Distribution Trends: 2007 Year in Review

Believe it or not, it’s time for my final post for 2007. In the spirit of the season, I take a quick look back at this year’s posts to highlight the major themes of Distribution Trends.

As you may know, I started writing this blog to help people get the most out of Facing the Forces of Change®: Lead the Way in the Supply Chain, a research study sponsored by the NAW Institute for Distribution Excellence. Many posts have been organized around the four major trends identified in the report, although other themes – economic trends and consolidation activity – generated very high levels of readership, too.

Here is a brief rundown of the year’s posts.

Trend 1: Private Label Products – The impact of private labels on channel relationships turned out to be an especially controversial topic. As I discussed in Brand Killers, private labels will continue to grow in categories where the manufacturer's brand does not add enough value to the customer. The debate in the electrical industry was particularly open because Graybar took a public stance against private labels. (See Private Label Static from Electrical Products.) I still think that private label products can be a way to strengthen manufacturer-distributor relationships by enabling the creation of jointly developed products.

Many private label products come from Asia, a fact that hit home over the summer with the recall of Chinese toys. Personally, I believe that The Risks of Chinese Sourcing have been overblown for political reasons, although private labels offer both Opportunity and Risk to a wholesaler-distributor. Perhaps we will even see a counter-trend toward Near-Shoring Private Labels from Canada and Mexico.

Trend 2: Demand-Driven Channels – The trend toward more data sharing between channel partners challenges many preconceptions about the wholesale distribution industry. I highlighted examples on the blog in channels as diverse as construction equipment and beer distribution. (I do not recommend combining the products from those industries!) Nevertheless, I believe that wholesaler-distributors should only share point-of-sale data with supplier organizations that have rigorous internal security policies for data management. (See Trust and Channel Data Sharing.)

Trend 3: New Profit Models – As I point out in Chapter Three of Lead the Way, many wholesaler-distributors are now successfully selling fee-based services and positioning themselves as suppliers of products with related services instead of only reliably providing goods. I highlighted examples from electronics distribution and industrial distribution. The new profit models trend also refers to the fact channel compensation is becoming more data-based and performance-oriented, as examples from John Deere and Coca-Cola demonstrated. I was also impressed with pay-for-performance forecasting in the beer industry.

Trend 4: Connected Customers – This trend was perfect for a blog because it refers to the growing interconnectedness of manufacturers, customers, and distributors. I advised wholesaler-distributors to Be Found Online, pay attention to Online Customer Communities, and recognize the power of Leads Searching for You. The Future is Already Here was one of the top posts this year on Distribution Trends.

Other Trends – Loyal readers know that I’ve strayed beyond the confines of the four major trends to look at other major issues.

My most popular posts (based on number of web hits) were analyses of economic trends, especially 2008 Economic Growth and You and 2007 Growth and the 2008 Economic Outlook.

As always, consolidation was a hot topic, especially as we all watched the twists and turns of HD Supply this year in Is M&A Peaking? (June), The Fallout from HD Supply (September), and HD Supply Begins to Unroll-Up (December).

Two posts on strategic planning also had very high readership. In Why Strategy Matters, I reminded wholesale distribution executives to pay attention to long-term economic trends when building a long-term vision for your company. In Building Future Leaders, I described how one CEO uses Facing the Forces of Change®: Lead the Way in the Supply Chain as a leadership development tool for managers.

What’s ahead for 2008?

I'm grateful for the positive response to this blog and very much appreciate the many positive emails and comments that I have received since launching 8 months ago.

As I told you in my 2008 Wholesale Distribution Economic Outlook, many wholesaler-distributors will face the toughest economy in nearly five years. Therefore, I plan to cover broader macro-economic developments throughout 2008 while continuing to interpret the news for wholesale distribution executives and their suppliers. Please feel free to email me if you have suggestions for topics or articles.

I'll wrap-up the year with some homegrown supply chain humor, straight from the pages of The Wall Street Jovial:

Santa's Supply Chain Keeps Pace, Despite Changes

I will be back during the week of January 8. Until then, I wish you a healthly and happy new year!

All the best,
Adam

HD Supply Begins to Unroll-Up

HD Supply has reportedly begun the un-roll-up (roll-down?) process.

The Home Channel News is reporting that HD Supply has agreed to sell its Lumber and Building Materials (LBM) unit to Pro-Build Holdings Inc. Modern Distribution Management estimates that the two largest companies in the division had combined sales of almost $800 million when they were acquired in 2005 and 2006. Total revenues in HD Supply’s LBM are surely lower today given the pressures that I highlighted a few months ago in The Fallout from HD Supply.

I’m sure HD Supply (and its new owners) are feeling the pressure of an especially sharp cyclical downturn. Last Friday’s construction data showed an unexpected monthly decline in non-residential construction from September to October. Read the complete release from the Census Bureau. Both public and private nonresidential construction activity has been partially offsetting the residential downturn this year.

