How to Select A Solid Core for Distributors

Sometimes, as in the case of Southwest Airlines when they started up, you are blessed with a clean slate, which affords the maximum degrees of freedom for making core business choices. In other situations, there are considerable constraints. However, by using the Profit Triad, you can answer three major questions to see if you can generate a competitive advantage. If you can answer positively to the following three questions, you have a good choice, provided that you have a passion for the resulting market segment:

1. Can you achieve superior density serving a market segment?

a. How do you segment the market?

b. Is the segment large enough to yield enough revenue and potential profit relative to the investment required?

c. Who are the leading competitors? What is your share relative to theirs? What are their strengths and weaknesses in his segment?

d. Can you offer a better product or service that this segment craves to get the density required for high return on investment? How?

2.        Can you be more productive than competitors in serving this market?

a. Sales (Front Room) productivity

b. Operations (Back Room)

i. Operations & Logistics

ii. Accounting

3.        Can you generate higher average gross profit per transaction? (Most often by broader product mix per customer)

a. Broaden product mix or quantity purchasing on each transaction

b. Sell more high ticket items more frequently

c. Optimize your pricing matrix

d. Optimize your SPA process: make sure your SPA process enters all pricing contracts accurately, timely, everything is claimed, claimed electronically and collected within 10 days

Three Dimensions Yield the Answers

Before doing the former exercise, you might assess your current position. That analysis gives you an idea of where you are and where you can go from there.

For example, I remember when I was asked to help out with product management planning at Cutler Hammer. I worked with the component and equipment product managers to dimension their product lines along three dimensions the way you would evaluate a portfolio of investments. The "Position" of the product line was based on three measures. I drew up bubble charts to show these measures, and the product managers and their department managers got instant vision of their positions, a must for sound strategy and decision making.

You can apply the same three criteria to evaluate your core.

1.        What is your current market share and share relative to the leader?

2.        What is the profitability of the product line?

3.        What is the growth rate of the business?

There can be some surprises. For example, modular metering equipment wasn't very profitable and Cutler had high share. That would normally cause you to plan an exit and source the product. But it was essential for pulling other products along with it. If you became cost uncompetitive, you would lose position on products with higher contribution margin. Be careful of disentangling "product bundles" that people buy together, or combinations that distributors buy from a major source, such as a distribution equipment manufacturer.

In residential lines, we clearly verified that there were two main positions in the market: the lower priced one-inch breaker markets and more premium priced ¾ inch markets. When we added up the brand shares, Cutler was not too far behind Square D. The only thing missing for Cutler to catch up to Square D in the ¾ inch market was enough distribution outlets, as contractors complained about this, but rated the Cutler Hammer breakers and loadcenters just as good or better compared to Square D.

I recommended this research to the residential products GM at the time, Dave Tallman. I crunched the numbers and Dave and I looked at the positions and designed separate strategies for the two positions in the market, dividing and conquering. That was all about defining the market positions correctly, and knowing what the value attributes were in each.

I remember another assignment at Thomas and Betts evaluating the lighting business. I was consulting to Dennis Sadlowski at the time. We communicated to the top brass that you had to take a specialist position and dominate that, or have a robust package in a product category. Rockwell, for example, took the specialist position in control and automation. There was only room for one in that space. All the rest took a broad package position combining distribution equipment and control products.

T&B had some good specialty positions, especially with the American Electric brand. They specialized in a product into a customer specialty: Utility Roadway Lighting, and had extremely high share. There are different alternatives for specialization: product, customer, and channel. If you can't dominate a specialty, you have a losing or weak competitive position. The other alternative is to go with the broad package that customers buy.

T&B had the option of buying LCA, one of the big lighting packages at the time and combining it with their lighting lines, which amounted to a pretty good position with emergency lighting and a strong hazardous lighting niche that was a good line but still third or fourth in the pack of competitors. They got into trouble right after I finished up with Dennis with a troublesome ERP transition and a little trouble with forward selling activities.

Hubbell ended up picking up the prize.

The next option was to get a lot of cash for the prize line: American Electric, and see what they could do with the odd men out: emergency and hazardous lighting. Better to trim the bush and concentrate on your real core: supply items. Lighting is a large specialty that you either get in with the package or you're going to scramble because the good reps have all taken sides with the big packages. So you get out of the mainstream and pick up some cash for the jewel. Good decision on T&B's part.

I can talk about all this now because it's been over for a long time.

