January 29, 2003 Distribution Channel Commentary # 9

 

Greetings:

 

            If you know what these commentaries are all about, go to “TOPICS” below; otherwise, read on.

 

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This is our ninth commentary. If you would like copies of some or all of the others, please feel free to request them from karen@merrifield.com. If you want more reading, we also recommend that you  request our 45 page E-Booklet (EB) entitled “New Solutions for a Different Kind of Downturn.” This has 11 articles and a case study exhibit that haven’t been posted on our existing web site, because our first web master had a mid-life crisis at 25 which we mistakenly, patiently tried to accommodate. We do make frequent references to the EB, so it could be handy to have. All of the references to our past documents will stop when we can put them all on the new site with hotlinks.

Until then, here is what our Reference abbreviations mean: 

1.       “WS-ART#” = at our web site, under “articles”, the specific article # (warning: the transition site doesn’t retrieve the articles, so request them via email as desired);

2. “DCC# x/y” = Distribution Channel Commentary-edition#/topic#.

3.       “EB#  = e-booklet article #.

4.       “VM#” = our video, “High Performance Distribution for All”, module #. Lots of info on the video is in the e-booklet: another reason to request it and skim through it.        

 

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THIS WEEK’S TOPICS:

 

1.       STALLED ECONOMY; HOW TO GROW PROFITS?

a.       free market facts win over cheerleaders; interesting deflation cycle graph

b.       lessons from: Stanley Tool; Depot vs. Lowe’s Service Duel; McEmpire declines?

2.       TIPS FOR REFOCUSING ON YOUR BEST NICHES

3.       TEAM FOCUSING ON KEY ACCOUNTS, “NEXT LEVEL” IDEAS FROM READERS

4.       EDUCATING ALL EMPLOYEES (FEEL GUILTY?); AFFORDABLE SOLUTIONS

5.       “HIGH PERFORMANCE’ VIDEO USERS’ SHARE-WARE (will this get you to the end?)

 

 

1.       STALLED ECONOMY; HOW TO GROW PROFITS

 

The Iraq war is being used as an excuse by all of the expert forecasters and Wall Street cheerleaders as to why the data from December and early January is showing the economy at stall speed; already less robust than what they were forecasting a few weeks ago. I believe that root causes of our muddle along economy are, instead, the excesses of our bubble economy (EB#1, DCC#6.1), the rapid growth of China(DCC#1.2) and our borrow-to-consume-keep-the-economy going federal policies(DCC#2.1). The combination of growing our money supply to maintain artificially low interest rates to induce the last, naïve consumer to buy a house and car with nothing down has both forestalled and aggravated our country’s need to collectively save and invest in productive investments.

 

Our economy, at any rate, is quite fragile and any shocks to it could cause another, tougher recession than 2001’s. When conditions are as stressed and uncertain as today, it is important to develop worst-likely-best scenarios and be prepared for them. Most wholesalers have already been through one to three rounds of cutting costs and trying harder, but few have figured out how to do all of the following: downsize, upgrade, refocus and revitalize their businesses. Most businesses are like overweight bodies in which there is a ripped athlete trying to get out. How do we liberate the athlete within to better cope with these tough times? It’s a key theme of these commentaries.

 

From the on-going dirge of weak economic/business news, I plucked a few case examples that might speak to a number of wholesalers and their high performance service issues. First, a typical PR hype-job from a common supplier to many durable distributors, Stanley Works. The title of the 1-25-03 release was “Profit at Stanley Triples.” Digging into the details the story isn’t so sweet:

a.       These numbers are only for the fourth quarter and roughly 60 days later the final, audited ones that will quietly be reported to the SEC, etc. I wonder if the final numbers by public companies have, on average, positive or negative surprises in them that are, of course, consolidated in footnotes of annual reports.

b.       During the quarter Stanley issued $350 million in new debt to buy Best Lock and added their profits into the “triple” total. Do you want more debt in a deflationary world when your incremental profit power is eroding faster than the lower interest rates that have to be financed? If you, incidentally, want to think about “the cycle of deflation” and how it already is working on the following industries and countries: airlines, hotels, telecom, autos, and all Asian countries. Then go to this URL and scratch your head:

http://www.comstockfunds.com/files/NLPP00000/110.gif

c.        Without adding in Best Lock’s numbers, sales fell 2%; earnings were less than forecasted for a second consecutive quarter; expenses for both the acquisition and raw materials were higher than anticipated.

d.       Gross margins fell from 34.2% a year ago to 31%.

