Time to Reduce Frictions

Past articles in the Wall Street Journal traced demand for an electronics product all the way from the consumer-facing retailer, Minnesota-based Best Buy,  around the world a couple times, and finally to a California machine tools shop near the opposite, upstream end of the supply chain.

As the Journal shows, the chain doesn’t really function as a unified system. It’s more a series of one-to-one contractual interactions. Separate pieces only connect with each other in a logistical sense.

Almost miraculously, and not through any real planning, the product (a DVD player) takes shape as it progresses from supplier to supplier back to Best Buy. Nobody in the process has a clear idea what’s happening with everybody else.

In good times, this crude set-up works well enough. But when demand or supply shifts suddenly in one part of the chain, the others get jolted. The thing is, because the data and strategy linkages are so weak, responses to the change in one place are apt to be too big in some places, too small in others. As a result, upstream suppliers have been caught with millions of dollars in unsellable excess inventory and the need to lay off much of their workforce.

Downstream, retailers haven’t had enough inventory to catch the wave when buying restarts.

I’m delighted to see this important issue getting press coverage. Businesses have to get much, much better at working together as integrated routes-to-market systems. Technologically and operationally, giant suppliers like Procter & Gamble and giant retailers like Wal-Mart have been discussing and dabbling in this for years. But strategically, “partners” in a value chain system rarely work together as partners.

As the Journal article shows, there is an urgent need to shift from frictional relationships to smooth ones.  And that is fundamentally the new generation's top management challenge.

Boeing: Don’t Give Up on Giving Up Control

Boeing and its CEO, James McNerney, have recently received high-profile coverage; both plus and minus.

Point: The relevant portion from my distribution angle concerns the apparent breakdown in Boeing’s partnership arrangement. I say, accent the positives.

Briefly, the world’s biggest aviation company has come out way ahead of archrival Airbus in the orders department for its latest commercial craft, the Dreamliner 787. That’s the plus side.

The minus is that Boeing has run into turbulence in its supply system and is having big trouble fulfilling the first of those orders booked. Part of the reason is that the 787 is the first major aircraft built with carbon-fiber plastics that are high strength but new technology; new technologies always have break-in challenges.  The other reason is that Boeing outsourced the design and fabrication of large component assemblies, such as the entire wing structure. At the same time, it coaxed (if that is the word) these ‘Tier I’ integrated solution vendors into waiting for payback and a share of profits when Boeing itself started receiving checks from end-customer airlines as they took delivery of their planes.

Suppliers can do handsomely for themselves in a Boeing-like arrangement . . . if they can deliver.  Unfortunately with the 787, some could not, at least initially. Boeing itself has since backed off from the integrated solution amd partner-dependent arrangement that was its own idea in the first place. The Times reports that “the company is retaking control.”

Counterpoint: Given the stakes and what’s happened, you can’t fault Boeing for retreating into command mode. But we shouldn’t generalize. Boeing was not unwise to attempt heavy reliance on lead suppliers.

I favor relationships of the kind Boeing bet on initially. When enterprising upstream distributors or suppliers package multiple products and helpful services into unified platform solutions, that’s terrific – especially in cases like Boeing’s. Management was trying to get to market fast, years ahead of Airbus. Could Boeing have hit that market-driven deadline if it insisted on owning  all the design, testing, and integration tasks itself? I don’t think so, and neither did Boeing. They were justified in taking the risk. That they have pulled out of the production dive before crashing proves my point.

More generally, should downstream OE assemblers like Boeing never surrender design supervision and close control over production quality? No, that would be the wrong conclusion to draw. The right conclusion is this: Partnerships aren’t easy. They absolutely demand good communication, fair dealings, rational division of labor, and most of all trust. Earned trust.

The Times article implies that Boeing made a good faith effort to put those elements in place.  If so, we should be optimistic for Boeing. Its problems will sort out and production will coalesce.  The planes will get built, and when they do the money will start flowing in. Ultimately Boeing and its Tier One vendors will be happy, very happy.

Healthcare Distribution - A Must-Read

In my twenty-five years of work on distribution strategy, I have never read a more fascinating analysis of distribution system challenges and opportunities as the one recently published by Dr.Atul Gawande, a surgeon, writer, and a staff member of Brigham and Women's Hospital, the Dana Farber Cancer Institute, and the New Yorker magazine.

If you have not yet read his piece in The New Yorker, I strongly encourage you to take the time. It's an absolute must-read analysis for anyone interested in designing and managing higher-performing, lower-cost complex distribution systems.

