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

An Ice Cold Bottle of Pay-for-Performance Forecasting

Chapter Three in Facing the Forces of Change®: Lead the Way in the Supply Chain predicts that manufacturers will use pay-for-performance programs to get more from their distributors.

I just read a great story about how a planning manager at beer-maker Heineken created a pay-for-performance plan that could be readily adopted by other manufacturers.

The original article was published in the Journal of Forecasting, but is not online. Supply Chain Digest published a good summary called Using Incentives to Drive Forecast Collaboration.

Beer Goggles

Heineken’s European-made beer is shipped to the U.S. based on orders from either its own distribution centers or orders from independent distributors. Unfortunately, Heineken was getting inaccurate and incomplete forecasts from its distributors in the Southeast of the U.S. (No, distributors did not create their forecasts after sampling products from the warehouse!)

This supply chain is fairly typical in many lines of trade. The manufacturer only sees orders from distributors. Distributors, in turn, only sees orders from their customers. There is no real-time visibility into the actual purchase or usage rate of the product by consumers, so this structure can create inefficiencies for both manufacturers and distributors. (See pages 32-33 of Lead the Way. One solution is to create a more demand-driven supply chain by sharing point-of-sale information.

Beer Games

A creative planning manager at Heineken developed a competitive contest for the individual forecasters at each distributor who created the most accurate forecast. Prizes included $500 gift certificates for the best two and four month forecasts. The best annual forecast won a $2000 gift certificate.

Guess what? Overall monthly forecast accuracy improved by 10% in one year. Another interesting dynamic was some friendly competition among distributors, although, although some distributors turned out to be better at forecasting than others. In other words, this program exposed previously hidden performance differences between distributors.

The benefits of improved forecasting to Heineken are not discussed in the article, but I’d guess that Heineken saw improved costs from better production planning and more stable production runs. They subsequently expanded the program to include other information, such as inventory reporting. If Heineken used the improved forecasts, then the program probably paid for itself.

Based on this story, here are two questions for manufacturers and distributors to ponder:

• What incentives (intended or not) are manufacturers creating for distributors with current discount and rebate program?


• How could a manufacturers use discounts/rebates/fees/marketing funds/prizes to get the attention of wholesaler-distributors and reward results?

---
On a related note, beer and scotch guru Michael Jackson (a.k.a The Beer Hunter) recently passed away. I had the privilege of meeting Mr. Jackson in May, discussing a memorable bottle of scotch with him (The Macallan Gran Reserva from 1982), and getting him to sign my copy of Complete Guide to Single Malt Scotch. Check out his books and then raise a glass to Mr. Jackson's unique legacy.

Trust and Channel Data Sharing

“I don’t trust my suppliers with my data.”

This is the most common response from distributors when I tell them about the data sharing prediction from the new Facing the Forces of Change®: Lead the Way in the Supply Chain book. The research found that suppliers will get more visibility into actual customer demand because wholesaler-distributors will share more point-of-sale data.

Getting over the trust hurdle requires more than just faith in a supplier. I increasingly believe that wholesaler-distributors should only share point-of-sale data with supplier organizations that have rigorous internal security policies for data management.

Don’t Pass Me By

Trust worries fall into three basic categories:

1. “Suppliers will use the data to sell directly to my customers.”


2. “Suppliers will use the data to move my sales to another distributor.”


3. “When the channel manager changes jobs, he’ll take the data to a competitor.”

Personally, I believe that the first concern is overblown. Most customers (especially smaller ones) still prefer to buy via wholesale distribution. Few suppliers can meet the needs of high-service customers.

The latter two concerns have much more merit. The majority of wholesaler-distributors are privately held companies that have been operating in their markets for many years and often multiple generations. Most wholesale distribution executives have seen channel managers come and go. Based on the comments I’m getting, many have personally experienced the abuse of data by a supplier or by a particular individual at a supplier.

Making Collaboration Work

Collaborating with supply chain partners (from the latest Industrial Distribution magazine) highlights all of the key issues.

The article describes the point-of-sale data sharing between building materials distributor CH Briggs and 3M Corp, one of its major suppliers. (Observant readers will notice that I profile C.H. Briggs’ experience on page 45 of Lead the Way in the Supply Chain.)

Julia Klein, CEO of C.H. Briggs, points out the value of trust in her company’s 30 year relationship with 3M “When we were first asked [to provide POS data] we were hesitant, asking, 'Are you going to go around us? Are you going to sell direct?' They've never threatened to do it, they've never had a mistake they've had to apologize for, so we're comfortable in sharing that information with them.”