 

Here are the questions I found myself asking:

a.       If top line growth is flagging and margins and profit power are both eroding partially because China is probably making more of both Stanley’s and its competitors hand tools, is Stanley in control of their core business?

b.        What if we are in the early stages of a deflationary period that already has gripped all of Asia and durable goods America? What if the stock markets are still in the early stage of a secular bear market? Do I want to buy another company to digest and run with debt at today’s prices? Or, should I first try to re-invent sustainable profit power (not just through headcount reductions) in my core business and do deals later on at even lower prices with a better balance sheet and presumably a higher interest rate coverage ratio?

c.        Wouldn’t Stanley’s numbers reflect the collective experience of all of the distributors that they sell to? What are those distributors doing to combat declining sales, margins and profits? I hope they aren’t pursuing more volume that runs up their working capital debt in hopes of achieving some sort of mythical economies of scale.

 

Next case, what is Home Depot’s real problem? I came across two different articles on why HD’s stock is down more than 50% in ‘02 and same store sales are off 10% in the fourth quarter amidst the biggest housing boom in history. The 2-3-03 issue of Fortune article, “Can Home Depot Get Its Groove Back?”, just reports the financial symptoms – same store sales off and likely to remain so for the next three quarters – and speculates on how they can get volume growing again by going into new markets. Sounds like Stanley Works’ strategy above; if your core business is flagging don’t fix it, buy more growth by getting into another game (or more locations if you are a distribution chain consolidator).

 

But, a 1-27-03 article in Business Week (“What Worked at GE Isn’t Working at Home Depot) offers, in my opinion, better, deeper insights to what HD’s real problems are. The article centers on what HD’s new CEO from GE, Bob Nardelli, has been doing. A retailing neophyte, Nardelli was a manufacturing star at GE who came into HD two years ago to bring it manufacturing efficiencies. He centralized all buying, consolidated suppliers and increased part-time sales clerks from 26% to 50% and improved margin percent by 1%. But, reorder lead times to the local stores stretched out and fill rates dropped. I also infer that service quality from part-timers probably dropped and customers defected to competitors. Here’s why HD’s same store sales drop of 10% in the fourth quarter was the seventh straight quarter in which HD lagged Lowe’s same store sales rates. Lowe’s, by the way, has 80% full time sales associates and has been scoring higher service satisfaction rates.

 

Conclusions, Discussion Points:

1.       Local fill rates are the cornerstone of great service, especially for distributors. HD seems to have made a pennywise, pound-foolish, financial trade-off decision to improve margins at the expense of fill rates. For more on rethinking your business around fill-rates see the case study in DCC#8.3.

2.       Attracting, keeping and educating the best quality employees is the keystone to the “service quality/customer retention model. Having cheaper, higher turnover, less motivated part-timers at HD seems to be another pennywise-pound-foolish trade off HD’s new CEO has made. I wonder if Mr. Nardelli understands the why’s and how’s of employee/customer retention practices? I transformed a distribution company with the “service economics chain” in the early ‘80’s. I borrowed and adapted it for a distribution branch environment from my service management professors at Harvard, Jim Heskett and Earl Sasser. For more on this topic see VM#3.12 and WS-Art#3.7. For a quick simple read on the subject that I found through Google on the web, check out this URL: http://www.loyaltypath.com/FourStepsArticle.htm

3.       It appears that HD’s new, centralized buyers are not as responsive to what local stores and local customers need in stock as HD’s previous methods. Wouldn’t you think that if you were put in charge of one of the most successful, historically service driven success stories in retail America you would try to see what was good about the existing systems instead of “fixing its inefficiencies?” Businesses like our bodies responding to prescription drugs are a lot more complicated and finicky than anyone can ever seem to know. Maybe consolidator executives from outside the service industries that they enter should practice a little “appreciative inquiry”(DCC#5.3) as to why “inefficient practices” seem to be working, on balance in an optimum way. Honeybees, for example, look ill equipped to fly, but when you consider their entire ecosystem and energy trade-offs, they are perfectly suited for their total job.