Enjoy!

Safer Foods Take Closer Cooperation

Responding to a rising tide of safety problems, the U.S. Food and Drug Administration has just announced that it plans to start coordinating with peer agencies in other countries, where some of these problems have originated. A spokesman says, “For us to do a better job at home, we have to do a better job with our counterpart agencies around the world.

The Associated Press reports that the FDA now has offices in Asia, Europe and Latin America, that the agency is “moving beyond border inspections” and back up the supply chain overseas.

It’s a sign of the times. Organizations must take more responsibility for assuring their own constituents about just what their disparate (and often distant) partners are doing. Increasingly, we are what we guarantee.

In a complex value chain, guarantees take cooperation. Just as the FDA is starting to realize it can’t do its job alone, so also must the manufacturers and retialers involved in the overall food industry. They must get more collaborative in how they share information, determine who is best qualified to perform specific safety-enhancing activities, and negotiating how much each activity is worth in the overall scheme of providing value to the end customer. Cooperation to this degree and of this importance takes more effort, new skills, and new-found diplomacy at the top levels of management teams across companies.

Let’s not be naive. There have been similar but cautionary situations where a company invested heavily in social benefits and received no recognition from customers for leading the charge. In the 1990s, Frito-Lay was first to reformulate its products for reduced cholesterol content. But even today when we think of high-fat foods, what comes first to mind? For many, its Doritos, Tostitos, Cheetos, and Fritos.

It won’t be any easier for brands to achieve competitive advantage by doing “the right thing” in safety. But branded manufacturers owe it not only to consumers but to themselves to try. Whether they want it to or not, the safety bar is rising. It’s an opportunity as well as a burden. And smarter cooperation within their value chains is one way for brands to prevail over retail private labels.

Togues Off to Sysco

Kudos to Sysco, the world’s biggest broadline food wholesale distributor. And hats off to Business Week for catching them doing it right.

Restaurants, Sysco’s prize customer group, are teetering on the brink. It doesn’t matter whether they are big chains or small independents, upscale or downmarket, virtually without exception they’re starving for business as consumers stay home more to eat.

As in any vertical value chain, when the retailer suffers so do its suppliers. So Sysco is stepping up to help restaurants. It’s offering classes at its warehouses to teach better and more economical cooking techniques, showcasing foods and ingredients, and generally trying to give its business customers the boost they need to stay alive.

"The company has a weapon it hopes will save customers and lead to greater market share during the slump: a free consulting service called the Business Review. Along with selling cases of napkins and three-gallon containers of ketchup, Sysco is using employees . . . to help clients design menus, train waitstaff, and market their businesses. The company has turned its warehouse kitchens into schools for its customers. "We felt if we could improve their business, that would improve our business with them."

I love this! In many industries, when business is off, manufacturers and distributors don’t respond this way at all. They don’t bend to the task of improving their distribution system. They step up their advertising.

There’s nothing wrong with advertising. But isn’t it great when companies make a material contribution rather than a symbolic one? And maybe in this new (hopefully temporary) economy, material contributions will start to get the recognition they deserve.

Postponed – And That’s a Good Thing!

Why would a Chinese fabric supplier buy a downstream furniture manufacturing customer in the U.S.? As a fascinating look at the furniture business in today’s Journal points out, labor costs in China are under $1 an hour whereas they’re closer to $15 in North Carolina. Doesn’t that mean more expense for the furniture supply system, not less? Labor costs do turn out to be part of the answer, but to get at the real answer, you have to read between the lines.

In a word, the answer is what distribution and supply chain academics call “postponement.” Component value added and final assembly activity is delayed longer in the system - typically closer to end consumption points, to reduce the risk (and costs!) of big inventory and availability bets placed long in advance.

In fact, in a under-appreciated shift emerging in global industries and their supply chains, once passive overseas component manufacturers (read: China) are making bolder moves downstream in local market distribution. To get closer to their ultimate end customers.

For good reason in the furniture example: 90% of exported fabric ends up in U.S. homes. Forward-integrating into local market assembly gives the Chinese a much more complete and timely picture of their prize market, reduced inventory carrying costs, improved end product availability, reduced supply chain disruption costs, and smoother production levels and scheduling back in Asia. And that's just a start.

