Industrial supplies distribution industry. What operating criteria define success in distribution companies?

The industrial supplies distribution industry consists of companies involved in the business of distribution of supplies such as packaging materials, electrical components, electronic and mechanical parts, etc. for the repair-maintenance of equipment, machinery to manufacture, mining, construction and utility sectors (together they are referred as the industrial segment). The industrial supplies distribution industry, thus derives its demand and revenue from industrial segment and move very much in synchronisation with the segment. The industrial segment in return relies on distributors for on time delivery of good quality supplies at competitive prices to ensure smooth operations. This is evident from the below graph, the United States industrial production index was on a rise during 2010-14, however, it has been declining following the peak of November 2014.

Source: Bloomberg

The revenue from the industrial supplies distributors in the United States closely followed the trend in industrial production index as can be seen in the underneath graph. The combined revenues of top 3 industrial supplies distributors in the United States registered a healthy CAGR of 8.7% from 2010 to 2015. It is worthy to note that though revenues continued to grow on a YoY basis during the period, the growth rate was declining mainly on account of increasing base. But, the revenues declined in 2015, which was in tandem with the decline in industrial production index succeeding November 2014. 

Source: Televisory’s Research 

In the light of the relationship between industrial supplies distributors and industrial segment wherein the business environment is governed by macroeconomic conditions, Televisory tried to identify operational parameters which define the success of industrial supplies distribution companies. Televisory examined a sample of three companies which are in industrial supplies distribution, Watsco Inc. (Watsco), MSC Industrial Direct Co. Inc. (MSC) and Wesco International Inc.(WESCO) for the study. The analysis revealed the following key attributes, inherent in large and successful industrial supplies distributors:

Diverse product portfolio (large number of SKUs) was key to customer servicing and retention

Televisory analysed that all the three companies had a large number of SKUs under their product portfolio. The company with a wider basket of product offering and a lower revenue dependence on a particular product generally has a greater capability to fulfil wider customer base’s demand requirements and serve as a one-stop destination for customers, thereby leading to a higher customer base and longer duration of customer association. This eventually leads to repeat orders from customers and higher revenues for the distributors.

Source: Televisory’s Research 

Large supplier base and diverse customer profile safeguard company’s revenue and profitability 

The companies with a larger customers’ base, lower dependence on a selected few customers, for a significant portion of their revenues have more stable operations as compared to the companies with higher customer concentration. The companies which have a higher dependence on particular customers are more prone to loss of revenue and also profits in case of customers’ loss. Additionally, these companies have lower bargaining power against their customers, thus leading to low profitability. Televisory analysed the average realisation per customer and operating profitability levels for WATSCO, MSC and WESCO. In the below chart, MSC has the lowest revenue per customer amongst the three players on account of the larger customer base. The company benefited in the form of higher bargaining power against its customers, resulting in higher profitability. 

Key profitability metrics

Source: Televisory’s Research

As in the case of customers, high dependence on a few suppliers also negatively impacts a company’s performance.

The companies with high supplier concentration have lower bargaining power resulting in higher inventory levels as suppliers tend to push their inventory to distributor’s books. Although MSC and WESCO had a similar number of product offerings, MSC had higher inventory levels, thus, resulting in a high inventory carrying cost to the firm. The higher inventory days, despite a similar number of SKUs for MSC as compared to WESCO are attributed to the limited bargaining power of the MSC with the comparatively lower number of suppliers. 

Procurement metrics

Source:Televisory’s Research

Effective working capital management bolsters profitability levels

The distributors offer customers a broad range of supplies requirement from different manufacturers hence, benefitting them in supplies procurement. However, distributors have limited control of the selling prices as they do not add value to the product and the prices are generally dictated by product manufacturers. These companies also need to stock a large inventory by the virtue of their large product offerings. In the view of high inventory requirements, lower gross profit levels, it becomes important for the companies to effectively manage their working capital cycle. As shown in the graphs below, when the cash conversion cycle of the companies improves so does their net profits and vice versa. 

Source: Televisory’s Research

Source:Televisory’s Research

Source:Televisory’s Research

Therefore, based on the analysis of Watso, MSC and WESCO it can conclude that in the backdrop of difficult industry scenarios, rising demands from customers and pricing pressure, a successful industrial supplies distribution company is built on the foundation of diversification, agility and effective working capital management. 

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