Power struggle
Manufacturers and distributors wrestle with the changes that consolidation brings to the channel
By Susan L Srikonda -- Industrial Distribution, 3/1/1999
If you think of manufacturers and distributors as being locked in a continuous game of tug-of-war over a muddy watering hole, distributors have too often found themselves with mud on their pants.The relationship between manufacturers and distributors has often been marked by misunderstanding and tension, though a recent study by Industrial Distribution, detailed in the September 1998 issue, suggested that the relationship may be improving. In that study, nearly seven of 10 manufacturers reported that their relationships with distributors have improved since 1993, but only half of the distributors surveyed said the relationship has improved.
Traditionally, manufacturers have made decisions on critical issues such as geographic and brand or category exclusivity that have greatly affected both independent distributors and end users.
But these days, consolidation has started to change the balance of power between manufacturers and distributors, and end users are adding their weight to the distribution side. Customers are demanding a lower cost supply chain and better service, which has set off a chain reaction that is forcing manufacturers and distributors to find new approaches to working together. Both sides in this tug-of-war are finding it necessary to adjust their business strategies, moving toward a goal of building a more balanced relationship that will better meet the end users' demands.
Who's calling the shots?
Fifteen years ago, a customer who wanted to buy a specific brand of saw blades, for example, had one source to turn to: the distributor chosen by the manufacturer. If that single source wasn't the customer's preferred distributor, both the customer and his preferred distributor were out of luck.
By virtue of the selective distribution system, set up by manufacturers to control the route of their goods to market, end users needed to do business with multiple distributors in order to purchase all their required goods. Tired of this cumbersome and costly system, end users are pushing for change.
"The customer's problem is that he has to buy a lot of industrial supplies that don't necessarily end up in the final product, that don't necessarily make up a significant amount of their total purchases, and yet their procurement costs are as much or sometimes more than the costs of the goods themselves," says Shelley Boxer, vice president and chief financial officer for MSC Industrial Supply Co.
"That's what's driving the consolidation: customers who want to cut only one purchase order or do business electronically, get it all from one place that has everything they need and not deal with multiple people in order to lower their people costs or paper costs," Boxer says. "Any business that can solve that problem will be successful."
Consolidation is one of the industrial distribution industry's primary responses to the end user's call for lowered costs and fewer suppliers, with other responses including the formation of alliances and buying consortiums. Consolidation simultaneously brings end users and distributors closer together and increases the size of distributors and their clout with manufacturers.
Adam J. Fein, president of Pembroke Consulting, Inc., describes the snowball effect this way: "Industrial distributors are acting less like the sales and marketing arms of manufacturers and more like the purchasing and procurement arms of customers. As consolidation continues, it creates larger, well-capitalized, professionally managed corporations that are better able, in some senses, to act on the customer's behalf against suppliers. That doesn't mean that there's necessarily going to be contentious relationships, it just means that there's going to be more of a level playing field of negotiations between suppliers and distributors and that the balance of power is shifting."
Distributors gain strength
The relationship between manufacturers and distributors is currently marked by uncertainty as each side tries to devise strategies to cope with rapid change. Experts predict that the distribution industry will continue to consolidate for at least the next five years ... as long as the economy remains solid and the sources of capital don't dry up.
But it is clear that distributors are gaining a bit more time at the podium.
"As distributors gain the freedom in size and clout to act independently [of manufacturers], they work to act in their customers' best interests," Fein says. "In many cases the customer's best interest conflicts with the manufacturers' desire to control the channel. For example, many large industrial customers want national contracts and they want access to all the brands that they use in the different manufacturing locations.
"A policy of very tight exclusivity, both geographic and brand or category exclusivity, by manufacturers conflicts with any distributor's ability to satisfy that customer need," Fein adds. "Ultimately, distributors who are acting in the best interest of their customers are going to push back against manufacturers to say 'We'd like you to remove these barriers so that we can meet the needs of our customers.'"
Manufacturers, in turn, have no choice but to react to pivotal issues like geographic territory and brand exclusivity agreements. Distributors may also ask them to invest more in technology, provide specialized support, etc.
Hardy Hamann, senior vice president for Hermes Abrasives Ltd. of Virginia Beach, Va., and chairman of the American Supply & Machinery Manufacturer's Assn.'s Partnership Enhancement Committee, provides a manufacturer's insight into this changing relationship.
Hermes Abrasives has traditionally believed in selective distribution, Hamann says, and previously sold its products through designated Hermes distributors. But, he says, consolidation within distribution has forced the company to revise its distribution policy even while mergers and acquisitions work to wrest the movement of goods away from the manufacturer's control.