The Chinese benefit from ownership in several other postponement-related ways as well. They shift some of the assembly costs from North Carolina to China, lowering final product costs and raising competitiveness, by shipping to what is now a US "assembler", pre-cut, pre-sewn Chinese fabric “kits” designed to the State-side assembler’s requirements. And a tighter materials/assembler supply chain gooses U.S. demand by helping the assembler assure on-time, to-spec delivery. The local market "assembler" wins new business by impressing retail furniture chains with its ability to develop living room “settings” unexpectedly fast and better than the retailer hoped.

Meanwhile, competing manufacturers in the US, with their arms-length fabric supplier relationships (and tensions) suffer miserably, even as they brag of "lower overseas manufacturing and sourcing costs".

Side note: one unstated moral of the Journal’s story seems to be that if a supplier wants postponement benefits it has to buy its customers, maybe even their customers too. While I don’t think ownership is always required, it certainly helps. It has other risks I'll discuss another time.

You can get postponement other ways. But that’s also another story.

Whose Job is Safety and Quality?

Anyone who has ever exercised in a neighborhood fitness club recognizes him. The meat head with arms and chest muscles bulging from his scissor-cut tank top, growling and grunting from machine to machine. But upper body muscles are the easiest to crank up for show, and indeed a quick glance at our meat head's rail-thin undeveloped (read: skinny) legs shows he's unwilling to do the harder work of creating a balanced weight lifting physique.

Or as they might say about him in Texas - "all hat and no cattle".

The same "go for show" mentality pervades the world of marketing, especially when it comes to managing product supply and distribution channel systems. Fears are growing that companies may be cutting big corners in their quest for uber-efficiency. They often get to wondrously low price points by pursuing long-distance suppliers with unbelievably low prices who provide the necessary performance enhancements that goose gross margins.

But just like the meat head at the gym, a big part of the process - trusted, quality-controlled and safe products - is overlooked. It's a game of chance that will increasingly catch up to shortcut takers in today's economy.

So it's with admiration that I read that Millipore, a mid-sized Biotech products company, has instead built a global quality control organization of over 350 employees. With expat salaries and other costs factored in, it's very possible they could be spending over $70 million a year on such activity. That's significant for their size; roughly 70% the size of their total R&D budget!

Why spend so much? the army of fresh-faced, hired efficiency consulting advisors might ask?

Millipore knows that trust is increasingly the new currency of global marketing.

Not Only a Matter of Time

Shipping is the circulatory system of the global economy. And as the economy’s metabolism gets sluggish, it appears that shipping is slowing down with it – quite literally. Freighters and tankers are steaming at reduced knots per hour.

Today’s Wall Street Journal also shows how boats are going the long way round to avoid toll charges at the Suez Canal. Supply chains are affected, all the way down to consumer and business buyers. Channels are feeling the pain.

Cost-cutting is certainly needed. But I hope owners aren’t decreeing half-speed ahead and manaña deliveries across the board. Efficient, long supply chains are fine, but it would be a serious miscalculation to let all their container vessels (read: valuable and costly inventory!) be caught at sea when smart competing skippers are racing into port.

Trade- and end-customers with time-sensitive cargos will defect, and once the economy rebounds they may not come back. Conceptually, these customers might appreciate that providers have to lower their costs to stay solvent. But no customer fully gets it that benefits to them – availability in this case – should have to fall too. And that is why shippers (and buyers?) who figure out how to maintain at least the illusion of a satisfying shipping experience for their customers will come out of this period stronger than ever.

Signs of New Distribution Era Emerging

Signs are everywhere that a sea change is occurring in how branded product makers and their channel partners chart growth strategies together. Many will start moving away form old-school adversarial relationships to find new ways to re-focus on providing consumers with the benefits of trusted brands.

For too long, manufacturers and their dominant distribution partners have danced around the trade-offs that price- and cost-only systems create. The trade-offs are especially acute when a marketplace is supplied by long, overseas supply chains where oversight and quality control are more difficult to assure. While long supply chains are an important part of the global economy, they still demand operating oversight which drives up costs and investment. Contract manufacturers (and distribution channels building their own store brands) are finding out there's more to sourcing than "spec and buy".

• NYT on risks of cost-only sourcing: a sales manager at a company in southern China said leaded paint was about 30 percent cheaper than paint without lead...it depends on the client’s requirement, if the prices they offer make it impossible to use lead-free paint, we’ll tell them that we might have to use leaded paint. If they agree, we’ll use leaded paint. It totally depends on what the clients want.”
  