At the same time, 3M appears to have above-average data security policies. 3M's director of channel management said: “We have a very intense security policy internally. It's on a need-to-know basis only. Employees with access have to take training on appropriate uses of the information.”

Trust then Verify

In my talks, I highlight the income statement and balance sheet benefits that channel data sharing can provide to wholesaler-distributors. But at the same time, wholesale distribution executives need to proactively manage the risks of sharing data.

For example, the EDI transaction set 867 (Product Transfer and Resale Report) is the foundation of point-of-sale channel data sharing. Wholesale distribution executives should manage and negotiate which specific fields get filled in along with the level of detail provided. At the same time, pay close attention to the data security policies of key suppliers.

"Trust then verify" was President Ronald Reagan's maxim for arms negotiations in the 1980s. The advice applies to today’s channel relationships, as well.

Checking up on RFID

Over the past few years, Radio frequency identification (RFID) technology generated a lot of excitement and press as a way to track products and radically change the entire supply chain. At a trade association meeting in 2005, I heard a speaker even claim that wholesaler-distributors had no choice but to embrace RFID.

However, the early projections have turned out be overblown. As I cautioned in The Road to Opportunity, the 2004 edition of Facing the Forces of Change: “Wholesale distribution executives should consider RFID when planning future technology investments, yet be wary of inflated claims, overblown projections and unrealistic expectations.”

The new Facing the Forces of Change: Lead the Way in the Supply Chain finds that one in ten wholesaler-distributors is using RFID in some way. RFID is improving internal processes at a distributor, such as eliminating the need to scan shipments in the warehouse receiving area and enabling more effective inventory management at a customer’s location.

As I discuss in Chapter Five of the new Facing the Forces of Change, the most effective applications to date have been inside individual companies on specific projects. For example, professors at the University of Arkansas found that RFID reduces stock-outs by 30% in Wal-Mart stores by improving shelf replenishment from the backroom.

Here are two good assessments that expand on the technology topics in the new report.

A SOBER LOOK

The RFID Revolution Starts... Soon? is a nice overview article from Industry Week with a sober look at the real-world benefits from RFID. Key quotes:

• “RFID remains a niche technology, whose broader deployment has been stymied by the usual suspects: high equipment costs, low return-on-investment and a workforce skills shortage.”
• “RFID remains a finicky technology that can behave differently based on any number of factors, such as the orientation of the RFID tag on the box, carton or pallet; the type of products being tagged; and the environment in which the tagged product is stored.”
• “The bottom line for RFID is that it's all about process change and the business case. In the end, business owners, and not the IT department, will be the decision-makers when it comes to adopting RFID.”

WHAT ABOUT DRUGS?

Many people point to the pharmaceutical industry to make the case for RFID as a supply chain security solution, especially in light of wholesaler announcements from that industry.

Unfortunately, there is a lot of misinformation out there. A good antidote is RFID as an Answer to Pharmaceutical Drug Counterfeiting. Sarah Scalet, a senior editor at CSO, took the time to analyze how RFID technology might actually be used in the pharmaceutical industry. Here is a quick summary of the five myths she exposes about RFID in the pharma industry along with some of my own editorial commentary.

Myth 1: RFID tags are anti-counterfeiting devices. Nope, they are inventory control devices. There is no supply chain security benefit unless everyone adopts and uses the tags, which is not happening.

Myth 2: RFID technology is necessary to track the movement of drugs. Not true. The key to supply chain is authentication at the point of dispensing, which can be done using older technology such as 2D bar codes.

Myth 3: RFID technology can be used to mark pills, tablets, and elixirs themselves. Again, not true. I recently learned how nanotechnology can be used to encrypt individual pills and tablets. Very cool! Of course, this technology still has the exact same authentication challenges facing every labeling/packaging/tagging solution, including RFID.

Myth 4: RFID technology will let consumers verify that they have purchased legitimate products. Not even close to reality for many, many years, if ever. Besides, 1 out of 9 U.S. adults has ordered drugs from another country to save money despite the known risk of counterfeit drugs, so at least some consumers do not actually care about validation.

Myth 5: The pharmaceutical industry is this close to widespread adoption. Alas, this is also not really true, despite the fervent hopes and occasional misrepresentations of RFID technology vendors. The Prescription Drug Marketing Act, which is the Federal law governing drug distribution, is completely technology agnostic -- both paper and electronic documents and signatures can be used to meet FDA requirements. RFID is also not required or mandatory to comply with California’s drug tracking law, which is due to be implemented in 2009. California will only require electronic track-and-trace using a “standardized nonproprietary data format and architecture.

