In the previous two parts of this series, we reviewed the financial and structural limitations to the dominant full-service distribution model and new convention(s) of solution selling online. To finish this series, we will review unique models for online commerce.
We differentiate unique online models as businesses competing with full-service distributor(s) with non-traditional models driven, largely, by e-commerce. There are, at present, a handful of model types competing with distributors and most were developed in the past 10-15 years.
The rationale for new business models in distribution channels
In early 2017, an article in the MIT Sloan Management Review, “The Best Response to Digital Disruption,” found that in global e-commerce, 47 percent of sales were due to new businesses or “digital entrants.” In essence, new business structures, started in the digital age, were taking a significant share from traditional brick and mortar/incumbent firms. They represented only 17 percent of companies but took nearly half of all online sales.
Our work in B2B channels, especially where established full-service distributors have dominated for decades, echoes this trend. There are a growing number of newer, “digital entrants,” which slice apart the B2B value chain in different ways. Many of these firms are below the radar on traditional distributors’ list of competitors. There is good reason for this. These competitors have little in common with traditional distribution, and most have few branches, few sellers, a different breadth and depth of products, and a very different value proposition.
New business models use technology to take cost out of the supply chain, give a quick and accurate online transaction, and drive productivity. They are highly targeted, lean infrastructure, and reduced-price entities that deftly steal sales from full-service distributors. It is important to understand the appeal of these firms and how they have succeeded online in ways that traditional distribution has had trouble with.
Traditional distribution started in the Industrial Age, as the U.S. was coming out of the Civil War. The industry provided a storage, transaction, credit, and local product knowledge solution for applications requiring different products from different manufacturers. Over time, distributors invested in brick and mortar locations, branch managers and sellers. This was necessary, as there was imperfect information in the supply chain where the customer did not know the product solutions available, if the product was close at hand, and the market price.
A preponderance of branches, excess inventory, and lots of commissioned sellers provided the solution for acceptable price and availability; but the cost was high. Additionally, sellers were paid on margin dollars, which makes all accounts, more or less, the same. Regardless if the account was industrial, commercial, residential, MRO, repair, OEM, etc., the seller sold as many accounts as possible within their geographic territory. Sales territories followed a Nuke LaLoosh model. Nuke, the lead character in “Bull Durham,” was a hurler whose pitches were “all over the place.” Today, we find geographic sales territories whose account types are all over the place. In short, margin dollar compensation drives an unsegmented model of business with very different accounts, which proliferates product offerings, local inventory, and unique services. Additionally, and over time, distributors in related industries began to buy-out each other. Today, full-service firms cover a variety of industries with numerous branches, sellers, and across diverse segments with unique product and service needs. The resulting firms are large and complex but expensive to operate. They are ripe for online plunder.
E-commerce technology, at its core, gives a self-service option. It gives adequate product information, content description, application information, price, and availability in real-time. The information is perfect or close to it. Hence the great reduction in the need for lots of branches, sellers who can advise on product performance, and inside sellers to hunt down price and availability. Also, new-age firms can target specific segments, which cuts down on SKUs and service complexity. They can easily spread their model across large tracts of geography at limited cost. Many, but not all, new age firms take their cost advantage to market as a price advantage. We often find where prices are reduced by 10 percent or so, and the firms have a ROS that is 2-3 times greater than full-service distribution firms. The effect of price advantage is evidenced by our research of the MRO/Industrial/Institutional sector in distributor online sales. In 2016, distributors sold 12 percent of their total revenues online. By 2018, this had fallen to 9 percent of revenues online. A big part of the online loss for traditional distributors are new-age competitors whose history started in the digital age.
Types of online competitors
There are four categories or types of new-age online competitors. They are listed in Exhibit I.
