Tougher Times Ahead

Distribution consultant Scott Benfield foresees accelerating consolidation among safety distributors.

• By Jerry Laws
• Jun 13, 2007

NEW research being published this summer finds durable goods sourced directly to the United States from China are 30-40 percent cheaper than goods that U.S. domestic suppliers can make there, which is a discouraging sign for smaller industrial distributors, said co-author and consultant Scott Benfield. He also said he foresees accelerating consolidation among safety distributors and a steadily tougher operating environment for smaller distributors.

"That's been going on for some time. Basically, on the industrial side where you've got manufacturing industries, the industries that are left are trying to get costs out of the process. Not only on the products, but also just the number of transactions--the number of people that they deal with," said Benfield, founder of consulting firm Benfield Consulting Co., Naperville, Ill. "They've gone to integrated supply." Vendor-managed inventory also has consolidated purchases among a smaller number of suppliers, he said.

"With most safety supplies, such as protective gloves, ear plugs, goggles and spectacles, basic medical kits and supplies--that's not anything the guy that is handling power transmission [supplies] can't handle," Benfield said. "Not to demean safety, but that stuff's fairly simple compared to some of the more engineered stuff that these guys supply."
Today's buyers, he said, are focused on cost savings and less on the product than on the cost of the distributors' support services. "That's where you look at all the products and you say, 'Well, 80 percent of these are things that I buy every day, and I know what they are. I don't need to see that safety guy in here that has that OSHA knowledge every time I want to buy ear plugs and safety glasses. But I wouldn't mind seeing him sometimes.' So some enterprising wholesaler goes out and buys a safety distributor, and he focuses that safety guy on some of the large accounts and some of the specialized work that needs to be done."

Industrial safety distributors have long provided an important training function for end users. Hazard analysis, safety audits, and product selection to meet site-specific needs are part of their service. Someone in tune with the rules and regulations of OSHA and other agencies is "invaluable," said Benfield, but the larger distributor can buy a safety distributor and bring that expertise in house or go to the trouble of learning it. "Or partner with a guy and be an integrated driver for that," he said. "In other words, if I have a safety distributor and a mill supply distributor, a power transmission distributor, a PVS distributor, all those different distributors--I'm not only paying for the products I use, but I'm also paying for some of their overhead: their IT, their human resources, their executive management. And when you have somebody that can combine those together, I only have one set of operating expenses to support my field sales as opposed to two. That’s what happens in the channel, in other words: The integrated supply is moving down that number of support people. They even move down the number of salespeople." The other factor that drove this was the movement of manufacturing to China, he explained.

High Legacy Costs for U.S. Manufacturers
The research about the impact of manufactured goods coming from China will be published by Benfield and co-author Steve Griffith in Progressive Distributor magazine, Benfield said.

"These relationships, from manufacturer all the way to the end user--many will change" as a result, he said. "Because with 30 percent less cost, the distributor is working with 30 percent less sales and 30 percent less margin dollars. And it's a thin-margin business anyway."

Distributors will be dealing with a lower cost basis for most of the products they supply and won't be able to float the gross margin and operating expense dollars they normally float, said Benfield. This affects the amount of expenditures they make and the number of salespeople they deploy. "That's all going to change because of this dynamic. So it's going to be a big shift in a lot of ways," he said.

White papers available on his company's www.benfieldconsulting.com Web site include "Cowboy Economics in the Durable Goods Supply Chain: The Chisholm Trail to Destruction." This paper, also co-written with Griffith, analyzes the flattening of the U.S. beef distribution system that doomed cattle drives and Chicago's stockyards. What wiped them out, Benfield said, were the same factors we see today from China: low-cost product and technology.

Foreign-manufactured products are big in safety and growing in all durable goods industries. "What we're finding is there is a huge propensity for foreign off brands to start selling directly into the United States," said Benfield. "Ubiquitous today. A lot of larger wholesalers are setting up direct relationships with suppliers in China, Philippines, India, the Pacific Rim, and they're buying container loads. . . . It takes a large distributor to do this. You have to hire an agent, you have to evaluate the products once he brings them in, you have to test them, and then you have to have enough cash to buy container loads. Small guys just can't do it."

If the product's quality is equal, the U.S. end user seems not to mind whose brand name is on it, he said. The reasons that products made in China are coming into the United States 30 percent cheaper than those made in China by a U.S. manufacturer include historic legacy and pension costs, insurance, extremely high CEO pay, and other built-in costs the U.S. manufacturer has, and these higher costs may be with U.S. businesses for another 20 years, Benfield said. Putting all of these together, there is a 30 percent differential across most industries, he said.

He said the same trend has happened, to a lesser degree, with the distribution of medical supplies and some other sectors. While thousands of specialty oils and lubricants distributors used to be in business, the number is down into the hundreds now, and this happened in the past five years, he said.

Benfield said that is an extreme example, "but most of these things will accelerate. They'll play out within the next 10 years. You'll see some very big guys that are pretty good at what they do. You might see some medium guys that are niche-y, maybe some high-service-levels guys. And you’ll still see some small guys out there doing really targeted niche things, whether it’s product or geographic or maybe services niches that they do. . . . It's not going to be the vast majority of wholesalers at $10 million and under, in the future. It's very inefficient. It's not going to happen."

Small distributors can survive, but they keep overhead low and focus on one or a few large customers, servicing them very hard. "But those guys are having a tougher and tougher time," Benfield said. "It's just harder for them to compete on any number of areas. The small guy has a tough time in information technology. Any more, most distributors, one of their biggest capital expenditures is trying to keep up with software and hardware. I just had an electrical supplier that I knew that went through seven figures, several times over, to put in a new software system. It wasn't hardware; it was software.

"You know, he had to. His old system was probably 15 years old, it was highly customized, it wasn't doing the modern-day things that he wanted it to do," Benfield added. "It couldn't do e-commerce very well; it couldn’t do full-blown activity [based] costing modeling very well. And it just didn’t have the reporting capability. But he's a large guy, on the order of about $400 million, so it cost him a lot of money but he can afford it. Software unfortunately doesn't go down with size. When you're looking at a small guy buying software, he still may have to pony up a large six-figure to seven-figure expense to afford that software. A lot of those guys are having tough times with that. Software itself is clobbering them pretty good right now."

Most U.S. distribution still is done by smaller distributors. "It's really tough to do, and I don't think it’s going to get any easier," he said. "I'm really not sure what these guys are going to do once the foreign products start to really come through. They're coming through now, but once they really take hold, I don't know what that small guy's going to do."

This article originally appeared in the June 2007 issue of Occupational Health & Safety.