January 22, 2003 Distribution Channel Commentary # 8

 

Greetings:

 

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

 

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The Merrifield Consulting Group, Inc. (www.merrifield.com) is in a transition process of beginning and circulating a weekly commentary service that will be eventually posted on a new-look, new-function web site. Until the web site is upgraded we will email the entire publication. We will try to keep them short, by referring you to documents elsewhere on the net.

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COPIES OF PAST COMMENTARIES, OUR E-BOOKLET AND OTHER REFERENCES

 

This is our eighth edition. If you would like copies of some or all of the first seven, 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 are not yet posted on our existing web site and to which all commentaries make frequent reference. Our references to the EB and other Merrifield documents within our commentaries will stop when we can put all of the information with hotlinks on our new web site.

Until then, This explains what our Reference abbreviations in this and other commentaries mean:

1.       “WS-ART#” = at our web site, under “articles”, the specific article #;

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 and at our WS.      

 

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THIS WEEK’S TOPICS:

 

1.       TOUGH ECONOMIC TIMES PERSIST; HOPE ISN’T A STRATEGY

2.       MANUFACTURERS’ CHANNEL FRUSTRATIONS

3.       “FILL-RATES” AS AN ORGANIZING THEME- DISTRIBUTOR CASE

 

1.       TOUGH ECONOMIC TIMES PERSIST; HOPE ISN’T A STRATEGY

 

With the Iraq war hanging over our heads, we didn’t need to hear the following economic news of the past week all of which “surprised” the expert forecasters:

a.       Consumer confidence plunged

b.       The trade deficit soared in November and December

c.        Industrial manufacturing continued to decline; another 65,000 factory jobs disappeared in Dec.

d.       Plant capacity utilization dropped to 75.5% (don’t look for capital expenditures here anytime soon)

e.       The producer price Index for 2002 was down .4% for the year, the lowest in its 30-year history.

f.        China’s manufacturing exports accelerated off an ever bigger base (This mega-factor will continue to affect most of these other economic data trends. See DCC #1.2) 

g.       The NFIB Small Business Optimism Index fell to its lowest since 10-01

h.       Big companies – GE, Microsoft, IBM, Intel - offered downward guidance with no growth for 6+ months.

i.         A US government budget guy confessed that the deficit will be at least $200B this year and $300B next year before Iraq and stimulus program costs: a doubling of the forecast in 6 months.

j.         But, off budget government spending is exploding too, because total Fed. debt rose by $450B since last July. This real borrowing increase rate + Iraq + a stimulation package = a lot! So what?

k.       The budget deficits for our states that have to be balanced this year are at $85B and climbing. (This includes $24B for California instead of the $36B exaggeration from Gov. Davis. For the real score on this big economic drag go to www.cbpp.org.

 

The list could continue. We could analyze and deplore the causes. We could wish the excesses from the global economy of the late ‘90’s weren’t still there to be worked through (EB#1). We could keep hoping that more money supply, lower interest rates and more borrow-and-spend stimulation on top of our excesses will make the second half recovery, which was forecasted by experts to happen in the last two years, will arrive in the third time’s the charm year of 2003. We could stick to our wishful thinking forecasts for our own businesses, because we are going to try harder in the same old ways. Or, we could realize the business environment has changed and so must our assumptions and practices. For more on this topic, we recommend our free E-booklet via email.

 

2.    MANUFACTURERS’ CHANNEL FRUSTRATIONS

 

Business is tough for most channel end-users; they are under the gun to cut costs and are shopping “price” more often and more aggressively. Responding to this pressure, distributors and manufacturers can try to:

a.       Reduce costs to pass on savings.

b.       Sell a customized, niche product/service solution that lowers total costs fast (in the customer’s mind, not ours) without much change management work on the customer’s part, because they don’t have the resources or patience to co-invest in a 1 + 1 = 3 down the road pitch.

c.        Pursue one or both of the above either alone or together in some coordinated, integrated, synergistic, partnering, win-win way. Did I leave out any adjectives for this perennial convention panel possibility?