4.       Neither article mentions what has happened to Nardelli’s inherited corps of store managers and local buyers. What do you bet that with changing the entire purchasing and sales associate model, a lot of them have left? How important do you think the quality and longevity of good store managers are to hiring, keeping, training and motivating good front-line service employees? I know from lots of experience and client case studies that this is hugely important for branch managers at distribution chains. (WS-ART#2.12)

 

And lastly, is McEmpire in decline? Did you notice that in December McDonalds announced its first quarterly loss in 47 years. They also first announced that they would close 175 of their some 30,000 global locations, then upped that by hundreds more in early January. This is not a sudden, new, turn of events. McDonalds has been doing a slow, profit-power erosion number for years. This has been punctuated with turn-it-around, touch-down-bomb announcements and investments in things like new high-tech, automated equipment and co-marketing toy-with-the-meal advertising deals with Beanie Babies, Star Wars stuff, etc. (McD’s did score a legal victory this past week when U.S. District Judge, Robert Sweet, threw out a class action lawsuit that sought damages from McD’s for causing obesity with this refreshing legal perspective: “Nobody is forced to eat at McDonald’s.”)

 

What are the real problems for McEmpire’s economic decline? After 12 years of having to go to McDonalds (Yes! I am a victim, I was forced Judge Sweet) with my now 14-year-old son and 10-on-Friday daughter (the end of this painful necessity is in sight!), I think it’s because of a steady erosion of what Ray Kroc pioneered and made famous – quality, service and cleanliness. Don’t just take my view that these basic, vital ingredients of their once compelling total value proposition have eroded badly. Go to epinions.com and read the vox pop reviews for Wendy’s and Chick-Fillet versus McDonalds: high 80’s and 90’s versus 50’s for big Mac. What are the root causes for this service deterioration? Here are a few points of discussion for your management team:

a.       Volume is vanity, profit is sanity? Maybe the executives got bored with maintaining basic service excellence religion and growing at a slower rate determined by their ability to attract, train and promote people who were ready from a service competency viewpoint. The sirens of Wall Street, big executive options and private jet trips to far off lands made them want to grow faster than they could maintain service quality, especially through franchisees.

b.       Pursuit of financial economies of scale instead of sustainable service profit power? Look where that has gotten them; they probably buy everything for less than their competitors, they just can’t make any money.

c.        Going from win-win economic thinking with their stakeholders to win-lose? Read Ray Kroc’s story about McDonald’s (“Grinding it Out”) or John Love’s book “Behind the Arches”, or at least read some of the reviews on them at Amazon. Both books were airbrushed to make both Ray and McDonald’s appear more enlightened and foresightful then reality, but they both capture the spirit of win-win thinking that McDonald’s had for developing suppliers, franchisees and turning jobs into careers for their associates. Today, McDonald’s franchisees, for example, complain bitterly about how the different ways they are being squeezed by the parent organization.

 

Final summary questions for the three case studies. Are most of America’s consolidating, distribution chains guilty of the same problems that we see in these three case studies:

a.       Too much growth through acquisition adding up to much debt which looks ominous in deflationary times?

b.       Industry outsider CEO’s adept at: “roll-ups’; managing by the financial numbers with an eye towards fast exit strategies with big stock option gains instead of improving local service metrics through employee and customer retention economics, making money off suppliers with ever bigger clout for short-term results and long-term problems.     

 

What percent of all distributors of any size and stripe truly believe and practice “high performance service management” principles? If they do, you can spot them easily. They are the ones that are growing faster than their industry and making 3 to 6 times the profit margin of the average distributor. That’s only 3 to 5% of the players. How do they do it? Read more in DCC#5.2; skim through our E-Booklet; or buy a total strategic planning, educating and high performance implementation program in a box (our “high performance” video) for a nominal cost compared to the value of your time and your lost profit-power opportunity cost.

