Competing capabilities
For now, the booming integrated supply market has room for all sorts of players, from "pure" integrators to commodity managers
By Ken Brack -- Industrial Distribution, 6/1/1999
When United Technologies Corp. decided to outsource its MRO supplies procurement for six divisions late in 1997, it chose a non-traditional distributor called Bruckner Supply Co.The contract requires Bruckner Supply to guarantee millions in savings from the $120 to $130 million that UTC divisions spend on MRO at 131 sites in the U.S. and Mexico -- where aircraft engines, helicopters, elevators and other products are manufactured. Implementing the program has not been easy, but costs were cut in the first 14 months. All of the divisions should be involved by the year's end, UTC's top purchasing executive says.
Bruckner won the contract because out of more than 100 bidders, it showed a low-cost track record and matched a model UTC devised for delivering savings.
Relatively unknown before its acquisition last fall by WESCO Distribution, Inc., Port Washington, N.Y.-based Bruckner Supply is one firm on the leading edge of an integrated supply market that is undergoing dramatic growth. As more end users seek to slash costs with outside management of MRO and non-MRO materials, distributorships increasingly form integrated supply divisions or join alliances, consortia and marketing cooperatives.
For the next few years -- two or three perhaps -- various types of integrators are expected to gain business because the demand will continue to greatly outstrip supply. Consultants anticipate the integrated supply market will continue its high double-digit growth and reach $11 billion next year. Measured another way, 20 percent of total MRO spending in 1999 is expected to be through integrated supply programs, up from 12 percent two years ago, according to industry expert Frank Lynn.
Yet meeting customer demands and beating competing integrators is no cakewalk. Some executives like Lynn predict there will be a major shakeout as the market matures and outside players -- such as investors and distributors from other industries -- acquire large integrators.
"There's a lot of people out there who don't know how to do it," says Dennis Circo, president of Precision Industries in Omaha, Neb. The firm expects up to 80 percent of its business to be through integrated supply by the end of 2000. "There's a lot of changing of the contracts, a lot of shaking out going on."
So how are those players that succeed meeting their customers' expectations?
Officials say keys to success include: being selective; building competency in numerous product groups; and developing proprietary software systems to manage MRO orders and inventory, and drive out transaction costs. More fundamentally, a few distributors have built low-cost operations in which they carry little inventory and most products get drop-shipped to customers.
Distributors come under tremendous pressure from customers to dig deeper and cut more costs after they deliver initial process and inventory savings in the first two or three years of a contract. To accomplish that, integrators must provide continuous process improvements and negotiate with suppliers to reduce prices or offer alternative products, says Rich Layton, vice president of operations at Fairmont Supply Co. in Washington, Pa., which has done integrated supply since 1984.
"After the initial cost savings are realized, there is more pressure put on price," says Layton. "It comes to the forefront."
Other officials say the jury is still out on many distributors' performances, and that hard evidence will surface as more contracts mature and are re-bid. Many end users have been unhappy with the results, particularly with technical support provided, Frank Lynn & Associates reported in a study last year.
"It's a tough, tough battle," says Donald Whitehead, director of corporate purchasing at UTC. "It's particularly tough for [a company] like UTC because we're at so many locations. It becomes very people intensive ... there is absolutely no way to handle it unless you're dealing with facts."
Flush with offers, distributors have become more selective and many are increasingly successful at least in landing contracts.
Winning selectively
Nearly half of the firms surveyed by industry consultant W.R. McCleave & Associates reported winning business from more than 40 percent of their integrated supply proposals in 1997, an increase from the previous year. The number of proposals not being awarded appeared to be declining, according to a survey of 225 distributors and manufacturers, which Modern Distribution Management published recently.
The marketing cooperative I.D. ONE is one player choosing its targets carefully. I.D. ONE recently decided it will primarily pursue national accounts where some of its 71 members are already engaged. It will stick with its members' core competencies and not branch out as an integrator, says Ed Kozlow, vice president of sales and its national account program.
"You have to be selective because there are so many opportunities," he says. "We've seen that some of these integrators have taken on all this business, but they can't really handle it. They come back to the individual distributor and say, 'We still need you because so and so can't handle the volume.'"
Circo says that Precision Industries is so busy implementing integrated supply programs that it is not looking for new customers. "It's easy to win these deals and it's hard to make them work right," he says.
Tom Meacham, executive vice president of sales and marketing at Fairmont Supply, says that unhappy end users occasionally provide opportunities for Fairmont in addition to its own leads. Fairmont Supply has contracts of more than $200 million and after experiencing a flat 1998, expects integrated supply revenue gains of five percent this year. "Sometimes there's a lot of spin and flash put into the marketing of the concept, but the results are not there," says Meacham.
Still, the sheer number of distributors entering the market has made it more difficult to secure new agreements, says Layton.
Maintaining the contract
After winning the account, distributors often struggle to manage prices, profitability and the entire contract. These three areas were listed as major concerns - after defining and winning the proposal - in the McCleave & Associates study.
Integrated supply activities typically involve these functions: management of the MRO storeroom, sourcing products, inventory ownership, integrating the end user's onsite system with the supplier's own order entry/inventory management system, consolidated billing and more. Typical contracts require integrators to reduce procurement costs by five to seven percent annually, Lynn says.