What's the moral of this story? Let's apply the screen

1.        Profitability was good but slipping

2.        T&B had "back in the pack" share positions in all but Roadway Lighting. They were struggling to maintain position with the better reps in the territory so they had little hope of being number one or two

3.        Lighting was a cyclical business that was heavily dependent on construction activity. Long-term growth potential was ordinary.

Plus, it was kind of an odd duck for the T&B people. Dealing with lighting reps is a world of difference from anything else they did with "supply" type items, pretty much the rest of their portfolio.

How To Read Your Position: Five Rules

I am going to cover adjacency initiatives later, but everything in life is relative, including the position of the core relative to possible adjacencies. So I need to cover them now in the context of assessing the position of the core business relative to the opportunities the business has in the future. You'll see as I move through these points. Here's how to read your current core position:

1.        Make sure you define your segments as groups of customers in a geography or market "space" for which a set of defined competitors competes. Then measure your relative position in terms of the percentage of the leader's share.

2.        If you have a strong position in your core segment where the market has matured or is shrinking and have optimized your productivity, you definitely need to consider adjacency initiatives to grow at all and avoid the shrinking core trap.

3.        If you have a strong market position with your core, but productivity and profitability are not optimized, you should concentrate on that before loading any adjacency moves on the business.

4.        If you have a weak number 3-4-5 or worse position in your number one business, you probably shouldn't consider adjacencies. Consider merging with a competitor or competitors, or prune off the weaker performing segments and concentrating on one segment where the three "Profit Triad" questions can be achieved. That's what Sam McCamy did back in the late 80's and early 90's. It was gutsy, but it worked. Eventually Sam turned it around to where he ended up consolidating many of the weaker number 3-4-5 players in Chattanooga, TN. We diagnosed that territory and predicted a recession would take out a number of them. Roden bought their assets and consolidated operations.

5.        If the growth rate of your overall market is very slow or shrinking, adjacent market growth initiatives could save your company long term. You never want to be stuck with a shrinking core and no adjacency moves. That spells eventual oblivion.

In short, folks, it is  mid 2010 as I write this. Since we have a low growth market staring us in the face for quite a while, many of you should consider combining with other distributors or selling if you can get a good price if you're not willing to think out of the box and craete some adjacency opportunities. Right now, selling for a good price is almost impossible, though.

Others will have to prune and expand from there. Get rid of the unprofitable, losing segments of your business. Anybody with discernable strengths in the core should maximize those and add adjacencies, because adjacencies are essentially getting into someone else's knickers. In a slow growth or shrinking market, you don't have to depend on rising demand to carry your business this way. It's the only way to grow profitably.

The 8 Point Checklist for Making Adjacency Moves

These are the things that can make or break adjacency initiatives:

1.        Verify competitive positions. More wars have been lost by miscalculating the strength and location of enemy positions than just about any other factor except blind arrogance. Of course that and laziness are the two leading causes of failure to assess!

2.        Verify you know how to compete: what are the key value attributes? What are the key resources required?

3.        Verify that you have the synergies you thought you had. I've seen many companies buy electrical lines because they were bought by distributors, maybe even the same end users. But different people inside the building bought the different lines. So they got no synergy with their current lineup of distributors. Not enough distributors were strong at the acquiring manufacturer's lines as the acquired in terms of covering the different buyers inside a customer's building.

4.        Verify that you can muster the resources to compete. What equipment will you need? Where will you have to locate? What will your organization have to learn? If it's another distribution vertical, commercial reasons can drop you like a drunken fighter, for example: the lines may all be chosen. Many people trying to get into Datacom late found that out, and sadly. Low share lines will usually give you low share market positions. Make sense?

5.        Make sure that you can achieve leadership productivity. In other words, you can get your costs to deliver lower than competitors through density and productivity.

6.        Make sure you can generate high GP$ per order, and you know the marketing and sales tactics you will have to employ in each part of your organization.

7.        Make sure that the adjacency makes use of substantial core resources and allows you to achieve even greater scale. This is the surest way to increase ROI dramatically. Think about a commercial cleaning company that has the opportunity to clean, replace and sell floor mats. They already spend the money to be onsite at a customer, Make more GP Dollars while you are there.

8.        Make sure it will fit your culture, or keep it separate until you figure out how to blend the cultures. One usually ends up dominating the other. Coarse chases out finesse. You can end up killing good specialty businesses this way when you allow your meat eating price cutting construction people to push the same tactics on a specialty niche like electronics or automation.

For more, catch my latest edition to my Eight Steps to Breakthrough Business Growth Executive Video Series as a subscriber.