(2)    TIPS FOR REFOCUSING ON YOUR BEST NICHES

 

A few clients have recently asked for more detailed suggestions on how to identify the exact core of their historic #1 best niche so that they can refocus on it; re-tune their service value offering more perfectly for the niche to better dominate it for maximum profit growth. Here are some steps and tools to use:

a.       With the mega-assumption that your historic strategy is where you make the most money, do a simple customer profitability ranking report to see what 10 customers are on top (EB#12; VM#s 3.1-7).

b.       Look for 4 or more customers in the top 10 that seem quite similar; they can then become the central voice for and co-creators of your re-invented service proposition. (VM#3.2 & 3)

c.        Besides giving this niche a name, define it by the top 5+ most profitable customers in the niche along with the 5+ most promising target accounts in the same niche that every employee most know by heart and look for “heroic (service) actions” to do for them (see topic #3.b below).

d.       Post the basic service metrics that these customers help to re-define on the wall and appoint a “service manager” who’s new job includes gathering, posting and enabling the continuous improvement of these metrics (VM#4.1-13; WS-Art#3.1, 3.9).

e.       Further segment the # 1 niche by two other dimensions: why they buy – loyalty/friendship, value or price and size/mode of selling – “A’s” by outside sales ($400 in gross margin/month and up), B’s by tele-sales, C’s by direct mail, catalog and D’s cash-n-carry retail counter(VM#3.6;)

 

For more general ideas on why every distributor needs to focus on value-added service basics tuned to one niche at a time, which can vary amongst multiple locations, check out the following web documents:

1.       “How the World Works, Part I and II” by Ray Alderman. Simple, elegant articles on what works for both manufacturers and distributors at these two URL’s:

Part I:   http://www.elecdesign.com/Globals/PlanetEE/Content/3785.html

Part II:  http://www.elecdesign.com/Globals/PlanetEE/Content/4491.html

 

2.       “The Electrical Marketplace (parts I and II by Jim Lucy editor of “Electrical Wholesaling” magazine). These two articles do a wonderful job of laying out and describing all of the distribution channels for electrical goods. If you are an electrical distribution channel creature, its good to review to better understand your ecology, your most important niches and who isn’t really your competitor. For all other distribution channel people, Lucy’s taxonomy can be generally applied to many niches in your respective channels.

Part I:   http://images.ewweb.com/files/32/50ways.pdf (great graphics; strategic planning forms too)

Part II: http://ewweb.com/ar/electric_electrical_marketplace/

 

(3)    TEAM FOCUSING ON KEY ACCOUNTS, “NEXT LEVEL” IDEAS FROM READERS

 

Once a distribution branch has zeroed in on the most profitable, historic, core accounts within one niche at a time AND the best, faster-growing, target, gazelle accounts in the same niche, what do you do? Here are some ideas from us and refinements from first-through-the-video users:

a.       Review the two pages of recommendations in DCC#7.3. Most of this stuff and more is in our video in VM#-3.7 with more ideas in VM#s- 3.10, 3.11, 4.13.

b.       A industrial packaging distributor went looking for past “heroic actions” that employees had taken which in turn help to land new chunks of business from old and new accounts. He not only publicized and thank the people retroactively, but coined the term going forward of “heroic actions.” We had fun toying with the idea of buying “action hero figures” in quantity at Wal-Mart to present to anyone who did an “heroic action for one of the accounts posted on the wall.”

c.        A distributor of both wine and wine accessories has had huge success by both solving a horrendous small order opportunity while super-focusing on his customers with a future. He went from 5 outside sales reps to one super-star calling on the “true A’s and gazelles” and one, new dedicated tele-sales person calling on the “true and potential B’s.” The super-star has landed major new chunks of business in all 15 accounts (that’s all!). The tele-sales person has grown net margins out of accounts that used to be covered by former outside sales personnel by 20%. The net results: sales are up 10%, average order size is up 40%, special service charges are up thousands per month, profits are up 600% and debt has been totally paid off.

