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5 Tactics for Distributors to Thrive in a Consolidating Industry

May 1, 2021 8:15:00 AM CDT

By Ian McCue for BrainyardI

n short:

  • A wave of mergers and acquisitions have changed the wholesale distribution market in a big way over the past 10 to 15 years.
  • A variety of factors have driven consolidation in this industry, from the age of company owners to more intense competition from industry leaders to the rising popularity of online shopping.
  • We offer five steps smaller and midsize distributors can take, like pairing products with value-added services and capitalizing on their size, to compete and grow in this new environment.

In the 1950s, an enterprising engineer by the name of Burt Belzer moved to Southern California looking to get involved in the burgeoning aerospace industry. Belzer and a partner saw potential in the tooling distribution industry and founded a company called Tool Components Inc. in 1956.

Sixty-five years later, Tool Components Inc. (TCI) is not only still around, but still in the family. Burt’s grandson Ben Belzer is the president and COO of the company’s two divisions: E-Z LOK, a master distributor of threaded inserts under that brand name, and TCI Precision Metals, a distributor of machine-ready metal blanks.

TCI is something of an anomaly, and not just because it’s a third-generation family business — only 12% of family-owned companies make it to the third generation — but because it’s a small distributor in an increasingly consolidated market. In the last 10 to 15 years, mergers and acquisitions have quickly accelerated in the wholesale distribution space. What was once an industry rife with small, family-owned distributors like TCI has seen larger distributors or private equity firms buy up many independent players.

Twenty-seven percent of large distributors have acquired another company in their industry since the 2008 financial crisis, and the average size of distributor acquisitions has increased by 35% compared to before the recession, according to McKinsey. Indeed, TCI has received plenty of interest — Belzer said he receives calls or emails “practically every day” from parties interested in purchasing or partnering with the family business.

There are numerous factors driving this surge of activity — some obvious, like owners who want to retire and lack a succession plan, and some more nuanced, like a lack of resources required to compete with firms that are proficient in selling online. This consolidation has put increasing pressure on many small and midsize distributors, pushing them to find ways to counter shrinking margins and competition from much larger players.

In this article, we’ll explore how the industry has changed, what’s driving increased M&A activity and steps smaller businesses can take to excel in this shifting landscape.

From Backyard to Global Competition

Like so many other sectors, the internet has had a profound effect on the distribution industry. One of the most commonly-cited changes ecommerce has incurred is the rise of manufacturers selling direct-to-consumer (D2C) to earn more dollars on each sale while cutting out the distributors that historically were responsible for getting products to businesses and consumers. Fifty-seven percent of consumer brand manufacturers now sell D2C, according to a study from Ally Commerce.

The ability to sell goods online also vastly expanded the field of competition in an industry where many distributors relied on a local and regional customer base.

“Before the internet, it was catalogs and networking and those types of things to find a local metal or inserts distributor,” Belzer said. “Then with the internet came competition on a national scale. Overnight, competitive pricing was available with just a click of a button.”

That much bigger pool of competition forced these businesses to lower prices and cut into margins that already lagged behind many other industries.

At the same time, distributors had to figure out how to support this new sales channel, one that has taken off in recent years. In 2020, B2B ecommerce sales reached nearly $1.4 trillion, up more than 10% from 2019 despite the economic uncertainty and challenges of the pandemic. And in 2019, before lockdowns forced more consumers to shop online, online B2B sales grew faster than online B2C sales. The number of businesses doing more of their procurement online is only expected to grow as more millennials, who prefer this channel, move into leadership positions.

 

What’s Driving Consolidation?

There are many reasons a distributor might decide to sell or merge with a competitor. But why is all this activity happening now? Let’s walk through several drivers.

Owners aging out

For some owners of distribution companies, the motivation to sell is simple: They don’t see a future leader for the company within their family or among the current executive team. The increase in M&A activity aligns with a period in which many first- or second-generation owners are approaching the end of their careers, according to Brent Grover, a long-time consultant to distributors who’s also an Excellence Fellow at the National Association of Wholesaler-Distributors (NAW).

