Keeping afloat in the distribution ocean

Times are tough in the IT industry and distribution is feeling the pressure more than most. With many in the sector claiming that things are only going to get worse, Sara Yirrell looks at what lies ahead

With stormy waters still facing the UK IT market it is understandable why many distributors have securely strapped on their lifejackets and are pushing full-steam ahead to ride out the choppy waves.

Over the past year the distribution sector has faced many blows, with margins being constantly squeezed, vendors making increasing demands on resources, while all the time VARs are still demanding a slick and efficient service at a reasonable price.

The general consensus is that the sector is faced with more consolidation and continued margin pressure. Many distributors are wondering in which direction to turn next, while all the time hoping to stumble across the next technology cash cow.

Shockwaves are being felt across the board from the broadline players, such as Computer 2000, which went through a corporate restructuring process earlier this year (CRN, 1 August), down to the sub-distributor level. The most recent example

being Mitek, which entered a Company Voluntary Arrangement last month to keep the business afloat (CRN, 10 October).

Even Ingram Micro – the daddy of distribution – has felt the effect of the choppy waters over its boughs. Last month the firm reported an increase in third quarter global sales to $6.96bn, but saw its profit tumble to $48.4m compared with the $77.3m in the same quarter of the previous year.

Hans Koppen, president of Ingram Micro Europe, told CRN a distributor has to work twice as hard just to make the same profit.

“I think pressure will continue in the distribution and IT sector. Prices will come down and impact on business, no matter how profitably it is run. Also margins are not changing, so we have to do more and more work to accomplish the same results. Transport costs are more significant, and the amount of money we get back is shrinking,” he said.

However, Koppen was bullish about the distributor’s performance in Europe, particularly in the UK.

“Europe is doing very well for us at the moment and the UK was excellent. It had a higher average growth than the rest of Europe. I would put this down to solid execution. It is all about having a low-cost base to operate from and concentrating on efficiency. If you become more efficient, you will win market share from competitors,” Koppen said.

Alastair Edwards, senior analyst at Canalys, said the market will continue to get more competitive.

“The whole distribution model has undergone a transition. The smaller players face a real danger of ending up annoying their resellers by competing with resellers own customers. We are also seeing certain players carrying on with cost reduction and restructuring.

“Several key factors are pushing the change in distribution – pricing and margin pressures. The fact that some of the big vendors are looking to reduce the level of rebates they give to their distributors means the smaller players have to think about where their future lies. Also, with the level of casualties in the reseller sector, more distributors are exposed to risk and the issue of margin becomes even more key,” he said.

Roger Mather, managing director of Actebis UK, claimed that sub-distributors will find it harder to stay afloat than the larger liners in the distribution fleet.

“Everybody is having to tighten their belts, and that is only at tier-one distribution level. The ones further down are suffering a lot more. With the power of the internet and a customer’s ability to get quotes online, sub-distribution is finding it difficult to add value to their offering. We are having to be very aggressive to maintain turnover and that makes life very difficult for a sub-distributor. I also think the rate of consolidation will speed up as well,” he said.

Les Billing, managing director of components distributor Microtronica, agreed.

“We are finding that it is the smaller companies that dabble in distribution who are going to be squeezed more and more. There is a lot of caution in the UK marketplace, nobody is spending any more than they need to and companies are only replacing what is broken. There is not a great deal of free business floating around. Rates have gone up dramatically due to oil prices and it makes it very difficult for the smaller players.

“There is going to be an ongoing shakeout, and this applies to resellers and integrators as well, not only distributors,” he said.

Andy Dow, commercial director at Westcoast, claimed that the key to survival is focusing on core values.

“We are having a pretty good year at Westcoast and are confident of a solid year ahead. It is no coincidence that when the market is tough, we flourish. That is a reflection of our core values and the fact that we are getting the cost structure right and delivering the key services that resellers need. When the market is tough, it all goes back to basics, that’s what we really concentrate on,” he said.

Dow claimed it is not the first time the industry has been in a downward cycle.

“The industry seems to spend more time in recession than not, and the pain is being felt by everybody. Distribution is constantly being squeezed from both ends – resellers are trying to buy cheaper and vendors are looking at cost structure. However, one thing we are noticing is more value being put around demand-creation. Marketing investment is not as glossy as it once was. The emphasis is – and should be on – investing more in helping resellers to sell,” he said.

Dow agreed with Koppen that a distributor is often running faster just to stand still.

“Prices are coming down and unit sales are going up. The market is growing in volume, but not necessarily in value, particularly if you look at how many boxes need to be shifted to make the same amount. However, the channel will never sell less,” Dow said.

Malcolm Roach, managing director for the Mitek Group, which quit distribution for a wholesale model last month (CRN, 24 October), said other issues such as credit insurance and bad debt have had a massive effect on the market.

“It has certainly been an extremely tough marketplace. I think that it will continue to be difficult and the market will be controlled by the big-name distributors. Sub-distribution is too difficult. One of the main reasons for this is poor credit.

“The credit insurance issue is a major problem for the industry. In some cases the attitude of the credit insurers accelerate the demise of companies that get into difficulties and often they don’t give them the opportunity to be able to reorganise and pull through their problems. We were extremely lucky – despite the credit insurers – that we had the support of all our creditors,” he said.

