Leading the way

Adam Fein reveals four trends shaping the industrial supply channel, as identified in the new NAW report “Facing the Forces of Change: Lead the Way in the Supply Chain”

By Adam J. Fein -- Industrial Distribution, 6/1/2007 6:00:00 AM

Anew breed of industrial distributor is emerging. These companies are building deep relationships with customers based on an understanding of the true value created by their services and activities. They are charging customers for new services rather than giving away their value-added services for free and hoping to recoup the costs with product margins. These distributors build clout with suppliers through superior performance rather than just through sheer size or volume.

This conclusion comes from the new “Facing the Forces of Change: Lead the Way in the Supply Chain” report, available from the National Assn. of Wholesaler-Distributors at www.naw.org/ftf07. The companies and examples described in our new report are not larger or luckier than their competitors. Instead, the executives running these companies are doing a better job of positioning their companies in the common external environment faced by all distributors.

The difference between winners and losers in the future will derive from the ability to link a fundamental understanding of external business trends with an awareness of how to profit from the trends, followed by appropriate strategy execution to deliver results. This article summarizes the major trends identified for industrial distributors of MRO and OEM products.

The market environment

Industrial distributors' sales hit $320 billion in 2006, up 9.8 percent compared to the prior year. And 2007 is likely to be another good year for the industry. Manufacturing capacity utilization remains above 80 percent, substantially up from the 20-year low of 72 percent in 2001.

Despite this recent turnaround, domestic manufacturing continues to undergo a dramatic transformation. Manufacturing employment has not rebounded following the unprecedented decline that began in 2000. The period from 1998 to 2004 saw a net loss of 27,000 manufacturing plants (7 percent of the 1998 total) and more than 3 million domestic manufacturing jobs (18 percent of the 1998 total). Some sectors were hit particularly hard. Fabricated metal products, which represents one out of six (17 percent) U.S. plants, lost 4,000 plants and 250,000 workers. Forecasts by the U.S. Bureau of Labor Statistics suggest a much slower rate of job losses in the future.

The long-term loss of a domestic manufacturing base has hit industrial distribution hard. INDUSTRIAL DISTRIBUTION's 60th Annual Survey of Distributor Operations found that four out of 10 industrial distributors have had customer operations move to China within the past two years. The average industrial distributor lost 9.2 percent of sales from no longer being able to sell to those customers.

Surviving manufacturers are using a variety of strategies to remain viable, such as flexible manufacturing systems, shorter production runs, complex value-added assembly, and more intensive use of information technology. The competitive pressures on manufacturing are also leading to a major surge in productivity. Output per hour among employees in durable goods manufacturing has nearly doubled in the past 13 years.

Forces of change

The four major trends in “Facing the Forces of Change: Lead the Way in the Supply Chain” are reaching critical mass in the industrial distribution industry.

Trend 1: Private-label products

The use of private-label strategies by wholesaler-distributors will expand substantially over the next few years. Private-label products—products branded by a wholesaler-distributor—represent a break from the more traditional wholesale distribution approach of reselling manufacturers' branded products. Global sourcing from Asia and South America provides a supply of low-cost manufacturing capacity for distributors looking to offer their own private-label products.

Almost one-half of MRO distributors and nearly two-thirds of OEM and production material distributors offer private-label products. OEM and production materials distributors are also more likely to source products overseas than other distributors.

During our research, executives at MRO and OEM wholesaler-distributors mentioned a diverse set of private-label products, including bright copy paper, carbide round tools, mechanical wedge anchors, molded or extruded shapes, spray foam insulation, and floor care products, to name a few. Products that provide superior performance and are not marketed by national brand manufacturers are particularly successful.

These results point to the new value proposition for intermediaries in industrial markets. As customers shop for the lowest price and highest value provider, products are becoming increasingly commoditized. Distributors have an opportunity to provide alternative products and help customers with sourcing, instead of only providing a sales channel for branded manufacturers.

