I was fortunate to have experienced 35 years in distribution credit management across three industry sectors. These were in the audiovisual and entertainment industry with the Rank Organisation, engineering and machine tools with B Elliott plc, and a long stretch of 18 years in IT with Ideal Hardware and then Bell Microproducts Inc.
In the early seventies to mid-eighties, Rank Audio Visual was a large distributor of audiovisual and photographic equipment, theatre seating/lighting and 8mm, 16mm and 35mm film. It progressed also to the distribution and hire of prerecorded video cassettes. Very profitable in the late sixties and early seventies, margin pressure, an inflated view of its relevance and an unwillingness to change or note manufacturer/vendor temperament meant final closure of the business in 1986. Brands such as Akai, Pentax and others had taken a direct route and the J Arthur Rank (the man with the gong) connection was not enough to hold major film/video production company interest.
A similar story followed in engineering in the early eighties to nineties. A decline in UK manufacturing in the sixties led to greater reliance on distribution of Japanese and Korean machine tools and associated spares. Margin pressure came to play with cheaper Italian, Finnish and Spanish manufacturers entering the fray, forcing Japanese and Korean manufacturers to adopt more direct models. An attempt to re-create a measure of UK manufacture failed miserably and a business that at one time employed more than 4,000 in the after-war years, and was publicly quoted, moved, finally, to insolvency in the early nineties.
Seeing and experiencing these changes naturally raises awareness of the fragile and volatile nature of distribution. It's not just the pace of change driven in many cases by technological developments or market forces but the very nature of big businesses frequently failing to anticipate their effect; it's easy to fall back into the comfort zone of 'we're too big and relevant to be affected or troubled' or 'we're flexible and can easily accommodate new and emerging partners/competitors and their technology'.
Many will have experienced working for a large organisation occupying premises fully utilised, then noting wide-open, unoccupied spaces appearing as divisions or areas of activity are forced to shut down. These are all signs of problems ahead.
And yet those early years were highly profitable. Distribution gross margins of between 15 and 35 per cent were common; even wholesalers were able to eke out five to 15 per cent.
In September 1992, I joined a highly profitable and successful UK storage distribution business, Ideal Hardware Ltd. This was a time of pulsating growth in IT distribution and being predominantly a specialist storage distributor, Ideal's gross margin yield of around 16 per cent was well ahead of more broadline players such as Frontline or Ingram, which were generating 11 per cent and nine per cent respectively.
A decade later and those gross margins declined considerably. Ideal was down to around 12 per cent, Computer 2000 (as it had become) eight per cent and Ingram was barely above six per cent.
In 2010, by which time Ideal had been acquired by Bell and Bell by Avnet Inc, gross margin had dropped to around eight per cent. Computer 2000 dipped below six per cent and Ingram UK was hovering just above four per cent.
Now, Avnet TS is part of Tech Data where margin hovers dangerously just above five per cent and Ingram UK (acquired by China's HNA Group) operate at just over four per cent. Westcoast, a new entry into the £1bn-plus UK sales club operates at a gross margin of just above two per cent. These are not distribution margins, these are extremely painful squeezed wholesale margins where value-add services, or pure services, are far too small to matter and too costly to expand.
In all four top distributors, pure services-driven sales that exclude product or software supply account for considerably less than 10 per cent of consolidated net sales over the last three years and is unlikely to increase; ostensibly, it's not what a distributor is supposed to provide, it's been forced to do so.
In a recent article, Barrie Desmond of Exclusive Networks accurately described the nature of channel players as an "ecosystem", where each contributes and generates the required return. He went on to describe the squeeze being felt all around that is tugging and pulling this ecosystem apart.
Consolidation, right across all channel players, accelerated considerably from the mid-nineties and shows no sign of abatement. This has crystalised wafer-thin margin; a result of excessive dependence on higher volumes passing through fewer vendors, distributors and resellers. Vendor fascination with complex, irrational, punitive and often unpredictable pricing and support mechanisms driven by volume, simply add fuel to the fire.
The channel, dare I say it, has become lazy and bloated. Resellers often rely on both distributors and manufacturers for lead generation, training, and marketing support. Distributors have been forced to not only swallow declining profit but increased cost in provision of services that should be the responsibility of the vendor and reseller. The distributor, therefore, wears a ligature around the neck and is slowly being strangled by the demand of those above and below in the supply chain.
The late nineties brought us the first significant distribution failures when Merisel struggled and merged with CHS Electronics only for the latter to fail ignominiously in 1999. We have recently witnessed a couple of smaller failures in Steljes and Entatech.
It became painfully obvious in an increasingly saturated market in the late nineties, which limited organic growth rates of preceding decades, that the only way to grow and increase market share was to acquire. The natural and lucrative target was always going to be the specialist VAD that carried not only sufficient sales volume but, more crucially, higher gross margin.
In 2010, I compiled and monitored a list of 62 UK distributors. At the time, there was just one distributor with sales in excess of £1bn, and that was Computer 2000. Below the top four were eight mid-sized VADs with annual sales ranging between £200m and £600m.
In 2017, that list changed quite dramatically to just 35 UK distributors. There are now five distributors with sales in excess of £1bn: Tech Data, Exertis, Westcoast, Westcon and Ingram. Below this top five, however, nothing remains of those eight mid-sized VADs evident in 2010. Indeed, below the sixth (Arrow ECS), and excluding the recent failure of Entatech, there are only four distributors with sales between £100m and £200m and only two of them offer the kind of double-figure gross margin that remains attractive.
What's more interesting is the comparative ratio of how this UK market pie is apportioned within distribution across these two periods.
In 2010, the average gross margin achieved across the top 30 distributors was 7.73 per cent. The lowest was 2.65 per cent and the highest 36.6 per cent.
In 2017, the average gross margin achieved across the top 30 distributors dropped to 6.76 per cent. The lowest is now 2.36 per cent and the highest 30.4 per cent.
In 2010, across the top 30 list, the top 10 were responsible for 74 per cent of total sales at an average gross margin of 6.08 per cent and an operating margin of 1.26 per cent. The top five accounted for 58 per cent of total sales at an average gross margin of 5.6 per cent and operating margin of 1.02 per cent.
In 2017, the top 10 (of 30) were responsible for 90 per cent of total sales at an average gross margin of 6.1 per cent and an operating margin of 0.72 per cent. The top five now account for 79 per cent of total sales at an average gross margin of 5.38 per cent and an operating margin of 0.45 per cent. One of the top five posted a significant loss in this review, distorting somewhat operating profit margin; discounting this, average operating profit had still dipped well below one per cent.
In the last 10 years or so, this process of consolidation has not been limited to the top and middle end. Distributors at the lower end of sales volumes (below £100m) working with second- and third-tier vendors at far more favourable gross margins have also seen the need to bulk up through acquisition. The well of acquisition targets has almost dried up.
The question is, how narrow will this supply chain get and how much lower will gross margin go? Fewer and bigger vendors, distributors and VARs are likely to constrict this playing field and make it more lucrative and open to alternative channel supply. Operating at pressured gross profit margin when sales stutter or decline while demand is for more services at higher cost, leaves no room for complacency.
There may be life in IT distribution but if the channel does not shake off its bloated, complex and business-as-usual approach to the challenges it faces, the current model is unlikely to exist in 15 years' time. An efficient, lean, unburdened profitable distributor, free of the shackles and barnacles of unwarranted demand is surely more relevant, even in today's globalised marketplace where reach nationally and internationally no longer depends on physical presence.
Eddie Pacey is director of EP Credit Management & Consultancy
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