Survive Or Thrive In The New Environment

February 4, 2009
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The recent and severe Recession will likely rival anything we have seen since the Great Depression. The downturns of ’73-’74 and ’81-’82 are similar in impact but their causes were much easier to pinpoint and they were not as pervasive across sectors and countries. We are now in a much different environment than anything we’ve seen. My take on the situation is that when the economy does rebound, it will be a different recovery and a very different operating environment for wholesalers.  

First, anyone thinking that a recovery will mimic the years from 2003-2007 needs to be taken behind the woodshed. The years of hyper commodity inflation, rampant construction, and profligate spending won’t come around for a long time. The commodity bubble was largely a result of money pouring into the commodity sector and this drove up the price of commodities 3x or more than their historic averages. Of course the inventory values skyrocketed and outpaced the cost of labor and other expenses and wholesalers’ bottom lines ballooned. Construction reached a fevered pitch with new home construction climbing to over 1.3 MM units in 2007, and fell to slightly less than 1 MM starts in 2008. Housing starts appear to be down in 2009 versus 2008.  In all, there is a likely 35% to 40% decline in housing starts from the peak in 2007 to the trough, which (we hope) is in 2009.

Lastly, consumer spending was rampant as homeowners used cheap money and rising house values as a bank account to fund excessive lifestyles. Of course this business climate helped wholesalers grow sales far in excess of operating costs and pass on price increases on a regular basis. The result was an environment that was about as perfect to lift wholesaler earnings than any other time I have seen in my three decades in the business. The recent past, however, was a gross anomaly and it’s gone for good and not coming back anytime soon. 

The press is awash with forecasts on when we will come out of this recession, but less is predicted on what the recovery will look like. My take is that we will begin a slow repair of the negative GDP in the third or fourth quarter of this year. Beyond this, 2010 and possibly 2011 will be slow growth. Construction and repair and remodel will be muted for sometime as layoffs will continue for much of 2009 and hiring probably won’t begin in earnest until 2010 and later. Hence, consumers will have little appetite for buying or building.  

Commercial construction is taking a dip later than residential, which means that recovery in this sector will be pushed out well into 2010 and possibly much later. Finally, the industrial sector will begin a slow and erratic recovery well into next year and possibly 2011. Global demand is softening and has lagged the U.S. down cycle which means domestic manufacturers won’t be able to ship near as much overseas for a long time. 

Today, most wholesalers are just beginning to feel the pain in a big way. They have burnt off most of their high-cost commodity inventory and witnessed substantial drops in top line sales. Our information says that layoffs started in December but have become commonplace in the first month of 2009. We expect more layoffs as wholesalers adjust their capacity downward. Most companies aren’t making anything in the way of substantial investments and are working off planning horizons of 90 to 120 days. For the most part, the words “hunkering down” apply and while this is a good short-term strategy, it won’t be much help when recovery does come. 

My estimate is that recovery will be slow, price sensitive, and ultra-competitive.  Therefore, my recommendation is for wholesalers to get prepared to operate in a new environment where efficiency, better measurements and better knowledge will be needed to compete. Slapping the warehouse full of inventory and hiring the best salesguy away from the competition won’t be of much help in the recovery, and many wholesalers will have to learn new things or they will be relegated to a “hunkering down” role long after the recovery starts. 

What's Needed In The New Environment?

I have been studying and working in wholesaling markets for nearly three decades.  I don’t believe that much of yesterday’s knowledge will help one thrive in the coming environment.  Much of the knowledge is old, research is limited or poorly done, and the tools and measurements are worn.   Hence my suggestions below may appear on the fringe but, again, I don’t believe you will win in the new environment by doing the things that allowed for success in the Shangri-La economy of a few years ago.  If you want a read on why I believe the old measures are worn out, see my White Paper on Transaction Management.

To thrive in the new economy, my suggestions are:

  • Get a good understanding of where you make money and where you lose it. This means using Activity Costing or Differential Costing or some other allocation methodology to help you understand what drives your operating profit. I prefer Differential Costing because it uses transactions but other consultants have other tools that may help. Whatever you do, don’t rely on traditional financial accounting, accounting ratios and PAR reports to give you much insight into where you lose money.  Financial accounting is a time period based discipline and it is limited in its ability to help stanch losses from operations.

     
  • Forget about single measure compensation systems such as rewarding bonuses or commissions on margin dollars or sales. Sales and margin dollars don’t mean much since they are not paired with the expenses they incur. We find that some 40% of all sales territories don’t contribute to operating profits. In essence, rewarding a seller on margin dollars means that they will bring in just about any margin dollar and many of these transactions won’t cover their costs. If you don’t want to reward bonuses or commissions on Transaction or Activity Profits, reward on margin dollars and corporate operating profit or simply pay a straight salary and give a year end-bonus based on corporate operating profit. 

    Margin dollar compensation is old and, in light of the new knowledge, has a high probability of destroying operating profit. And, forget the debate about Straight Commission, or Salary and Bonus or Salary and Commission being the best compensation plan(s). All of these plans essentially fail because they are based on single measures of sales or margin dollars to drive performance. Whatever you have learned about compensation in the past should, for the most part, be thrown out. You could probably have as much effect on operating profit by rewarding sellers on phases of the moon than by driving single measure compensation plans. 

     
  • For transactions that lose money, raise the price, limit their number, or streamline the process. For the most part, wholesalers make money on stock (original order) and drop shipments. Most other transactions including non-stock, counter sales, cash sales, and stock transfers lose money. Mitigating loss on these transactions is important and it will allow you to offset losses and salt away money to fund the demands of large customers who will expect much better pricing in the coming recovery.

     
  • Train sellers on how to drive transaction size and type. If you could have sellers that take large stock orders and drop shipments and diminish other transactions, you will be much better off.

     
  • Consider pricing based on order size. In essence, if a customer orders $600 list price of goods, give them 30% off versus ordering $250 list price of goods where they get 12% off.

     
  • Consider paring back the hub and spoke system and satellite branches. When I have used Differential Costs (transaction based costing) to measure the profitability of satellite branches and branch transfers, my clients often turn green. Why? Because branch transfers typically cost 25% to 30% more to process than an original stock order and satellite branches have a disproportionate number of these transactions that often creates a negative operating profit situation. The most profitable branches are those that have a high level of original orders and drop shipments and minimize counter sales, non-stocks, and stock transfers. Again, to understand this you will need to develop a costing methodology outside of traditional allocations based on the income statement. 

     
  • Get knowledgeable on global supply chains and global sourcing. Foreign off-brands, according to our 2007 research, are streaming in at prices that average 30% less than domestic brands. Our financial modeling shows you will have a rough time competing against distributors who are sourcing high-quality/low cost off-brands.

    In summation, the new times and new environment will demand new tools. The old systems and measurements of the past won’t help much in the new environment of efficiencies and price sensitivity. Of course you can play the “hunker down” game and live from quarter to quarter playing tactical games with your employees, their salaries, the vendors, and your banker. But this is not much of a life and it won’t hold up against wholesalers who learn the new knowledge and use it strategically.


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