Shift for distributors

March 1, 2007
A FUNDAMENTAL shift of identity is taking place with distributors, according to Andy Thomas, director of innovation and process development with WW Grainger.

A FUNDAMENTAL shift of identity is taking place with distributors, according to Andy Thomas, director of innovation and process development with WW Grainger.

In his Heavy Duty Aftermarket Forum presentation, “Forces of Change in Distribution,” Thomas said the choice of the term distributor makes sense only from the point of view of a manufacturer — a company that has just made 40,000 units of a product that somebody else can handle by talking to customers and selling it.

“But the customer is supposed to be king,” he said. “The big change in the late 20th Century was that there was a worldwide surplus of manufacturing capacity — it's made multiple places around the world. The emphasis is shifting from selling. In most businesses, the customer is going to have more choices. The successful folks in the middle truly understand and identify with the real needs of the customer. Every time somebody describes a distributor, cross out distributor and think provisioner.

“Think like Radar O'Reilly, the quartermaster (on the TV show M*A*S*H). The boss says, ‘You know, I could really use a 6×6 truck,’ and the next morning, there's a 6×6 truck in the yard. And Radar says, ‘Don't ask where it came from.’ Think of yourself as the products and services you choose to specialize in to identify with customer requirements. What is it they're going to need? Be ahead of that curve and be representing that on their behalf.

“Represent the customer, so that the neon sign on your counter is really your customer's sign. You're a franchised buyer on behalf of the customer, and the whole process is purchasing across your counter. You go to the manufacturers and other sources and you're basically representing the customers in terms of their buying power. Middle men are obviously in the middle. In the 21st Century, they're actually going to be serving the manufacturers' purposes far better if you let them take this mindset.”

Thomas calls himself Grainger's “futurist” — the person who knows what should be done today so the company can be positioned to compete in five years, the person who asks, “How do we add value to our customers and suppliers?”

He said that traditionally, a low-tech local business was very easy to get into, adding that a lot of entrepreneurs used to say, “Anyone with a truck, a shed, and a line of credit can get into the distribution business.”

They were people-powered, with very low barriers to entry.

“The flip side is that there are dis-economies of scale,” he said. “If you get above the size of a business that a small group of people can run, it gets difficult to grow a business beyond that. There are many distribution businesses that stall at a few million dollars. There were 350,000 distribution businesses in the 1980s, and that's starting to collapse, mainly because those dis-economies of scale are breaking down. People are still vitally important, but a lot of back-end functions of distribution are starting to be amenable to real industrialization — global real-time communications, product and application knowledge bases, nationwide overnight delivery, and third-party fulfillment contractors.

“It's less about what's in the box than how it's selected, delivered, used, and paid for. It allows you to offer a very standardized service across a much larger range of products and geography that has really helped the consolidation of the distribution business. Products themselves are starting to become uncommoditized. So if you're concerned about managing pressure, you have to change the nature of how you add value from focusing on the product and how much you can get for selling it to somebody, to focusing on the services. Why do you exist as a player in this value stream?”

Up and running

He said Grainger, a Fortune 500 company with 2006 sales of $5.9 billion, is a system of access to MRO (Maintenance, Repair, and Operations) solutions.

The company helps its customers — 1.8 million businesses and institutions across North America and China — save time and money by providing them with the right products to keep their facilities up and running. While each customer has a unique facility to operate and a different problem to solve, all of them share the same requirement: When they need one of Grainger's products, they often need it right away.

Grainger's employees serve customers more than 115,000 times every day through multiple channels. Grainger works with more than 1,300 suppliers to provide customers with access to more than 800,000 products. With more than 425 branches in the US, customers can go to their nearby Grainger location to pick up their order the same day or have it shipped directly to them.

The 2007 catalog offers customers a resource for more than 138,000 facilities maintenance products. Grainger's e-commerce solution (grainger.com) offers customers the ability to order more than 300,000 products online and have them shipped directly to them or picked up at one of 428 US locations.

Grainger once ran an ad with these words at the top: IT TOOK SEVEN PEOPLE TO BUY THIS HAMMER. Below that were the people. Below them was the hammer. And below it were these words: THE HAMMER COST $17. THEIR TIME COST $100.