The first type of online competition is the Transactional model. In this model, there is a direct attempt to use operating efficiencies to drive a cost (read price) advantage. Transactional distributors have few branches, few sellers, and limited service diversity. They target broad segment(s) with an attractive price and great technology. An example of a transactional play is Zoro Tool, a division of Grainger. The entity started in 2011 as an attempt to secure small/medium sized accounts with an attractive price and limited service. The parent, Grainger, was positioned to serve large accounts with significant product variety and a high level of service. Zoro Tool’s price was significantly less than the parent, however the firm, as of the end of 2015, had online sales of over $300 million. Recently, Zoro Tool was launched in the U.K.
Transactional firms compete, primarily, on efficiency and top-shelf online technology that leads to a great buyer experience. They can be found in a growing number of vertical markets competing with full-service distributors. Prices are generally 10 percent or less than full service distributors and ROS is in the 8 percent range.
Thin-Slice firms are the next type of online competitor. These firms take broad segments and slice them several more granular layers to develop a highly differentiated online model with a customized feel. An example is Wilmar, a division of Interline Brands and purchased by Home Depot in 2015. Wilmar serves the multi-family housing sector. The “thin slice” comes from targeting multi-unit complexes with in-staff maintenance where the buyer is often the installer. The granularity of the segmentation gives a business focus that is custom-made for the segment. Hence, when targeted customers try out the thin-slice offering, they feel as if the site was made for them. Thin-slice entities can either compete on price driven by efficiency or at a parity price. They grow quickly and seldom have to worry about competitors. However, when they blanket their geographic market, their sales growth abruptly stops.
The third type of competitor is the Restructure the Value Chain entity. These firms often use technology to take cost out of the value chain, give a better online experience, and secure growth. An example is Civic Solar, which uses technology to design the entire solar installation and drop ship the components from a handful of manufacturers. Traditional distributors serving the industry keep common inventory on hand in numerous branches and seldom offer a guaranteed design option. Civic Solar has few branches and very specific sales people who sell solar installations. They have grown, rather easily, against traditional electrical industry competitors who are full-service distribution firms. Value Chain entities often use online configurators to take the “pain” out of the customer’s day-to-day operations. Sub-assembly and design/build services are often part of their offerings. By offering these services, they restructure the value chain, take cost out with technology, and assemble much of the finished installation before it is shipped.
Sustainable Supply restructures the value chain by offering numerous parts for plumbing, HVAC, and electrical markets. The company has excellent product content and search engines for parts including online break-downs. The content is supplied through close relationships with suppliers who have a large established base where quick identification and delivery is important to diminish downtime. To cover the hundreds of thousands of SKUs in various parts, Sustainable Supply drop ships them from the manufacturer. Traditional wholesalers often shun parts as they are numerous, small line sales, and difficult to inventory. Sustainable works around these constraints with expansive online content and drop shipping from the manufacturer.
The final online model is the marketplace or putting the buyer and seller together. Sites such as Amazon B2B marketplace and Kinnek are examples. These efforts take a fee from the seller to match them with a buyer. Fees are usually determined beforehand but payable when the transaction is made and shipment commences. In some instances, marketplaces take an upfront membership fee and let the buyer and seller transact as they wish without any transaction-based fee(s). Marketplaces, such as Amazon B2B, have the advantage of understanding SKU sales and who the buyers are. If sales of an SKU are significant, they can stock the product and sell it direct, cutting out their partners in the marketplace. In a backhanded sense, wholesalers who use marketplaces are paying for the possibility that they may lose the future sale to the marketplace provider.
The future of non-traditional competitors
We have found non-traditional competitors in many wholesale vertical markets. We believe there will be many more in the next decade and they will take a significant share from full-service firms. Today, in PHCP markets, we have non-traditional models such as Zoro Tool, Build.com, HVACDirect.com, and PlumbingOverstock.com. These entities are new-age and use e-commerce as their primary avenue to market. Generally speaking, they either bypass parts of the traditional channel while giving a better price or reduce infrastructure and take the cost advantage to the marketplace. We expect these models, and others like them, to grow against traditional wholesale distributors.
The digitization of traditional wholesale channels is business as unusual. If wholesalers try to combat new-age entities with their usual business model, they tend to lose an unusual amount of sales. The best way to combat new, online entities is to develop new models before they show up in your marketplace.