Disruptive forces will likely have a transformative effect on wholesale distribution. In our previous two articles, we assessed the financial performance of the wholesale distribution industry and an array of disruptive forces already impacting participants. We also introduced a framework for harnessing these disruptions and the capabilities distributors will need to develop to successfully navigate the current industry inflection point. In this article, the third in the series, we discuss the final two parts of the framework: executing the value chain and energizing the business.
Many distributors have struggled to drive top-line growth, resorting to a steady stream of tuck-in/fill-in acquisitions. However, the additional physical infrastructure, IT systems and headcount when post-merger integration is not completed strains company earnings. Indeed many acquisitions fail to realize their potential as branches, DCs, customers, suppliers, delivery routes, product lines and inventory accumulate and calcify.
As they look to engage customers and deliver the expected experience, distributors of the future will have to extract the value stranded in their value chains and reinvest proceeds for sustainable differentiation. For inspiration, they should look outside distribution to examples such as Fast Radius’ creation of an automated, distributed manufacturing hub that leverages 3-D printing technology on the UPS Supply Chain Campus in Louisville, KY. These and many other truly innovative technology and business model innovations are reshaping the end-to-end distribution value chains.
Execute the value chain
Distributors of the future who execute the value chain will continue to offer high fill rates on A, B and C items and on-time delivery; they will harness a broad ecosystem and invest in new capabilities. But their journey starts with extracting stranded value.
There are multiple, analytically driven approaches that distributors can leverage to help extract stranded value (see Figure 1). Proceeds from these foundational initiatives can be used to help fund investments in more forward-looking, transformational opportunities. Explicitly linking the initiatives at the inception helps build organizational excitement and maintain focus on long-term value creation.
A relatively quick assessment of current performance vs. leading practices and benchmarks can assist distributors in prioritizing investments in these areas for maximum benefit. Here is some additional perspective on four of the improvement areas.
A significant source of distributor gross margin leakage can be found in their management of vendor rebates, chargebacks and deviated pricing. Based on research from Deloitte Consulting, typical distributor EBIT margins are around 6 percent and rebates range from 5 percent to 10 percent. As such, it is no exaggeration to say that effective rebate management can make or break a distribution business. There are many potential sources of rebate leakage, including: new items added with incorrect rebate amounts, poor tracking of vendor agreements that include marketing incentives or rebate tiers and not updating systems to pass along vendor freight charge increases.
Quick-hit areas for benefits include shifting spend to maximize incentives across manufacturers, reducing rogue spend, tracking compliance, and empowering the organization with insights (i.e., true net/net cost comparisons) to negotiate more effectively with suppliers.
Distribution businesses tend to be very good at adding to their portfolio and touting the number of items in stock, but they can struggle to rationalize their portfolios. The application of SKU management analytics can reveal duplicate items and significant hidden, non-value-added cost. Variant tree analysis of the nitrile glove assortment at one MRO distributor revealed 73 different SKUs (color, thickness, manufacturer, powdered, powder-free, pack size, etc.), but just eight of those SKUs generated 55 percent of unit volume at a higher margin than other SKUs – and customers were completely indifferent about many of the attributes driving the SKU count higher.
If given a clean sheet of paper, most distributors would likely position DCs and branches, stock inventory and route deliveries very differently than their existing network. Too often distributors have grown via acquisitions and accumulated a disjointed, duplicative network. As a consequence, much of the value
they expected to realize from the transactions is left – metaphorically speaking – on the shelves of the DC. A network optimization that assesses both product flows and operating footprint can surface opportunities.
A growing number of distributors are applying advanced analytics to their most sacred of assets – their inventory – and more effectively managing the trade-off between service levels and stock levels/locations. Traditional thinking is that distributors must manage a direct relationship between service levels and inventory levels. Graphically this relationship takes the shape of a curve, and by changing performance, distributors can move up and down this curve. However, application of proven analytics and supply chain process improvements can shift the curve, allowing for reduced inventory levels and improved service levels.
In other instances, distributors engage directly with customers to validate service-level requirements: Are current service levels higher than customers actually need to efficiently run their business? It may be that distributors could reduce inventory levels without impacting customer satisfaction. Questions distributors might ask include: Do you really need items delivered overnight or is two-day fulfillment acceptable? Would you rather receive a single bundled order than multiple orders each week?
Harness innovation to create new value
Executing the value chain effectively also requires that distributors harness innovation. Distributors looking to create “moats” and sustainable differentiation may want to assess the internet of things for their business.
Many underlying IoT technologies, such as tags and sensors, have already passed the pilot stage creating near-term opportunities for distributors to create new sources of information that they can monetize. For example, a waste-to-energy cogeneration facility may place great value in knowing the timing and composition of inbound loads, as well as projected energy needs of its service area. If enough high-energy coefficient materials are inbound, a utility can avoid purchasing fuel, improving profitability.
The true power of IoT isn’t the technology but the business model innovations it enables. Construction companies that previously relied on a fluid power or bearing distributor for their MRO needs as parts failed can contract for predictive maintenance that leverages sensors and tags embedded in equipment. In foodservice, increased information about cold chain integrity and humidity conditions during storage and transport can help operators reduce spoilage of meats, fruits and vegetables. Applying IoT to an existing business process in a small scale pilot can be a low cost, low risk starting point.