For the consortium Affiliated Distributors, the keys to maintaining accounts include monitoring the performance of AD members and communicating with the customer, say Jim Malicki, AD's integrated supply director.
AD officials attribute the group's growth to their network of 283 affiliates and the software that manages suppliers and tool inventories. Last year AD doubled its national account "wins" and the value of those contracts is nearly $1 billion today. In January, Eastman Kodak Co. awarded AD a major contract.
Members' technical service teams often work with suppliers and the end user's staff to reduce costs on site. Reports on cost savings, support services and other items specific to the end user's plant go back to AD executives, who provide quarterly reports to their national account customers. Malicki says sharing cost savings ideas - such as one where deploying certain end mills for a pharmaceutical manufacturer increased throughput - is a "powerful tool."
John Salvadore, vice president of North American sales and field operations at AD, says its members must meet demanding performance requirements.
"It is this baseline of capabilities that ensures our customers that they are dealing with a distributor that knows their business and can react quickly to challenges with people, technology and facilities," he says.
Precision Industries maintains accounts in part by tracking 49 key indicators of cost savings, tapping what it calls a broad core competency of product expertise and using its proprietary software. "All of these deals require heavy software modification," says Circo.
Fairmont Supply's work includes a focus on price reductions realized through alternative products, inspections of critical materials, sponsoring training by suppliers, and a longstanding documented savings program. Underlying that is a focus on clear communication.
"If there's one main element we think solidifies the contract, it's understanding the customer's expectations and discussing our performance against these expectations frequently," says Layton.
Choose your model
For now, at least, the integrated supply market has room for a number of different players or models.
In a report last year, Lynn suggested pure integrators like Bruckner Supply and Industrial Systems Associates have a competitive advantage because their cost structure is well below industry averages. Unlike consortia, for example, those firms do not maintain both on-site facilities and local branches.
Despite having about $300 million in I/S revenues last year, Bruckner has no outside salespeople. It also does 98 percent of its customer transactions through e-commerce and arranges drop-shipments for many products. Its operations costs as a percentage of revenue are well below 10 percent, Bruckner president Robert Rosenbaum says, compared to an industry average of 18 to 22 percent.
The Lynn report also suggests that not having branch-based product specialists to provide local support might hurt Bruckner.
Rosenbaum responds that his company designs and tailors programs to meet specific needs and has acquired "the appropriate relevant technical capabilities to make technical a strength, not a weakness." With high-profile customers like General Motors, IBM and American Airlines, he says hiring skilled people isn't that difficult. Bruckner has provided integrated supply programs for nearly 20 years and Rosenbaum says one or two potential customers contact the firm each week.
Naturally, competitors promote their alternatives to the pure integrator model and say they offer crucial technical support. Fairmont Supply's Meacham and Layton contend it has yet to be shown that some integrators like Bruckner Supply can find continuous process improvements, and they argue that process costs get shifted to suppliers and end users.
"Yes, they have a lower operating cost structure, but they have an inability to bring significant savings to an end user over a long period of time," says Meacham.
"Bruckner doesn't provide technical support and we do," adds Circo.
Rosenbaum argues his company's low-cost model is ahead of the curve.
"In our indirect materials outsourcing programs we own and manage the customer's budgets. We believe this is the future," he says. "We may be a little different this way; but because our scope of product offerings and service includes every commodity group, we find an ever increasing expansion."
"We believe the long-term survivability and benefit of integrated supply is to be based on a low-cost model," says Rosenbaum. "Our view is that the demand will be for an ever increasing scope of indirect materials and a movement in a more real direction for outsourcing."
Whitehead, the UTC purchasing executive, says it was a tough call for his firm to go ahead with one integrator. During the first 14 months he says neither Bruckner Supply nor UTC personnel have been perfect. Combining the companies' information systems has been a struggle, as has overcoming resistance within some divisions.
But with Bruckner expected to drop ship more than 60 percent of some 125,000 parts, and with weekly cost and performance reports available electronically for UTC's for plants, Whitehead says he is not looking back.
"I think we made the right decision," he says. "We just need to have the backbone to get through the startup and continue to amass data so that we can deal with the issues. We need facts to make this work, and we expect the savings to continue to flow."
Lynn: Large investors eager to buy up integrators
Here's a prediction from industry expert Frank Lynn: Watch for many major integrated suppliers to be acquired by outside players in the next few years.
Lynn, chairman of Frank Lynn & Associates in Chicago, told ID in late March to watch for consolidation within the top ranks of distributorships that do integrated supply. Distributors are scrambling to raise the massive amounts of capital needed to service major customers with numerous plants. The entrance of equity investors into distribution and the rush of initial public offerings demonstrates this.
"Over time, almost all of the integrated suppliers will be bought, because it's a cash flow problem," Lynn said.
During the winter, for example, Lynn said a well-heeled investor looking to put as much as $75 million into the distribution industry contacted his office. He says computer industry distributors are other likely acquirers.
Lynn expects what he calls a "feed chain of acquisitions" to continue as small to large integrators seek to grow.
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