Integrated supply in the new millennium
To make sure integrated supply works in the future, integrators and manufacturers must shore up lagging customer service
By Jeff Baden -- Industrial Distribution, 1/1/2000
As we enter the new millennium, one of the fastest growing areas of distribution will continue to be integrated supply. In fact, the integrated supply market is growing at over 30 percent per year, with most of the growth coming from traditional industrial channels of distribution.The bad news for independent industrial distributors is that integrated suppliers have seized a piece of their business -- often in the form of long-term contracts. Integrated supply enables end users to significantly decrease their total cost of procuring, holding in inventory, and using MRO. However, the good news is that although integrated suppliers pose a serious threat to distributors' traditional sales and inventory support functions, they have a difficult time matching traditional distributors' product and technical support capabilities.
New market research assembled by Frank Lynn & Associates, Inc. demonstrates that integrated suppliers are not meeting customer expectations for product support. In fact, most integrated suppliers don't even consider product support services a core part of their business. In our survey, over 50 percent of end users served by integrated suppliers that do offer some levels of support indicated dissatisfaction with the services they receive. And not surprisingly, pure integrators -- those that provide no technical or product support -- left 67 percent of end users unsatisfied.
Customers aren't the only ones who know integrators aren't filling this void in the market; manufacturers are very aware of the problem. They are well aware that distributors are important in addressing segments of the industrial marketplace, and have technical and product support capabilities that integrated suppliers cannot provide. Studies with manufacturers in a variety of MRO product categories have shown that it is possible to create a strategy that takes this realization into consideration, and also:
- Limits the fallout of selling to integrated suppliers
- Generates a competitive advantage in the marketplace
- Prevents a wholesale collapse of the manufacturer's existing channels
This strategy requires distributors to redefine their economic value-add position in light of marketplace changes. Long-term business success is dependent on the willingness of industrial distributors to move away from their traditional inventory and transaction functions and replace them with fee-based product support functions. This may require manufacturers to take the lead in developing these service packages and offer them to their distributors in a franchise-like or licensing arrangement in order to ensure that the services are delivered consistently across all of the industrial marketplace.
Today, manufacturers are already implementing several changes that will affect the functions distributors perform, like using multiple channels of distribution to serve different buying needs of end users; paying distributors fees for providing product support at accounts operating under integrated supply contracts; and, experimenting with hybrid channel marketing systems, in which different organizations simultaneously perform specialized marketing functions. These components are welded into an integrated system that appears seamless to the end user.
Despite some distributors' fears, manufacturers are not out to eliminate their distributors. However, it is also evident that manufacturers need distributors to answer some key questions, such as:
- Will distributors invest in activity based costing studies to identify their economic costs for different product groups and different sizes and segments of their customer base?
- Will distributors be willing to share this cost data and information with manufacturers to better manage the economics of the manufacturer's channel marketing system?
- Will distributors be willing to provide fee-based presale and postsale technical support to end-user accounts that are operating under integrated supply contracts even though they do not make the sale and supply these products?
- Are distributors willing to shift the primary focus of their business from traditional inventory support functions to product support functions as more efficient and effective logistics channels take over more of the fulfillment and inventory management functions?
- Will distributors be willing to increase revenue from end-user support services to offset the loss of their inventory support functions if manufacturers take the lead in developing these new service packages?
Distributors considering making the shift from a sales function to a sales support role should be aware of compensation implications. In order for dual roles for integrated suppliers and distributors to work economically, manufacturers will have to change compensation structures to reward each party for the discreet functions they perform. Under this model, manufacturers will compensate distributors for performing sales support functions such as training, design engineering, product specification, and troubleshooting. In this marketing system, integrated suppliers will be compensated based on transactions or sales. Determining functional compensation for channel members will require manufacturers to identify the key value-added services these channels perform, and gauge an appropriate cost-to-value ratio. This is the reason manufacturers need answers to the questions cited above.
Traditional distributors have an average gross margin of 20 percent, with operating expenses totaling 19 percent, leaving a one percent operating profit. On average, eight out of 20 points of the distributor's gross profit can be accounted for by technical and sales support value. Manufacturers need to hone in on the figures for their particular product and channel. Simply put, integrated suppliers' low cost structures simply do not allow for performing many of the key value-add functions (see chart: Technical and Sales Support).
Functional discount structures would allow a local authorized distributor that "lost the business" to an integrated supplier to capture a revenue stream by performing technical support. Moreover, this local distributor can carry less inventory, lower its accounts receivables, handle fewer transactions, and reduce its costs in other ways. So while revenue may decline, profitability may rise.
Savvy distributors will play on their strengths and adopt business models that generate profit and add value. With the new millennium upon us, things are bound to change faster than anticipated. The time to make this shift in business models is now. That represents good news for distributors, manufacturers and end users alike.
Jeff Baden is a consultant with Frank Lynn & Associates, Inc., in Chicago. He can be reached at (312) 558-4822 or jbaden@franklynn.com.
Integrated supply survey facts
In its 53rd Annual Survey of Distributor Operations, INDUSTRIAL DISTRIBUTION magazine devotes several pages to integrated supply. Among the findings are:
- Seventy-nine percent of distributors who are already involved in integrated supply expect the number of contracts they service to grow over the next three years.
- While the average length of an integrated supply contract can vary, they are usually for more than six months. Ninety-six percent of respondents say their contracts run approximately 18 months.
- Nearly 30 percent of distributors responding to the survey are involved in integrated supply relationships on a second-tier basis.
- Integrated supply contracts are more common among midsize and large distributors. Nearly half of distributors with sales of $20 million or more have integrated supply contracts. The number drops to 16 percent for distributors with sales of $5 million or less.
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