March 12, 2003 - Distribution Channel Commentary
(DCC) # 15
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THIS WEEK’S TOPICS
1. ECONOMIC NEWS ITEMS; STOP HOPING, START INNOVATING
2. SERVICE LESSONS FROM THE DECLINES OF HOME DEPOT AND McDONALDS
3. HOW EXTENSIVE IS REBATE ROT IN DISTRIBUTION CHANNELS?
4. RE-THINK YOUR “CORPORATE UNIVERSITY” TRAINING PROGRAM.
5. TWO SLIDE SHOW OFFERINGS
1. ECONOMIC NEWS ITEMS; STOP HOPING, START INNOVATING
This past
week had a lot of grim economic news with the “Iraq war uncertainty” just being a side
show with no financial strategy behind it. In no particular priority order,
here were a few things that caught my eye:
a.
Economists
were predicting a loss of 10,000 jobs for February in the US, the total came in at 308,000. It
looks like the "soft spot” in our economy that Sir Greenspan has been
talking about for a few months is softer than the experts seem to be able to
see. The job market’s future doesn’t look any better. Want Ads are at
all time lows. The Challenger report for announced layoffs in the months to
come is climbing. Lots of US manufacturers are still investing into China
factory capacity at an accelerating rate that will eventually lead to more jobs
there and fewer here. This would normally be an OK “creative destruction” process,
but this time the scale, scope and speed of what China is doing is overwhelming
our national capacity to create new jobs in spite of best effort new hires by
the government’s Transportation Security Agency and the mortgage origination
industry. And, those who are being laid-off have record levels of debt for
their refi’d homes, plus 0-0-0 auto payments.
b.
It
looks like both housing and autos are finally stalling out which might
end the string of new, world records for consumer debt that US consumers have
just broken again for January. Auto sales fell off a cliff in spite of higher
incentives per car than ever before. For those of you in building supply
channels that feed stuff into home construction and improvement, Sir
Greenie stated this past week (between the lines) that: there is a housing
bubble; it’s not his fault; and watching the bubble movie in reverse isn’t
going to be pretty. For a best interpretation of what Greenspan was really
saying and for a hint of what is to come, go to www.google.com and type in this
article title in quotes: “Analysis: Greenspan’s second bubble.” It was a
March 4th UPI article, so you will have to go to one of the general
sites that pop up and dig down to the date to find it.
c.
The
SEC has asked public companies to give investors more realistic accountings of pension
liability deficits (3-6). The future announcements of earnings being down,
because of pension shortfalls that expand faster than stock markets fall, will
be similar to the ever expanding state deficit announcements we have been
hearing over the past nine months. Of course companies don’t want to make these
earnings hit announcements because it will drive the stock market down which
will increase pension liabilities. 50% of all pension money is still invested in
stocks. Can you see the vicious cycle brewing?
d.
The
stock market is really trying to have a “post-war” rally, but the buying power
for stocks has dried up. Meanwhile, Japan’s market hit a 20-year low 12 years
after the peak of their stock market bubble high. These bear markets can last a
long time if the government tries to pump money supply, lower interest rates
and deficit spend enormously as Japan has done and the US currently is doing.
All of these measures haven’t worked in Japan, and they won’t work in the US
because the bubble damage was done from 1982 to the present and beyond.
Borrowing to spend more and drive debt levels higher isn’t the solution. P.S.:
Europe exchanges are at new 7 year lows with the German exchange off 70% from
its high. This meltdown is a global event.
e.
Finally
when the bombs drop, the petrodollars will go on strike and not be re-cycled
into dollars and dollar-denominated US treasuries. Just for starters, Iran now
wants all contracts denominated and paid for in Euros. How will we finance
current and climbing federal deficits + the battle + the endless nation
building in the Middle East that is to follow? 45% of treasuries are currently
being bought by foreigners who may have noticed that the US dollar has already
dropped 20% against the Euro in the past year. They are going to go on strike
to some degree unless we offer them higher interest rates and assurances that
we won’t keep debasing our currency by pumping up the money supply to keep
short term interest rates in a negative return area. This war doesn’t have a
financial plan that will ultimately be friendly to people around the planet who
have saved, invested and directly or indirectly lent money. Your after-tax,
after inflation negative returns on money market funds in a depreciating
currency should already be telling you this. But, the futures markets for
short-term treasuries is currently forecasting that the Fed will lower interest
rates again, if not this month then in May.
Enough
grim news, the good news is that 90%+ of distributors that are averaging 5% in
pre-tax return on total assets aren’t making the 15%+ ROTA that the top 10%
are; or, the 20%+ of the top 3% (DCC 10.1). If you happen to not be in the top
3% and envy their numbers, then you can choose to stop doing what you have been
doing harder and try some high performance management ideas. Two quick sources
for ideas: our “e-booklet” (a 45 page word document) that we will email
to you upon request; and, our 30-day guaranteed video, “High Performance
Distribution Ideas for All”, a turn-around, revival solution in a box.