 

For taking costs out, the big fantasy for independent distribution channels since the early ‘80’s has been to achieve some Wal-Mart like product-flow efficiencies by harnessing the potential of the two basic building blocks of supply chain management, EDI industry standards and bar code scanning. Factory production people fantasize, for example, about knowing real-time inventory levels and daily outgo numbers for their goods in all distribution warehouses. Both manufacturers and distributors imagine a paperless world in which everything is scanned along the way like UPS and FedEx do.

 

Well there is quite a history of case studies to look at. Wal-Mart named their continuous replenishment system (CRP) “quick response”; other formal channel efforts have acronyms like ECR (grocery), EFR (foodservice), PIDX (petroleum), etc. There is even a new wave of channel efforts that have been built around web-based technology that continue to grind along. Leading edge examples are rosettanet.org (electronics) and covisint.com (auto supply chain). A good case for durable goods (lots of items, lower turns) through independent distribution channels is www.idea-inc.org (electrical).

 

Read the news at these referenced sites. Between the lines, the results have been elusive for most. Only Wal-Mart has gone through all nine stages of progress from 1) EDI + barcode scanning to 9) “collaborative planning forecast replenishment” (CPFR) with great success and they continue to spend millions per year on evolving CPFR. For my summary of the nine steps request the CPFR Model from karen@merrifield.com. For a book that covers the history of continuous replenishment efforts in different channels through year end ’98 check out the first three quarters of my book “Electronic Commerce for Distribution Channels” (www.nawpubs.org, 1999).

 

Who, realistically, has a chance of making CRP efforts work? The up-front costs, complexity and on-going maintenance costs of creating CRP capability between channel partners is so great that it initially is only viable on a cost/benefit basis for the biggest volume, commodity producers and distributors/retailers in the biggest volume channels. Even in those channels, K-Mart failed miserably at trying to imitate Wal-Mart after letting WMT get a 7-year developmental lead. The grocery channel has taken 10 years to get some real traction with the top 10%+ of the retailers while having the additional incentive of being eaten alive by Wal-Mart’s application of QR at their grocery-driven “super-centers.” Some very big, patient distributors (think Grainger, Graybar, Owens & Minor) have gotten some benefits especially when the distributor has huge, regional distribution centers that feed hundreds of local distribution points.

 

For a case story on long-term persistence, read the “news” at www.graybar.com and www.idea-inc.com to notice how Graybar “supports” the industry data warehouse at idea-inc, and keeps opening up regional warehouses. Meanwhile note that idea-inc’s participation numbers gradually keep increasing. Between the lines you might correctly guess that Graybar and a few other distribution giants have been spending big, patient, long-term bucks on automated infrastructure starting with strategic thinking back in the mid-‘90’s.

 

Looking at all of the failures in the CRP movement that started in 1983 with Wal-Mart and the U.S. textile manufacturers, what are the main reasons for failure?

1)      Lack of vision and willingness to try new things on a test-cheaply, ramp up basis. K-Mart and J.C. Penney were invited to participate in the ’83 experiments with the textile manufacturers; only Wal-Mart forged ahead.

2)      Not sharing the costs and benefits from day one. Both partners need to co-develop and agree on detailed flowcharts for what currently is going on in their transactional activity and what could in theory be happening. Then, they have to quantify who has to spend, learn and do what to generate what benefits for each party. The supplier usually has more up front costs while the customer usually gets the lion’s share of the early benefits; both the costs and the benefits have to be shared. There also has to be a development-implementation team with co-captains from each company. These folks have to have the same goals and incentives to play good and bad cop roles on both sides of the fence to break down old ways and create new ones.

3)      Not being patient and persistent enough to solve all of the problems through the nine stages to CRP heaven which is really the starting point for another new world opportunity.   

 

Will big distributors have a killer advantage if they can make CRP work? Not a killer one like Wal-Mart. For retail, consumable commodities to have the lowest every day prices with 99% fill rates on 60,000 items is compelling. Big distribution chains could lock up a few more points of operating profit margin potential to perhaps waste away on dis-economies of local service effectiveness at their branches. At the branch level is there is a lot more that goes into the best one-stop-shop, lowest total procurement cost supply relationship with different segments and sizes of customers. Service metrics like zero errors, on-time performance and delivery and heroic targeted actions and recoveries are more important in wholesale than retail.  

 

WHAT ABOUT NICHE PRODUCTS?

