Is bigger better?

The merger and acquisition craze is causing small, independent distributors to think harder than ever about their place in the channel

By Victoria Fraza -- Industrial Distribution, 8/1/1999

Distributors in every market segment are weighing the pros and cons of remaining independent versus joining with a larger firm -- through merger, acquisition, or some other form of alliance. There are many factors contributing to the situation -- the graying of industry execs, many of whom lack successors or are simply looking for a quick way out; increased competition from large firms with deep pockets; the high prices offered by consolidators looking to gain market share quickly; and the gloom and doom message small distributors say they are constantly bombarded with in studies, reports and magazine articles.

In June, ID sat down with seven industry executives to talk about the fate of the small independent distributor. Most were from small or mid-sized firms, themselves. Some chose to sell their firms to large companies like MSC and Applied Industrial Technologies, while others decided to remain independent or seek alternatives such as aligning with other distributors. All offered insight on why they have chosen their particular paths and what they think the future holds for distributors of all sizes. The following article was excerpted from that meeting.

This is the third and final installment of ID's roundtable series on mergers and acquisitions. The roundtable series was co-sponsored by private banking firm Brown Brothers Harriman of New York. The meeting was co-moderated by ID's associate publisher/editor Jack Keough and by Rick Witmer of Brown Brothers Harriman.

Can the family-owned, entrepreneurial-type distributorship succeed today in light of all the mergers and acquisitions that are creating larger players in the marketplace?

HARRIS: "It's going to be very tough to survive. I think this change is all driven not by us -- we like to say it's by us -- but by the end-user. And I think it's all driven by one word -- cost-reduction.

"What we had to do as a family-owned business was say 'how are we going to survive in this changing marketplace? How is MIT going to compete against the MSC's? How is MIT going to compete against a Grainger?' So what we had to do was form an alliance with other distributors, create a value-added service for the end-user and survive in that mode. And that's worked out very well for us.

"I think as long as we bring value to the end-user we'll survive. And it's [the end user's] perception of what we bring to them that's important."

GALLAGHER: "I agree exactly with what Mort said. As long as our customer perceives that we bring value to them, we'll succeed.

"What we've found, especially in the last five to seven years, is that in the downsizing of corporate America, our customers don't have the personnel resources that they used to have ... to go out and do the investigation work on specifying products. If you're on the inside [as a specialist], you're in a great position. When a customer of ours has a new sealing application, they call us because we're one of their chosen suppliers. Technical expertise is just one of the services our customers expect."

McBETH: "The question really is, can a family-owned business survive in the current environment? And I think that when an industry consolidates as this one is doing, it's a tough task.

"A family-owned, independent distributor has got to have a strategy ... The scale of things is changing. What you're going to see is that the medium-sized category is going to move. It is moving ... We were a general-line industrial distributor, and combined with Dillon [Supply], [we have] maybe $125 million in sales. That's now medium-sized, where it was once considered large.

"And, of course, there's increased competition. We used to be able to name on one hand the competitors that we were faced with. Now I can't count all our competitors on both hands and both feet. There are a lot of new people, and they are not all from our area."

PARRISH: "You may not recognize your competitor."

McBETH: "Yes. So the environment is changing. It's going to be more challenging."

PARRISH: "I've got to agree. As a small, family-owned distributor, I sure hope that we're going to be able to survive. And I have to agree with Bob that it's going to take some strategy.

"When you envision a traditional, family-owned business, especially in the industrial supply business, you think of generations of the 'mom and pops' who started the business, who are there as chairman and vice chairman of the board, and are drawing salaries and maintaining an office, coming in once a month, basically to pick up their checks. You think of brothers or cousins who have been in the business and are occupying places on the payroll that are not productive. I think those days are absolutely gone, and I think that kind of traditional family business structure is right out the window.

"The family business of today probably needs to be referred to as privately held. It may be owned by my family, but I'm the only one drawing a paycheck from it, and I think that's an important distinction. Like all businesses, the small, family-owned is going to have to flatten its hierarchy.

"I do feel that there is a future, but I think, once again, the strategy is going to be absolutely important. You've got to look at new markets, new niches, new alliances, different ways of getting to market and getting access to capital, too."

For those of you who have sold your businesses, what are some of the benefits? Is bigger necessarily better?

GLIDDEN: "What the company that purchased us [Applied Industrial Technologies] brought to the table are assets all over North America. So, if I have a problem in King of Prussia, Pa., I don't have to send somebody down. I can call up the local talent to go in and help the situation."