“I think we’re in a stage right now where they’re looking for somebody to buy their business and to afford them enough proceeds to live for the rest of their lives,” said Grover, formerly the CEO of his family’s distribution company, National Paper & Packaging, which he sold in 1999. “It’s their retirement fund.”

In addition to the difficulty of keeping any business in the family after a certain amount of time, the next generation is often hesitant to take over a company in a market with an uncertain future. Many daughters and sons would rather take their chances elsewhere.

Extensive fragmentation

For much of its history, the wholesale distribution market was — and in many cases, still is — composed of countless small companies that distributed a very specific category of products to customers in a particular niche. McKinsey notes that the biggest player in most categories of industrial distribution accounts for no more than 6% of that total market.

This fragmentation created a natural opportunity for consolidation, said Ritesh Chaturbedi, COO of Systemax, a billion-dollar distributor and direct marketer of industrial, technological and other supplies.

“Whenever you have a fragmentation in this kind of an industry and then there are opportunities, either great economic boom or great economic recession, every company looks for operating leverage,” Chaturbedi said. “That drives M&A; that is traditional in any industry.”

Catching up to industry leaders

Increased M&A activity is not unique to the distribution space, and some of the same forces at play have impacted other sectors. Chaturbedi points to consumer-focused retail giants like Amazon, Walmart and Target that have conditioned customers to expect to get any product, any time, through whatever channel they choose, and all at a competitive price. These expectations have bled into the B2B world.

As the bar keeps rising, many smaller companies struggle to match the outstanding customer experiences which top companies provide. They need access to additional capital and expertise to contend with those top players, and merging with or acquiring another company can help them reach critical mass.

“That competitive factor is not because of [market leaders’] size but because of their approach to the customer experience,” Chaturbedi said. They’re really driving selection, price and convenience at such a higher magnitude of experience that customers expect it. For you to compete in that market, you have to change.”

“Market leaders are driving selection, price and convenience at such a higher magnitude of experience that customers expect it. To compete in that market, you have to change.”
—Ritesh Chaturbedi, COO, Systemax

Plus, buyers increasingly prefer to purchase a variety of supplies from just a few sources, according to Grover, which has also challenged smaller players. For example, a customer may prefer to purchase janitorial supplies from its industrial distributor rather than another company focused on those products.

Shift to digital

Related to the last point, some owners see the transformation necessary to meet customers’ rising demands as simply too daunting. It requires a serious investment in new technology and some degree of workforce retraining, which can be particularly intimidating for companies that have failed to make incremental improvements over the years.

This shift has created two different scenarios that convince distributors to sell. The first is when owners decide they don’t have the patience or interest to reimagine and modernize their companies (and likely sell at a reduced value). On the other end of the spectrum are organizations that capitalized on these new purchasing habits, figured out how to serve the modern customer and now generate a hefty percentage of their sales online. That makes them an extremely appealing target for larger distributors looking to quickly improve in this area.

“Getting digital enablement and having that stick at a certain price point takes a lot of investment and a lot of time to get the economies of scale,” Chaturbedi said. “Many companies just don’t have that time, so they just would rather acquire it.”

 

Expanding customer bases

Acquisitions offer a faster and often easier way for buyers to expand their customer base, even those that have the capacity to do this organically. Some businesses may be able to both pick off a major competitor and steal their customers through a merger or acquisition. Belzer said this has long been common practice in the aerospace industry — companies purchase small machine shops, roll up their customers and then sell off the shop’s equipment and real estate.

It’s not just the biggest names in the industry that see value in this approach. Growing distributors may want to move into adjacent categories when they reach a certain size and see acquisitions as the best path to accomplish that.

Private equity

Over the past 15 years, private equity firms have also become convinced of the investment potential of distributors. Just as they’ve done in other industries, these groups buy up several smaller companies that offer similar or complementary products, combine them and benefit from economies of scale. After a few years, they usually sell off that bigger company they’ve created for a healthy profit. (In our next article, we’ll explain why private equity became more involved in distribution in greater detail.)

How Can Smaller Distributors Prevail?

Leaders of small and midsize players in the distribution market must realize the old playbook won’t work anymore. Tight, decades-long relationships with customers and a salesforce that makes regular client visits to add a personal touch no longer comprise an effective long-term strategy.

