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Last month’s column listed the Five Stages of E-Commerce in Wholesale Distribution. These five stages correspond to our research, observation and field work in the sector since 2010. This year was the benchmark for fast development of B2B e-commerce in durable goods markets and was made possible by specialized B2B software. In the past seven years, the distribution sector has embraced technology and change management to secure sales in a rapidly changing marketplace. Albeit the overall usage of e-commerce in the sector lags manufacturing, the pace of change is increasing and there is a Pareto of distributors, in different product/markets that tend to dominate online sales.
As the cost of software decreases, including SaaS options, we expect an increasing number of distributors to secure the technology available to offer a competitive online experience. In this installment, we discuss First and Second Stage firms and their reticence to move online.
Stage I blues
Our 2016 research of 170 distribution firms serving MRO/Institutional/Industrial markets found that some 60 percent of distribution firms sell less than 5 percent online. This is despite that more than 20 percent of sales that have moved online in the blended MRO markets represent some $120 billion in sales. Stage I distributors have maintained sales volume, but risk being left behind in the technology race with the 8 percent CAGR in B2B online sales. These mostly smaller firms have been able to defend their key customers against online competitors by creating specialized services for their Pareto Customers. Their fee-based service revenue, as a percent of sales, can easily climb to more than 20 percent of total revenues. Mid-size and large wholesale firms have found it difficult to capture sales from these mostly smaller firms despite aggressive competitive actions using technology.
Services for distributor customers have distinct advantages over traditional methods of competition including:
Our service research of 120 wholesale firms found that smaller firms invested in services to stop online competition and save their larger customers. Management is, for the most part, fully aware of services as a competitive barrier and some 60 percent of smaller firms expect to invest more in service development including technology and a new service development process.
However, customers show a strong preference for going online; even if this means splitting product sales from service sales. Our field work and research shows that more and more end customers are sourcing products online and the online experience gives distinct advantages over purchasing through traditional channels. These advantages are most notably a perpetual order window, reduced prices reflecting reduced operating costs, and more buying choices. Many distributor customers are breaking commodity purchases from other purchases for top suppliers. The buying risk of these products are low as the approved brands are known, functionality is standardized and verified substitutes are numerous. Hence, the position of smaller distribution firms, flush with unique services, is that many run the risk of losing their commodity sales from leaner and less expensive online competitors. As commodities in most distribution industries are over half of all sales, it doesn’t take a substantial drop in these product revenues to wreck the firm.
The upshot of e-commerce technology growth is that many distribution firms do not participate to any great degree in the technology. As the online buyer grows, these firms have reworked their value propositions with services to thwart more technically astute competitors. Our view is that this defensive strategy has peaked and smaller firms are increasingly suffering loss from firms with better online technology.
The Second Stage turnaround
Distribution firms in the Second Stage of the e-commerce life-cycle represent 20 percent of all companies; their online sales range from 5 percent to 11 percent of total volume. These firms, however, have taken a very important first step in moving online in that their top management has made a prior commitment to driving customer activity to the web. The timing of management’s online commitment is important. In the early stages of e-commerce (before 2010), the need for e-commerce was unknown but there was a general “buzz” in the marketplace that the technology was a must. This early market hyperbole was followed by distribution executives developing proprietary transaction engines for e-commerce- of which many are still in use today. However, these early proprietary systems don’t compare in functionality and customer experience with off-the-shelf software available since the Recession. Especially crucial are the use of transaction platforms and product information management (PIM) software systems. These options are crucial to a modern day online experience.
Second Stage firms that have added off-the-shelf software in recent years, are much more likely to grow their e-commerce sales and become Third Stage firms whose online sales range from 12 percent to 25 percent of sales. Why? The early proprietary platforms don’t offer the same customer experience as more modern technology. Their functionality and ease-of-use is less, product content is less rich and current, ordering errors are higher, and online buyers quickly realize the difference and move to the more current technology. Hence, how current the investment in online software has a lot to say about the ability of the firm to grow sales. Our research shows that firms with proprietary systems are starting to lose sales hence many Second Stage firms actually reverse performance to the First Stage.
Second Stage firms are more likely to be mid-market distributors — in the $50 million to $150 million in revenue range — and rely on their co-operatives and marketing groups to provide content. This decision to use outside generated content has both upside and downside. The upside is that monies can be aggregated to develop top-notch content and significant pressure is placed on vendors to comply. The downside to outside content is that it cannot easily and quickly be syndicated for different marketing events. Most distributors who source significant content from outside vendors don’t have a PIM. Unfortunately, this limits their ability to syndicate content, to any great degree, for different marketing events or to appeal to different customers with different needs. Without technology to do this, distributor online marketing efforts, involving product content, become stale and customers move to more informative and relevant sites. Our mantra in development and management of product content is that it is the online salesforce of today and tomorrow. If one outsources this function, they outsource proprietary ability to influence the buyer.
Decision to invest or divest
First and Second Stage distributors are behind the curve of online activity which, in 2017, is estimated at 25 percent of sales in core MRO markets and approximately 14 percent of all sales activity in Durable Goods distribution. Many of these firms have developed proprietary services for top customers and thereby reduced the ability of online competitors. However, the growth of millennial buyers, reduced product costs from online commodity specialists, and better technology all point to a time when much of the interaction between distributor and customer is done online and not through traditional sales and customer service. First and Second Stage e-commerce lifecycle firms are increasingly marginalized in their ability to compete for the customer and attract top name vendors. If management is not forthcoming in their investment in online efforts, soon our advice is to consider selling the firm; sooner than later.
In our next installment, we will discuss Third and Fourth Stage firms and the online competitors who will shape distribution’s next generation.