Most of merchant wholesaling is entering the third generation. This generation has a rather interesting history in American Business and, if the history of family-owned, third generation businesses apply to merchant wholesalers, the next decade will be interesting indeed. The third generation of business is, generally, marked by the following traits:
We find graduate business degrees in many sizable firms in the manufacturing and service sector but seldom in the third generation managers of family distribution companies. Those that do have graduate degrees typically run much more profitable firms than those who don’t.
All these challenges are not evident in all distribution companies but you can usually find several of them at work. How does the third generation guard against these issues? The bottom line is that family must agree to run the business as a business, hire the best managers regardless of whether they are family or not, and develop goals that are best in class for growth and profitability.
In essence, family members of the third generation should have to compete for the top spots in the firm and justify their position with best in class performance. Of course, our experience is that many don’t do this and this is why most third generation family businesses underperform or fail. In a conversation with two, experienced, well-educated, and non-family executives, I asked them how does one change the third generation family business? The overall opinion is that it is almost impossible to do so unless family cedes major decision making to outside elements and challenges the often sedentary practices wrought by three generations of success.
In this environment, however, I believe it is an opportune time to succeed. Far too many distributors I interact with are satisfied and rather sedentary businesses. Many distribution executives think they are busy and don’t see how they, or any one else, could do much more in their respective firms.
However, the financial performance of most durable goods distributors, over time, is not good. Some two-thirds of family distribution businessesfailto earn a satisfactory return on investment. Generally, the wholesale firm must earn a consistent and minimum 2.5% to 3% of sales before taxes to get the same returns, liquidity and diversification that they could in public markets.
Unfortunately, most distribution firms, over time don’t do this and this is why they underperform and are vulnerable. Today, many distribution firms are experiencing an earnings “pop” because of commodity inflation. The prices of steel, copper, petroleum and other base metals have skyrocketed 2.5x to 3.5x and this has lifted earnings of the average wholesaler. We caution wholesalers that this effect is only temporary and the commodity prices will come down and, over time, reflect marginal cost and inflation led earnings will be a fond, and sometimes bitter, memory.
In this predominant third generation environment, the firm that does things differently, smartly, and consistently can profit handsomely. This means breaking up the family gene pool with the best management that can be found. Whether or not the management is family is not as important as what they can do. Secondly, the third generation firm that hires experienced, better educated, and hard driving execs will have a better chance to succeed.
Extended family members who are clipping dividends and distributions will have to sell out or come together and agree to let outsiders drive the firm. They will have to give key outsiders stiff objectives when, once reached, pay off handsomely. And, finally, our research leads us to believe that the innovations and competitive advantage in distribution will come from changes in the business model and less from typical sales, product, branch, and acquisition growth.
The opportunity in distribution is as rich as it has ever been. The third generation impediments are real and those governing families who acknowledge, understand, and fight against them are going against the well established history of observed decline in third generation family businesses. In essence, they take the historical bull by the horns and, in the paraphrased words of Winston Churchill, history will be kind to them for they intend to write it.