• WSJ on toys supply chain: After a summer of toy recalls, toy licensors and trade associations are counting on stepped-up safety pledges to reassure parents before the holiday shopping season...some industry analysts question the effectiveness of tighter safety measures by companies that own brands and images but may have little manufacturing know-how...licensors have less experience... toy manufacturers such as Mattel and Hasbro Inc. are better seasoned at quality control.
  
• NYT on government oversight: A working group appointed by President Bush recommended preventing problems by building safety into manufacturing and distribution, intervening when risks were identified and responding quickly after an unsafe product made its way into the country...Representative Rosa DeLauro [said] the plan should detail how bad actors will be held accountable, how strict safety standards will be developed and enforced, and how such a system would be funded

What's important about this development is the impact it has on total system costs and end prices. It turns out that buyers who came back from overseas sourcing trips exclaiming - "it seems too good to be true" - were spot on. It was, and consumers are getting more and more concerned about who to trust.

In a related development, earlier this summer the U.S. Supreme Court seemed to anticipate such developments when they overturned a nearly 100 year old ruling to give manufacturers the right to set minimum resale prices. Why would the court suggest that higher prices are better for consumers?

The underpinnings of the court’s new reasoning were developed long ago by economists at the University of Chicago who argued that allowing manufacturers to stipulate prices on branded products can lead to greater benefits for end consumers when increased retail margins are used to fund required service levels. In reaching its new decision, the 2007 court acknowledged and embraced this view of consumer market dynamics, and concluded that any given instance of resale price maintenance is now within the law – if the manufacturer can show it has not concentrated market power to drive a supplier or retailer cartel, and if it can show that in setting a minimum price at retail, it is promoting consumers’ best interests and driving up overall demand.

Current consumer sentiment seems to be supportive of the Supreme Court's direction. None of this, however, suggests that manufacturers and their resale channel partners have free reign to drive up prices beyond what customers are willing to pay. But watch for new developments. In the new era of distribution, forward-looking manufacturers and their channel partners will once again offer trusted products at price points required to actually deliver on the brands' promises.

Retailers Morphing into CPG Players?

I've been describing for some time the danger to 'old school' CPG manufacturers of the ravenous retailer appetite for private label growth. In fact, for some grocery categories it's getting harder and harder for shoppers to find anything new and interesting - unless it's private label.

Ouch, that must hurt when the subject comes up in executive meetings at national brands and big name CPG companies.

And now we see retailers rubbing salt in the wounds, or maybe showing mercy by driving a stake through the CPG players' hearts. Strategy advisors to these retailers have encouraged them to take the last step and actually become "integrated CPG manufacturer-retailer" powerhouses.

Translation: forget independent manufacturers and brand developers - we can do it all ourselves!

That's certainly very big news, and only the tip of the iceberg froim what I'm hearing.

And check out this striking news from a recent New York Times article by Rob Walker:

..."Safeway has initiated the Better Living Brands Alliance, with the highly
unusual goal of selling these two store-brand lines in places other than the chain that created them — school cafeterias, foreign markets and, ultimately, other U.S. grocers. In the judgment of the trade publication Refrigerated and Frozen Foods Retailer, which recently named Safeway as its retailer of the year, the experiment is “breaking the mold on what we all thought we knew about private label.”

These strategic moves are bound to restructure consumer markets in ways we have not seen before. And it won't be confined to just the grocery sector. Keep your eyes out for similar developments in other markets- especially Home Centers and Consumer Electronics.

Contractor or Architect?

A recent Wall Street Journal article draws an intriguing contrast between Sharp Electronics, the Japanese maker of liquid crystal displays, and Apple, Inc. Sharp, the Journal author says, is becoming a vertically integrated manufacturer, whereas Apple is doing just the opposite, outsourcing all of its hardware fabrication. (See “Sharp Focuses on Manufacturing”).

So, is it smarter to be like Sharp, the 'integrator', or like Apple, the 'architect'? The Journal’s comparison, neat as it appears to be, is a red herring. It assumes that Sharp and Apple are both manufacturers in the same sense, when they aren’t really. By the nature of its product set, Sharp is betting on conventional 'old school' manufacturing. LCD’s are pure hardware, or 99% so. Apple, on the other hand, is more 'new school' solution developer. Granted it’s the programmer sitting right at the hardware interface. But at their business ends, the iMac, the iPod, and the iPhone are all about sexy, exciting new interfaces and software.

