April 2, 2008 - Distribution Channel Commentary (DCC) # 104
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1. WARM-UP QUOTES
2. DOWNTURN DO’s AND DON’Ts: Al Bates’ New Book
& “Break from the Pack”
3. “THE ILLUSIONS OF ENTREPRENEURSHIP” (TRADE
ASSOC. READING)
4. PRIVATE
LABEL GOODS NEWS/UPDATE
WARM-UP QUOTES
“If the American people ever allow the banks to
control the issuance of their currency, first by inflation, and then by
deflation, the banks and corporations that will grow up around them will
deprive the people of all property, until their children wake up homeless on
the continent their fathers conquered. The issuing power of money should be
taken from banks and restored to Congress and the people to whom it belongs. I
sincerely believe the banking institutions having the issuing power of money,
are more dangerous to liberty than standing armies." ~ Thomas
Jefferson
“By a continuing process of inflation, governments can confiscate,
secretly and unobserved, an important part of the wealth of their citizens...
There is no subtler, no surer means of overturning the existing basis of
society than to debauch the currency. The process engages all the hidden forces
of economic law on the side of destruction, and does it in a manner which not
one man in a million is able to diagnose.“
~ John
Maynard Keynes
“The blue pill will leave us as we are, in a life
consisting of habit, of things we believe we know. We are comfortable, we do
not need truth to live….Remember, all I'm offering is the truth. Nothing
more….You have to understand that many people are not ready to be unplugged,
and many of them are so inured, so hopelessly dependent on the system that they
will fight to protect it." ~ Morpheus’ offer of the blue and
red pills to Neo in “The Matrix” (I)
“When they claim that the current credit cycle
liquidity problems can be corrected with a little fiscal stimulus and cheap
money to jumpstart the ailing economy. It is not liquidity that is preventing
the money from flowing; it’s insolvency!.... Why is America looking so insolvent? Well,
for one reason, the easy money policies of the past have resulted in at least
three trillion of really dodgy loans issued for mortgages, automobiles, home
equity lines of credit (HELOC), and credit cards (+ covenant-lite-LBO & Muni
debt).” ~ Richard
Benson (Benson’s Economic and
Market Trends Report: 2/8/08)
"The only true
voyage of discovery is not to go to new places, but to have other eyes." ~ Marcel Proust
DOWNTURN
DO’s AND DON’Ts
The
“surprising to the downside” economic news continues unabated – two recent
reports to consider: 1) Goldman, Sachs analysts announced (3-31) that $120B of
an estimated $460B of illiquid, debt-instrument derivatives and loans have been
written off by “leveraged money lenders” and a grand total of $1.2T must be
written of by the end of 2008 by all holders. The $1.2T seems in line with the
title of a newly released book, “The Trillion Dollar Meltdown”; here’s a link
to a 3-30 USA Today review: http://www.usatoday.com/money/books/reviews/2008-03-30-trillion-dollar-meltdown_N.htm?csp=34.
The grand total for estimated write-offs continues to climb.
2) Was February’s
up-tick in homes sold “a bottom for the housing market”? For more perspective
on housing, read John Mauldin’s weekly commentary entitled: “Where is the
bottom in Housing?” (and the two slide show sources that he draws upon and
provides links to) at this link: http://www.safehaven.com/article-9817.htm. All three sources have done the rigorous
pipeline model analysis work instead of taking the blue pill and hoping for the
best.
Their
cumulative conclusions:
·
It will be a buyer’s market for 3-4 years (until
the supply of homes gets back to 6 months instead of the current 10 months to
which foreclosures continue to add).
·
Median resale prices will bottom in 2010 (one of
the linked reports gives forecasted bottoms for each of the top 20 metro
marketplaces).
·
Housing will go from “the greatest investment” in
2006 to “a bad one” in 2009.
·
“In summary, today we are only seeing the tip of
the iceberg….We believe it will get so bad that large-scale federal government
intervention is likely.” (But, I can’t foresee a new RTC-type entity functioning
until well into 2009 which will debase the dollar - inflating away saved wealth
spending power - and leave a bigger bill for our heirs.)
