Innovation — a popular subject across the $3 trillion dollar in sales North American durable goods distribution sector — has filled many association vertical meetings. The idea is that with a proper introduction to the subject, distributors can innovate their existing business model. When we research the growth businesses in the distribution sector, however, we find business from outside the sector who are the most innovative. These businesses aren't found in innovation workshops, but they are found with great online technology and are quietly and swiftly gaining against established firms.
Overweight Models in an Old Sector
Durable-goods distribution is an old sector. It got its start in and around the Civil War when Union factories needed parts close by to keep the machines running. The industry grew as the industrial economy grew. The central value is an application-driven transaction of different vendors where the margin dollars exceed the fulfillment costs. Over the last three decades, distribution has found success moving further into the value chain with services, assemblies, and field diagnostics and repair. More than half of durable goods distributors get revenue from these efforts.
But this success has come at a price. These full-service distributors are complex firms. They have to do many things well for many customers. They are part commodity distributor, part manufacturer, and part service provider with multiple branches. Added service and assembly sales create added complexity; often where incremental margin dollars are exceeded by incremental costs and scale is almost impossible. They are, strategically, in quicksand. Their full-service models are, increasingly, the enemy of future success. They are, increasingly, vulnerable but don't see it and their incremental innovation style of the past is seldom a match for the competition.
The New Distribution Competitors-Lean, Mean, Market-Growth Machines
In the early years of the Millennium, we became aware of a new type of competitor. The firms used e-commerce to solicit customers while negating much of the old business model namely, sellers and branch establishments. Their operating platforms were lean, they targeted the Pareto SKUs and went to market at 10 to 20 percent less than the competition. Their value propositions were based on a well-defined slice of the value chain. They had top-notch technology but they were small in sales. Full-service distributors often referred to them as "price prostitutes." We called them Transactional.
Today, transactional distributors are one type of five new distribution models that use technology and thin-slice the value chain for competitive advantage. Four of the five models reduce price, substantially, over full-service distributors. Their CAGR's are phenomenal.
For this blog, we'll go over a few of the models and tangible representatives.
Transactional Distributors — Innovate the existing model. Their success is in traditional channels against traditional competitors hence they are found intra-channel. They have limited sales presence, limited brick and mortar, limited inventory, and great online tech for self-service. One of the best examples of a transactional firm is Zoro Tool. The online entity is backed by Grainger. The parent company, the envy of most people and things e-commerce, started the entity as a focused, low-cost competitor in 2010. In 2015, Zoro Tool, www.zoro.com had almost $300 million in sales and larger than many top distributors. The sales growth in the recent year was 62 percent.
Auctioneers — Are firms that put buyer and seller together for a fee. Kinnek (kinnek.com) serves the commercial foodservice industry putting buyers and sellers together for RFQ's. The site also ranks suppliers and a recent search for Brewery supplies yielded 1162 vendors — something the average foodservice wholesaler has difficulty doing.
Channel Slipstream — Are distributors that bypass parts of the channel, have low-cost operating platforms, and give a great price to the end user. Unlike Transactional distributors, they are often channel agnostic or inter-channel. Examples include the A/C Wholesaler division of HVAC Stores (acwholesaler.com). The entity sells direct to the public and bypasses the dealer portion of a redundant three-step channel. Prices for condensing units, based on our analysis, are 25 percent or more less than buying through the traditional channel. Another slipstream model is CivicSolar, (civicsolar.com) which uses proprietary software, a unique business model, and streamlined channel to sell solar supplies. Their operating platform is some 40 percent less in cost than traditional full-service competition and compounded CAGR averages 20 percent.
Transactional distributors, auctioneers and channel slipstream firms are growing. They are increasingly found in many of the four-dozen durable goods channels and they are becoming large; sales can be at or around the $100 million dollar range, which is the traditional benchmark for "large" distribution companies. They also plow back significant funds in technology; especially e-commerce or tech to further digitalize the business platform and this is where they differ, significantly, from full-service distribution. You also won't find them at innovation seminars, at most (but not all) association meetings. Most, but not all, of the associations don't want to talk about outsiders who are taking share; it isn't politically correct.
The Advantage of Tech
Three years ago, we surveyed distributors on their e-commerce sales. Some 70 percent of firms sold 5 percent or less online. In 2016, we are conducting the same survey. One-hundred responses so far find that 62 percent of distributors sell 5 percent or less online. In industries where B2B sales, according to Forrester, grow at a 9 percent CAGR, this showing is not progress. Simply put, traditional distribution is lagging behind in online capability. The emergence of alternative models, driven by technology, supports the assertion.
Time and again in supply chains, technological innovation separates winners from losers. Often, winners are firms you've never heard of. For example, we traced the beef livestock supply chain from 1860 to 2000. We called it Cowboy Economics. From the 140 year history, there were over a dozen major technology innovations that made unheard of companies winners over seemingly unconquerable competitors. Grain fed beef farms using conveyor systems and silage wiped out huge grazing ranches in East Texas and refrigerated trucking companies wiped out the great stockyards and rendering houses in Chicago and Omaha. The grain fed farms and refrigerated truckers were literally laughed at by the Texas spreads and massive stockyards. The spreads are dude ranches today and stockyards are dust. The process from fame to shame took less than a generation. Along the way, the quality of the strip steak increased while price decreased from a day's labor in 1900 to less than an hour by 2000.
Where Innovation Talk Fails
New distribution models have more than a 60 percent chance of being from outside the industry. Where they are from the industry, they are typically financed by large companies who have spent millions, maybe tens of millions, on tech. They get rid of redundant services including sellers and numerous branches and let the customer self-serve. Our attendance in two recent industry innovation seminars never mentioned these facts.
We don't expect huge waves of wholesalers to disappear overnight to new models of business. Firms that fail to understand e-commerce and change their business models should expect to lose sales. In a growing number of sectors, this is underway. Over time, some full-service distribution firms will fail but many will sell out to billion dollar firms for asset value or something less.
The time is now to move away from ethereal innovation talk and get down to brass tacks about tech investment and new models of distribution that are emerging and growing. We encourage the associations and trade magazines who have been playing politically correct to get their hands dirty and challenge their membership. And we encourage wholesaler executives to invest in specific research, hard study, and put pencil-to-paper on how to invest in tech and take the cost of the business model down to compete in an online world.
Scott Benfield is a consultant for B2B supply chains. He has been quoted in Forbes and the Financial Times and is the author of six books on the durable goods distribution channel. He can be reached at (630) 428-9311 or firstname.lastname@example.org.