“Any business of any size has a purchasing process that is optimized to buy products customers care about,” he said. “They don't care about the products we sell. So buying a hammer in a hurry creates heartburn inside a typical customer's purchasing process. All these people have to sign off and fill out forms, which is why the product we're going to sell them ends up costing vastly more in process costs than the item itself.

“We explain the problem to our customers this way: The product is less than 16% of the total value chain cost. It costs the customer $230 to fill a typical MRO need. Only $35 is the direct cost of the product. $195 is the total non-product cost in the value chain, reduceable through collective process improvement. Our business is all about driving down the $195 process cost, which is really about interactions between maintenance management and the buying process of the customer, our buying process and distribution processes, and the manufacturer's cost of dealing with channels like us.

“Our objective is to take the $195 and get it down to $50, which is about moving the focus from what's in the box — the margin on the product — to how we are creating value in the process and how we can help our partners become more efficient. All the new e-business technologies make this a lot easier. The idea of sharing information between business partners is very practical now. It wasn't doable 20 years ago.”

The Aftermarket Forum also included two other presentations:

Supplier Consolidation: Its Impact on the Distributor

Dave Scheer, president, Inland Truck Parts Company

SCHEER said Inland, a heavy-duty supplier of quality transmission, differential, clutch, brake, driveline, spring, suspension, steering, engine, power take off (PTO), and hydraulic parts, usually tries to define and implement a program that fits the distributor.

“A distributor counts on our suppliers to provide a lot of value in the relationship: integrated marketing plans, freight policies, return policies, field sale work, training and customer clinics, and limited distribution,” he said.

“Usually in any relationship with a vendor or supplier, there's a defined number of distributors in the marketplace. We know at any given time how many other distributors are in any given market and also have the same products that that supplier is supplying us. So in a sense, we have some form of limited distribution. The point is that the supplier provides a lot of value for us. They're integrating part of our business plan going to the marketplace.”

He said a common scenario is that Supplier A (with 350 distributor customers across the US and six primary product groups) acquires Supplier B (with 200 distributor customers and three primary product groups). As a result, the new Supplier A has 500 distributor customers and eight primary product groups.

“Everybody that was in the original company wants access to all of the products and services that the new company can offer,” he said. “And the acquiring company of course wants to make its acquisition work. So one of the results is that it's not uncommon to end up with too many distributors in the marketplace. There's not a clear rationalization of how we manage distribution in a consolidated company.”

Scheer said suppliers must have a clear, well-thought-out, and thorough plan to integrate their products with the distributor. Without a well-executed plan, the integration will likely fail and the product will be devalued.

“Don't rush to market,” he said. “Make sure you're ready.”

He said one of the drivers of consolidation is technology. One company needs the technology that another company has, so an acquisition is made.

“That simple act of consolidation changes the availability of that technology,” he said. “Truck computers are electronically controlled and they're integrated with other computers. The truck essentially is one giant computer network. So if we're going to sell parts for these trucks, these systems, these computers, we must have access to technical and product information.

“I'd say this is a significant issue for distributors. But in any business, we've been complacent. My goal is to raise awareness. Let's take a truck. What if you couldn't get access to service or parts information to work on the vehicle? What if you couldn't read a fault code on the engine? What if you couldn't get information even by the diagnostic tools? Same thing on the transmission. What if its electronics shifted and you can't get that information? What about the braking system on the drive axles of a trailer or steer axle? What if its ABS system can't be accessed so a technician can work on it?

“As an independent distributor, if I'm going to work on this vehicle or sell parts on it, I have to have access to that information. Do you believe that what is good for the customer — truck owner — is good for us? And if it's good for us, isn't it good for the industry? If the answer is yes, then we have to solve that issue. The customer deserves the right to choose who works on or sells parts for their vehicle. If we can't solve this issue, then this is what I have left for the independent distributor: If I can't get the information I need to work on the electronic components, that's what I have left to work on.

“It's a growing issue. I'd venture to say trucks are not going to become less and less electronic. They're going to be more and more. We can't wait for someone else to solve this issue. It's time for us to come together as an industry around this common issue.”

