Consultants To The Aftermarket     

Size May Not Matter After All

Integration and Focus Key to
Acquisition and Consolidation Turnarounds

The bottom 90% + of heavy duty distributors in most mature markets could make better returns by liquidating and investing in municipal bonds, because they are selling commodity products and undifferentiated, “good service” on a last-look, meet-the-price basis.

This seems to apply equally across the size spectrum of general line and specialized industrial distribution. Recent studies indicate that this slow rot reality is reaching crisis proportions in independent dominated distribution and service markets, such as the North American truck parts market.

While the top performers are reaching profitability goals established by large consolidators (acquirers) over the past five years, the bottom 90% (which includes many of the consolidators themselves) - on a pre-tax return on total asset - are slowly dying; they just don’t know it..

After visiting a number of successful “about-face” situations personally, here’s a quick review of some general stages of a successful turnaround we’ve found (in the most frequent chronological order):

For starters, in the pre-turnaround, action-contemplation stage, the company has to stop assuming that the current survival is equal to long-term viability with an eventual, good, liquid exit valuation possibility.

Before they get bigger, they have to get better. Therefore, they have to:

• Unlearn existing bad habits;
• Confess flawed, unspoken, “success” assumptions;
• Agree on how to free up some operational slack by weeding out losing customers, products and employees that don’t fit into the new direction.

There are five stages to the turn-around process:

1. Downsize the losing elements of business to free up some operating slack;
2. Up-grade what is best and most promising;
3. Re-focusing on the more profitable core of customers, one niche at a time;
4. Revive/re-invent the basic value proposition to be a distinctive #1 in total installed cost/ value;
5. Consider pursuing new best customer niches or other types of “adjacencies” (related, profitable expansions).

One lesson from our experience is abundantly clear…

Trying to diversify away from a losing core will always fail.

It is instructive to review some actual case studies recently in the news. While these consolidators are large public examples, we think that a number of smaller, private distributors could benefit from following their examples.

Industrial Distribution Group, the publicly traded Atlanta-based roll-up of small, industrial supply companies made a recent issue of Barron’s.  It was even referred to as an emerging “mighty mite”.

This poof-company, similar in concept to Transcom in the heavy-duty business, went public in ’97 at $17 per share, soon peaked at $23, hit $1+ three years ago, and closed 3-22 at $7.35.

According to both a recent article in Barron’s and our interviews, IDG’s turn-around story is still underway. The turn-around CEO, Andrew Shearer, arrived in August ’01 and has pursued the first four stages cited above – downsize, upgrade, refocus and revive.

For downsizing and upgrading, here are a few stats:

• The company’s sales peaked at $546 million with a profit before tax (EBT) loss of -$12.7 million for year ending December 2000.

• For 2003, sales came in 12% lower as unprofitable customers were re-priced to either become winners for IDG or losers with some other competitor (that must be into increasing incremental volume for vanity’s sake.

• Assets and people were downsized in parallel to both lower sales and small order activity, so the PBT for ’03 climbed to $4.4 million. Total assets were $230 million for ’00 versus $133 million for ’03, so sales to assets turns has improved from 2.3 in ’00 to 3.6 at year-end ’03.

• Total debt dropped from $65.8 million to $36 million during this period at lower, re-financed rates. (Major lesson: Why borrow to finance receivables and inventory to support losing sales volume from losing customers?)

• This performance represents a net swing/change of + $17.1 million at the PBT line in 30 months time.

• This turn-around has happened, more impressively, as the manufacturers IDG sells have gone through a depression marked by 42 straight-months of net layoffs! Sound at all familiar to the heavy truck parts business?

There are some additional operating aspects to what we think is a lightning quick turnaround. Integrated supply contracts (for which IDG uses proprietary software and runs in-plant store rooms for the customers) now account for 51% of the company’s total sales, up from 44.6% in ’02.

They seem to have “revived” their core by capturing and retaining customer niche share faster than it is immigrating to Asia.

The fund managers have raised the stock price target substantially, during a time period that distribution can hardly be considered the darling of either public markets or local bankers.

IDG’s credibility is improving with customers, suppliers, employees and financial institutions. This is vital when trying to sell, achieve and share inter-dependent channel cost savings ideas.