2. MORE SERVICE LESSONS FROM HOME DEPOT AND McDONALDS
In our
01-29-03 DCC (#9, topic 1) I discussed the declines of both Home Depot and
McD’s due to obsessing on numbers and growth instead of service quality that
makes growth with profits happen. There has since been more instructive media
coverage on these two case studies.
On
February 26th Home Depot announced historical financial news
results; both its quarterly sales and profits for the quarter ending 01-31
dropped for the first time in history. Sales were off 2% from the same quarter
a year earlier, profits were down 3.4% and same store sales were down 6%. The
day before Lowe’s had announced their quarterly results: sales were up 16%;
profits were up 46%; and same store sales were up 4%. This 10-point
difference in same store sales is one of the best illustrations I have ever
seen in the head-to-head power of service retention economics. Lowe’s has
better fill rates and service, so they don’t drive away as many customers to
Home Depot as HD is driving to Lowe’s. The average for the two firms is –1%
same store growth which is consistent with the slow down in both consumer
spending and housing. This further illustrates that it is possible to grow quite
profitably in a contracting industry at the expense of a competitor that is
focusing on financial strategies like: “buying lower, consolidating suppliers,
and centralized spend management.”
Let’s dig
deeper into the differences of the two in both performance and longer-term
momentum. This was the 7th quarter in a row in which Lowe’s has
beaten Depot in same store sales numbers. In spite of what Home Depot execs
might say, this performance difference was built in and out years ago and won’t
be easy for Depot to change. What’s my assessment beyond the DCC 9.1 comments?
Lowe’s was
started in 1946 and grew impressively as an employee and service centric outfit
with retail stores all over the Carolinas. Home Depot started up in 1978 by
pioneering the big box strategy for the “home improvement” category unlike
traditional specialty stores: hardware, lumber, etc. Depot’s original culture
was great pay, great people, great service which was further fueled by stock
appreciation and promotions for all due to rapid opening of new stores in new
prime locations in new big cities. Once the big cities were saturated with
Depot stores, both the attractive promotions and easy growth slowed down. The
hyper-growth culture and stock appreciation game was over. So, the two founders
diversified their holdings. Bernie retired and Arthur bought the Atlanta
Falcons and went into civic-leader, social stuff in Atlanta. Depot brought in a
cost cutting manufacturing CEO from GE (Nardelli) who centralized buying,
consolidated suppliers and unwittingly hurt local store fill rates and cut
costs further by using more part-time employees in the stores.(More in DCC 9.1)
Lowe’s, in
the meantime, has always been a slow, but steady innovator. They decided in
1989 to stop the small store, rural strategy and to compete with Depot in the
big box game. At first they opened stores in rural areas focusing on items that
were distribution-center friendly (TOOLS!) and using independent distributors
to feed their stores the lumber-type stuff on a just-in-time basis. Depot, on
the other hand, had always tried to maximize store direct purchases and crack
suppliers’ heads on price rather than collaborative, integrated process
improvement like Lowe’s.
Then, in
1994 Lowe’s felt that they had evolved a better big box model than Depots with
brighter lighting, better looking décor and signage and more emphasis on home
decorating that appealed much more to woman than the tough guy, dim-lit format
of Depot. They went into the big cities head to head with Depot stores and
measurably took away a good 20% of a Depot store volume pretty quickly. Then,
it appears from the latest numbers, that they gradually and steadily have won
defectors from Depot with their superior, consistent service edge.
Lowe’s is
about half the total size of Depot today with half the number of stores. They
may be able to keep eating away at Depot and be a growth story and growth
culture for some time. What is Depot going to do? On 2-26 Arthur Blank took
time out from his other life to announce with Nardelli that they plan to:
a.
Balance
an efficiency drive with a commitment to great customer service.(Arthur had a
back to our original service culture basics speech.)
b.
Launch
a $250 MM store remodeling plan (copy and one up Lowe’s? Can they tack on all
of the improvements or do the stores have to be reconstituted?)
c.
Increase
training for workers to improve customer service. (What if part-time folks
aren’t the same raw material and aptitude as life-long, associate recruits;
and, will the 75% of the new store managers and regional VPs who replaced the
original culture crew go along with it? A new generation of political, suck-up,
number-crunching bureaucrats might not change as easily as Nardelli thinks.)
This
entire competitive race reminds me of the one between Wal-Mart versus K-Mart.