Stylish looks aside, what makes an Apple an Apple is innovative functionality, innovation. And what makes Apple a great company is something deeper – an almost uncanny focus on customers, knowing what they want better than they do. Aside from the success of Apple’s products, remember what it’s accomplished with its Apple Stores and its daring, if not entirely successful, gambit to get some of the recurring revenue stream on the iPhone.The real distinction between Sharp and Apple isn’t integrating versus outsourcing. It’s the direction they choose to look. Sharp’s head is turned upstream. Apple’s points downstream toward the end consumer.

Both companies root their strategies in technology bets, but Apple’s has a more solid grasp of the new playing field and where winners in the consumer electronics marketplace are staking out their territory.

Unfair Match?

"Size is the only thing that gives you power these days. Little companies have no chance."

– Richard Heckmann, CEO of sporting-goods maker K2

I question this view. Little guys do have a chance. But I don’t deny that Mr. Heckman’s view is widely shared by executives. In fact, I think lots of incumbent management teams make it the main part of their business strategy. The bigger we are . . .

As reported in the July 7 issue of FORTUNE, Mr. Heckman recently sold K2 to Jarden Corporation so that could play the game as though it were in fact big. Jarden is a holding company that collects overlooked brands, creates joint economies among the little companies it acquires, and injects its own guidance (control would be too strong a word). Jarden’s portfolio now numbers 19 companies so, if Mr. Heckman is right, K2 should be flourishing soon.

I don’t think that selling out to achieve administrative scale economies or greater negotiating power when facing mega-retailers is strategically imaginative. In fact, it sounds more and more like 'old school' growth strategy.

More important, it isn’t particularly successful either, judging from the record. Conglomerates tend to get broken up over time. Good Luck, Jarden. Maybe you’ll be the one to bring diversification back into vogue.

But I have an alternative for little companies. And it can work just as well for the K2’s of this world that have indentured themselves, or even for holding companies like GE that want their business units to be nimble again.

“Commodity” Mindset ........................“Differentiation” Mindset
Leverage scale-based power .......................Leverage unique value-based power
Consolidate operations .................................Innovate the customer experience
Create value upstream ................................Create value downstream

Most big players view their markets as commoditized and think on the left side of the table. It is precisely this old-school thinking that eventually gets them in trouble. They assume that’s the only possible game. But all it takes is somebody working on the right side to redefine competition from low-cost/low benefit to capturing customer’ attention, selection, imagination . . . and expenditures.

You don’t have to be big to approach customers in new, better ways. For that matter, you don’t have to be small either. Just value-oriented and differentiation-minded.

A New Supply Chain Perspective

Last month I had the pleasure of speaking a couple of times to executives and managers from Latin American companies gathered at the annual VISUM conference in Mexico City (http://www.sintec.org/contenido.asp?seccion=128&idmenuGN=85 ).

VISUM is all about supply chains and much of my audience was procurement folks. For them, I had a simple message. If you take the conventional procurement view of a supply chain system (see diagram at right), you believe the chain ends at your company. But that’s a limited view. The company sits in the middle of the real supply chain, which extend s all the way to the company’s end customer.

If you’re a procurement person, why should this distinction matter to you? Because you can’t do your job properly if you don’t take a total system view, you won’t do your job properly. Worse, a limited perspective, which tends to focus on procuring parts and materials for the lowest cost, may compromise the company’s larger vision of delivering an optimal customer experience.
What if, for instance, in going for low cost you trade off timeliness of delivery on a key component?

If the whole assembly of what you make has to wait for this component to show up – late – your customer’s entire order could be delayed. If your customer is a business, its projects could get backed up. Bad customer experience. Your customer’s customers could become unhappy. Bad end customer experience. They could fire your business’s customer. That customer could pull its business from your company.

In other words, saving a little on the component just isn’t worth it.

I concluded by saying, If I manage to convince you of three things today, I’d like them to be:

1. Customer experiences are important. They are becoming the critical factor in whether or not your company’s products sell or don’t sell.
   


2. You in the supply chain help create them. Your work effects not just the price and quality of products. It effects whether a customer has a good or bad experience buying and owning your company’s product.
   


3. Creating them is exciting. You should be looking for opportunities to get involved. It will make your work more interesting. It will give you a bigger role in your company.
   Those suggestions go not only for Latin America but all of the Americas, and anywhere in the world.

Competitiveness and Intellectual Accounts

A recent Op/Ed piece argues that our competitiveness as a nation in coming decades will be determined not only by our financial accounts but also by our intellectual accounts. That same prediction is being made about a less lofty realm as well - at the level of global go-to-market and supply systems.