During this turn-around, Mr. Shearer has been able to overcome much of the same time honored claptrap that is faced in the heavy-duty industry every day, like:

• You can’t shrink sales; we will lose manufacturer rebates, which are our biggest source of profits!

• You can’t shrink sales, we have lots of fixed costs, so our losses will grow!

• We don’t have any losing customers; they are all contributing margin contribution dollars to our fixed costs!

•  You can’t raise customer contract prices and terms, they won’t like it and will all leave for competitors (truck dealers?) that are already offering them better deals!

Dealer Consolidation May Also Be Running on Empty

While thinking about the future “phase two” of consolidations in the heavy-duty parts distribution and service business, we ran across a parallel situation with an unbelievable number of coincidential factors.

This is the case of the enormous consolidation of car dealerships that peaked during the same period that marked the roll-up peak in the independent and dealer sides of the truck parts business. For those who don’t want to read the entire sad Business Week story about six, publicly traded, roll-up companies, we have distilled a couple of especially relevant points:

• It’s getting tougher to keep growing fast by making big acquisitions. Recent history of non-performance is driving the price of prime targets up.

• At the same time they haven't’ figured out how to perform any better than the mom-and-pop dealerships they bought. Indeed, most have lower net margins than the independents. Many make only 5% to 6% return on assets, while paying between 6% and 10% on the money they borrowed to buy more dealerships.

• Ford vetoed a chain’s bid to buy a dealership noting, “the chain has lower profit margins and weaker customer-satisfaction ratings than other dealers.”

• The chains save money by reducing advertising costs, consolidating their back-office work, and paying lower interest rates on inventory from the manufacturers. But the savings aren’t enough to offset the cost of extra management layers, the effects on sales of alienated, top performing middle management or the regulatory expenses of being a public company.

This Is Not Rocket Science… But It Is Heavy Lifting.

Large acquisition or small… passenger car or heavy truck dealer… across town or across the country…somewhere common sense has to come into play. This is not a matter of highly refined management strategy.

• What did you think would happen to local management effectiveness when you toss out a 20+ year, veteran owner-operator who’s name, face, voice and/or reputation is tied to lots of local fleet relationships and where they guy has lived his entire life?

• What do you bet that the new “profit-center” managers (who may also be new to the heavy duty business) get lots of new by-the-numbers reports and turn over every 2 to 4 years?

• The lack of supposed (and promised to the bank) local service and resource investment economies are not sufficient to match the savings that good local operators continue to achieve.

Therefore, the immediate focus has to shift to operations and having the right people to pull it off. We think that the following are the key questions that must be resolved for acquisitions of any scope and scale to be successful:

• How should most distributors re-think how they hire, train, pay and keep profit center managers at one location for longer periods of time? In the heavy-duty business, the evidence is indisputable:

Tenure Pays Disproportionate Dividends!

• Will larger entities have economies of knowledge for developing and supporting more totally effective profit center managers than the local independents?
• This is rapidly becoming an information dependant business with an aging core of experts. Winners will be those investing in technology transfer during the current business boom.
• Do you think most rapidly acquiring businesses or interlopers from outside this industry even ask these questions to begin with? If they do, do most assume that they can achieve a longer-term, breakthrough solution for the channel?

Our estimate is that fewer than 10% of operators of any size have done it! This seems to indicate that this is not a battle dominated by size. Instead knowledgeable people with a passion for customer service will dominate it.

Here is a radical thought: When you have a contaminated channel culture that has grown up with a dysfunctional, unbalanced incentive system, it may be easier to change managers than it is to try to change managers’ thinking and habits.

Leadership has to extend to every level of these organizations, including regaining the trust of all employees. Trying to win essential trust from all of the employees takes both an ethical philosophy and a willingness to lead by example.

Top down dedication and understanding of the nuances of the heavy-duty business will eventually provide the basis for the most effective and efficient alignment of purpose by all involved… including the all important supplier base.

About the Authors: Bill Wade has been in the automotive and heavy truck aftermarket on both the manufacturer and distributor sides for over thirty years. He has written and spoken extensively on the effects of distribution consolidation and buying groups. He recently formed Wade&Partners, a marketing services company specializing in issues such as unexpected growth opportunities, strategic development, startup or turnaround counsel, brand building and restoration.