Defined Distribution Trends Guide Industry

Distributor profitability depends greatly on the supply chain’s ability to predict and then adapt to changes in technology, the market, and multiple other factors. These changes often create new trends that provide each supply chain participant a guide to continued profitable success.

Dr. Adam Fein, Ph.D.’s latest research report, Facing the Forces of Change®: Lead the Way In The Supply Chain, helps expose the new trends facing distributors in diverse industries across the nation. The study, published in book form through a partnership between Pembroke Consulting Inc. and the National Association of Wholesaler-Distributors (NAW) Institute for Distribution Excellence, surveyed more than 1,300 industry insiders and observers. Using these survey results, Fein, president of Pembroke Consulting Inc., delineates four major trends that “will dominate wholesale-distribution’s agenda for at least the next five years.”

PRIVATE LABEL PRODUCTS

Private label products are the specific products branded by individual distributors. Brought about by global sourcing from countries such as China, Korea, Taiwan, India, Chile, Canada, and Mexico, Fein predicts that this emerging trend will expand substantially over the next few years. According to the study, 43 percent of distributors are already marketing their own private-label products and 65 percent plan to do so by 2012.

There are three major benefits to investing in private labels: buy-side margin, sell-side profitability, and differentiated product assortment. Distributors can sell private labels at lower prices and remain profitable because of the lower initial costs.

They can also capture part of the branded margin that would traditionally go to a manufacturer’s brand, creating sell-side profitability. Increased availability due to multiple manufacturing company sources and the offering of a distributor exclusive brand can put the distributor on track to provide alternatives to the current hierarchy of products available to contractor customers.

These three factors help strengthen the relationship with contractor customers and continue to increase a distributor’s profitability. According to the study, 75 percent of distributors bringing in $1 billion or more of revenue in 2006 were offering private label products, as compared with 38 percent of the distributors whose revenue totaled less than $20 million.

Fein cited W.W. Grainger Inc. as an example of private label profitability. The company globally sourced more than 9,000 SKUs, equaling approximately $400 million in sales. The gross margins on these products were reportedly 20 percent higher than other products sold through the company’s branch network.

According to Fein’s report, a distributor’s value-priced private-label product offers a less expensive alternative to a branded product, and strategic sourcing programs create opportunities for distributors to grow their private-label brands. Strategic sourcing, a “structured process by which larger, multiple-location customers attempt to leverage their purchasing power,” consists of three major activities: assessment and spend analysis, sourcing and contracting, and implementation.

When considering the positive benefits of private-label products, Fein also cautions distributors to consider the strain that can be placed on supplier relationships. While considering adopting a private-label strategy, distributors must understand that they are changing their traditional supply chain role. With this change there will be some bumps in the road as supply chain power shifts.

DEMAND DRIVEN CHANNELS

Traditionally, manufacturers push products through the market towards customers. With demand driven channels (DDC), however, products are pulled down the supply chain to the market, based on actual customer demand. Driven by advances in supply chain technology, according to Fein, the three keys to DDC are supply chain data transmission standards; evaluating new profit streams from data transmissions to suppliers; and the application of DDC concepts to daily business.

Sharing information through the supply chain is imperative to the success of DDC.

“In a DDC, shipments should respond to real-time or near-real time (daily) information that is shared across a network of customers, wholesaler-distributors, and suppliers,” said Fein.

“The consequence of not sharing data is often referred to as the bullwhip effect. The bullwhip analogy comes from the fact that a small change ripples forward to create large variations.”

Consequently, the lack of information leads to stockpiling and extra inventory for every link in the supply chain, and this contributes to lower profit margins.

DDC not only helps alleviate overstocks and decreased profit margins, but it can also help alleviate supply shortages. Operating under DDC principles will allow scarce products to be allocated based on actual demand patterns rather than on historic distributor sales patterns.

DDC success depends on the willingness of supply chain participants to increase their supply chain visibility. According to the data gathered from the survey, Fein predicts that the order stream will be automated, suppliers will gain visibility into distributors’ product movement data, distributors will gain more visibility into contractor product usage, and distributors will adopt automatic product identification technologies.

As of 2006, approximately 26 percent of mid-size manufacturers’ order streams were automated. This number is expected to increase to 55 percent by 2012. In 2006, 40 percent of distributors didn’t share point-of-sale data with their suppliers and those who did, shared only with a select few. By 2012, almost 80 percent expect to be sharing this data with almost double the amount of suppliers.

Distributors increase their supply chain visibility with the adoption of new supply chain technologies. The use of vendor managed inventory (VMI), warehouse management systems (WMS), bar codes, and radio frequency identification (RFID) are predicted to increase significantly in the next five years. Currently the adoption rate is slow, especially among smaller distributors, but by 2012 the numbers are expected to almost double, according to the survey.

NEW PROFIT MODELS

New profit model trends will deviate from the customary profit concepts. According to Fein, distributors’ gross margins conventionally come from manufacturers setting prices or providing buy-side margins that allow a distributor buy-side discounts. These discounts help a distributor to earn a profit margin. Gross margins also come from customers paying a sell-side markup above the cost of the products, and support services are included as a value-added commodity.

These current profit models can greatly limit a distributor’s ability to increase profit margins and remain successful. As tides change, distributors are preparing for the 91 percent of manufacturers surveyed that reported they expect to stop doing business with highly unprofitable distributors by 2012.

According to the survey, two new general profit models will be-come extremely important within the next five years. With the functional compensation model, manufacturers/suppliers provide a basic list of discounts available on a regular basis. They will also supply a list of additional discounts that distributors can take advantage of by performing specific tasks such as paying promptly, penetrating a new market, or maintaining a certain level of inventory.

With the fee-for-service model, “the manufacturer/supplier separates product costs from distribution costs by paying directly for the activities performed by a wholesaler-distributor.”

Fein cited the Gustave A. Larson Co. as an example of a distributor providing successful fee-based services. This HVAC distributor offers a crane lift service for commercial rooftops, compressors, and pipe.

This trend will change the role of the distributor from reliable goods provider to supplier of products with related services.

CONNECTED CUSTOMERS

Warehousing and inventory technology aren’t the only advances that will affect distributors and the way they do business in the supply chain. There has been an explosion of Internet usage and applications that are slowly causing customer interactions to shift online.

Even though, according to the survey, only 3 percent of contractors reviewed their purchase history online in 2006 as compared to the 12 percent of retail stores and dealers who performed this self-service activity, the percentages are expected to increase to 29 and 44 percent, respectively, by 2012.

This increased adoption of self-service activities also includes auto-generated e-mails and online ordering. As technology adoption slowly advances, distributors will find themselves hearing about and using things such as instant messaging (IM), online workspaces, live chats, online trade shows, and more.

Customer interactions will also change due to the Internet and technology explosions. With the ability to do more presale information gathering, distributors should expect customers to request an increasing amount of price matches. They will also need to guard against the possibility of getting bypassed due to online, direct from the manufacturer ordering capabilities.

Fein also cautioned distributors to keep an eye on the unpredictable effects the recent elevated acquisition activity will have on the supply chain. He also warned about the changing workforce that is experiencing aging, slower growth, shifting composition, and increased diversity.

For more information, visit www.pembrokeconsulting.com. To purchase Facing the Forces of Change®: Lead the Way In The Supply Chain, visit www.naw.org.

Publication date: 10/01/2007