Channels add value to their members; more often than not this is accomplished by reducing supply chain costs while improving quality. This goal is usually accomplished by technology. As B2B commerce moves online, technology is opening up new channels, reducing costs across the supply chain and creating problems for less-efficient channels.
The core value added by wholesale distribution is the aggregation of different vendors to fulfill an order. If an average order has three lines, there’s a good chance it takes three manufacturers to complete it. Distributors break inbound bulk shipments, reassemble them into an order to fit a specific application and, we hope, generate more margin dollars on the order than it costs to fulfill.
Today, however, the core value added by traditional full-service distribution is being challenged and manufacturers are, if they are dedicated to preserving and growing their share, taking notice.
Channel Choices in Manufacturing
Manufacturer and distributor partnerships have a generations-old history of success. As manufacturers expanded their product lines, distributors were there to cover new accounts, geographies and applications. In many instances, largely because of consolidation, a growing number of distributors are larger in revenues than their manufacturers and control the balance of power in the channel.
Size, however, is not always an advantage. There are any number of examples of dominant channels and sizable channel members who have succumbed to new models of distribution that use technology with new business models to gain competitive advantage. This is happening, today, in industries dominated by full-service distribution. New models and new players are emerging who are challenging full-service distribution and manufacturers need to carefully examine their channel partnerships to make sure they are viable in light of new competitors.
In Exhibit I, we’ve listed the more prominent channels open to manufacturers that compete against traditional full-service distributors. Six of the entrants were not around a few decades ago (less-traditional full-service distribution and big-box stores). As online commerce grows, currently at 15 percent of overall B2B sales, the online channels will grow and challenge full-service distribution with their technology and, often, a lower cost-to-serve platform. We define and give examples of these alternate channels in the remainder of this installment.
• Transactional distribution. These entities compete with full-service distribution on a low-cost fulfillment platform. They have excellent product content and e-commerce capabilities overall. They usually have few branches with limited sales support. They may carry a full inventory in intraline-depth, interline-width and intraline-breadth. The overall M.O. to market is an easy-to-navigate website and a great price.
An example would be Zoro Tool (www.zoro.com), a division of WW Grainger. These models can grow quickly and take a sizable chunk of sales from traditional full-service distributors; competitive responses are limited and it is absolutely a big mistake to try and take them on in a pitched battle. For most full-service distributors, it is better to reexamine segments and move further in the value chain with services.
For manufacturers, transactional distributors are powerful and should be engaged if at all possible. Waiting to see if they succeed, beyond a certain length of time, is not recommended. Their quick growth can end up costing the manufacturer share by taking it from their traditional distribution. Initially, transactional distributors served the economic buyer but, today, we find many buyers try them and often move a certain amount of their purchases to these entities.
• Online marketplaces. These are an aggregation of different suppliers. Marketplaces come in all shapes and sizes but their primary attraction is the difference in product/service combinations available to the buyer. The best-known marketplace is Amazon Business, which launched in 2015 with sales of $1 billion. The entity crossed the $10 billion mark in 2018 and Forrester projects Amazon’s B2B sales will pass $25 billion by 2021.
Distributors are encouraged to view the possibility of partnering with Amazon Business as a supplier with the knowledge that, over time, Amazon is tracking sales volume and customer types per SKU. If the SKU reaches significant volume and Amazon can sell the customer segment on a direct basis, they probably will.
For manufacturers, marketplaces are, with few exceptions, essential to maintain their share. Approach with some caution as marketplaces are primarily sales and not service entities. If the product has a high need for technical support or post-sales service, the marketplace may not be the best option. But for commodities easily handled and shipped, marketplaces are worth serious consideration.
• Big-box/retail entrants. These players have been a part of PHCP channels for more than 30 years. The primary suppliers are Lowe’s and Home Depot. In recent years, Home Depot has invested in the contractor segments, especially with their online capabilities and contractor specialty stores. In the prior year, Home Depot contractor/professional sales grew to 45 percent of total revenues, as online sales grew 21 percent to represent 7 percent of total sales.
We see Home Depot as a big threat to distributors for the contractor/professional installer segment of the market. Its online capabilities are, for the most part, far more advanced than most distributors. The company recently set aside $1.2 billion to add 170 new stores/warehouses within the next five years with the goal of reaching 90 percent of the country in one day.
Manufacturers not reviewing the efforts of big-box stores may want to rethink their reasoning. We believe that, as e-commerce grows, these competitors will take share from their product and markets. These firms are large, can afford the latest technology and hire specialists to make it work.