Power bases are shifting - to expertise, which will always trump its weaker cousins coercion and even reward. Expertise about opportunities to create incremental new value for all the players in these complex supply and distribution systems. From strategic conversations that provide insights directly - in the voice of the end customer.

When marketing channels are championed, or stewarded as Professor Kash Rangan describes, from an external perspective, an end customer perspective, surprising things happen. Customers see new value, and improved buying and decision alternatives. Intermediaries are winners, focused on creating tangible growth-oriented advisory and physical distribution value for both their customers and their vendors. And branded product and solution manufacturers operate on a strategic path of differentiation.

Differentiation in not only product dimensions, but total customer experience. The kind of customer experiences that build excitement and new options for end customers. The kind that grow a marketplace and increase the margin pool. The kind that optimally-structured marketing channel systems provide. Finally. Welcome to the 21st Century.

* * * *

Disclosure - But then I think this could finally be the Cubs' year. The team not only has talent and seasoning, the team has chemistry. And they think. Can they build momentum - from a .500 start?

Pricing Wars in Canada Fraying Relationships

Wal-Mart announced today that their stores in Canada will no longer be stocking best-selling LEGO building block products. For some time, Canadian's have been lamenting that retail prices of goods sold in canada have been too high relative to what the canadian dollar can purchase in neighboring US markets. It seems that retail prices have not been adequately correcting for shifts in US dollar-Canadian dollar exchange rates.

With a long legacy of building relationships based on muscular strong-arming of suppliers, it's hardly a surprise to anyone that Wal-Mart is looking outside the company to extract retail price relief from vendors. When that doesn't work, they start looking to boost sales of more vulnerable (and compliant!) second-tier products on their shelves. in LEGO's case, that means Wal-Mart is reallocating it's shelf space to Mega blocks (made by Montreal-based Mega Brands).

Two strategic problems with Wal-Mart's old school strong-arming tactics. First, consumers want LEGO brand products. Does Wal-Mart really have research to the contrary? I wouldn't bet your stock investments on it!

But secondly, LEGO products are euro- (or kroner-) denominated purchases. They're made in Denmark. If you look at what's happened to euro (and kroner) exchange rates, you see that it's US retailers feeling the squeeze in 2008 as their cost of goods sold rise in US dollars. LEGO products selling for $35 (CN) today at a 40% gross margin have COGS of $21 (CN). That $21 (CN) is equivalent to 14 euros. And that same 14 euro wholesale price from Denamrk (with similar mark-up) would be priced at $35 in the US. The same pattern holds for kroners.

So where is the pricing gap? (US and canadian dollars are essentially at parity today) .

We know what's really behind the news, and so does LEGO. Wal-Mart is disingeniously using this exercise as a PR smoke screen to strong-arm LEGO into margin concessions. Not surprising.
The good news for consumers is that LEGO is standing firm. Passing system efficiency gains on to consumers in the form of lower prices is smart retailer-vendor strategy. But unhealthy and unrealistic price pressure to simply grab retail share in a tough market can only lead to cheapened products, cheapened brands, and eventually safety problems as subcontractors make risky cost-cutting decisions.

But then, Mega Brands knows that story well. Remember the toy recalls last year? It seems that price isn't the only concern consumers have.

Hitting the Wall at Wal-Mart?

Wal-Mart is going to the next level in its drive to provide more value. Long the king of everyday low prices for consumers, the biggest retailer on the planet now wants to take better care of the planet itself.

Wal-Mart wants to sell electric/hybrid cars, use windmills in its parking lots to recharge them, reduce paper use and improve medicine at the same time by digitizing physician prescription records in its network, and make its suppliers more energy efficient, both in their products and in the processes used to manufacture them. And it will demand offshore manufacturers to comply with U.S. environmental and safety standards.

Wow! That’s a fantastic goal. And who better to create the momentum than Wal-Mart? So it may seem boorish to ask, Is Wal-Mart going about this praiseworthy task in the right way? I’m suspicious.

Wal-Mart is notorious for its heavy-handed application of market power. While early on it delivered low prices through fantastic supply chain reinventions and improvements, it has for some time simply gained the upper hand by squeezing suppliers. More and more, this is less about making suppliers more efficient (which is good), and more about leaving them drained, disheartened, and increasingly less differentiated. That’s not good.

To judge from Wal-Mart chief Lee Scott’s public statements, as quoted last week in The New York Times, Wal-Mart is still resorting to the heavy hand. …”[If suppliers do not fall into line by joining the international environmental standards organization C.I.E.S], Wal-Mart will in fact lead; we will move forward by ourselves.”