HOLLOWAY: "All in all, it has made selling much easier. We were always the underdog in the market, and we were selling on price a lot of times. We didn't have a catalogue. We had to say, 'No, I can't get it to you this week, it'll be next week, but heck, I can save you 10 or 15 percent.' And we were relegated to that because of our market ... So now I feel it's much easier to compete. I feel that we have a whole bag of tricks now. I can pull out the CD-ROM and throw it on the guy's desk. I can pull out the big catalogue. You want to bar-code the inventory? Sure, we can do that."

KAHN: "But some of the customers still, for whatever reason, continue to buy from their local distributors who have no alliance in place."

HOLLOWAY: "Yes. Relationships are very important. I won't deny that."

KAHN: "I had a meeting not too long ago with a former executive from a large national distributor. He admitted to me that in every conversation management had with their strategic planning staff, they would be confounded by the fact that the greatest competition they faced was from small local distributors operating in the same geographic region as their branches. Apparently, the customers preferred to do business with distributors they've known for a long time and that understood their operations on a day-to-day basis."

What is driving the decision to sell your company today? What are some of the key elements -- other than the financials?

HOLLOWAY: "There are so many more channels of distribution now ... There is just so much more competition."

PARRISH: "I think some people are overwhelmed. You read some of these trend reports and they tell you you're going to be out of business ... You've got the mega guy moving into town."

HARRIS: "Small and medium-sized distributors would notoriously call on large accounts in their area. That's who they got a great chunk of their business from. And those are the accounts that have hurt small and medium distributors the most by moving towards integrated supply. They hurt a lot of the small distributors, and how many small hurts can you take? Pretty soon, you get an offer, or somebody asks you, would you like to sell your business? And you say, 'You bet.'

"It's not going to get better, because, like Scott said, everything you read, everything you see, everything you hear ... says it's not good to be a small- or medium-sized distributor. You're in the middle. You're in the crossfire of what's going on."

McBETH: "But who can remember a better time to sell? In prior years, you didn't have people calling you wanting to buy your company. This is a proactive environment. You've got good economics. You've got a very stable environment. You've got capital. There are a lot of acquirers. Somebody who never thought about doing it gets a phone call, and starts thinking about [selling]. Everybody wants to look at their alternatives.

"All of this doesn't mean that [smaller distributors] should get scared and run. I'm not advocating anybody get scared and run. That's the world's worst reason to sell your business. I wasn't scared. I wanted to be a buyer, not a seller. But you've got to be realistic with what's going on in the marketplace. It's a tougher ball game out there."

HARRIS: "Very tough. It's almost like you're playing table stakes poker now, and you're used to playing nickel-dime poker -- but when you win ..."

KAHN: "Since the majority of our sales are to small independent distributors, we understand the competition they face in their local markets. This competition is coming from large, well-financed consolidators and public companies that are trying to establish their presence in every major market.

"Many small distributors feel that their only options are to go out of business, join a marketing alliance, reestablish their business as a niche player providing specialized products or services ... or to sell out to one of the consolidators. The last option is appealing to some distributors because it provides an easy exit strategy, especially if there is no succession plan already in place for family members or other interested parties. Also, several of the larger consolidators are paying a premium for these businesses in order to gain immediate access to their customer base and market share.

"Whether or not the end-user customers benefit when their local distributor is sold remains an important question. I believe that a local distributor with the product support of a master distributor or marketing alliance can compete effectively against any consolidator."

What role will the Internet play in the changing channel? Will this make the smaller distributor a larger player?

KAHN: "As the cost for Internet technology plummets, everybody will be able to have the most sophisticated e-commerce site with a full array of features and functionality. The nice thing about the Internet is that the customer can't see what's going on behind the Web site. Whether you're a national consolidator or a local distributor, you can present a powerful image with a lot of capabilities.

"But is the Internet going to be an equalizer? I think it's going to enhance relationships that are already in place, not replace those relationships."

McBETH: "I've been negative on the Internet up to now. I don't know how this thing will unfold, and I don't think anybody does. But it's going to have a tremendous impact on this business and on distribution. Forty percent of the cost of the product is in the channel of distribution. So something has got to come and squeeze that down. Integrated supply, materials management, systems contracting ... This is going to have a big role to play".

KAHN: "The Internet is just another challenge for the small distributor ... and another opportunity to put into his bag of tricks. It's one more thing he has to gain competency in if he's going to remain competitive."

GALLAGHER: "Someone asked earlier if [the Internet] is part of our marketing strategy. When you spend 60 to 65 percent of your selling time in front of engineers, it's only part of your strategy. Discussing technical products, it's difficult to do that over the Internet.

"We recently assisted a prospective customer in North Carolina with a difficult application. In return, we received a significant order and are now working with them on new applications."

What do you think the industrial distribution landscape will look like five years from now? What will happen to the small distributor?

KAHN: "I keep going back to the basics. That's what I grew up with, and that's what I understand best.