 

Enough on taking cost out! The CRP trend is an on-going book by itself, but it isn’t going to solve the short-term pain or viable, long-term strategies of 90%+ of all manufacturers and distributors in the US. They must, alternatively, make it on value-added propositions and try to “get niche quick.” Just for starters, there are lots of under-sold, viable, niche products that manufacturers can not get distributors to stock and/or continue to sell. Distributors will rebut this by pointing to all of the dead items already in their warehouses that were yesterday’s new product efforts. How should one or both parties address this every-channel problem? Here are some discussion questions and issues:

 

a.       Why have the number of under-sold, niche products continued to rise?

1.        How many of them are un-viable in the sense that their value proposition to the end user doesn’t exceed an un-subsidized price that should really be charged? Subsidies? In most channels, manufacturers, distributors and retailers were making 140 to 200% of their profit dollars on as few as the top 10% of their fast-moving, established often commodity products. The excess profits then subsidized all of the new product launches that never panned out. Discounters then emerged to offer just commodities at every day low prices forcing the full-service players to drop prices on the subsidizing products and raise them on the niche items to the point that often exceeds their value to the end-user.

2.       The cost of selling through channel reps has continued to rise, but their activity/productivity hasn’t kept pace; they don’t drive, wait and pitch any faster than they did 50 years ago. On line, searchable web sites and best industrial catalogs have filled the vacuum to some degree.

3.       The few, successful niche products that do take off get knocked-off and then discounted ever more quickly. The net present value of the eventual profit stream to offset start up costs has dropped making the true hurdle rate for product launches go up.

4.       In mature market spaces, after niche products succeed and become commodities, the micro-niche products face a law of diminishing return. The bigger opportunities in mature product spaces have become not to add more micro-niche solutions, but invent dramatic manufacturing (China) or distribution cost process (Wal-Mart, Dell) breakthroughs.

5.       Can you add more answers or discussion points to the original question above? 

 

b.       If an industry is mature and the number of micro-niche products is excessive, what criteria should both distributors and manufacturers use to determine which of the items in a line are still viable, under-sold niche opportunities?

c.        If distributors count the number of dead items in inventory that were yesterday’s new product promotions, what can they do for their total process of screening new products and then promoting them to increase their success rate as well as terminate the losers faster? How can they rethink this process with the manufacturer(s) to then experiment with changing resource risks (marketing costs and responsibilities), reward benefits and information sharing?

d.       What’s wrong with this business model? Train all distributor sales reps to effectively sell specialty items to all of their customers in the hope that 1 or 2 accounts per territory might become economically viable customers for the niche product(s). More new business on other items might, counter-intuitively, result from a series of great pitches on new products that are interesting to a customer, but not what he needs today. Why would a buyer sometimes respond with a new, but different opportunity than what is being pitched? Would your sales people be looking for these alternative opportunities?

e.       What’s a new way that the factory reps could efficiently find and sell the few big customers and the distributor could then be the low-cost repeat maintenance seller of the item? Has there been enough consolidation in your particular channel amongst manufacturers and distributors to realize that you can’t play each other off against competitive alternative partners? Is there more to be gained by sharing information and working together than the downside risks of a partner going to another player who might not practically-speaking exist any longer? Distributors can you identify the #1 niche manufacturers in their space and re-think how you sell together sharing account information and responsibility? Manufacturers can you identify the most progressive, consolidation winners in your distribution channels and try new business model ideas with them?

f.        How can you generate new niche selling ideas? Distributors try asking your best niche manufacturers for the best practice case studies they have had within their entire national distribution network. Ask other distributors in your town that are in different channels for their best, novel niche marketing case studies. Both manufacturers and distributors study 3M’s niche product marketing methods for both commercial and consumer channels. No other manufacturer that I can think of has sold more commodity and niche products through more channels AND DIRECT more effectively than they have over the years. What are they doing so well?

g.       What will be the eventual, web-based, just-in-time, education-on-demand methods that manufacturers can use to get any new product information to any potential person in a channel? The idea seeds are out there already if you look for them. Amazon gives every publisher from big to small visibility and distribution on millions of books that book wholesalers and retailers can’t afford to stock and sell; on-line searchable directories do work. Everyone has email addresses for potential self-selected alert services. Everyone can watch a 10+ minute video or DVD and take an on line follow up test to win trackable, reward e-points and/or free product samples in exchange for knowing channel reps will be in follow up contact.

