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The pond is getting smaller (and the fish are getting meaner)

Brent Grover offers his take on major changes taking place that are impacting the industrial supply channel

By Brent Grover

How is the accelerating pace of consolidation in the world of wholesale distribution affecting you and your company?

1. We're constantly looking at our options and figuring out how to thrive on change!
2. The rate of change is so confusing that we don't know what we're going to do.
3. Huh? Don't know what you're talking about.

First, a bit of history. You have to admire the resolve of the British during World War II. In 1939, under threat of invasion, the Ministry of Information prepared 800,000 of these posters as a morale booster "just in case." Thankfully they were never needed. On another historical note, Kevin Bacon's character Chip Diller came close to reviving this slogan in the movie "Animal House" in 1978 ("Remain calm. All is well!") but the original British poster was long forgotten until it was rediscovered in 2000.

Fast forward to the distribution business world of 2011. Can distributors afford the luxury of complacency about the sweeping changes on our playing field, including the accelerating rate of consolidation of competitors, customers, suppliers and service providers? Should we be preparing a supply of morale-boosting posters in case of "invasion" in the distributor marketplace? I will focus on three specific areas of particular and very current interest to wholesale distributors.

Mergers & Acquisitions
2011 is a year of high M&A activity for wholesale distributor companies. There are several underlying reasons:

• Acquisition valuations improved markedly with signs of economic expansion as "unusual uncertainty" gave way to "optimism with (or without?) caution" – in spite of fears of double-dip recession, potential default of Greek sovereign debt and other goblins in the worry closet.

• Financial buyer activity has picked up as private equity funds aggressively seek acquisition opportunities due to the vast amount (about $500 billion!) of "dry powder," capital committed by investors for PE fund investments. Impatient investors are pressuring the funds to put the money to work and fund managers are hustling to find acquisitions before investors' capital commitments expire.

• Middle-market wholesale distribution platform companies (generally at least $5 million of cash flow) are of special interest to financial buyers. There is also strong demand for "quasi-strategic" acquisitions of smaller distributors to bolt on to existing platform companies.

• Larger sellers are commanding much higher valuation multiples than smaller distributors that don't "move the needle" and lack competitive advantages of larger targets.

• As strategic buyers, larger distributors have plenty of cash on their balance sheets and lenders are willing to provide cash flow financing for larger transactions.

• Credit is still tight in the middle market (less than $50 million of cash flow) but overall valuation multiples are strong for the right platform distributors. Smaller distributors with solid track records and a good strategic fit with the buyer are also selling well.

It appears that the current bull market for attractive wholesale distribution businesses will continue for the next 12 months, in spite of recent shocks to the economy.

Electronic Commerce
Order entry via the Web has reached a milestone level of 25% of sales for some leading-edge distributors and the 50% mark is now in sight.

• Grainger reports that 25% (over $1.7 billion) of 2010 sales were placed on the Internet.

• Grainger projects that will rise to 40-50% of total sales within a few years.

• Thirty percent ($511 million) of 2010 MSC Industrial sales were entered through the Web.

• 233,976 industrial product SKUs were available on Amazon as of the end of last November.

Our feeling is that mainstream customers of wholesale distributors are (finally) adapting to the advantages of obtaining information and placing orders using the Internet. It seems likely that the use of electronic commerce will accelerate extremely rapidly now that the "turning point" has clearly been reached.

Information technology
Recent developments in the software world indicate that two major trends are unfolding: 1) the world's largest software companies are making serious bets on ERP systems, and 2) many software providers of popular ERP systems for distributors continue to combine with one another.

• Microsoft owns and is investing heavily in Dynamics AX, originally released as IBM Axapta in 1998 but owned by Microsoft since 2002. Microsoft completed the latest version of Dynamics AX, now supported in 45 languages, in 2009. Microsoft Dynamics AX includes 19 modules; the core package has been extended with modules such as Balanced Scorecards, shop floor control, service management and other functionality needed by wholesale distributors that offer value-added services such as converting and light manufacturing. External components also include many Microsoft products such as SQL Reporting Services and WorkFlow. Dynamics AX 2012 is coming.

• In April 2011, Infor, provider of popular distributor ERP systems such as SX.enterprise, A+ and FACTS, merged with Lawson, provider of M3. The deal makes Infor the third largest ERP vendor after SAP and Oracle.

• Epicor Software Corp. and Activant Solutions Inc. were acquired by investors in April 2011. The combined company has more than 33,000 customers in over 150 countries and over $800 million in annual revenues. Software giant SAP continues to penetrate the wholesale distribution market with products for mid-sized users such as the "mySAP All-in-One solution."

Our view is that smaller providers of ERP systems will continue to succeed only in niche areas, for example, wholesale distribution trade lines with highly specialized needs. The smaller software firms provide personalized service and support – but we feel it will be harder for them to compete with the vast resources of major international software firms. We expect that companies such as Infor and Epicor will now accelerate their plans to combine their legacy ERP systems for distributors.

Gentle readers, these three seismic changes in the wholesale distribution world promise to provide new challenges and opportunities for you!

Brent R. Grover is a nationally recognized distribution industry consultant, speaker and writer. An NAW Institute Fellow, he has written six NAW books including Strategic Pricing for Distributors. He founded Evergreen Consulting LLC exclusively to advise companies in the distribution channel. Two new books are scheduled for publication this year: The Sweet Spot: Strategic Planning for Distributors and In Search of the Perfect Customer: Cost to Serve for Distributors. Reach him at brent@evergreen-consulting.com or (216) 360-4600.

This article originally appeared in the Sept./Oct. 2011 issue of Industrial Supply magazine. Copyright 2011, Direct Business Media.

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