Distributors’ Staying Power, Despite Forces of Change
Edition: November 2002 - Vol 10 Number 11
The year 2001 was tough for distributors. 2002 has been pretty much the same. And 2003? Don’t expect any miracles. But don’t underestimate your staying power, either.
That’s the message from Facing the Forces of Change Outlook 2003, a report on wholesale distribution published by the National Association of Wholesaler Distributors’ Distribution Research and Education Foundation (DREF) and Pembroke Consulting, Philadelphia, PA. It follows by one year the publication of NAW’s Facing the Forces of Change: Future Scenarios for Wholesale Distribution. And even though the report addresses all wholesalers, many of its points apply to those in the healthcare niche.
For example, the study talks about two forces that distributors are expected to continue to face through 2003:
• Global manufacturing competition, which continues to lower the real-dollar prices of products. “As a result, generating margin dollars from product markups is becoming more difficult than ever,” according to the report. “This deflationary environment rewards companies that can quickly shrink operating expenses.”
• A slow-down of merger-and-acquisition activity, due to uncertain business prospects and attempts by consolidators to digest past acquisitions. “As a result, business owners face greatly reduced business valuations and fewer possibilities for the sale of a business.”
Seven forces of change
Pembroke Consulting President Adam J. Fein and his colleagues interviewed 75 consultants, analysts and others; and studied 1,600 responses to an on-line survey of senior wholesale distribution executives along with their customers and suppliers. They identified seven forces of change – some positive, others more challenging – affecting distributors:
1. Wholesaler-distributors will continue to play an important role in marketing channels and supply chains. Wholesale distribution remains an important force in the economy, according to the NAW report. “In 2000, sales of all wholesaler-distributors reached $2.8 trillion. The industry has been growing at a 5.6 percent annual rate since 1991….Wholesale distribution still represents the most significant channel to market for manufacturers and the most important supply chain for customers, particularly when there are many small customers and a wide variety of manufacturers. Consider the fact that more than 75 percent of all product sales occur through distributors in a broad range of industries, such as building materials, foodservice products, pharmaceuticals and industrial MRO products.”
2. Online ordering will be adopted -- slowly. “Customers will adopt new e-business technologies when it benefits them, and limit technology usage when the technology does not help them,” according to the report. The phone, fax and sales rep will remain common modes of order placement despite the Internet and other new technologies.
3. Fee-based services will grow as an important source of revenue and profit. “Many distributors have fallen into a trap by providing services beyond product fulfillment ‘for free’ to generate competitive advantage and become a preferred supplier,” says the NAW report. “Instead of making up the additional costs through product margin on increased volume, distributors have been squeezed by powerful customers and deflationary product economics.
“The introduction of fee-based services is emerging as a logical evolution of the traditional gross margin pricing model for distributors. A shift from markup margins on product sales to service fees provides a more direct and accountable means of measuring value and functions in the supply chain. It unbundles traditional pricing models by splitting product prices from the costs of services. Distributors also have the opportunity to finally get paid for the service activities they provide to customers.
“Yet the ultimate success of fee-for-service pricing remains uncertain. Today, many buyers still have a very low willingness to pay for services that they used to get for free, even if they acknowledge the economic logic behind the concept. Some customers are already denouncing the fee-based service trend as self-serving behavior by distributors.”
4. The distribution salesforce will remain under increasing pressure. “Smaller customers, such as contractors or small industrial buyers, typically rely on a distributor's inside or outside salespeople to obtain technical and business assistance in product selection and use,” notes the report. “However, customers increasingly value the Internet as a source of product information, even though online order placement will only grow slowly.”
Consequently, the value of the sales rep in the eyes of the customer is changing.
“As Facing the Forces of Change [NAW’s last report] predicted, customers and purchasing managers are increasingly using the Internet to bypass sales channels and directly gather product specifications, warranty and rebate information, material safety data sheets and potential suppliers,” says the report. “The Internet overcomes traditional cost limitations of geography, time and number of customers, giving manufacturers an affordable way to take greater control over the information flow to the customer.
“In other words, online technologies are giving customers lower-cost, higher-service alternatives to a wholesaler-distributor’s salesforce. As a result, the role and activities of the salesforce of the future will be significantly different from today’s. When the role of a distribution salesforce has declined, as in channels such as pharmaceuticals or automobiles, distributor margins also drop, since the intermediary is adding less value.”
5. Customers will continue to concentrate their purchases through fewer distributors. The trend toward vendor rationalization by customers is expected to continue as they seek additional efficiencies in their supply relationships and buying processes, according to the report. “Wholesaler-distributors will either consolidate or join alliances in response.
