y (vertical) axis at about 2 years of experience with the company and/or in the industry. The assumption is that if you hire a person from outside the industry, they will need some time to learn enough to be effective with customers. (Questions: Can we accelerate our training program to develop rep effectiveness faster?  Can we hire experienced sales people from other industries who are great learners who can become more effective than most of our vets within 3 to 9 months?)

6.       Analyze the average age for and distribution pattern for the sales force. When should we start a steady, on-going renewal of the sales force?

7.       Weight the dots on the chart by “gross margin dollars managed” by drawing vertical columns around clusters of dots. It shouldn’t be surprising that the oldest reps have accumulated the most, best accounts with the biggest gross margin dollars. What if 30% of our most veteran reps are managing and unwittingly harvesting 70% of our margin dollars? What if they resist: team-selling their best accounts for more penetration; re-assigning some OK accounts in which there is huge untapped, target potential; and/or resist the possibility of upsetting an account with OK margin dollars that is abusing us with small order transaction costs?

 

After doing this charting exercise and writing down the big unresolved questions, do a similar chart for managers and management trainees. (Note: some of the young sales reps can be on both charts, because they do have management potential.) Do we have a steady pipeline of up and coming talent in both charts? Do we have methods for recycling both accounts and responsibilities to the next generation of reps and managers? Or, are we optimizing the present and unwittingly harvesting the company in the longer run?

 

That’s all for this edition of DCCs!  All the best,

 

 

Bruce Merrifield

 

bruce@merrifield.com