Earlier this year, I had the honor of moderating a panel on master distribution with two companies focused on the plumbing and piping industry. During this discussion, I took a quick dive into the rationale behind this part of the supply chain. Often referred to as two-step distributors, master distributors are often misunderstood and sometimes feared by traditional lines.
Over the years, I have encountered clients who believe their dominance in a market is undermined by the business model of master distributors operating in the same region. The greatest fear is access to lines and brands supporting only full-line distributors writing large purchase orders and carrying copious inventory amounts.
I am not against this philosophy, in general. I grew up in a supply house focused on heavy investment in select lines and appreciated this quasi-exclusive distribution arrangement. However, I would be remiss if I didn’t admit that master distributors were a large part of the success of our organization — and continue to be a large part of the line fulfillment strategy. Yes, I took the time to verify this with my brother’s purchasing director. Wouldn’t want to be one to exaggerate the truth — too terribly much.
A little history lesson. In speaking with one of my friends who manages a large purchasing team, he shared a little back story on why the two-step model came into existence in his industry. A few decades ago, in the pipe business, the larger steel mills decided to clean up the accounts on their books and essentially fire the customers who couldn’t meet a certain purchasing threshold.
I get it; handling a bunch of smaller orders is incredibly expensive and inefficient. Even if the pricing was higher, the mills couldn’t make up the difference in processing costs. When the smaller distributors got cut off, it left a giant hole in the market. Some of the largest distributors recognized that they could fill this void and sell to the smaller distributors at a premium. The two-step market was born.
As many of you know, this is not the only vertical enjoying a thriving two-step market. I recently had a conversation with my father, who started his career in the roofing distribution business. Along the same vein, there were big players and small players.
The original company he worked with was one of the smaller players snubbed by the big roofing manufacturers. It relied on master distributors to supply the product for its customers. And because the firm wasn’t able to get the deepest discounts, it had to out-hustle and out-serve the traditional market.
I have seen this model thrive in the door and hardware markets. I also have seen this strategy deployed on the commodity side of electrical distribution. This leads me to an important question: Is the model only viable when dealing with commodities?
The simple answer is no. My recent journey of discovery may have begun with two master distributors with more of a commodity offering to them, but I have met several players in this model who could hardly be accused of slinging nontechnical tonnage. In one example, a prominent HVAC distributor focused its business on a large, well-known brand that chose to pare down its customer list.
Similar to the steel mill example, the large entity realized it was too expensive to fulfill small orders to a wide array of distributors. Because this is a highly technical product with a vast array of different configurations, most distributors have a challenging time investing in the breadth of the line. To fill the void, this master distributor not only invested in the entire breadth of the line but is stocked to the point that makes an old inventory guy like me cringe a bit.
These folks invested heavily in warehouse automation and fulfillment so they could effectively fill the niche of small-order processing. When you order from this master distributor, you pay a premium — but it will be on your doorstep in days, not weeks. I could cite examples from dozens of distribution verticals. Where there is a scale gap between manufacturer and distributor, two-step distribution becomes a viable option.
Perceived Disadvantages of Master Distribution
As I mentioned earlier, master distribution does not always garner favor with owners of large supply houses. There is fear. One client, who owned a larger entity, was appalled to learn that a master distributor was in his company’s top five list of suppliers. He directed his purchasing manager to do what he could to minimize their use.
His argument? He didn’t want to support a business directly assisting the smaller distributors in his market. How was it fair that his company, which buys in copious quantities and carries the whole line of SKUs, needs to compete with smaller entities that don’t have to follow the same standard? Even if there was a pricing difference, it wasn’t enough to level the playing field. You might think this is a bit shortsighted, and you would be right, but it is not an uncommon sentiment.
Another common argument from full-line suppliers is that buying through two-step distribution, pulls from potential backend benefits even in an immediate pinch. For many distributors, rebates are the difference between positive and negative net profit.
This scares me when I see this with a client. Distributors should be net profitable in spite of rebates. Can you count on these programs long-term? A change of ownership or a new VP rolling in could spell the end of your program. Rebates are the gravy on top; they should never be considered the main course.
However, it should be noted that many of the more prominent master distributors have joined marketing groups, which provide rebate dollars to the members or set up individual programs with larger customers. This argument is beginning to fall flat.
Another argument against heavy reliance on master distributors is the lack of available marketing dollars. Now, this is not omnipresent in all verticals, but most manufacturers have some form of cooperative advertising program where they provide dollars to help distributors promote their brands. These funds were traditionally used for events, promotions, marketing collateral and logo apparel.
