The 2020 Mid-Year Economic Update_long

Key Issues for Distributors in 2006

channels because of increased visibility. While this blockbuster deal shifts the competitive landscape dramatically for a few product channels immediately, and longer term potential threats elsewhere in other product sectors, it may offer some potential benefits in the near-term for those in search of an exit strategy.


Rising Costs
Health insurance costs continue to be a headache for many distributors, apparently without near-term relief. As health coverage is one key to retaining and recruiting quality employees and drawing younger workers distributors are feeling squeezed to find a way to provide competitive coverage packages while managing the bottom line. The health and benefits issue is compounded as the cost of providing coverage continues to outpace inflation and wage growth.


“We just continue to get hammered,” says one MDM advisor, Larry Goode, CEO of RT Dygert International Inc., a sealing products distributor based in the Midwest. His company has 45 employees, which he says gives him very little negotiating power each year when it comes time to renew benefits.


The volatile nature of fuel costs and raw materials is also challenging 2006 budgeting. Survey results indicate it’s a very conservative climate right now, in spite of some solid sales results in 2005. “Distributors have to continue to watch margins more closely,” Mechlin notes. “I’m seeing more distributors very focused on covering all their anticipated costs and then some.”


An economist for the Associated General Contractors of America expects the cost of fuel, asphalt and plastics including PVC pipe to average 10-20 percent higher than 2005 because of high petroleum and gas costs. Reuters recently reported that aluminum prices jumped by a quarter in 2005 to their highest level in more than a decade, and copper prices doubled in 2005, ending at a record high. Prices of palladium and platinum, used in catalytic converters, spark plugs and electronic systems, soared about 50 percent in 2005 and could rise another 10 percent by mid-2006, Reuters reported. One bit of good news: Steel prices are expected to have hit a plateau. But tungsten carbide prices remain volatile, hitting an all-time high in 2005.


The Economy
An eroding U.S. industrial market was the deepest underlying concern expressed by MDM readers in the survey. Many distributors voiced their need for more information on how to fight the outflow of manufacturers to Asia and other low-cost manufacturing hubs. More and more, parts are being manufactured overseas, brought to the U.S., and used for assembly here, noted one distributor. To fight it, a few distributors are figuring out how to move where their customers are. That’s a trend likely to continue in 2006 and beyond, as global barriers get less formidable for more U.S.-based distributors and more foreign markets stabilize to attract customers.


Goode followed one of his largest customers to China recently, opening a warehouse facility there in collaboration with another company. “It was not by desire so much as necessity,” he says. OEMs, which his company services, were the first wave heading to China. “In a lot of markets, if distributors don’t follow their customers like I have they are heading toward a downward spiral that will end up terminal,” he says.


Despite concerns of costs pushing down on the bottom line, many distributors are optimistic that 2006 could be a growth year, but off the pace of the past few years. Beyond the more specific concerns noted above, MDM readers are considering the impact of macroeconomic issues in the U.S. and globally, including interest rates, inflation, import competition and foreign currency valuations. One distributor summed up what looks to be the key question for most distribution executives in 2006: “How do we sustain the growth of 2004 and 2005 in a changing environment?”

Healthcare costs lead a laundry list of issues on the front burner for wholesale distribution executives as 2006 gets underway. Also on the list: margin erosion, the growth of national contracts, customers moving or expanding offshore, and a resurgence of mergers and acquisitions. MDM polled its readers in December to identify emerging issues, and also asked the MDM Editorial Advisory Board what they are hearing in their respective distribution channels. Here’s what we discovered.

With a solid year of growth under their belts, distributors are actively exploring ways to stay viable, whether it be expanding into other product channels or implementing value-added services to hold onto business. Those development activities were not on the radar screen a year ago, as many distributors were still emerging from a few difficult years of financial performance. Profitability and fighting margin erosion aren’t new issues, but they seem to be taking on new meaning as most distributors have enjoyed a few solid growth years. MDM’s survey findings indicate distributors feel there are even greater threats to profitability and growth than in the past.


Investment is increasing in both growth and cost-cutting initiatives. Survey respondents say they are implementing lean programs. They are also shopping and buying technology again. Acquisition and consolidation of distribution software solutions is causing large numbers of distributors to move to a new solution,” observed one distributor. At the same time, there is some real concern about attracting quality employees to support growth modes.


Channel shifts have also become front and center in many distributors’ minds. Due to the proliferation of e-commerce, “a customer can buy anything they want, wherever they want,” says Kevin Boyle, vice president for industrial distribution and channel management for the Loctite Industrial Division of Henkel Technologies. “That’s a key channel shift.” MDM’s survey supports that conclusion with the threat of the Internet a common concern. “The use of the Internet for information gathering and sourcing has challenged the concept of regional distribution,” said one distributor. Another said that expanding their presence on the Internet was essential for small businesses to effectively compete as both customers and vendors demand it.


Boyle says national accounts are also becoming more common and integrated supply is expanding. That’s posing some new challenges and complexity for channel management for manufacturers. “I think the growth of national accounts in industrial distribution is one of the factors attracting The Home Depot to this industry,” Boyle said. One distributor in the survey shared a concern that national accounts have caused a shift to where price is most important and past relationships are not always taken into consideration. Some see this national accounts trend as driving increased polarization. Noted one distributor: “There are no middle market folks left. There are either boutiques or huge corporations.”


To compete in this climate, distributors seem to be looking harder at their core competencies. “Independent distributors see themselves as much a provider of service and knowledge as tied to a specific product area,” says Stuart Mechlin, vice president of the Industrial Supply Division of Affiliated Distributors. “Increasingly, they are managing their service and knowledge capabilities as a brand to gain competitive advantage as much or more than any specific manufacturer’s product. The really successful distributors doing this are in a much better position to fight some of the other pressures on profitability outside their control.”


Meanwhile, 2006 is primed for another round of mergers and acquisitions. One consultant says the now-pending acquisition of Hughes Supply by The Home Depot may draw a new surge of investment into wholesale distribution

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