Highlighting
this type of rigorously done and negative news is not a popular strategy for me
to offer readers, but if our objective is to grow wealth for our corporate
stakeholders, then we need to align ourselves with the objective trends, change
accordingly and make lemonade. The US economy, on balance, will, IMHO,
muddle through this tough patch, so it is time to start figuring out business
strategies and tactics that will get us out of “commodity hell”; usually at the
expense of the weak, over-leveraged and least adaptable competitors. Two good
sources for ideas are:
1.
Al Bate’s new book entitled: “Profit Myths in Wholesale
Distribution” (http://www.naw.org/publications/pubs_item_view.php?pubs_itemid=71)
2.
Oren Harari’s latest book: “Break From the Pack” (http://www.amazon.com/Break-Pack-Compete-Copycat-Economy/dp/0131888633/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1206974621&sr=8-1)
Al has
been doing distribution trade association financial comparison reports since
the mid ‘80s; he currently crunches the numbers and interprets the results for
40 distribution association studies (www.profitplanninggroup.com). He
also happens to be a keen analyst and a wry, pithy writer. Below are some highlight conclusions from Al’s latest book which
offers the big, longer-term view:
·
The average pre-tax return on total assets (ROTA) for all distributors – across 40 different
distribution channels – is 7% which has dropped during recessions to 6% and
climbed as high as 9% at economic cycle peaks. (DBM comment: investing in muni
bonds would do as well or better than the average 7% on an after-tax basis with
less risk, headaches and more free time! Sounds like too many competitors are
selling the same thing, the same way for price: “stuck in the middle of the
pack”; “commodity hell”?)
·
Good performers in all channels made 10-13%; great
performers 15-23%; and they are the same companies year after year. (DBM
comment: These guys aren’t just “high-performance” operators, but have real
positive leverage on borrowed funds from suppliers and banks. They make 4-6
times the after-tax return on equity that the average firms achieve.)
·
For calendar year 2005 the average (ROTA) for Al’s 40 different association reports ranged
from a low of 3.2% to a high of 17.1%.
·
The high ROTA channels had 1 or more of the
following characteristics: barriers to entry (e.g. drug wholesalers with: state
and federal regulations; huge inventory investment/warehouse; and big automated
warehouse ante); low % of commodity sales volume (valuable, exclusive or
selective supplier franchises available); high sales growth (or inflation
growth in the case of copper and steel in 2005 suggesting lengthening lead
times and tightness of supply); mid-to-high need for local expertise.
·
The ROTA numbers
and ranges have not changed much over 20 years in spite of all of the
investments in technology and other progressive changes. (Sounds like everyone
is doing the same incremental changes to remain in the pack; how can an average
performer break out?)
·
If firms want to improve their ROTA, then no change
is as sensitive as raising prices by 1% or reducing purchase costs by 1%,
assuming that all other variables stay the same (which they do in the real
world; still “sensitivity analysis” will deliver key insights if you dig
beneath the financial calculations.)
·
Reducing days outstanding on receivables or
investment in inventory has a surprisingly low impact on ROTA.
Taking write-offs on receivables and inventory is, of course, another story and
much more ROTA sensitive.
·
In tough times, don’t cut the price by 5%, because
it will require a 20-30% increase in sales volume to maintain the same ROTA depending upon your assumptions for how much of the
firm’s expenses and assets will rise with sales volume increase. (Most costs
are far more variable sooner than most distributors think; the optimistic
assumptions are that: all costs are fixed and inventory will just turn faster
with more sales.)
·
Unlike one dollar of increased sales volume, a dollar
of expense reduction flows 100% to the operating profit line. 60% of the
average distributor’s expenses are in payroll; all other expenses are many and not
very big, so 1% improvement in a small number does not budge the ROTA. Reducing payroll across the board is not, however,
very strategic. It will affect everyone’s morale and drive away the very best
contributors who are the only ones that can lead value innovation. Better to
weed the worst to feed some to the best and some to the bottom line.
To take
Al’s conclusions to a deeper level, readers are welcome to check out my
writings on “sensitivity analysis” for distributors at this link: http://www.merrifield.com/books/Chapter%202.pdf
In 22
pages, you will be turned on to additional financial guidelines like:
·
Selling 1% higher has much more flow-through to the
bottom line than 1% more in sales, although both tactics increase sales by 1%.