-----

Bottom line: RFID technology is an incredibly powerful tool. RFID enables cost-reductions or improvements to existing ways of doing business, but it does not fundamentally change the basic structure, functioning, or purpose of a supply chain.

P.S. I've written about RFID in the pharmaceutical industry on my Drug Channels blog.

Near-Shoring Private Labels

I am on the road almost non-stop this month talking with distributors and manufacturers about the new Facing the Forces of Change®: Lead the Way in the Supply Chain report, giving me real-time insight into how executives are responding and interpreting the results.

Discordant Trends?

Here’s a really thoughtful question that I got recently: “Doesn’t the Private Label trend counteract the Demand-Driven Channels trend?”

The short answer: Maybe. (I said it was a thoughtful question, not an easy one!)

The Demand-Driven Channels trend describes how to build a lean supply chain and reduce inventories through closer relationships with suppliers. In contrast, the Private Label trend describes how wholesaler-distributors are taking over more functions and risks from suppliers.

I mention this trade-off very briefly on page 29 of Lead the Way in the Supply Chain when I write: “Geographic distance makes planning more difficult because lead times are much longer and more uncertain, thereby inflating inventories in the supply chain. Ironically, global sourcing strategies by wholesaler-distributors represent a trend opposed to the demand-driven channel trend.”

Demand-Driven Private Labels

To better understand this trade-off, I suggest that you check out a very useful article called Revisiting LCCS in a Demand-Driven World from the new Supply Chain Management Review.

(In case you are wondering, LCCS stands for “low-cost country sourcing.” Hey, it wouldn’t be a real supply chain article without some MUFLAs -- Made-Up Four Letter Acronyms!)

As I note in Chapter One of Lead the Way, the lower costs and ready availability of overseas sourcing opportunities makes it easier for wholesaler-distributors to get their own private label products manufactured. Nearly 2/3 of distributors with private labels are using LCCS from an overseas plant.

However, the article advocates a reevaluation of “near-shoring,” such as sourcing in Mexico for goods destined for the U.S. and Canadian markets. Key points:

• “While offshoring provides clear reductions in the product cost, the associated overhead and processes required don’t always sustain the value.”
• “Near shoring may not yield production costs as low as the offshoring sites, but it can provide less cost and process fluctuation in the value chain.”
• “Companies that have products with variable demand, require low inventory, have bulky but labor-intensive products, and require significant buyer-led supplier development or engineering support are good candidates for the near-shoring option.”

Read this article to better understand the supply chain burdens of a longer inbound supply chain.

Demand-Driven Excavators

The Wall Street Journal recently published an interview with Jim Owens, Chairman and CEO of Caterpillar Inc. (See Global Trade Galvanizes Caterpillar - you may need a subscription.)

The following exchange caught my eye:

WSJ: You've also said you want to get away from the automotive model of stuffing dealers' inventories with products.

Mr. Owens: We want to keep some dealer inventory out there so they can see it and buy it and try it, but we want to get away from having them carry significant amounts of inventory. If you look back ... dealer-inventory swings have in every case aggravated the business cycle for Caterpillar. We work overtime to build inventory in the up cycles, and then [in down cycles] help them get it moved by price discounting or other bad practices. We've got to convince them that they don't need to hold the inventory. This is a huge cultural change.

This is a nice summary of the idea behind Demand-Driven Channels (Chapter 2). As I note on page 31 of Lead the Way in the Supply Chain:

"The term demand-driven refers to the idea that products are pulled down the supply chain to the market based on actual customer demand data. It also represents a contrast from the more traditional notion of products in a marketing channel being pushed by manufacturers toward the customer. Both manufacturers and distributors will be able to manage their respective inventories better when demand-based information is shared."

Clearly, CAT is building on its strong dealer relationships to bring this innovation to the construction equipment industry. In a classic Harvard Business Review article from 10 years ago, the then-CEO of CAT famously stated: "We'd sooner cut off our right arm than sell directly to customers and bypass our dealers."

My challenge questions to you:

1. How and where could you get the benefits of having a more demand-driven relationship with key suppliers?
2. Which of your suppliers are trustworthy enough to share data with?

These questions could be great team discussion starters, especially if you combine them with the Questions for Management Discussion on page 47.