Instead of educating the entire channel about a new product through lots of marketing methods at great expense over a few years, why not let those who are intrigued raise their hands tomorrow by responding to an email alert process. This would generate real time, super qualified leads that can direct the channel to sell and stock niche products far more efficiently. (Electronic reward point services are out there; check out, for example, www.emaritz.com. Tell the General Manager, Brian Fitzpatrick, I sent you. Read about Graybar’s use of “epoints” to build contractor loyalty purchasing. Could they build on their customer directory to add niche product alerts with video-test-reward-follow up services to both end-users and sub-groups of their own employees for all manufacturers? For more thought food on this concept request a copy of our PowerPoint slide show on “VEMCOs.”  

 

Enough on niche product selling, but one final offer. If you would like our 30 page handout on Finding and Securing Niches as the total idea starter for this subject area just request that too.

 

Final thoughts on “partnering” with either suppliers or customers in a channel for 1+1= 3 potential. You can’t do next level thinking and innovative things in tough times with people and a company that have no track record of trying new stuff in the past, especially when the economy was more supportive for new stuff. Then, for those companies that have done new stuff in the past, ask them diplomatically how their partners did and if you can talk to them about their win-win view. If the answer is “it isn’t our policy” to tell you who those partners are”, then there probably aren’t any happy past partners. “Trust” is, therefore, a track record of making 1+1=3 happening in the past with partner testimonials.

 

You might also ask why a potentially great partner would want to partner with you. Are you partner-able? Which past partners will provide your win-win testimonials? Company’s that are partner-able had to start out by partnering their employees with a high performance culture which in turn made high performance value happen for customers. Happy, best, progressive customers then decided to partner these few great suppliers, because they were so reliable. The best end-users that choose the best service distributors will then grow those distributors faster than the industry. Which distributors do you think all of the suppliers will want to talk to first about any new living edge, next level, value improving proposition.

 

So, it all goes back to your employee at the receiving-shipping dock. If I ask him how the company was doing? What would he tell me? Would he give me an up-beat “here’s what we are doing and how I’m part of it story”? Or, would he shrug and tell me he doesn’t know what “they” are planning to do? Need a transformational, educational tool to turn all of your stakeholders into commonwealth capitalists? What ever that is supposed to mean. Read Pete’s story below.

 

3.    FILL-RATES” AS AN ORGANIZING THEME; A DISTRIBUTOR CASE STUDY

 

Pete is the CEO of a third generation plumbing supply business with one big hub location and a number of cash-n-carry locations in a 2MM+ metro area city. They go after the small and medium repair market contractors, property managers and do-it-yourself type segments. It’s about a $10MM business with a 7%+ operating profit ratio. They have been very happy and prosperous users of both our video and audio tape products since the early ‘80s. I was visiting with Pete recently about his latest breakthrough results that have resulted from using our “High Performance Distribution Ideas for All” tape. Here is how the interview went:

 

Bruce:  “Pete did this video help you that much? You were so fanatical about using the prequel (Dynamics of Distribution; 1986); was there much incremental gain to be achieved?

 

Pete:  “Bruce, we have had unbelievable results over the past year with your new tape. First of all, it has everything the first one had in it with 4 times more how to stuff to boot. We all forget stuff over time or fool ourselves into thinking that we are still doing the same “service excellence” levels that we were doing in the late ‘80s as a result of your first tape. So, this new one was a great review for the old guys; new religion for the new guys; and all of the new stuff made us realize that we had slacked off on the old stuff and we could take it to new levels we had never thought about.”

 

Bruce: “By example, is there one best idea from the latest video that has served you best? ”

 

Pete:  “FILL RATES!” It’s amazing how we all picked upon that being the cornerstone of basic service excellence. You know your drill about what good is the rest of the service package - zero errors, on time performance, etc. – if we don’t have it right now. And, here is where the repeat stuff from your old tape packaged in new words and more how-to’s really hit us.

 

You know how fill-rates are especially crucial to and instantly comparable with some of our stores that are right next door to some competitors. We have talked in the past about how higher fill-rates with some guarantees has, in some cases, literally liquidated the other guy down the street.