·
To sell higher, don’t raise all customers’ prices
the same, but rather: segment customers by size; growth potential; and current
profitability ranked from extreme winners to losers and apply a range of price
and terms change tactics. Rank all of the tactics by their potential impact and
ease of implementation, then start implementing down the list. (Scott Benfield has
created customized ranking lists for many distributors – by branch – providing
them with opportunities that have yielded 5 to 30+ times the return on their
investment in his work. http://www.benfieldconsulting.com)
·
Before you “sell higher”, however, you might want
to define, measure, dramatically improve, sell and then get paid for and
leverage basic “service brilliance. (The “how to’s are in 14 video modules –
out of 53 – in my “High Performance Distribution Ideas For All” DVD educational
curriculum. It is value-priced and guaranteed at www.merrifield.com. Several thousand
distributors have broken out of commodity hell to higher ROTAs using this
educational product.)
·
Don’t just “sell more” break the opportunities into
four distinct patterns which range in difficulty from “X” to 15X. They are
more: 1) old products to old customers
in a better systematic way that builds average order size to yield “X”; 2) new
products to old customers (yields .33X); 3) old products to new customers
(.10X); and finally 4) new products to new customers which will yield .067X.
·
Etc.
If
reading financial management stuff is a bit weary, then one of the most
entertaining and practically-useful in a strategic-way, business book reads
that I have had in a long time is Oren Harari’s “Break From the Pack”. It
was delightful serendipity that I happened to be on the same
distributor-convention program with Oren in February. Even though I, along with
all of the other attendees, got an autographed copy of Oren’s book, I don’t
think that I would have opened it long enough to get hooked if I hadn’t had a
couple of days to hang out with him including playing some tennis; he’s an
excellent player, btw, and at 6’6” his serve is a bear. So check out the rave
reviews for his book at Amazon and invest.
For now,
here are some of my summary takes on Oren’s “ten compulsions guaranteed to keep
you mired in the pack.”
1.
Cut Costs. Without a good strategy of
where you are changing this will cut both fat and muscle, especially across the
board reductions which will turn off and then lose your best employees while
the weakest continue to stay. (DBM: if you lay off the bottom 10% of a pool of
employees and reinvest some of the savings into the best 10%, you will at least
get better at what you are doing. But, this type of weeding to feed is still
not better focused by a fresh, new, more effective strategic vision.)
2.
Cut Prices. This concedes defeat. It puts
zero value on the value of the service and people that envelope the commodities
that you may be selling. It also starts a downward spiral of competitors
matching and customers waiting for the reverse auction between competitors to
continue. (Al Bates’ work also suggests that you need about 25% more sales
volume to break even on a 5% price cut which will be hard to come by in a
shrinking market. When offered “last look to meet the price” by solid,
profitable customers with a growth future, offer to do even better than a
simple price cut savings by offering a “team audit” to see how your firm can
sell the same and more stuff to and through the customer at a dramatically
lower “total procurement cost”.)
3.
Fine Tune Your Offerings.
Competitors will knock those off, because they are easy. How likely is it that
the customers will even notice, care and pay more for them anyway? It’s a low
risk, we-all-understand-how-we-are improving on the past way to go, but it is
actually more risky than innovating with the EMBER model in mind. E=
does it make us Extraordinary? M= does it Matter to the right, best customers in the right best niche for us?
B= does it Break new ground? E=does
it encourage Evolvement (is it a
platform or vector that we can continue to build on)? R= is it Real (can we
demo this quickly, because it exists in other industries and partners exist to
help us, or is this a bit of a fantastic, first-ever-in-the-world reach)?
4.
Concentrate on Boosting Marketing and Sales. This
has pitfalls like: a) trying to sell even more (new) products to (new)
customers instead of selling more old products to old/best/growing customers
with more in-depth team, systems, selling focus; b) trying harder across the
board instead of trying smarter where we could do some EMBER stuff; c) looking
for a magic bullet (like Dotcom companies buying super bowl ads) or putting
lipstick on a pig (why sell harder if what we are offering is not a good, best
fit for many existing, marginal or potential accounts). The most successful,
organic growth companies generally have the lowest sales and marketing budgets
because their value proposition is so unique and well-targeted at the limited,
right, best customers they not only retain their customers, but those customers
sell their similar friends via word of mouth.