I read into that single word “lead” a new application of Wal-Mart’s old strong-arm methods. Wal-Mart will in fact mandate. It’s all for the good of the planet, dear vendor. But all the same it’s our way or the highway. The squeeze is still on.

I wish Mr. Scott had said something more like this: Helping the planet is starting to make competitive sense for all of us. Suppliers that differentiate their products on environmental effectiveness will have an enormous and supportive outlet in Wal-Mart. Come work with us in this better way. We’ll feature you.

In other words, how about a little less strong arming and a litte more partnering, Wal-Mart?

Read The Times’s coverage, “Wal-Mart Chief Offers a Social Manifesto,” at: http://www.nytimes.com/2008/01/24/business/24walmart.html?scp=1&sq=wal-mart++%2BC.I.E.S.&st=nyt

McKesson to Focus on Sourcing as Advantage

Just like their retail cousins, large business market distributors are moving to lock in power and marketplace negotiating advantage from their sourcing systems. Pharmaceutical distributors, such as McKesson Cardinal Health, and Amerisource-Bergen, are evaluating opportunities to change out their largest generic drug makers in favor of smaller contract manufacturers. The hope is that increased margins follow increased market power.

Exim-Pharm, an India-based provider of bulk pharmaceutical drugs and formulations, is one company hoping to benefit from the move to more aggressive drug sourcing by leading distributors. In fact, India is a popular destination for aggressive buyers seeking out and evaluating new low-cost generic drug supply opportunities.

Not surprisingly, internet-based portals and services such as "trade2gain.com" have emerged to help eager drug buyers link up with hungry players in the fragmented overseas drug manufacturing sector. Yet the parallel activity in the retailing sector offers the B2B marketplace and its distribution powerhouses some important lessons.

In fact, the largest U.S. retailers are in the midst of a major re-evaluation of what many are now calling an era of "rushing to the bottom" in prices and service levels. After years of obsessive strategic focus on private label and house brand sourcing from overseas contract manufacturers, these retail distribution powerhouses are increasingly calling it quites and returning to their critical roots as 'merchants'. Why? Because end-customers have become numbed into price-only shopping behavior. Not because that's all they care about (look at Apple's astounding retail store profitability!) but because that's all they're being presented with in most U.S. retail systems. And commoditization is an unattractive growth path for anyone involved, be it manufacturers or retailers. It's a treadmill with no upside.

So McKesson - and other B2B distributors - would be smart to balance their short-term drive for sourcing advantages against increased differentiation in service levels. But finding ways to create real 'distribution value' for pharmaceutical customers requires collaboration and more strategic manufacturing relationships. Commmoditization only requires an internet portal.

Physical Distribution Intermediaries Thrive in Global Economy

With branded product manufacturers focusing more on product innovation, and downstream mega-retailers returning to their merchandising roots, a new window of opportunity has opened for best-in-class wholesale (physical) distribution intermediaries.

In fact, the rapid growth of overseas suppliers to growing U.S. markets has been a major boon to independent wholesale distribution companies that once regarded themselves simply as small warehouse and distribution businesses. Three small to medium-size companies in particular are on the cutting edge of technological and social trends, from Internet commerce to evolving Latino markets, writes the NYT's James Flanigan:

• Weber Distribution has 11 warehouses in three states, 500 employees and more than $120 million in revenue distributing products that come mainly from Asia through the enormous Southern California ports. The company invested heavily in computing and communications systems, and gives clients information about products all the way from factories in China, on ships across the Pacific and through the ports of Los Angeles to final delivery. In its warehouses, forklift operators now use personal digital assistants to keep track of goods stacked on shelves several stories high.
  
• CaseStack has 320 employees and will bring in $74 million in revenue this year through its network of half a dozen warehouses and 1,000 independent trucking firms, linked by the Internet, and transporting goods from manufacturers to retailers nationwide.
  
• Source Logistics helps food companies in Latin America gain access to supermarkets and specialty stores in the United States through its warehouses and distribution centers in Texas and Georgia. It has 50 employees, $7 million in annual revenue and serves 80 companies in Latin America.

And economist John Husing has said that at $900 billion in annual revenue, logistics now accounts for some four million jobs nationwide and it is the largest single source of employment in Southern California.