They both started up in 1962 when fair trade laws were struck down by the
Supreme Court allowing brand name goods to be discounted. Wal-Mart went after
little towns with a strong employee/service culture using a 2-step, eventual
“quick response” (QR) distribution capability and initially grew much more
slowly than K-Mart. The big K raced to open big boxes in big cities and took
direct store delivery. But, when Wal-Mart eventually went into the big cities
with their QR capability and superior service culture, they killed the Big K.
K-Mart tried to imitate Wal-Mart’s advantages, but they couldn’t tack them on
to what they had organically grown. If you have a cat and it needs to bark, you
can’t modify the cat; you have to get a dog.
How do
these case examples relate to distribution branch location dynamics? Here are a
few thoughts:
1.
Lowe’s
big boxes targeted customers more carefully and effectively than Depot; they
are lady-friendly. What is each distribution branch’s #1 historic niche? How
can each branch re-tune their focus on this niche for better, sustainable
competitive advantage over local competition. (See video modules 3.1-12)
2.
Lowe’s
has always put high, consistent fill-rates ahead of buying lower; the total
economics are superior. Lowe’s replenishment systems, local purchasing and
relations with suppliers all reflect the fill-rate objective. Depot went for
low-price from suppliers to improve margins; a simplistic, financial management
objective. If a branch can maintain a 5%+ fill-rate advantage for a target
niche of customers over the next best service competitor, that edge and time
will contribute heavily to a general, profitable same location growth
differential over competitors that pursue the same niche. (For more on why
fill-rates, as an organizing force, provide superior total profit growth
economics see DCC 8.3 and video modules 4.1 to 4.3).
3.
Home
Depot will not improve their service culture, metrics or results without first
stabilizing, improving and re-culturizing their store managers. Excellent
service is a daily discipline that happens at a (decentralized) location,
because a local, hands-on leader believes in it and is making it happen in a
way that attracts and keeps above average employees. There is a direct
correlation with growth, profits, returns and service quality (one niche at a
time) at a distribution branch location. But, the service quality will rise and
fall, in turn, with the service quality coaching ability and longevity of the
branch manager. Big distribution chains that think that they can break up a
branch manager’s functions into operational/departmental specialists that
report to their regional specialty counter-parts will never win the local
service retention game.
Enough on
this battle of big boxes for now. But, stay tuned, I’m forecasting that Lowe’s,
like Wal-Mart eating away at K-Mart, will continue to win this battle for some
time to come and that there will be more lessons for us to learn as we watch
the contest. My sense is that Home Depot isn’t as damaged and poorly run as
K-Mart was in 1988 and both Lowe’s and Depot will have a tough time weathering
the unwinding of the housing bubble that has peaked here in the US. Now what’s
new with Mickey D’s?
HAMBURGER HELL UPDATE
In DCC
9.1, I discussed how financial management coupled with volume is vanity had
overcome McD’s historical service excellence and bottom-up, innovative and
committed franchisee culture. Business Week’s March 4th issue
followed up with an extensive analysis of what’s wrong at McD’s and what they
should do to fix it. It’s an excellent article worth reading, here is the URL:
http://www.businessweek.com/magazine/content/03_09/b3822085_mz017.htm
The
article confirmed a few of my suspicions. The parent organization stopped
measuring service metrics at locations in the early ‘90’s and allowed
franchisees to cut back on training. McD’s average service metrics have since
gone down while defections to the best fast food service operators have gone
up. And yet, they are planning to open up another 1,230 locations worldwide in
2003 on top of their 30,000 locations. There are times when a company has to
stop growing through managed numbers to right-size, get back to service basics
to start growing organically through service retention to provide better
quality returns for all stakeholders instead of imploding from empire extension
metrics.
Plenty of
distribution chains are guilty of wanting to acquire and expand today when they
need to rank all locations and downsize, upgrade, refocus, revive and
revitalize what they have, not just with locations, but within the customer
portfolio of most locations. Volume is vanity, profit is sanity and positive
cash-flow to pay down debt during deflationary liquidation downturns is most
important of all!
3. HOW EXTENSIVE IS REBATE ROT IN
DISTRIBUTION CHANNELS?
Speaking
of death by managed top-line growth at all costs, I made some observations on
how US Foodservice’s rebate games had torpedoed its parent company’s future
(Ahold of the Netherlands) in my 3-5 DCC (14.2). Do you think that USF’s rebate
rot is only the tip of an iceberg. First, within the foodservice industry,
there has been an adverse stock market reaction, perhaps as much over-reaction
as wisdom. Ahold and Fleming (who partnered with K-mart supercenters) are being
investigated by the SEC, and their stocks dropped by 60% from a few weeks ago.
This past week, however, the stocks of Sysco(syy), the country’s largest
foodservice distributor, and Performance Food Group(pfgc) dropped faster than
the S and P index by 10%+. The suspicion is that just like Enron’s games forced
all of the other power companies to play number enhancing games, this may also
be going on in the food distribution channels where rebates are huge and most
creative.