5.
Get Bigger. The assumption behind most
industry consolidation deals has been - “with scale will come greater
economies”- when statistically this is overwhelming not true. Consolidating the
past is not the same as growing to bigness organically, because of great core
value offerings. Besides, 80% of the S&P stock valuations come from “intangible
value” not book/tangible asset value. Don’t acquire empty sales volume and tangible
assets; figure out how to create or acquire the most valuable intangible
assets.
6.
Centralize and Control. Nothing
like some good old fashion autocracy to squeeze out inefficiencies. This
presumes that front-line people: don’t know what they are doing; spend the
company’s money inefficiently; can’t make simple operational expense decisions;
but, then how can we expect them to try harder and smarter to create new value
propositions for our customers to get us out of selling commodities for less?
Empowering the troops is good, just run all of the decisions by the bean
counters at HQ.
7.
Ask Customers What They Want. This
can work if we avoid the broad, superficial surveys that give us all of the
“fine tuning” requests. Customers aren’t very good at articulating what their
deep, latent needs are or guessing what new value propositions we might provide
for them. To find new value gold, we have to staple ourselves to both our product
and paper flows that go through our customers’ businesses and ask all of their
employees the questions of an “inter-business process re-engineer” (http://www.merrifield.com/exhibits/processx.asp)
while observing and listening with the eyes and ears of an anthropologist who
has no preconceived notions. http://www.mpdailyfix.com/2006/12/cultural_anthropology_in_marke.html
8.
Best Practices Fads. Six
Sigma, ISO 9000+, etc. are good disciplines, but they can’t improve and refocus
mediocre, existing strategy which is a prerequisite for sustainable results and
higher stakeholder morale.
9.
Get (government) Protection. This
happens in those industries in which lawyers and lobbyists can work to try to
reduce competition or increase industry subsidies. This type of rescue keeps
innovation from happening until the industry business model collapses in the
long run.
10.
Get Busy. When times are tough, start
working earlier, longer and harder. This is unfortunately unfocused energy and
not laser energy going into EMBER initiatives, and the pace is not sustainable,
especially if there is no compelling value vision that everyone can believe in.
Beyond
deer-in-the-headlight compulsions that all human managers resort to in
downturns, Oren offers lots of guidelines around a central model for how each
company can find its own best pathways out of the bubble on conventional industry-think.
And, if the two books in this topic don’t interest you, check out the next one.
“THE
ILLUSIONS OF ENTREPRENEURSHIP” (by Scott Shane). Management of trade associations for small,
fragmented industries – wholesale, retail, contractors, niche manufacturers,
etc.- and the members who volunteer for all of the associations’ committees are
going to hate the objective-data-based conclusions and negative-small-business-America
public policy recommendations that Shane offers in this book. He really slams small
business America.
But, the book now has 28 reviews at Amazon of which 27 have five stars (and I’d
have to give him at least 4), so we better know what the enemy is advocating
from a public policy viewpoint. http://www.amazon.com/review/product/0300113315/ref=pd_bbs_sr_1_cm_cr_acr_img?%5Fencoding=UTF8&showViewpoints=1.
If we
read between the lines of this important research, we will also find some ideas
for how:
·
Wholesalers that sell small business segments can
effectively rethink their marketing and customer education efforts.
·
How trade associations should rethink their
educational offerings.
·
And, what anyone you know who wants to be an
entrepreneur should read and know before they do a start-up. (Parents of
college kids: the fastest growing segment of college studies is
“Entrepreneurship” which is ironically being taught by academics with PhD’s, most
of whom have never had a professional job in the private sector, let alone been
involved in a start-up.)
Here are
some of my outtakes from the book with a sprinkle of comments:
1.
It is well organized around FAQ-type chapter titles
–“Who becomes an entrepreneur?”- in which Shane does a thorough job of
summarizing all of the (academic) research studies results on the chapter question
concluding with a succinct summary of “Busted Myths and Key Realities” of which
he has 67 cumulative ones in the book.