Other innovations include exponential technologies, such as drones, additive manufacturing, driverless vehicles and robotics. Innovations in this domain occur in fits and starts and often move in unpredictable directions, but leaders are already experimenting. At least one distributor Deloitte Consulting has examined has explored leveraging drones to assess the condition of utility power lines and towers following a storm. While widespread adoption of these technologies may be several years down the road, distributors should consider potential applications of these technologies.
Energize the business
Too many distributors continue to view IT as a cost to be managed or minimized. Few distributors operationalize aggressive use of IT for real action and incremental investment. To effectively energize the business (versus just enabling it), distributors need to leverage digital ERP and edge applications, embrace big data and analytics, and right-source IT infrastructure, apps and services business.
Distribution is among the last industries to make the transition to packaged ERP solutions and the expanding universe of edge applications. Perceived implementation risks, competing priorities and a false sense of security about the ability of legacy systems to support changing business needs have kept distribution lagging.
Advances in technology and implementation can be applied to reduce risk, even as the risks of not embracing a modern ERP grow. Some factors to consider include:
- Variety of sales channels supported (e.g., vending, consignment, VMI, CMI and digital)
- Product portfolio expansions and customized, configured, complex and bundled offerings
- Ability to accurately cost and price value-added services
- Efficiency and effectiveness in areas such as pricing, rebates and other variable drivers of profitability
- Complexity and timeliness of customer cost-to-serve calculations
Today’s leading ERP packages leverage flexible and modular core architectures, extensive middleware and in-memory databases and they leverage partners’ agile implementation approaches to mitigate risk,
accelerate implementation speed and reduce cost. Agile bolt-on applications and extensions further enhance the flexibility and scalability of the solution. ERP implementations create opportunities to transform your business with streamlined processes, centralized back-office functions, new service offerings and a better understanding of business profitability.
Many distributors believe that their business and processes are unique and a source of differentiation. The truth: Most processes are standard, repeatable or otherwise handled by out-of-the-box ERP solutions. Finding the right balance between standard application and needed customizations requires 100 percent engagement from affected business functions and knowledgeable implementation partners who can introduce best practices and challenge where necessary.
Embrace big data analytics, BI and master data management
Few industries are as awash in complexity and underused data as distribution. Without efficient means to capture, store, analyze and act on this data, wholesale distributors large and small are likely missing opportunities and losing competitive value. Data is the fuel for transforming the customer experience (e.g., what cross-sell offer will resonate), executing the value chain (How many nitrile gloves should I stock?) and improving financial performance (What gross margin will I realize with a 1 percent price increase?).
One of the primary innovations with great potential for distributors of the future is in-memory computing. The ability to conduct on-the-fly, what-if analyses in real-time will be a game changer for those with the vision to transform the way work is done as a result of these innovations. It facilitates asking questions about how my business would look if:
- Sales reps could model the cost-to-serve and profitability impact of different service-model scenarios in real-time with customers
- Real-time allocation decisions regarding scarce inventory could be made based on customer lifetime value and competitive analysis
- CFOs could close the books in hours – not days, monitor the performance of the business in near-real-time and conduct extensive what-if scenarios
Competitors like Amazon already apply big data analytics to continuously improve every facet of the customer experience.
Right source IT infrastructure, apps and services
But what about the cost of all these investments? How can a distribution business with 1 percent to 3 percent net margins possibly fund all the required infrastructure, application and service investments and organization?
While advances in technology and their adoption create a compelling need for the outlined capabilities, they also help reduce the cost, complexity and potential risk of the investments. These innovations – which we put under the umbrella of right-sourced IT – include cloud technology, in-memory computing, software as a service, web applications and other hosted/outsourced models for application development and maintenance.
The flexibility of dynamic cloud and SaaS also creates a new competitive dynamic in the industry (small distributors are able to harness technology innovations) and fundamentally rebalances the risk and cost. Cloud-based innovations offer financial flexibility by creating a more variable cost structure and providing greater transparency into IT costs and usage. They also offer more rapid deployment and scalability, an unparalleled ability to access upgrades and innovations, and leading security and resilience capabilities.
New vs. old complexity
Distributors of the future will have as a core competency the ability to chart a capability road map that puts energy behind the aspirations of the business to assess myriad options. Implicit in this road map-building exercise is a well-developed ability to assess available and emerging options, quantify benefits and costs, and mitigate change management considerations.
Effectively harnessing these innovations and aligning the organization behind them involves a visionary CIO who can work hand-in-hand with the business, as well as third-party suppliers and service providers. More distributors are waking up to the reality of industry disruptions and the inflection point – and looking to technology to energize their businesses.
Beyond functional leadership, distributors of the future will also transform their IT organizations in terms of structure and skills. Factors influencing these decisions will include corporate culture (e.g., highly decentralized decision making), geographic scope of the business, customer segmentation, branding and digital aspiration.
While the distribution industry faces a true inflection point and the decisions and investments appear daunting, leaders are building the capabilities to position them for the next phase of the industry’s evolution. Winners will emerge and deliver the financial performance that allows them to create further differentiation.