Nitin Joshi, director at insolvency and accountancy firm Vantis, said distributors always need to be aware of the bigger picture.

“From observing the industry, I think that around 1,600 companies will go bust over the next 12 months, and that obviously has an impact on distributors.

“The more adept they are at dealing with a continually changing marketplace, the better they will fare. We are definitely going to see more merger and acquisition activity at a distributor level.

“There are still structural problems in the distribution market, particularly where credit is concerned, and those players that have implemented a state-of-the-art credit function will succeed more than those with an embryonic function.

“Sub-distribution is another risk. Although some are backed by companies in the Far East – the picture is changing. Prices have come down but the question is: is it sustainable?” Joshi said.

Another argument facing the distribution industry is the need for specialist versus broadline. Earlier this year Ingram’s chief executive Greg Spierkel warned that niche distributors would be squeezed out of the market by the broadliners (CRN, 27 June).

Mukesh Gupta, managing director of specialist security distributor e92plus, said it has an advantage in dealing with niche products.

“The market is tougher than it has been, but we have been going for 17 years and have survived two other recessions. It is the way we work that makes the difference. Because we are dealing with products that are neither commoditised nor volume, we can make better margins. We add value to the products as well, unlike some distributors that sell commodities,” he said.

Bernie Dodwell, vendor alliances manager at Westcon, said there are three types of distributors: broadliners, specialists and the ones in the middle that are moving down from broadline into a more value added offering.

“Westcon sits in that middle space and we are moving to value rather than volume.

“From a specialist point of view, unless they can find another market niche, their niche will start to become mainstream and eventually they will get swallowed up. Either a niche distributor evolves and moves into new areas, or it whithers on the vine and gets acquired.

“In the specialist market many tend to make money while the sun shines, but those at the top-end that can’t afford to invest in new markets buy into new markets by making acquisitions. I think we will eventually see all niche distributors being swallowed up by the bigger players,” he said.

However, Andrew Saunders, divisional managing director at networking distributor Crane, said there was plenty of demand for a more specialist service.

“There is always going to be the debate about broadline versus specialist, but there is a need for specialist distribution, especially around converged solutions.

“One thing that will continue is pressure on margins. We have always been a value-add distributor and differentiate ourselves by offering value. There is too much competition at the moment based purely on price. Offering a lower price creates expectations among resellers which is unsustainable in the long run,” Saunders said.

But he added that vendors need to do more to police their distribution channels.

“Distributors are squeezed between vendors expecting them to do more and more with their accreditation models and charging for technical support. Resellers want everything provided at a lower price. Vendors need to be seen to be fairly and equally policing their accreditation programmes more and not just appointing random new distribution partners to get incremental business. There needs to be more consistency in a number of vendor’s strategies,” he said.

Microtronica’s Billing added: “It also depends on how specialist a distributor is. We specialise in components. The bigger players are looking for something they can get more margin on. What was a niche last year may not be a niche next year, and as products become commoditised, some players will find themselves eaten up by the bigger players.”

Nick Culley, managing director at Midwich, said it is about getting the right balance.

“I don’t think we have been completely immune from channel pressures, but we are pleased with how we are doing. It has been a difficult market and there is a lot of price erosion and margin pressure – this causes a shrinkage in IT and audiovisual (AV) spend, but we are in pretty good shape.

“For a start some of the brands of technology we work with have had a good year. We set up our Home Entertainment division earlier this year and it has performed very well. We always focus on profitable business, unlike some competitors that go after low margin business for the sake of it, purely to boost turnover. We are not interested in business unless it is profitable.

“At Midwich we have a relatively narrow business focus. Some try to do all things for all people but that often doesn’t work. One area we are particularly strong in is AV. Other big distributors have an AV business, but we don’t see them as a threat because they don’t focus. We have a range of value and services that we offer our customers,” he said.

Culley added that a distributor should concentrate on an area it knows, rather than trying to steal market share in less familiar territories.

“We have found ourselves having to work even harder and smarter to keep the business in good shape. The market is showing signs of improvement in places, but you have to choose where you are going very carefully. Focus on business that is the strongest and demonstrate that you are a business that can offer value add,” he said.

Mark Hatton, managing director of Sphinx, agreed with Culley.

“It’s about having a balanced portfolio of products and services that feature the appropriate blend of higher volume and lower margin offerings, complemented by new technology where the margins are higher but the volumes are lower. A lot of our revenue comes from the security space and that is growing very nicely. The industry is reaching a point where organisations are looking to consolidation to fuel future growth, and that is being driven by the vendor community, not just the channel.

“The bottom line is that there will always be room for both specialist and broadline. It depends on individual vendors and where their products are in the technology cycle. For a vendor that wants to develop their channel in a specialist fashion, focused players do a better job and that will always remain the case,” Hatton said.

It seems that the majority of players in the market have learned their lesson, either from personal experience or by watching competitors go through the pain, and have pulled out all the stops to ensure they can stay afloat in rough times.

No-one has a crystal ball to see the future and no-one can precisely predict the exact level of consolidation that is to come. But providing distributors can weather the ups and downs of the channel, the argument over niche versus broadline, and who is acquiring who should continue for some time to come.