 

Well, I thought that everyone knew all of that and they were killing themselves to do what ever they could to create and maintain the best fill rates with the leanest inventory investment – not so! You should have seen the light bulbs going on over associates heads during our tape sessions. The reaction was – “sure, I knew fill rates were important just like the air I breath”, but I kind of just took it for granted and coasted along.”

 

Bruce:  So, what specifically happened as a result of this conceptual revival?

 

Pete:  “The total team has gotten obsessed with the new how to tips you packed into the latest tape with incredible results. Let’s start with the warehouse guys. They have new personal best streaks going for: same day receiving at the main hub; same night replenishing and pulling for early AM delivery to the stores; cycle count accuracy rates for A items at both the hub and stores has hit and stayed at new highs. They now know how all of these quality inputs improve the effective fill rates and satisfaction for customers as well as boost average order size, reduce split orders and back orders and boost overall employee productivity. We are all on a year-end gainsharing bonus system here and we gave out the biggest bonuses ever for 2002.

 

My buyers have gotten less pennywise in how they buy. They use to try to get truckload quantity pricing and save on freight to a harmful extreme. We actually have some suppliers as well as a few master wholesalers for miscellaneous items from whom we can take more frequent, smaller order quantities with better total economics. We trade off reduced margins, but both our turns and fill-rates improve far more to the good than the “earn” drops. With one vendor, for example, we are averaging about 3 turns per year at a 40% margin, now we are doing low 20’s on margin with 12 turns – more than a double on turn-earn productivity – and fill rates are up about 30%! The buyers priority list has changed from: 1. Price 2. Freight 3. All other concession deals 4. Take backs to clean up inventory 5. Fill rates. Now, fill rates is #1, turn-earn is 2 and the rest are in the same order.

 

Our sales promotions then picked up selling the TPC (total procurement cost) advantages to the customers of our Guaranteed fill rates on one-stop-shop. Get it fast to get more work productivity done on time, etc. We have guaranteed in stock quantities at our stores. We have worked with suppliers on special dating to do special in-stock fill rate promotions for their products. We have given front-liners permission to do creative upscale substitutions for free AND not screw up true demand forecast numbers in the computer like you told us in one of the video modules.

 

Which brings up what our inside and counter guys are doing on lost order demand inputs. We have created these simple little forms that our front-liners use to fill in the customer's name and what they wanted that we didn’t have, not just the one goof ball item that no one in town probably has, but the rest of the milk and eggs list too. Then, if they are an A account (using the segment and serve concepts in the video) we ask them more information about their annual, repeat usage of the goof ball item and ask them if it would be important for us to put in stock. If we do this, we tag it with the customer’s number for future follow up pitches to them if they don’t in fact buy it. We think that this will obviously increase our SKUs and our investment, but it will continue to round out our one-stop shopping for A customers within the defined, targeted niches we go after. Oh, and when we put the new item in, we contact the customer to make a big deal about the fact that it now is here if and when they need it with the rest of their stuff.”

 

Bruce:  So, Pete what is the bottom line for all of this? You mentioned 2002 bonuses, what were the big numbers for this past year?

 

Pete:  “Our year-over-year sales growth was 12% and trust me our metro area was down. Our margin dollars were up 20%, reflecting more growth on out of stock business do to higher promoted fill rates while our bid, drop-ship business, which is maybe 15% of our business, was off by more than half. But, hey, we don’t want it if we can’t make a profit, and these days you can’t most of the time on the bid stuff. Our average transaction size was up 10% because of better fill rates, our gross margin dollars per employee was up 15% to about 125k which is very good for our channel and mix of employees. Our profits were up 25%, and our operating margin ratio was up 1.5 points to 8.5% a new record. My big problem now is what to do with the free cash flow we are throwing off. A good problem to have that we can talk about some other time.”

 

Bruce:  So you recommend the video?

 

Pete:  “It’s the most unique educational value and transformational tool that I have ever seen in my 35 years in the industry. As you know, I have sold a bunch of them already for you to my other distribution channel buddies in my in-town forum and a few of best pals in my buying group.

 

Bruce:  Thanks Pete!  We may be back to you about what’s next after you reach high performance land.

 

More next week.  Regards, Bruce