“Vendor rationalization represents just one of the many changes occurring in business procurement in an attempt to improve inbound supply chain efficiencies. Facing the Forces of Change forecasts that business customers will continue to consolidate supply contracts, install e-procurement systems and experiment with reverse auctions.”
6. Manufacturers will explore new distribution options. “Another strategic uncertainty…is the emergence of new competitors to wholesale distribution in the physical movement of goods to customers,” according to the report.
“Third-party logistics providers, who have traditionally been package-handling enterprises, are moving ‘inside the box’ by offering product-handling services such as warehouse management, order processing, pick/pack/ship, just-in-time parts delivery and many other wholesale distribution functions. Manufacturers are also turning to logistics companies to provide ‘master distribution’ services to the highly fragmented industrial distribution channel.
“The implications of this logistics shift have already been felt in many lines of trade. Local distributors are able to stock less inventory and rely on the manufacturer—via supply chain logistics companies —to drop-ship to customers on their behalf. Manufacturers are reducing or eliminating stocking requirements for their authorized channel partners. And most important for wholesaler-distributors, manufacturers can more easily serve direct business.”
7. Manufacturer-distributor relationships will evolve. “Manufacturers and distributors continue to rely on each other’s actions and resources,” says the report. “Simultaneously, each side struggles to maintain autonomy and control over its own operations in this era of dynamic uncertainty. This mutual dependency creates conflicts about direction, strategy and commitments. Business relationships between manufacturers and distributors are not altruistic, nor should they be. Both parties need to perceive a benefit from the relationship.”
Action Steps for 2003
The seven trends suggest an “uncertain era for manufacturer-distributor relationships,” says the study. “Given new routes to market, many distributors are uncertain about whether their manufacturers will be investing in traditional channels during the next five years.
“At the same time, manufacturers know that the Internet can be a viable source of content but still be poorly suited to the buying behavior and requirements of customers. Few customers are willing to migrate their entire purchasing process to a direct relationship because it often means sacrificing local service, technical support and complex fulfillment requirements.”
Despite today’s economic uncertainties, the study’s authors are optimistic about the “staying power of distributors and their importance to the national economy.” They urge distributors in all industries to consider the information they have presented and make a commitment to the following three action steps:
• Understand which strategic actions make sense for your company to implement in the near term and which actions you can address later.
• Use this period of economic uncertainty to clarify expectations and define your role in the supply chain before the cycle turns again.
• Remember that the goal of strategic thinking is action, not just analysis.
“Make an effort to ‘lead from the middle’ of the channel, shaping the strategies of suppliers and customers while thwarting competitors,” urge the authors. “Plan wisely, play to win and expect to succeed!”
For more information on the report, including ordering information, visit www.nawpubs.org.
Consider the Possibilities
Pembroke Consulting President Adam Fein and his colleagues develop four alternative scenarios for the future of wholesale distribution in Facing the Forces of Change Outlook 2003, the new NAW report. By doing so, they hope that distributors will consider their “range of futures and develop strategies to address them.” Following are the four scenarios.
Scenario 1: Distributors fully integrate technology into their companies. “Customers want distributors to work with them seamlessly via multiple online and off-line communication interfaces,” suggests the study’s authors. “Distributors have successfully responded to this need and remain the primary route to market for manufacturers.”
Scenario 2: Customers seek more information directly from manufacturers. In this scenario, “Manufacturer websites provide current product specifications, detailed technical data and other information that helps customers select the appropriate product features,” say the study’s authors. “Distributors continue to take the customer’s order and remain the primary providers of inventory and fulfillment activity in the channel. Manufacturers and distributors use the Internet to collaborate on product, marketing and inventory management in the channel. However, distributors must provide information back to the manufacturer and must meet new performance qualifications.”
Scenario 3: Customers and manufacturers pay for only the specific supply chain and marketing channel activities that they require. In this scenario, “Distributors compete directly with supply chain organizations (SCOs) that specialize in a single supply chain or channel function, such as transportation, warehousing, logistics or sales and marketing,” suggest the study’s authors. “Intermediaries in this scenario are compensated on a fee-for-service basis that is tied to the number and type of activities performed on behalf of customers and/or manufacturers.”
Scenario 4: Groups of large customers have formed open and neutral nonprofit online exchanges. In Scenario 4, “These common platforms manage and automate the data translation and order placement processes between supply chain partners,” suggest the authors. “Many customers eliminate local buying decisions and rely on regional or national contracts that are managed by the common platform. Distributors have had to adapt to a new order process and to a new level of shared supply chain information with customers.