Trend 2: Demand-driven channels

The term demand-driven refers to the idea that products are pulled down the supply chain to the market based on actual customer demand data. It represents a contrast from the more traditional notion of products in a marketing channel being pushed by manufacturers toward the customer. Manufacturers and distributors will be able to manage their respective inventories better when demand-based information is shared.

Moving from the traditional structure to a demand-driven channel requires innovation at every level of the supply chain. Distributors need to send information electronically to suppliers, while simultaneously accepting a new level of visibility and transparency in their operations. We found that 36 percent of MRO supply wholesaler-distributors and 44 percent of OEM and production material distributors expect to be sharing point-of-sale data with more than 10 suppliers by 2012. The lower figure for MRO supplies reflects the challenges in building true downstream visibility for customers with shorter purchasing horizons.

Other enabling factors for demand-driven channels are present in industrial markets. Almost half of MRO supply distributors use bar-coding, which is the second highest adoption rate of any market studied in our report outside of retail channels.

Trend 3: New profit models

Manufacturers will increase their share of a wholesaler-distributor's profit margin from product distribution, leading to greater use of pay-for-performance channel compensation models by manufacturers. Functional discount programs and fee-for-service agreements are the two most common methods used by suppliers to link a distributor's compensation more closely to outcomes. The shift to manufacturer-led compensation is most pronounced in OEM and production material distribution. Fee-based services related to contract manufacturing on behalf of suppliers has emerged as an established practice for OEM distributors.

On-site inventory management, the most common service offered by MRO distributors, provides an operational version of strategic sourcing aimed at the traditional plant-level buyer of industrial products. One executive at a distributor of industrial MRO supplies said: “I believe that in the next five years, there will be a continuation of vendor reduction by our customers. They will use integrated supply through major integrators and alliances to accomplish their goals. The ultimate goal in this strategy is to outsource the procurement, inventory and order processing of all MRO products.”

Trend 4: Connected customers

The use of technology for sourcing and purchasing will continue to grow in OEM and MRO markets. Online ordering will continue to expand, especially for orders placed directly on a distributor's Web site instead of by phone or fax. While traditional methods still account for more than 80 percent of all orders, industrial distribution executives project dramatic growth in online orders via any method (Web, e-mail, EDI) to represent about 40 percent of their orders.

Online collaboration tools, such as online work spaces and virtual trade shows, will emerge as new ways for industrial distributors to interact with their customers. Adoption of self-service technologies, which has grown significantly in the past three years, will continue, so distributors must allow customers to gain information, place an order and solve simple problems themselves when appropriate. Industrial distributors should also use their Web sites as effective sales lead-generation tools and information resources.

However, the availability of online information does not mean customers will stop buying from distributors, and it does not signal the end of distributors' sales forces. Customers will continue to combine online and offline channels. According to our survey, 45 percent of OEM and production materials customers will go online to get product information by 2012, up from 21 percent in 2006. The figures for MRO supplies customers are slightly lower—13 percent in 2006, growing to 37 percent by 2012.

Walk-in and counter sales will remain a small but crucial portion of MRO distributors' business for customers with urgent repair needs. The high proportion of non-stock (unplanned) MRO purchases and large number of potential MRO suppliers makes it time-consuming to conduct online research, favoring a distribution channel that can consolidate vendors and provide product information. A customer may research and interact online, but then place a call to a sales representative or visit a branch to make a purchase. In contrast, in-person orders placed through an outside sales rep will be somewhat higher for OEM products than MRO products.

Leading the way

Each of the major trends described in our report is designed to pull distributors away from current events so they can consider the more complex issue of fundamental change over time.

The world is changing, and industrial distributors must keep evolving in order to stay relevant in their industry's supply chain. The economic environment provides a favorable context for supply chain leadership by distributors. Take the time to build a fact-based strategy for your company that can take profitable advantage of the trends in the new “Facing the Forces of Change” report. Industrial distribution executives who understand the big picture trends will have the best opportunities to lead the way.