"When I need to fix something in my home, I can go to the Home Depot or I can go to a local, family-owned hardware store down the street. It depends on what my requirement is. If I'm not sure what to buy, and I need some personal assistance, I'm going to go to that small family business. They have people that can help me select the tools I need and tell me how to use them. Price is not that critical. If I walk into the Home Depot, this process becomes much more cumbersome and impersonal. Again, it all depends on what my needs are. The same principals will continue to apply in our industry. Customers that value the services of a local distributor will support that distributor in the future."

HOLLOWAY: "The one thing I truly feel is that there is a role for a small distributor in the market. But I do think the small distributor will have to specialize and will have to develop certain capabilities that the general line or larger distributor doesn't have."

HARRIS: "The role of the small- or medium-sized distributor has to be backed by some value-added services that they provide to the end-user -- services that the customer perceives as value. And when they perceive it as value, they would much rather buy from local distribution. When they don't [perceive it as value], we force them into some other avenue of distribution.

"But I believe that it's still personal selling. It's still local distribution. It's good for the community. You're still dealing with people. And they'll still buy that way as long as we, as small- and medium-sized distributors, provide the value to the end-user."

PARRISH: "I think it's just critically important that distributors of all sizes identify their markets and their strategies and attack accordingly. We've heard a lot of discussion back and forth -- that the small guy is going to be here, and that he's not going to be here. That it's all going to go over the Internet, and that it's still going to be face-to-face [selling]. And I think, bottom line, it's all true. We just all need to sort out where we're going to fit in -- if we don't, we won't be there.

"This still is a people business and there still is a niche out there to sell locally. There is a whole array of one-man distributorships out there, so it's not all going to the big people. We need to constantly evaluate our place in the market. It may mean having an Internet presence. It may simply mean loading the old station wagon or Suburban or minivan and going out there and taking orders, just like everybody's grandparents did."

McBETH: "I don't think bigger is necessarily better, unless the company is well-run. If you're in the box-moving business and you have bigger, centralized warehousing and that sort of thing, there are certainly efficiencies and economies of scale. I think all the forces that we've talked about today are going to put pressure on family-owned distributorships and, over time, we'll see those dwindle."

GALLAGHER: "I concur with what's been said. I think [industrial distribution] is a relationship business. And you need to have a strategy.

"We think that face-to-face calling on customers, discussing products and applications, is still a very important part of our business, and we continue to see that for the future. In fact, our staff of customer service people has grown because of the expectations customers have today."

GLIDDEN: "I truly agree there is a niche for small distributors, as well as large. I think it's the mid-sized distributor that's going to be pressured to decide what they want to be when they grow up. And a lot of that, perhaps, has to do with their succession plans, which we didn't talk about today. I see many distributorships fall short because of that. If it comes down to the wire, and you don't have a succession plan, the for-sale sign is going to go up."

THE PLAYERS

Mark Kahn

President, Production Tool Supply

Kahn's father founded PTS in 1951. Today, most of the firm's revenue comes from the relationships PTS has formed with small, local distributors across the country -- relationships in which PTS acts as a master distributor.

Bob McBeth

President, AIS, Dillon Supply/AIS

McBeth merged his successful mid-sized distributorship with Dillon Supply of North Carolina in January. The new firm has combined revenues of roughly $125 million and benefits from the resources of its French parent company, Descours & Cabaud, a $2.2 billion firm.

Terry Glidden

Manager, ESI Power Hydraulics, a subsidiary of Applied Industrial Technologies

ESI Power Hydraulics is a regional distributor of fluid power products covering the Chicago area. Founded in 1992, the firm was sold to Applied Industrial Technologies in 1998.

Scott Parrish

President, Parrish-Keith-Simmons, Inc.

Parrish-Keith-Simmons was founded in 1898. The small, general-line house remains independent today. Parrish says he will look to specialization as a strategy to compete in the changing marketplace.

Joe Gallagher

President, Gallagher Fluid Seals, Inc.

Gallagher Fluid Seals is a second-generation, family-owned company based in King of Prussia, Pa. The specialty firm sells fluid seals, o-rings and and related items primarily to OEMs in the Northeast and has made two acquisitions in the last 15 years.

Mort Harris

VP Sales & Marketing, Minnesota Industrial Tools, Inc.

MIT has annual sales of between $25 and $30 million. In an effort to compete in the changing marketplace, the firm joined Source One Alliance several years ago -- a "very positive" move, according to Harris.

Eric Holloway

Branch Sales Manager, Holloway Tools/MSC

Holloway's grandfather founded this small, general line house in Wilmington, Del. Eric Holloway decided to sell the company to MSC Industrial Supply in 1998, a move he says has given the firm a whole new "bag of tricks."