The best raise you'll ever get
by Scott Benfield, Benfield Consulting
Now that the markets have a had a correction hovering around a 10% to 12% decline, many distributors who thought the worst was over are contemplating a nominal growth environment lasting throughout the decade. We dub this economy the "slog" for distributors in B2B markets, and few sectors will be spared the current and future changes that are emerging in the new slow-growth, price-sensitive environment.
Of course, there are many opinions as to what the future competitive environment for distributors will be but, based on 30 years in the business and 11 as professional channel consultants, here is our best guess:
- Cost will continue to come out of the distribution platform. Many distributors who feel they've cut all they can and who are operating on low margins will be forced to trim more. New cuts will come from the significant restructuring of major functional processes, especially sales and supply chain efforts.
- Measurement systems will become more complex and move away from financial accounting. Distributors are learning that one cannot look at the annual sales, margins, and margin percent of an account, seller, branch, order, marketing program, etc., and make any reasonable forecast whether or not the investment yields an acceptable profit. Cost-to-serve models will become mandatory for running the business but many of the models will fail to address the new standards of one baseline logic and and the measurement of labor capacity.
- Outside sales positions will take a beating. The reliable cost-to-serve models find that 40% of accounts make significant profits, 20% make unacceptable profits, and 40% drain the service capacity of the organization. Many sellers are still deployed on the losing or low return of 60% of the accounts but this will fade as it makes no financial sense to place an outside seller on an account that produces little to no return. The idea of throwing more sellers and sales effort at losing accounts in a slow-growth, price-sensitive market is like trying to get out of a pit with a shovel and pick axe.
- New stripped-down models of distribution will emerge, often as start-ups funded by larger distributors. The start-ups will have a different identity from the parent and will offer low prices and a simple, low-cost service bundle. If you know what you want and want to buy it through e-commerce, you will get a great price.
- Distributors will become value savvy or they will have a tough time financially. Value savvy means that instead of looking at financial accounting metrics to drive the business, they will look at capital returns specific to capital outlays. In essence, distributors will look at customers, sellers, branches, transactions, marketing programs and market segments as investments, and those with a poor or negative return won't get much in the way of service support.
- Plenty of distributors will want to sell but many will get asset value which is an admission that their management failed to create and capture value. This can be avoided but many won't invest the time and effort to improve their valuation and hence shareholders will take home something much less than top dollar.
Our predictions may or may not come to pass but we believe they are already in motion. Over the past several months, we've compiled research on the propensity and wishes of distributors to sell their businesses. We are still looking for more responses. However, our current research in the area of mergers and acquisitions finds the following trends:
- Deals will become bigger and more complex. Many sizable private firms want to sell out.
- Only a few acquisition strategies will work, including consolidation of excess capacity, giving a niche player access to more customers, and acquirers with better management. Roll-ups, market share consolidations, or buy-low strategies won't work.
- Multiples will be in and around historic averages. Only firms with top quartile earnings and that show consistency in the top level(s) of profit performance will fetch higher than average multiples.
- Family-managed firms are forecasted to fetch a lower value than non-family firms.[i] The difference in price for a family-managed firm versus a non-family firm, from our experience, is 20% to 40% and is called a "control premium," as most family firms run the business for control and not earnings.
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To help distributors sell for a higher valuation, our planned releases include works on driving value and recommendations on what privately held family firms need to do to maximize their value. As of today, family firms should allow 3 to 5 years of planning before they sell the firm and consider that if their return on sales are 2.5% or less, they will likely get little more than asset value. To improve their earnings, family firms should hire a professional advisor with help in driving value or hire a non-family professional manager with a track record of improving earnings in supply chain companies. The best raise that privately family-held firms will likely ever get will result from checking their egos, getting professional help, and working diligently for several years toward an above average and consistent earnings stream.
Scott Benfield is a consultant for B2B distributors and manufacturers. He is the author of five books for B2B channels and has consulted and worked for some of North America's top distribution and manufacturing companies. Scott's firm, Benfield Consulting, is located in Chicago and their work can be seen at www.benfieldconsulting.com. Scott can be reached at bnfldgp@aol.com or (630) 428-9311.
[i] Villalonga, B., Amit, R., "How do family ownership, control, and management affect firm value?" Journal of Financial Economics, December, 2004, pg. 21.
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