• Online segment specialists. These firms are dedicated to serving a well-defined segment(s) with an online model. A good example is AZ Partsmaster (www.azpartsmaster.com), which serves the multifamily housing industry in the central Midwest. The company started in the 1980s but has added e-commerce as a vehicle for order management and growth. Its focus is multifamily MRO, which makes it a segment specialist. The company is a hybrid in that it has traditional branches and sellers but also e-commerce.
Another broad segment specialist is Sustainable Supply (www.sustainablesupply.com). The company is an online entity selling parts into the PHCP industry. Most of the parts sold are stocked at manufacturer sites. Sustainable Supply makes it easy for customers to find the parts they need; their advantage is in the technology and breadth of parts displayed.
Full-service distributors have difficulty in understanding segment or product/niche companies. Their market perspective is sales-driven, which translates to “sell everything you can in your geographic territory.” To craft a segment-driven strategy in a sales-driven industry is almost impossible, especially if this involves moving the company to self-serve over sales-assisted.
We see a great future for online segment specialists in a sales-driven industry. They have advantages of focus and efficiency driven from dedication to defined segment(s).
Manufacturers are often surprised there are online segment specialists within their product lines. This is often a sign of poor channel management. There are, within most distribution sectors, segment specialists. Many have made a successful transition online or started online and have grown. Manufacturer channel managers should carefully review the online presence of distributors within their market sectors to review the possibility of adding them as a partner.
• Online product-value specialists. These firms compete with full-service distributors but use a combination of online strategy and value-added services to differentiate their offering. An example is Civic Solar (www.civicsolar.com), which sells solar supplies to commercial and residential firms. The company competes with firms that stock solar supplies and sells them to contractors for jobsite assembly. It makes heavy use of online technology for ordering and communicating with the customer.
Civic Solar helps contractors design the individual job with its engineers and product experts. They then ship job-specific equipment to the contractor, often from manufacturer warehouses. The company has few branches and limited stock compared to full-service distributors and this gives them a cost advantage.
Another online product-value specialist is Hudson Tool Steel (www.hudsontoolsteel.com). The company heavily advertises online and gets customers to place orders online whereas competitors use traditional salesforces. The company also configures product to customer specifications with online tools. It is growing at significantly higher-than-industry rates.
Full-service distributors often have nascent product-value models within their firms. Generally, however, they roll them up into an overall “bucket” of value-added, fee-based services. If they would break them out and give them a value proposition, separate online M.O. and dedicated managers, they could have significant niche-growth firms within their portfolio.
Unfortunately, most distribution firms are so geographic territory/sales-driven that they have trouble understanding how or why they should specialize in an online niche value-added business.
• Online auctions. These are similar to marketplaces in that they have numerous suppliers for the customer. However, auction sites push for pricing negotiation between seller and buyer and often vet suppliers for buyers as a service. A good example of an auction site is Kinnek (www.kinnek.com), a site for the foodservice industry, among others.
In the PHCP sector, Plumbing Supply dotcom (www.plumbingsupply.com) and Supply dotcom (www.supply.com) are hybrids between transactional distributors and auction sites. The firms — located in Chico, Calif., and Atlanta, respectively — have numerous vendors and everyday low price(s). They have limited brick-and-mortar locations and limited outside sales presence. The firms are new, established within the last 15 to 20 years or so and will grow as the industry moves online and looks for efficiencies translated in the product price.
• Online inventory clearance. These sites are specialists in overstock, returned-under warranty or recently expired products. Sites include Plumbing Overstock (www.plumbingoverstock.com) and Liquidation dotcom (www.liquidation.com). These firms move devalued inventory online. Their connection to suppliers, including manufacturers and distributors, is essential to their business.
We expect their ranks to grow as more products are developed for more narrowly defined niches, especially in decorative sectors.
What to Consider with Expanding Channels
E-commerce has given new entrants a shot at the PHCP sector in ways that were scarcely imaginable a decade or so ago. Many of the online competitors have significant sales growth and profitability outpacing traditional full-service distributors. These firms often don’t look like traditional distributors in that they don’t have local branches, expanding product portfolios, numerous served vertical markets due to acquisition and lots of geographic outside sellers.
Instead, they use technology to give a sales-assisted experience and have limited geographic presence in branches and sellers. They choose a lean-operating model through technology and self-serve and plow the cost advantage into a price advantage. Manufacturers who are not reviewing these models as potential channel partners are likely losing share to competitors who sell them.
Full-service distributors who dismiss these competitors are missing out in several ways. They often can sell these firms as partners in the channel or start an online entity on their own. Ignoring them as a competitive threat, however, is increasingly foolish as most of these companies grow easily and quickly against full-service, asset- and people-heavy distribution.
Prior to these definitions, we have advice for manufacturers on evaluation of these channels.