Here are five tips for distributors looking to carve out a profitable place in this marketplace:

1. Provide a unique value-add for your offerings

It’s hard to win on price and selection in a world where customers can plug an item name into a search engine and quickly find out how much it costs and when they can get it. So the value-add, often a service, must be something online or non-local competitors cannot match.

“There used to be a saying 20 years ago: ‘Get specialized, get bigger or get out.’ I don’t think that applies anymore — I think it’s, ‘Add value or get out,’” Grover said. “Your company has got to add value to the products, typically through services that cannot be easily copied — what Warren Buffett would call a moat.”

Grover uses the example of a welding products distributor that sends experts to customers’ facilities to show them how to use the equipment. A company that sells industrial forklifts and box trucks could have a team of mechanics who service that equipment on-site for customers regularly for an additional fee. That type of hands-on, technical expertise will distinguish you from larger distributors with deeper pockets.

2. Invest in the digital tools customers want

As the numbers suggest, distributors like E-Z LOK, which has sold online since 2017, have observed a steady increase of customers looking to buy online and a corresponding decline in orders via phone and fax. While adopting B2B ecommerce is a laudable effort, it has become more table stakes than a differentiator.

Distributors need to support mobile buying — perhaps with an app — and should have online account management tools that allow customers to review available trade credit and order history, set up automatic reorders and track current and upcoming orders. Their ecommerce sites should provide customer-specific pricing, show current inventory levels, have detailed product content that answers potential buyers’ questions and offer loyalty programs. These capabilities are among the “omnichannel convenience” features that 57% of customers in the McKinsey survey ranked among the top three improvements distributors should make.

Chaturbedi agrees ecommerce is a “huge accelerator” but noted that distributors also need to strike a balance between expansive product selection and an overwhelming catalog of items. Getting that right could require detailed sales analysis, testing and soliciting feedback from customers.

 

3. Own your niche

Some distributors solve a particular need in a particular market, like providing maintenance, repair and operations (MRO) parts for machinery used in a certain type of manufacturing. Boutique distributors can lean into that specialization and concentrate on capturing additional market share so they become the go-to vendor for those products. In these niche spaces, the risk of a bigger player stealing market share is much lower.

“For big players, either the size of that prize is not big enough for them to focus or even if they want to focus [on it], they have other focus areas that they really need to drive capital allocation on,” Chaturbedi said.

Exclusive brands and products can also be more effective than competing with the biggest companies on price, selection and speed, said Ben Argov, president of International Wine Accessories (IWA), a distributor and retailer of wine-related products and accessories. With that in mind, Argov and his partners have acquired five companies with well-known brands and name recognition over the past decade, in order to sell their exclusive brands to customers.

Serving a particular corner of an industry or selling exclusive brands is only possible for some companies, and as Grover said, broader specialization as a strategy is not as effective as it once was. And distributors that fit into this category still need to offer self-service online capabilities and find creative ways to meet evolving customer expectations.

4. Find the right customers, then hold on to them

Lowering customer acquisition cost plays a central role in the long-term sustainability of many smaller-scale distributors. Additionally, these distributors should target buyers who will not just make one-time purchases but order regularly. That latter comes from having the right product selection, including specialty items or exclusive products. Companies should also consider extending discounts to customers who sign up for subscriptions to their products or services.

“You really want to go after a segment of customers that are very, very sticky,” Chaturbedi said. “So the … per-unit metrics of customer acquisition, repeat purchases, basket size, are you growing in that basket or not, I think are very critical.”

Ecommerce and the self-service tools within can help lower the cost of acquiring and servicing customers, especially if you can suss out the most lucrative digital channels for reaching prospects. Your ability to meet ever-changing expectations will also affect whether customers continue to buy from you and their customer lifetime value. The metrics long-used in B2C commerce hold real value in a B2B setting, as well. In fact, Brainyard research on leaders’ plans for 2021 found that, in both the broad market and manufacturing and distribution, marketing was a priority for new customer acquisition — versus sales, which came further down the list. Support online self-guided discovery, because that’s how customers are deciding what to buy.