"With the changes we saw developing over the last five to 10 years," Hamann says, "we took a hard look at our product lines and made changes to where we're selling highly technical products through a limited number of preferred distributors and adding more training to clearly set those distributors apart. But our commodity type products we allow almost any distributor in the country to carry ... We are moving, step-by-step, to a more open distribution contract."
Hermes Abrasives has also devised "named account agreements" which provide some flexibility for Hermes distributors that acquire distributorships carrying competitive lines. In a named account agreement, the acquired company will only be authorized to distribute Hermes' line for a specified, or 'named,' account, like an integrated supply account.
The reactions of manufacturers to the consolidation efforts of MSC, Industrial Distribution Group, Ross-Willoughby Co. and others have largely been supportive and often enthusiastic, according to company principals.
However, the principals admit that there are some manufacturers who greet their consolidation efforts with concern, which most often centers on upsetting relationships with established distributors in specific territories.
"That's the real fear," Boxer says, "that their [independent] distributors will gang up on them and they'd lose other parts of their business simply because they went with a national."
Finding common ground
While the balance of power shifts between manufacturers and distributors, both parties recognize that it's the customer who is in control. That leaves manufacturers and distributors to restructure the channel in order to satisfy the end user.
Ron Cory, president of Ross-Willoughby, says that most manufacturers are finding ways to work through the competitive brand issue, such as setting up a distributor to manage specific integrated supply accounts.
"That's tied to preserving their own market share," Cory says. "We all realize that the customer is essentially laying out the strategy and calling the tune, so to speak. We now represent a variety of manufacturers in very specific accounts only and not in the balance of our territory."
As for geographic territory conflicts, Boxer says MSC works with concerned manufacturers by establishing agreements that respect existing local distribution channels and uses that as a basis from which to grow the business and "build a combined business strategy and a partnership for the future."
Experts say there are enough benefits of consolidating the distribution industry that the players should be able to meet on common ground.
"Ultimately, the real source of value for the industrial distribution channel is going to come by reducing what is a fairly costly channel to market for suppliers and customers," Fein says. "As distributors get larger and have the ability to move market share in a very large and significant way, you're going to see forward-thinking suppliers addressing the marketplace differently, moving away from strict volume purchasing agreements and moving toward more partnering types of agreements."
Perhaps less obvious than the benefits that distribution consolidation offers distributors are those that manufacturers stand to gain -- one of which is lower cost of sales, says Marty Pinson, chief executive officer of IDG.
"If I have 17 companies that distribute product around the country, [manufacturers] can make one sales call on IDG or they can make 17 sales calls on all 17 of those companies," Pinson says. "So if IDG distributes their products, they've lowered dramatically the cost of sales associated with that distribution channel. Another significant benefit is that they get greater market share if we take on their product ... To the extent that we become a stronger player in any single market as a result of being part of IDG, we enhance the position of the manufacturers whose products we represent in that market."
Manufacturers also stand to gain more sophisticated channel partners which will make the channel more efficient for everyone, and will benefit from better capitalized distributors who can better present their products and can more fully absorb distribution functions.
Feeling the pressure
While consolidating distributors and manufacturers work at coming to terms, the relationship between smaller independent distributors and their suppliers is becoming increasingly strained.
While some manufacturers are enjoying new market opportunities created by consolidation -- access to previously off-limits distributors, for example -- their established, independent distributors are feeling squeezed by the increased competition.
Listening to projections of anywhere from five to 10 years of consolidation, the thousands of independent distributors in this fragmented industry are struggling to determine where the future will lead and, in the meantime, to hold on to their current market share.
"[Consolidation] is opening the market," Hamann says, "but this opening will not happen without growing pains. It's painful because there's tension between the old established Hermes distributors who have a hard time accepting that all of the sudden someone else will gain access to our products through acquisition."
Hermes is trying to ease that tension by providing its independent distributors with the additional training necessary to become experts in Hermes' technical products, and by promoting those distributors to the end user and stressing the value-added services they offer.
But the consolidation process has already been set in motion and small independents will have to choose between selling, folding or adapting.
Both Boxer and Pinson predict that the pace of consolidation will quicken and that its pattern will mimic the consolidation of the office supplies industry.
"A lot of the [smaller distribution] companies will disappear and you'll see mega-companies emerging," Boxer says. "You'll see master distributors emerging and at the same time you'll find that the survivors in the small businesses will find comfortable niches where they are involved in buying consortiums, dealing also with a master distributor, but are basically selling on relationships which is an extension of what they do now."
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