Another Apparel Brand Faces Key Strategic Choice

Kellwood Company, maker of midtier department-store clothing brands such as Sag Harbor, is considering an unsolicited buyout offer from Sun Capital Securities Group LLC. The strategic question now is will Sun Capital drive to re-invigorate the company's innovation engine and push for stronger lifestyle branding? Or, as Li & Fung and others are doing, make a big bet on continued commoditized retailing and low-cost overseas sourcing and logistics-based suppliers.

WSJ's Cheryl Lu-Lien Tan reports that in recent years, Kellwood's portfolio of midprice brands has suffered as department stores have consolidated and shifted toward lifestyle and designer brands. Last year, Macy's dropped Sag Harbor, one of Kellwood's major brands. Kellwood has since been trying to beef up its stable of unique brands.

Morgan Keegan & Company analyst Brad A. Stephens said, "Sun Capital can unlock a lot of value in the company if it invests in more efficient manufacturing, distribution and marketing of existing Kellwood brands..."

Sun Capital could go in two very different directions if their offer is accepted. Will they follow the path of their premium, innovation-oriented portfolio companies (Creekstone Farms, Dale & Thomas Popcorn, Lexington Home Brands, Lillian Vernon catalog, The Limited) or do they leverage the Sag Harbor brand and other Kellwood assets for quick penentration of declining commoditized retailers still clinging to private label strategies?

Sun's investments in Mervyns', Pamida, Nationwide Warehouse, ShopKo, and Wickes Furniture suggest they might follow the more questionable Li & Fung path. While we think that path would be risky and have short-term benefits at best, it may carry Sun long enough to exit profitably.

It's interesting that Brenon Daly of The Deal.com worried as far back as 2005 that Sun Capital's ShopKo deal "...added another retail chain to its portfolio of struggling stores...they already own out-of-fashion clothing chains Mervyns LLC, Anchor Blue...". It will be interesting to see what direction they take in the new emerging era of lifestyle brands and retail innovation.

Here's some encouraging news in the ShopKo saga from Chairman and CEO Mike MacDonald (quoted in Progressive Grocer):

"You always have to stay fresh -- the customer demands that...what we tried to accomplish with this new store is a softer look and a more inviting atmosphere. The new design incorporates a number of elements intended to give the store a stronger connection to women. The store's color, lighting, and fixturing all have been redesigned to create a warm, inviting, residential environment that allows the customer to easily see the merchandise and visualize how it might look in her home or on her body...."

Industrial Products Leader Focuses Distribution on Tangible Value

French aerospace electronics and systems group, Thales, is making a bold strategic statement about its approach to aftermarket parts and services business. The company has taken steps to localize parts distribution support and has employed Web-based technology to boost service levels.

In a trend we're seeing in more and more industrial markets, Thales has moved its aerospace support and distribution activity closer to its end customers. The moves resulted from abroad strategic review which found that fewer and fewer airlines were choosing to repair avionics systems because the total costs of stocking spares combined with test equipment, training and documentation is uneconomic unless the service provider achieved scale and logistics advantages.

Favorable to the OEM, the company also learned that most airlines preferred to subcontract their electronics maintenance to OEMs. This enabled Thales to develop offerings ranging from turnkey services, which include line maintenance at an airline's stations, to new logistics support for spares, repairs and replacements to individual spares or services.

Here's an example of the innovative distribution services that Thales has structured to create tangible value for its customers and partners:

• Repair, distribution, logistics support and "Integrated Supply Services", ranging from repair contracts based on flat-rate, cost-per-hour use to more comprehensive avionics-by-the-hour (ABTH), which includes replacement, repair, overhaul and guaranteed spares availability plus a line maintenance service.


• Repair parts stock has been moved to in-country facilities to support smaller airlines


• Repair operations have been moved to new regional repair facilities


• Set up a centralized center to provide specialist support for every fleet equipped with Thales products


• IT tools are being developed that can integrate with airline operations systems to track each aircraft's location or next destination on an hour-by-hour basis -- thereby providing the center with complete visibility of any IFE problem wherever it occurs.


• For fragmented product markets, such as helicopters, Thales is setting up network solutions with partner OEMs using Web portals.


• Developed an online data interchange to help airlines with their engineering and technical activities: for example, downloadable component maintenance manuals. Ultimately, creating a centralized portal for all services


• Joined together an OEM Services consortium with Diehl Aerospace, Liebherr Aerospace and Zodiac to provide component support on a cost-per-hour basis for a group of parts on major aircraft platforms with large global fleets

Creating tangible value through sophisticated, customer-driven distribution is an astute direction for Thales and one we expect to see players in other tough, global markets employing. An excellent go-to-market case study!