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Eddie Pacey

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Eddie Pacey is a 35-year veteran of the credit industry, spending more than 20 years running the credit function in IT distribution. He is now managing director at channel consultancy EP Credit Management.
By | Eddie Pacey 17th May 2012 11:09

Distie business: Lines get blurry for channel big boys

What can we learn from J Arthur Rank?

In the early '70s to mid-'80s, Rank Audio Visual – a division of the Rank Organisation – was a large distributor of audio visual and photographic equipment, theatre lighting and 8, 16 and 35mm film. It later progressed to the distribution of pre-recorded video cassettes. But what does a man with a gong have to do with the distribution business?

Well Rank Audio Visual was very profitable in the late '60s and early '70s, although margin pressure, and – perhaps crucially – an inflated view of its own relevance combined with an unwillingness to change or note manufacturer temperament meant final closure of the business in 1986.

Brands such as Akai, Pentax and others took a direct route and the ‘J Arthur Rank’ connection was not enough to hold major film production company interest.

Before you ask, it wasn’t because business fell out of love with gongs. A similar story was noted in engineering in the early '80s to '90s. A decline in UK manufacturing in the '60s led to greater reliance on distribution of Japanese and Korean machine tools.

Margin pressure came to play with cheaper Italian, Finnish and Spanish manufacturers entering the fray, forcing Japanese and Korean manufacturers to adopt more direct models. An attempt to re-create a measure of UK manufacture failed miserably and a business that at one time employed more than 4,000 in the years after WWII and was publically quoted, moved finally to insolvency in the early '90s.

Where’s the analogy?

Market forces and technological development always force change upon channel players and distribution will continue to undergo significant transformation and re-alignment. What accelerates this process is sudden, more accentuated change when aligned to fiscal and macro-economic conditions and market or consumer trends.

Distribution’s traditional leverage and support to manufacturing was reach (market coverage), logistics and channel credit.

That’s it: no frills attached and no real value-add. Distributor terms in some cases expressly avoided liability in the event an employee should give an opinion or suggestion in the context of product supply or suitability.

The beginnings of value-add

The late '80s and early '90s were good for technology distribution, annual growth rates of 30 per cent were common and specialist distributors achieved gross margins of 15 per cent while larger broadliners made between 8 and 11 per cent. Margins began to wither around the mid-to-late '90s and it was here the notion of value-add kicked in, primarily an attempt to stall margin decline and differentiate.

The interpretation of value-add is measured differently. In the early years correct delivery at the right time, in the right condition and correct quantity was “sold” as value-add. This was of course nonsense and was simply an integral expectation of a business transaction.

Value-add progressed to direct deliveries, storage agreements, white labelling of boxes, order tracking, online facilities, e-commerce, EDI, system build, software pre-loading and a host of services including technological and infrastructure support.

It now extends to managed services and collaborative engagements, effectively complementing what the reseller has or does not have much of. But terms can still exclude direct liability should anything go wrong with installation or service provision.

Distribution is, and always has been, a tricky place to be. It’s reliant upon manufacturers producing innovative products people are willing to buy and which deliver a profit opportunity. Selling at cost or below cost and relying on back-end volume rebate is not a sound way of doing business long term.

It’s also reliant upon the integrity of manufacturers and their chosen route to market. Open admission that 30 per cent or more of sales are retained as direct means this lucrative segment is out of reach and there is no absolute guarantee this balance is constant.

In most industry sectors and in early years, manufacturer terms to distributors would be 60 days or more. Many moved to demand settlement within 30 days with a percentage discount for payment in 15 days.

Distributors, nonetheless, remain obliged to offer principal clients terms of 45 to 60 days. This disparity drives distributor management of cash conversion cycles so as to be in a position to take settlement discount, effectively an option to stall margin erosion.

Distribution today

Significant events shape the way distributors work and how they will work if they are to remain relevant: commercialisation of the World Wide Web in the late 1980s; the emergence and collapse of the dot-com bubble (save for some notable exceptions); the major banking crisis of 2008; the subsequent recessionary period and Eurozone uncertainty; and, more recently, the emergence of cloud, mobility, virtualisation and static or declining hardware sales.

The web delivered instant distribution globally, client knowledge and a rise in consumerism. A new and emerging manufacturer has immediate access to markets and clients globally, negating the need for distribution in terms of "reach", encouraging more direct paths. Direct delivery models remove value in pure logistic terms and emergence of new technologies lessens the relevance of product supply and inventory hold.

While some show increases in software and services supply, hardware sales values are flat or in decline and in a recent article, only one major distributor, Ingram Micro, was willing to say what volume of “cloud-based” sales had been achieved in 2011. Ingram said that from a launch in early 2011, it "expects its cloud revenue to reach $200m by 2015". None of the other distributors were willing to detail their cloud-related revenue or growth projections.

Squeezed margins

Margin pressure continues to a point where gross margin is now less than half what it was in the early '90s and growth is largely driven through acquisition. Large resellers push supplier tenders adding further margin pressure, calling into question the merit of trading with such resellers at a loss, more so when services are integral to the tender.

Resellers generally are moving activity away from difficult hardware markets placing greater emphasis on managed services and while hardware is still part of the picture, a decline is evident and will accelerate over the next decade.

The differentiator between a distributor and reseller has narrowed as never before. Not everyone can be a data centre, trainer, cloud aggregator, solution and service provider or outsourcer, and the conundrum will be how one will spot any difference between distribution and reselling activity.

Encroachment into common territories and activities is now silently and tacitly accepted and evolution and transition appears key to future success. How long perhaps before we witness an MSD (Managed Services Distributor).

Can you hear the gong yet?

This last decade has seen a shift in business buying patterns, global reach and markets, consumerism, massive consolidation, a lack of research and development by some popular hardware manufacturers and now, simultaneously, lower hardware prices and demand.

Apple has been phenomenally successful with no significant dependence on distribution. Amazon and Google may yet threaten traditional players like Microsoft and the emergence of strong Chinese manufacturers such as Huawai, Lenovo and others, yet to arrive on the scene, may well tip the balance in favour of more mixed channel strategies and direct supply. It has been reported that Chinese acquisition of Western businesses is likely to quadruple by 2020.

Rackspace, a service leader in cloud computing, recently produced healthy growth figures. It referenced growth in both clients and servers of 172,510 and 79,805 respectively.

Simple arithmetic suggests this equates to roughly 2.16 clients per server and these are early days. How many servers would have applied 10 year ago to this number of clients? Astute resellers are moving to at least a 60:40 hardware/services ratio. New and emerging resellers are indeed heavily biased toward managed services, selling little or no hardware at all.

To remain critical to the sector, distribution needs to move to new and aligned products and services and to recognise that the tag of "distributor" may shortly no longer accurately describe their core business activity across all regions and markets.

What we see today is a hybrid model that overlaps where cost, benefit and scalability applies and the extent of this overlap will determine future roadmaps and route to market definition. New and emerging cloud manufacturers and ISVs should be viewed as potential acquisition targets by distributors as well as other direct competitors or resellers.

Relying upon and trusting major traditional and emerging manufacturers to permanently park themselves in indirect routes or hold fast on the level of direct business they do is no longer an option, as they hold the better cards.

Operating at a pressured gross margin of less than 8 per cent when sales are static or in decline and the demand is for more services at higher cost leaves no room for complacency.

It was once said: "Get big, get niche or get out." This could easily change to: "Get smart, evolve, or fade away". ®

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