Today, these funds are increasingly spent on digital marketing and social media campaigns. Because these programs are becoming a larger part of the distributor spend, there is more reliance on marketing fund participation from the manufacturers. Generally speaking, you will not get this type of cooperation with your master distribution partners.
Advantages of Master Distribution
The arguments in favor of working with a two-step partner far outweigh the negatives. Sure, I could draw upon my personal experience, but wouldn’t you rather hear from those cutting the purchase orders day in and day out? It’s OK; my ego isn’t too bruised. I often draw on my facilitated workgroups for inspiration, and this topic was no exception. In my research, I asked members of my purchasing managers’ group for their thoughts on why master distributors are a viable and reliable part of the supply chain. They never disappoint.
One of the first key points was regional distribution. When teaching on the subject of distributor value, I often point out that local inventory is a great advantage for the customer base. Rather than having to source product from across the continent or a large body of water, the local master distributor can be counted on for relatively quick sourcing of material. Why wouldn’t the same ring true for these larger masters?
It has been especially true during this time of supply chain disruption. No longer can we rely on overseas shipments. With the recent port shutdown in Shenzhen, and the inflation of container costs, do we really believe the supply chain crisis is coming to an end? Most of my group agreed that we wouldn’t see a return to “normal” for two to three years.
I had a discussion with a friend whose company relies heavily on semiconductors to produce its products. He said the buzz in their industry is reverse globalization. This means they are actively looking at domestic and continental sources of supply. If this concept doesn’t play into the hands of master distribution, I don’t know what does.
Regional distribution mitigates high transportation costs. One of my group discussion members pointed out that it was more effective to use master distributors to supply his smaller branch locations. Direct shipment from a master produced a lower overall cost than using his own internal transfer replenishment methods.
Freight expenses, or higher product pricing, may be highly visible at first glance. However, when comparing this method of replenishment with traditional hub-and-spoke, many distributors fail to examine all the costs associated with the transfer. They see the lower unit cost and the freight but fail to look at the internal labor dollars facilitating the transfer process.
The ability to purchase smaller quantities of a brand without the burden of going direct has several advantages. One of the biggest advantages is the ability to fulfill customer sourcing requests without purchasing more than the exact quantity required.
Over the years, I wound up with leftover quantities of oddball product because I was forced to meet a minimum order quantity with the manufacturer. This is the inventory doomed to sit on the shelves for all eternity.
Our value proposition is all about easing the pain of our customers. In some verticals, sourcing and supplying nonstock product can amount to 30 percent of the annual revenue. Rather than rolling around to a dozen specialty distributors, it is far more efficient to consolidate our purchases with one or two strategic master partners.
On a funny side note, it was interesting to see the group realize that master distributors are often in their top 10 annual purchase volume. I have a theory on this. What kind of supplier takes up most of our headspace? Is it the easy business relationships or the ones causing us the most pain? I think we forget about our reliance on master distributors because they are so darn easy to do business with. Sure, they might cost a little more, but what is the ease of transaction worth?
Another key advantage of smaller order requirements and localized inventory is it allows us to be experimental. As distributors, we are the consummate sales optimist. We can sell sweaters in the Sahara. Before you all jump on me about it getting really cold at night in the desert, I get it. Just looking for a colorful analogy. You get my point, right? We think we can sell anything.
Because of our nature, we tend to go after new markets fairly regularly. Rather than begging for a relationship with a super brand, the master distributor offers us an alternative method of getting into the business. We can start slow and feel out a new opportunity. Instead of dumping a ton of money into this unproven venture, we can become the dreaded cherry-picker until it is prudent to go direct.
With the efficiency of some of our master partners, we may never want to.
The more I write about master distribution, the more I realize how important this segment is to the supply chain. There will always be times of customer consolidation by the major brands. There will always be holes in the market. Someone needs to allow smaller distributors to thrive.
We were all the small fish in the pond at one time in our history. We revert to small-fish status anytime we take leave of our sanity and decide to go after another customer segment. Big fish to small fish in a never-ending cycle. Master distributors help us with these transitions and allow us to mitigate global disruptions in supply.
Remember, they are still distributors. They think like us. They do business like us, only a little more focused. In case you were wondering if I am sponsored by the National Association of Really Awesome Master Distributors (totally fictitious), I can assure you I have not been paid for this literary endorsement. On the other hand, if any of them have an independent writer’s slush fund, donations are always accepted. Be well.