5. Use size to your advantage

Just like in other industries, there are certain advantages inherent in being a smaller distributor. For example, such a business might have the flexibility to source a small number of items it doesn’t usually sell, like face masks and hand sanitizer, in order to capitalize on sudden demand, say, during a pandemic.

“If I’m a big player, I’m sourcing in container loads,” Chaturbedi said. “But if you want to get a small SKU base online and you have a sourcing capability from Far East or domestically, and in a small truckload you can put it near the customer and deliver it now, the time to market is significantly shortened for a small niche player.”

TCI saw both divisions grow in 2020, despite the year’s challenges. Belzer said he believes that his company can provide higher and more personalized service than a global one.

“We actually gain customers on the metal service side of our company, because there’s somebody on the other side of the phone. We focus on building relationships, because we’re a small company,” he said. “People tend to like to do business with us for that reason.”

“We focus on building relationships, because we’re a small company. People tend to like to do business with us for that reason.”
—Ben Belzer, president & COO at Tool Components Inc.

Smaller players may also be better positioned to solve the issue of availability. Large businesses are structured so as to minimize costs, Chaturbedi noted, which sometimes comes at the cost of speed and agility. A local distributor, however, could have a facility in or near a major metro area and an attentive sales rep able to deliver a critical tool or item same- or next-day to a customer in a pinch. Big distributors might have a hard time pulling that off.

How Technology Helps

For many of these steps, execution either requires or gets easier with technology. At a basic level, software systems can give distributors the information they need to better understand the current state of their businesses. It can shed light on a company’s efficiency and margins, revealing processes or areas of the business that are performing well, as well as those falling short of expectations. Accessing and tracking this data often starts with an enterprise resource planning (ERP) system that handles back-end functions — companies usually start with finance ERP modules and add inventory and order management, procurement and shipping.

Many of the family-run distribution businesses that got their start in an earlier era have realized the importance of these systems in recent years. The initial hesitancy to invest in software and other technologies has started to dissipate.

“When I started here almost 20 years ago, we didn’t have an IT budget,” Belzer said. “We built and fixed things as necessary and used a hodgepodge of software. When told we should allocate 1% of total revenue to IT, we thought it was nuts.

“Our budget nowadays is not only 1% but much higher, and so is our profitability. You have to get out of your comfort zone and be willing to invest in technology and infrastructure. It pays back.”

Belzer estimates E-Z LOK would need twice as many employees without an up-to-date ERP that offers visibility into its financials and automates and manages order receipt and fulfillment. In his eyes, the platform lowers overhead and helps the business remain competitive. Similarly, Argov said this software has allowed IWA to grow the top line without a proportional increase in payroll. That boosts the business’s profitability and gives it more money to spend on things like R&D and marketing.

Regarding customers, selling online and tapping into a dramatically larger audience requires an ecommerce system. And basic web analytics tools, like Google Analytics, help distributors track metrics like customer acquisition cost, repeat purchase rate and customer lifetime value and uncover buying patterns and trends. Similarly, a CRM can help companies target customers with more relevant offers and give them more personalized service to strengthen those relationships.

There’s no denying that replacing existing systems or implementing them for the first time does require a significant investment of time and resources. But outdated, heavily-customized ERP systems hold organizations back, according to Grover, especially if they attempt to bolt on an expanding repertoire of solutions to address various needs in the business. Up-to-date systems are a necessary investment if distributors want to compete in a market that is, in many ways, more challenging than ever before.

The Bottom Line

Even in the face of rapid consolidation, there is no doubt that smaller and midsize wholesale distributors still have a place in this market. It may take them some time, along with continuous experimentation and adjustments, to find their exact place, but the future is not bleak. Businesses with seven-figure revenues can coexist with the powerhouses that bring in billions every year. In many cases, they may serve different customer bases or address entirely different needs.

Even if they have to reimagine themselves, there will always be companies like TCI — distributors that not only serve a niche, but strive to remain independent and continue to resist attractive offers. They’ve grown through market changes before, and they’ll do it again.

“From a personal and business perspective, I’m just not interested [in selling],” Belzer said. “This is my legacy and my livelihood. This is what I do, and I love doing it.”

Oracle NETSUITE

Written by Oracle NETSUITE