2.
By averaging hi-tech, professional start-ups with the
ocean of self-employed American ones, Shane is able to average-down to these
kinds of unflattering generalizations: “the typical entrepreneur in the US is a
married, white man who dropped out of college. His company is a low tech endeavor
operated as a sole proprietorship costing about $25,000 from his personal
savings.”….he earns less money and benefits and works more hours than if he
worked for someone else in the same industry, and he isn’t happy about it…the
New companies – those that are one or two years old – employ only 1% of the
people in this country and account for only 6-7% of the net new jobs created
every year (and not good paying ones)…many entrepreneurs start businesses,
because they are overoptimistic about their chances of success…..the US is way
down the charts for most every startup metric you can think of…
3.
Here are quotes on his public policy conclusions:
·
“Our public policies toward entrepreneurship work;
they increase the number of start-ups.
·
This is lousy policy because we have no evidence
that the new firm formation causes economic growth.
·
Investing a dollar or an hour of time in the
creation of an average business is a worse use of resources than investing in
the same resources in the expansion of an average existing business.
·
The jobs in start-ups pay less, offer fewer
benefits, and are more likely to disappear over time than jobs in existing
businesses.”
4.
At the other end of the start-up spectrum, he does
point out that since 1970 venture capitalists (VCs) have funded on average 820
start-ups per year out of 2MM total. By 2003, companies that had been VC funded
employed 10mm people (9.4% of the private sector jobs in the US); had $1.8T
in sales; and disproportionate amounts of high paying jobs and public stock
market value. In short, almost all of the value generated by start-up comes
from a handful of firms.
IMHO, what’s missing from his research,
observations and conclusions?
1.
He looks narrowly at only economic data and doesn’t
offer the wider perspectives of how self-employed America fits into the broader
business ecosystem or social fabric of any democratic, capitalistic society.
Lots of people start businesses, because they can’t get hired or keep a “better
job” with some other firm in their industry. From a social stability viewpoint,
it does give them literally occupational therapy as well as an MBA from the
school of hard knocks; probably a better education at less cost to society than
what they would learn at a community college. The fact that they do get some
business suggests that they are filling a need better – in the minds of their
customers – than the other more established businesses in
their competitive game. In Europe, there are countries in which trades, retail
groups, etc. have gotten legislation protection to raise the barriers to entry
for new competitors resulting in higher chronic unemployment and less
user-friendly services and hours for the customers of the protected businesses.
2.
He misses the entire thinking behind “gazelles” which
are the 3-4% of entrepreneurs that start out as Mom & Pop (M/Ps) mice, but
actually “grow” businesses dramatically. M/Ps that just “do” business might
create the one-of-a-kind, funky retail spot, but the gazelles grow,
by-definition at least 20% per year compounded for four or more years (David
Birch study). They account for 75% of all of the job growth and a huge
percentage of the non-capital intensive innovation. They are what “Inc.
Magazine” is all about. (Wal-Mart, Starbucks and most retail franchise systems
started out with one retail location run by a monomaniac on a mission. For more
on “what’s a gazelle” see http://www.synchronist.com/PDF/WhatsAGazelle.PDF
and http://www.inc.com/magazine/20010515/22613.html).
3.
How can we then leverage off of Birch’s conclusions
that 3-4% of entrepreneurs are perpetual innovators that grow gazelle
businesses?
Moribund towns can get into “economic gardening”
(see this link about how Littleton, Colorado does it: http://www.littletongov.org/bia/economicgardening/default.asp)
Wholesalers that sell segments of small
business can apply a bell-shape curve to customers’ ability to and desire for
growth by:
a)
Super-team focusing on the gazelles (3-4%), because
if you marry them, they will grow you. They are the only customers who will
also understand and be able to co-create next-level, inter-business supply
solutions with a gazelle wholesaler.
b)
The next 10% of the curve, which is a blend of
former gazelles that are good-sized, but being maintained/milked by next
generation managers and wannabe gazelles who are good copiers, but not good
innovators? These businesses can benefit from simple: how-to recipes for
running their businesses better; software-as-a-service tools; and youtube
type, video training clips delivered via
the internet for JIT learning moment needs (I’m willing to help with
this type of training for any would be sponsoring organizations!).