More specifics on target account team activities: Every employee knows the top 15 core and target accounts by heart, because the sales rep quizzes them during monthly review meetings for the entire team. The rep, in turn, has guaranteed the accounts that no matter what their problem is “everyone at the company will do extra effort service actions to solve their problems and grow their bottom line.” Also the rep has brainstormed regularly with the management team on:  what else they can find out about the targets? What else they can do to sell not just to the accounts but through them at the lowest total procurement cost with the highest internal productivity for the customer all to put more measurable profits to the customer’s bottom line. And when company honchos should go out to visit key account honchos to talk about working together on “next level” business building ideas. It is all working in a tough to down economy!

d.       A regional plumbing supply distribution chain has identified 50 accounts that are costing the firm $100,000 in lost profits due to huge amounts of small orders(VM#3.5-10; EB#11-14). Instead of expecting the assigned sales reps to turn these lead accounts into gold, he has identified a manager who’s total job for the next 6 to 12 months is to do “free TPC (total procurement cost) Reduction Audits” and implementation guidance for these accounts. This “consultant’s” goals will be to identify things that the two companies can do together to both lower the customer’s TPC as well as the distributor’s cost to serve significantly. Their goal is to do two audits a week over 25 weeks and turn 100K in losses into 20 to 50k in profits – a monster swing in profit for this company. Think about it. If a distributor can improve their bottom line by 150k by selling more to the same customers that also buy less often in larger quantities to both parties benefit, that is like going out and getting $3MM in new sales that generate a 5% operating profit margin or $6MM at 2.5%.

 

Anyone else out there have refinements and successes to share?

 

(4)    EDUCATING ALL EMPLOYEES – SEVERAL GREAT SOLUTIONS

 

Most distributors will admit:

a.       Employees are our most important asset and the key to our service quality.

b.       But, we can’t afford to invest in their continuous education.

 

To break out of the doom loop of: 1) Profits stink. 2) Let’s cut costs including educational expense and payroll increases. 3) Good people leave or can’t be hired to begin with due to poor pay, training and job growth prospects. 4) Our service is, therefore, “average” (or undifferentiated which makes us price takers) so back to #1. You might read EB#10, “Affordable Education for Front Line Employees.”

 

Or, you might go to this web site www.univid.org

TO CHECK OUT THE BEST EDUCATIONAL VALUE IN WHOLESALE DISTRIBUTION FOR ALL TIME. This “university” has been run about 10+ times over the past 5+ years by a consortium of 20 distribution trade associations that are all in the durable goods, distributor-to-industry category. The product is combat tested, great. And, as a long-time faculty member I can guarantee that all of the faculty members have worked in lots of distribution channels besides those represented by the 20 sponsoring associations. The teaching is 95%+ applicable to any type of distribution channel, and “how should I apply this in my channel” questions are always welcome. You don’t have to be a member of the 20 sponsoring associations; anyone can go. So, for those of you who are looking for a great educational experience for some important employee(s), why not try an experiment. Send them to this best cost-benefit program with the understanding that they are going to come back and make a full report on what they have learned of value that can be applied at your company.

 

(5)    “HIGH PERFORMANCE’ VIDEO USERS’ SHARE-WARE

 

Two happy users of our video have offered to share the following items. The plumbing supply distributor mentioned in #3-d above sent me this quote and a form that you are welcome to request from Karen@merrifield.com.

 

A.       “After running the management team through the video, we are now running all employees through it. After 6 modules you can already see the light bulbs going on. At first, the ambitious wanted to fire the slackers, but quickly everyone realized that everyone has a chance to become part of the high performance solution and those that don’t will self-weed themselves over time.

 

We have been focusing on getting people to realize that change can only happen if they are involved and committed, they can not look to me or other managers to make their future better. To that end, we have asked everyone to come up with one thing that they can work on to make themselves more productive and valuable for our common cause. It doesn’t have to be grandiose, we just want them to start thinking about any sort of proactive effort on their part. Attached is the form that we are using.”

 

B.       The industrial packaging, Jan-San distributor referred to in #3-b above put together a 21-slide power point presentation that he has used with excerpts from the video for regional meetings of his buying group (Afflink). His firm has improved their net profit by +70% and their return on total assets from “average” for their industry to “high” with lots more upside to come. If you want a copy of the slide show, the CEO has given us permission to forward it on.

 

 

Regards,

 

 

Bruce