May 6, 2007

Dealing with the Intricasies of Distribution


The economics of channels can be cruel, avenging angel. Shifts in customer needs and expectations, buying patterns, technologies and economic conditions can rapidly redefine the factors for success. The personal computer industry provides a poignant example of just how quickly, and radically, such economics can change.


Over the last few decades, the proliferation of personal computers throughout businesses, educational institutions and the home has been a rising tide that attracted and carried many distributors. In the early years of PCs, manufacturers came to market with direct-sale organizations. But because of heated competition and dramatic declines in prices, PC makers quickly sought alternate distribution channels. Distributors such as DaisyTek, Merisel and MicroAge, and retailers like CompUSA and Micro Warehouse took off, offering buyers a range of choices and cost advantages. However, just four years later, nearly half the PC distributors were gone, and the carnage wasn’t over.


It is such reasons that one is unlikely ever to hear a distributor say it is a “simple” business. Channels are fundamentally economic entities. They exist to divide labor, add value and share economic rewards via the margins each party in the channel enjoys. When channels form, each level performs certain activities they can do efficiently and which add value. Typically, the margins enjoyed reflect the value added for say, taking title (risk), maintaining inventory, providing outbound sales, or offering toll-free information and service. Over time, the value of these activities may increase or decrease, as well as the ability or willingness of channel partners to execute them efficiently and effectively. If the existing channel fails to fix its economics, a new or reconfigured channel will emerge.


Many other industries are suffering from similar distribution convulsions. The office stationary channel faced an onslaught from large retailers like Staples/Office Depot, Office Max and Quill. Ophthalmologists have been sideswiped by direct mail sources of contact lenses, and neighborhood bookstores have been running fast to keep with superstores like Borders or Barnes & Noble and “virtual” bookstores like Amazon.com.


These channel revolutionaries are not all in the consumer product arena nor are they always outsiders. W.W. Grainger, an industrial and commercial equipment and supplies distributor is a strong example of a traditional company that kept up with channel changes. In business since 1927, Grainger offers its million-plus customers some 67,000 products, ranging from abrasives and air compressors to ventilation and welding equipment. It has never stood still. The company’s passion for efficiency and value added service is legendary. Grainger maintains more than $700 million in inventory at 350 branches around the U.S. and regional distribution centers.


Because of Grainger’s assortment, depth and proximity, customers are able to reduce their own MRO (maintenance, repair and operations) inventory by up to 60 percent. The company has an advanced on-line ordering system for customers. In 1996, Grainger put its 3,588-page catalog on the World Wide Web. It also offers consulting services to reengineer customers’ MRO materials management processes. This sleek and creative distributor generates a return on equity double its nearest competitors and four points above the average for all U.S. distributors. Clearly, Grainger’s management understands the economics of distribution.


The intricacies of distribution are not limited to economics, however. Power is a fundamental element of distribution and is ultimately rooted in the ability to deliver superior value to end users. Product quality should be thought of as the ante to enter the game: Great distribution cannot save a lousy product. But those who exercise power in channels can control the fate of specific products and services.


One of the most dramatic ways of gaining power is to rationalize a fragmented and inefficient distribution system. American Hospital Supply did that for hospitals years ago- about the same time Grainger began building its distribution network. What McDonald’s did for hamburgers and Blockbuster did for videos, Auto Nation and CarMax have done for the used car market.


The keys are often building the proper assortment (one-step shopping for hospitals), standardization (try ordering half a Big Mac), cleanliness (not just the absence of dust and litter), location convenience, courteous and quick service. In short, the design of these channels is based on insights about customer preferences, and they employ systems designed to deliver on those insights consistently. Mom and pop operators and third-tier national chains have a tough time competing.

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