Are they
guilty? We will see, but in the meantime consider the role that supplier growth
rebates have had in many distribution channels. Most roll-up companies or even
aggressive distributors that have been growing their debt faster than their
sales have been too obsessed with rebates. Think about it. The bigger you are,
the more aggressively you can negotiate next year’s growth rebates with
targeted commodity volume suppliers. One of the suppliers goes for the extra
incentive proposal, because short-term it will help them make their year end
numbers. To maximize rebates, the distributor then switches volume from other
competitive suppliers as well as negotiates to add the volume of any deals from
acquisitions done during the year. Before you know it, 100%+ of year end
profits are coming in the form of rebates or “sheltered income” in channels in
which there are a lot of landed-cost-plus contracts with customers.
The game
escalates as all of the suppliers and distributors start to play to try to keep
up. Then, each year- end gets more wooly because:
1.
The
channel load ups at last year-end to get maximum rebates had to be worked off
in the first quarter of this year, putting this year’s purchases into a big
initial hole. This hole has to be made up by both supplier and distributor with
even bigger and more year-end enticements to load up even more.
2.
Big
distributors can only switch volume from one supplier to another or add new
acquisition volume to last year’s base one time for a good earnings pop. What
should a publicly traded company do to beat last year’s profits that include a
one time pop? Should they do more and bigger deals at a faster rate and
at higher prices with greater premiums (goodwill assets)? This works well as
long as there are enough sellers in a rising market. Acquisition times are
now over. Valuations are heading south with the global bear market, but
sellers want yesterday’s price. Buyers, however, must offer a price that
discounts a deteriorating economy. Even if buyers and sellers could agree on a
price the buyers’ financing is gone. Stock deals don’t work for either side in
a bear market, and deals by debt don’t work when there is already too much debt
on the balance sheet with deflating asset values.
3.
As
volume starts to drop in many channels due to the on-going grind of our global,
synchronized, post-bubble economy, all growth rebates disappear.
The trends
are not friends of the rebate game. So, how about announcing big, new,
supply-chain or cost-reduction infrastructure projects. Sounds like McDonald’s
and Home Depot above. Maybe. But, what is missing is talk about creating a high
performance service culture that will win share profitably from competitors due
to service value on the front end that attracts customers that are defecting or
rebelling from the low-cost, mediocre service guys. Every day low cost, low
price (with highest fill rates!) wins for only one player in retail, Wal-Mart;
everyone else can’t have low-cost, so that they have to have some unique
service proposition. In wholesale games, companies have to create a fair degree
of customized value for the customers on the front end of their business. Even
with low-cost and good fill rates, there is still more service execution
brilliance for customers to attend to.
Here’s a
closing prediction. The rebate rot is pervasive in any distribution channel in
which there have been distributors that grew fast through acquisitions or
price-cutting that grew volume and debt instead of strong reinvested profits.
The fast growers dependent upon growth rebate games have run out of time. Will
they be able to reinvent service excellence by re-thinking their entire
culture? It can’t be added on to what they have. Many companies need to
re-think their service education capabilities.
4. RE-THINK YOUR “CORPORATE UNIVERSITY” TRAINING PROGRAM.
Most
hot-house tomato distribution companies that got caught up in growing their
numbers, especially the public ones for Wall Street, are at different places on
a spectrum between financial management and service retention economics. (For
more on “service retention economics see the PDF file with the 5 annotated
slides discussed in #5 below).
How
could they or any distributor re-educate all of its employees to win at service
retention economics? Most
distributors invest very little in in-house education. How could even the
smallest firms re-think their educational investments, themes and methods? Try
our video, “High Performance Distribution Ideas for All." It’s a
service excellence university curriculum in a box that can play at even the
smallest location for the cost of the personnel time that is invested. It
offers 53 bite-size “ideograms” that in turn serve as a platform and
methodology that any company of any size can adapt further to their needs.
5. SLIDE SHOW OFFERS
We
recently had a manufacturing client who had bought our video inquire about
procuring the 316 power point slides that are used in both the video’s
53 modules and the “Implementation Guide.” It was a first time request, but
their ideas for how they wanted to re-purpose our slides for their distribution
channel made sense to us. So, we offered to send them the slides either via
email (big file!) or on a disc for $150. We would like to extend the same offer
to anyone else who has already purchased our video.
As a
web site experiment, we have posted five slides with annotation notes on our
site in a PDF file.
The slides cover the topic of how to achieve a “strategic service training
breakthrough” in a distribution company. For those of you who check it out, we
would appreciate your comments on whether it has any value and how we might use
the annotated slide medium service in the future.
That’s all
for this week!
Best
regards,
Bruce
Bruce@merrifield.com