Economic Overview

Robert F Dieli, president, RDLB Inc

DIELI gave tools to use in tracking the Federal Reserve's “soft-landing strategy,” in which growth is targeted at its potential rate of 2% — the rate of growth that allows full utilization of resources with no capacity strains, in essence slowing growth while controlling inflation.

Those tools are the Aggregate Spread and Truckable Economic Activity (TEA).

He said the Aggregate Spread is RDLB's forecasting device, which gives 20/20 hindsight nine months in advance, forecasting when recessions are going to happen. Dieli said it hasn't been wrong in 40 years because it's a “no-spin forecast that's not based on somebody's market strategy or product.”

He said the track of the Aggregate Spread indicated the “soft landing” would succeed, then went on to correctly predict the recession that happened in 2001 and the recovery from the recession. He said the latest reading of the Aggregate Spread suggests that the success of the new “soft landing” attempt is not assured.

Dieli said the key variables are: the federal funds rate (under the direct control of the Federal Open Market Committee); the long bond (controlled by the bond market); the longest maturity actively traded Treasury bond (now the 20-year, but used to be the 30-year); and the core rate of inflation (the Consumer Price Index excluding food and energy prices).

“While the track of the Fed Funds rate in this episode is quite similar to that of the ‘soft landing,’ the track of long interest rates is not,” he said. “The yield curve inversion that has come into being this time is a new development. History suggests the Federal Open Market Committee (FOMC) is going to have to address this issue sooner rather than later.

“The Federal Reserve wants to be absolutely sure that the inflation threat has been contained before proceeding further. The reason for this is that they know they cannot afford to make a mistake.

“As you might expect, the stock market did very well in the last ‘soft landing.’ The recent rally has been based on the idea that the Federal Reserve would succeed. However, the inverted yield curve overhangs the equity market as much as it does the fixed-income market.

“The Aggregate Spread gives us a very good idea of the size and shape of GDP growth one year ahead of time. In the ‘soft landing,’ GDP continued to expand at a brisk pace. GDP slowed in the recession by about the amount, and by about the length of time the Aggregate Spread said it would.”

He said TEA was developed by MacKay & Company an indicator of trucking demand based on the GDP statistics. TEA includes only those components of real GDP that can move by truck: consumer goods, investment goods, export and import goods, and government purchases of goods. TEA also differs from GDP in that it counts imports as a positive (they have to get from the port to their final destination).

“TEA is more sensitive to the cyclical swings in aggregate activity than is GDP,” he said. “TEA is a better predictor for trucking activity than GDP.

“The Aggregate Spread provides us with a forecast of TEA, the same way that it gives us insight into what GDP will be doing a year from now. TEA outperformed GDP in the ‘soft landing.’ TEA fell more steeply than GDP did in the recession.”

Dieli gave the Class 8 market outlook, saying US sales set a blistering pace in 2006 under the combined effects of strong freight demand and a pre-buy motivated by the uncertainty and costs of the 2007 engines.

“We expect sales to fall off sharply once the last of the 2006 engines have been installed in vehicles that will be assembled during the first quarter of 2007,” he said. “What happens after that will depend both on the strength of freight demand and reports from the field about engine performance.”

Talking about factors affecting the heavy-duty aftermarket, he said that while TEA and GDP play important roles in how trucks are used, there are several other factors that determine after market activity:

  • The size of the vehicle universe.

  • The age of the vehicle universe.

  • The service life of truck components.

“The 10% gain in aftermarket activity we saw in 2005 was the direct result of a sharp increase in power generation and power transmission activity associated with the need to overhaul trucks that came into the fleet in 1999, which was a banner year for new Class 8 sales,” he said.

His conclusions:

  • The Aggregate Spread is pointing to slower GDP and TEA growth in 2007.

  • The Class 8 pre-buy has pulled a considerable number of vehicle sales into 2006.

  • The pre-buy, along with the slower pace of TEA, will combine to slow 2007 Class 8 sales significantly.

  • The heavy-duty aftermarket is expected to slow slightly from its 2006 pace.

About the Author

Rick Weber | Associate Editor

Rick Weber has been an associate editor for Trailer/Body Builders since February 2000. A national award-winning sportswriter, he covered the Miami Dolphins for the Fort Myers News-Press following service with publications in California and Australia. He is a graduate of Penn State University.