The monthly data are notoriously volatile and often subject to substantial revision. I’m more heartened by the fact that commercial construction was up 17.5% versus October 2006 compared to a year-over-year decline of 16.2% in residential construction. Nonetheless, tightening credit standards and growing vacancy rates suggest that 2008 will be weaker for non-residential construction. Unfortunately, I don’t think we’ve hit the bottom on the residential side.

Be sure to join me this Thursday for my Wholesale Distribution Economic Outlook webcast. I’ll give you more details on the 2008 forecast and its implications for wholesaler-distributors.

The Fallout from HD Supply

In June, I wondered if M&A activity in wholesale distribution was peaking. Well, I guess we don’t have to wonder anymore.

As you’ve surely read, Home Depot was forced to lower the price of its HD Supply unit by $1.8 billion and guarantee $1 billion of debt for the buyers – private equity firms Bain Capital, Clayton Dubilier & Rice, and Carlyle Group. HD Supply CEO Joe DeAngelo was “thrilled to be associated with this group of distinguished private equity firms.” (See HD Supply Deal Closes.)

Many big private-equity deals outside wholesale distribution are facing similar troubles because of so-called “turmoil in the credit markets.” Translation: lenders were taking on too much risk to buy companies that were over-valued. The Wall Street Journal’s Deal Journal summarized the status of many big deals last week.

But the renegotiation is not surprising given the sharp slowdown in revenues of building materials wholesaler-distributors. The chart below, which updates data from my NAW Economic Reports, shows double digit drops in revenues in 2007. The numbers look equally bad after adjusting for price deflation (not shown).

In chapter 5 of Facing the Forces of Change®: Lead the Way in the Supply Chain, I warned that industries do not consolidate forever, as evidenced by the sharp slowdown in acquisition activity after the peak in 2000. The current cycle began in 2004, as shown in Exhibit 5-1 of Lead the Way. The HD Supply deal signals the end of this cycle.

The next big shock will come if commodity prices return to historical levels, closing an inflation-led growth gap. For example, electrical wholesalers have been riding high on the price of copper for a few years and face an especially painful return to earth.

Bottom line: I suspect that valuations of wholesale distribution companies will return to more sensible levels over the next few years. Good news for companies looking to expand by acquisition, but bad news for sellers hoping to get out at the top.

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CORRECTION: In an earlier version of this post, I incorrectly reported that Joe DeAngelo had resigned from HD Supply. In fact, he has resigned his position as COO of The Home Depot but remains CEO of HD Supply. I apologize for the confusion.

Is M&A Peaking?

Modern Distribution Management just held a great audioconference on M&A trends in wholesale distribution. Read the provocatively titled summary Is the Market Too Hot?. (You can order a transcript and CD from MDM here.)

As I document in Chapter Five of my new Facing the Forces of Change®: Lead the Way in the Supply Chain wholesale distribution trend report, announced acquisitions have more than quadrupled in the past 2 years for wholesaler-distributors in construction, and industrial and commercial markets. (See Exhibit 5-1 on page 92).

In light of these trends, wholesale distribution executives should have a strategic plan for their business that recognizes the reality of acquisition activity, yet maintains a focus on profitable growth.

ARE WE PEAKING?

Wholesale distribution remains one of the top targets for buyout investments by private equity firms. These financial buyers are displaying a far greater ability and willingness to pay premium prices for leading distribution companies. They are being attracted by the ongoing need for wholesale distribution to end markets insulated from global competition, such as facilities maintenance, construction, or health care services.

The recent sales of HD Supply to a trio of private equity firms (Bain Capital, Carlyle Group, and Clayton, Dubilier, & Rice) shows the strong appetite for wholesale distribution. (See Home Depot Agrees to Sell Supply Unit for $10 Billion.) All three firms have made multiple investments in wholesale distribution over the years, although Chapter Five only discusses CDR.

However, the MDM panelists believe that this activity may have reached a peak. Brent Grover, a fellow Fellow of the NAW Institute, made some pointed comments about the market, stating: “I think there are some pretty unattractive companies that have been dressed up and the market figures out pretty quickly that it’s not the kind of firm they want to buy.”

Jim Miller of Vetus Partners, who I consider to be today’s leading expert on M&A in wholesale distribution, sees the market “…at or near a plateau.” Strong words from a major player. (Full disclosure: I am on the Advisory Board of Jim's new venture called Supply Chain Equity Partners.)

PLANNING YOUR FUTURE

The courage to face the future honestly often leads owners to look for a profitable exit strategy or even favorable terms for a recapitalization. However, acquisition dynamics should play a role in the decision, because industries do not consolidate forever, as evidenced by the sharp slowdown in acquisition activity after the peak in 2000.

Well-run, independent distributors continue to thrive even in consolidating industries due to their great skill in maintaining high levels of customer service and generating customer loyalty. One distributor summed it up in a comment that I include on page 94 of Lead the Way in the Supply Chain:

“I think [consolidation] will increase the value of the independent distributor related to servicing the customer and providing value to the vendor. The progressive independent will have a distinct service advantage. We will be more nimble and more reactive to local market conditional changes. It will raise the bar on the independent, however.”

Well said.