c)
And, the remaining 85% of the M/Ps that just “do’
business? As long as you can extend them JIT internet-delivered youtube type of
education and other semi-franchise type business aides for little to no
expense, then they can self-select themselves for getting a bit more energetic
and managerially effective. The key guideline is to take care of them at
prices and terms that allow the company to make a profit, which – as human
costs rise without service productivity offsets – precludes traditional
full-services at wholesale, list prices. The total activity-cost for
full-service (including outside sales coverage) exceeds the margin dollars. These
accounts must be increasingly sold on a “wholetail” basis meaning that they
drive themselves to light commercial locations to help themselves to goods, pay
with cash or credit card and get prices between traditional wholesale and
retail. Many contractors, for example, have shifted to this mix of service,
price and terms when they buy from Home Depot, Grainger, Fastenal and MSC
Industrial. I’m working on a wholetail start-up right now in the janitorial
supply channel that has radically outsourced business activities to provide
both breakthrough operational cost reductions and service value propositions.
(Want a tour of the facility starting around June 1st? Let me know.)
Trade associations that represent small business
industries and/or have members that sell to small business can use the same
three gazelle-centric segments for small business America and the same
educational guidelines.
In summary, Shane’s right: let’s not get all mythical
about “entrepreneurship”; would be entrepreneurs should read the book to
clarify their thinking and intent. But, I would hope that public policy would
still aim to make it as easy as possible for new M/P’s that just “do” business
to start-up, because they do stabilize neighborhoods and society while offering
the best practical, real-world economic education value. I would hope that
trade associations, buying groups and wholesalers would all adopt
GAZELLE-CENTRIC marketing and educational strategies that still allow the
bottom 85% of the M/Ps to feed on affordable, business enlightenment on a
self-selected basis. And, finally, government doesn’t have to get into the
VC business. There is already more investment money parked with VCs and
investment angels of all stripes than they are gazelle entrepreneurs to invest
in.
PRIVATE
LABEL GOODS NEWS/UPDATE
During
economic downturns, I would expect that Wal-Mart would sell more private label
goods at lower prices, but it isn’t the case with soft drinks. WMT announced
recently that they will be reducing shelf space and vending machines for Sam’s
Cola , etc., to focus on marketing name-brand products in their stores. This
has been a big hit to Cott, “the largest retailer-brand soft drink provider,
which has gotten 38% of its sales from WMT.
I can’t
determine if WMT’s decision to sell more name-brand goods applies to only soft
drinks or perhaps other categories in which it may have reached a saturation
point for private label sales growth. Brand power is especially strong with
drinks of all kinds. It does make me wonder, though, about what is the
finite share of private label penetration in industrial/commercial product
channels? And, how quickly can private label sellers like Cott and
importing wholesalers get hammered when off-shore pricing turns against them
because of the weakening dollar, rising energy costs, etc. There can’t be
an easy answer to the question, because there are many dynamic and
inter-related variables that will govern that shifting equilibrium point.
Supply
Chain Digest (3-27-2008) had a recent post entitled: “China ain’t so cheap” for
several reasons:
a.
Wages have risen 15% in the past year in coastal
manufacturing areas, so some companies are moving production into the interior.
b.
Energy/transportation costs are rising with the
price of oil.
c.
China has reduced exporter tax breaks on
manufacturing of goods that are either or both low value-added or polluting.
d.
The yuan has increased against the dollar by 16% in
the past 18 months
Perhaps the easy arbitrage play of buying
clone products for a lot less in Asia to undercut American brands in the US is
over. If private label goods prices are now going up faster than the
domestic brands and/or the margins for the (re)sellers are being squeezed more
on private labels, then private label sales may have peaked in many instances.
Will this in turn convince a lot of independent distribution channel players to
get back to rethinking how they can get a cost/value advantage by re-designing
the supply channel? Structural supply-chain infrastructure and IT solutions is
still, after all, WMT’s core advantage regardless of what mix of brand-name and
private-label goods they sell.
That’s all for this edition! Let me know if you need any
help “breaking from the pack”.
Bruce
bruce@merrifield.com
