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The Distribution Model and Change: Nothing is Forever

by Frank Hurtte

The roadside is littered with the charred, cast away remains of obsolete business models. We’re not talking obscure fads like the Pet Rock Store or Chia Pet franchises; mainstream stuff most of us never dreamed would someday be road-kill along life’s highway. Here’s a short list. Pay phone franchises, VHS movie rentals, dial-up Internet service, encyclopedias and, arguably, travel agents are either gone or irrelevant. Now let’s turn inward and do a bit of self-examination.

We are all part of the wholesale distribution model, but the term really doesn’t differentiate between distribution in our fathers’ day and today’s process. The basics are the same; we buy stuff and sell it to customers with a reasonable gross margin. And while that description applied from the late 1800s onward, a peak under the hood reveals the comings and goings of telephone service, cars, computers, the Internet and instant information.

For knowledge-based distributors (those who sell more than just a brown box with a part inside), the last major change in the model began in the Carter-era recession of the 1970s. Just as North American distributors entered the first major modern economic slowdown, their business model was hit with a couple more “game changers.” First, buying patterns shifted under the weight of the newly emerging UPS and FedEx logistic systems. No longer were distributors protected by the geography surrounding them. Some distributors never adjusted; their companies were either absorbed by others or dissolved completely.

Technology (as primitive as it seems today) challenged the model, too. The fax machine only provided a brief glimpse of information yet to come, but distributors felt the first margin pressures as purchasing departments used mass faxing of RFQs to an ever expanding troupe of distant distributors. The search for lower pricing was on.

A Half-Century Old Model
The result of these shifts and several others came by way of a tweak in the distribution business model called “Value-Added” selling. The concept is best summed up as a distributor-customer handshake deal that reads (if it were ever written out):
“Buy products from our distributorship and we will provide non-product services that justify our slightly higher price.”

For years this premise mostly worked, but as value-added nears the half-century mark of its existence, a good many external factors nick and chip at a model’s usefulness. Time changes everything, but in the case of our 50-year-old model, a handful of situations impact distributors most directly.

The cost of most products is going down
The ratio of product price to expected life continues to drop, creating increasingly better deals for the customer and negative results for the seller. Simply stated, stuff costs less and lasts longer than ever in history. Distributors discover they must sell more units to make the same money. Even if the gross margin percentage remains the same, we handle more widgets to keep our business afloat.

Universal information drives down prices
Just like the fax machine before it, the Internet and the price-driven tactics of discount sellers applies continuous pressure against the old business model. Referring to our agreement above, we promised to charge just a little more because of our service. Even though most customers profess rock-solid love for the mass quantities of service and expertise distributors provide, purchasing departments still leverage the lowest priced discount guy to drive our price down.

Hundreds of thousands of times a day, knowledge-based distributor sellers must match the price of the low/no service guy. They call it getting a “last look.”

The complexity of products and demographics have reached a perfect storm
Further, products and their application and selection have become increasingly complex.
Customer assistance and training may be required even with relatively low-cost products. Government regulations join programming and configuration in creating a
high-pressure stream of customer needs washing over our industry. The cards are stacked against the trainer in a game of keeping customers ahead of the curve. At the same time worker demographics are shifting and millions of Baby Boom generation workers are taking their product and application skills to the shuffleboard courts of Central Florida.

Customers are addicted to our services
Distributor sellers continue to offer up more and increasingly expensive value-adds to need-hungry customers. What used to be an informal product familiarization session is now a half day of free engineering. The JIT delivery scheduled for the maintenance dock now involves taking inventory and putting away stock. Customers have re-engineered their companies for outsourced services and distributors fill the need. The problem becomes who pays the bill.

The distributor’s share of the price tag for this kind of service has gone through the stratosphere and continues to climb. Whole new groups of non-selling and customer value creating individuals populate the office cubes of distributors across the land. Research conducted by River Heights Consulting for the National Association of Wholesaler-Distributors Institute for Distribution Excellence reveals that more than 75% of the distributors serving North American industry employ specialists, application engineers or a combination of the two. While I am convinced that properly deployed specialists enhance the distributor’s bottom line, I am equally convinced this stable of qualified help is expensive to feed and care for.

The distributor business model needs some work
All these points line up to convince me we are using an obsolete business model. The value-add thing so many distributors cling to is done. Like the operator of the local movie rental store, we can cling to the old model, sucking every drop of profit from the operation until all that remains is a boarded up store front, or we can modify, adapt, evolve with the reality around us.

For knowledge-based distributors, the guys who provide application assistance, engineering support, training and other real service along with their product offerings, I believe fee-based services are an essential part of the future. Discount distributors that compete by providing the lowest price in the market won’t be affected. Nor will logistics-based distributors whose calling card reads “We have everything by UPS tomorrow” will be immune too. It’s important to know who you are and where you stand. From where I stand, the majority of the independent distributors serving our industry are in one way or another knowledge-based. They need to start seriously examining fee-based service now.

What stands in the way of a new model?
I don’t purport to be the first person to speak up in behalf of fee-based services within the distributor channel. Any mention of new migrating to a new model was met with five angry shouts.

The Legal Play – Charging a fee for services opens our company up to a number of liabilities we currently don’t face. It’s a litigious world out there and collecting a fee for our work is akin to looking down the barrel of a high-powered rifle with a Philadelphia lawyer ready to squeeze the trigger.

The Competition Fear – If we charge for services and our competitors don’t, customers will swiftly take their business and go home. We’ll lose money and market share. We’ll go broke.

The Compete with Customers Issue – Some of our customers will be concerned with a move into the services business. If we go into the services business, it will drive a wedge between us and create enemies. We will lose the customers and everything they buy from us.

Our Supply Partners have an Issue with Services – Some supply partners have established service groups. If we begin charging a fee for our services, we jeopardize the relationship. Other partners are concerned that our fee-based service offerings might impact their market share as we lose customers based on Nos. 2 and 3 listed above.
Unbundling of Products and Services Concerns - By separating products and services, customers will come to know our internal pricing structures and use these against us in the marketplace. Basically, we will give away easy margins and never recoup the loss through services.

Neither time nor space allows us to give each of these concerns their proper attention. Instead, let me say, these are real. If distribution were easy, there would be no need for the cadre of skilled managers strategically guiding industrial suppliers into the future. However, it is my hope that each of the automatic responses above be carefully examined and explored with expert care. For instance, in the “Legal Play” wouldn’t it be nice to speak to an attorney with experience in the matter? How do service-based companies cover their liability? Are liabilities there when no fee is charged and the service is bundled with products? I ask you to have a rational data-rich conversation.

Finally, I sincerely believe distributors need to migrate into fee-based services. I believe the move to fee-based services is fundamentally important for the continued health of our industry. I put my thoughts into a book called The Distributor’s Fee-Based Services Manifesto. It’s available on Amazon. I’m not asking for you to buy my book (although I would be honored if you did). I’m not asking that you agree with me on the topic. However, I do sincerely hope you to put solid objective thought into the topic.

Frank Hurtte provides Strategic Insight for New Times. He speaks, writes and consults on the new reality facing distribution in a post-recession world. He has a new book called “The Distributor’s Fee-Based Services Manifesto.” Contact Frank at River Heights Consulting via email at frank@riverheightsconsulting.com or via phone at (563) 514-1104.

This article originally appeared in the Nov./Dec. 2013 issue of Industrial Supply magazine. Copyright 2013, Direct Business Media.

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