How distributors can build momentum in a slowdown

| Article

In February 2020, the COVID-19 pandemic broke the back of the longest continuous economic expansion in US history.1 And in February 2022, Russia’s invasion of Ukraine shattered 75 years of relative peace in Europe, worsening global supply chain challenges, further compounding historic levels of inflation, and setting off rounds of interest rate hikes.

Uncertainty will continue to roil markets and vex leaders across industries. While growth in gross domestic product has declined for two consecutive quarters in the United States, the economy continues to show some strengths, including low unemployment, healthy corporate and household balance sheets, and continued, albeit slower, demand in important sectors, from motor vehicles to housing.2Something’s coming: How US companies can build resilience, survive a downturn, and thrive in the next cycle,” July 28, 2022.

We expect high-performing, resilient distributors to gain a considerable strategic advantage during the current environment of uncertainty, just as some did in the Great Recession.

Regardless of how the next few months unfold, demand volatility, inflation, and supply chain issues will affect the distribution industry. These challenges and geopolitical tensions are likely to persist, as are labor shortages, especially in warehousing and delivery.

Based on what we learned from the Great Recession of 2007 to 2009, we anticipate impacts on distri­bution overall, but we also expect a few distributors to gain a considerable strategic advantage against competitors. In analyzing the performance of approx­i­mately 40 publicly traded industrial distributors in the Great Recession, we found that 20 percent significantly outperformed peers through both the downturn and recovery, increasing total shareholder returns (TSR) in the decade through and after the recession by an average of 70 percent (Exhibit 1).

A subset of ‘resilient’ distributors significantly outperformed peers through the 2007 recession and recovery.

We call the outperformers “resilient” because they had the flexibility to adapt quickly to changing conditions—and the courage to act in an uncertain environment.

What we can learn from the most successful distributors in the last recession

We studied the most resilient industrial distributors—those that achieved top quintile in TSR growth through the Great Recession and during the recovery, from 2007 to 2011—by reviewing their investor presentations, financial metrics, and reports and interviewing some of their executives.

The outperformers had four strengths in common: an unrelenting focus on profit­able growth during the slowdown, which helped them set the stage for significant acceleration during the recovery; a heavy emphasis on margin manage­ment through disci­plined pricing and category management; careful control of selling, general, and administrative (SG&A) expenses; and the willingness to invest in priority growth opportunities and program­matic M&A with a through-cycle view.

These strengths helped them significantly outperform their peers during and after the downturn across revenue, cost of goods sold, and SG&A expenses. The outperformers achieved slightly lower margin growth than nonresilient companies during the recovery. This trend can be explained by the fact that outperformers experienced lower drops in margin during the downturn than nonresilient companies (Exhibit 2).

In the last recession, resilient distributors did better across key financial metrics.

A resilient industrial distributor in North America, for example, pulled back on unnecessary costs while doubling down on commercial excellence to outperform through the downturn and emerge stronger in the recovery. First, the company optimized capital spending and eliminated unnecessary costs, closing operations in several underperforming locations and reducing low-turning inventory levels. The distributor reinvested the savings in improving customer service: increasing high-value inventory stock and enhancing service levels, especially for high-value customers. The sales team “mapped” all the customers they wanted to win and attracted them with focused efforts and targeted value-added services. Finally, the company leveraged its strong revenue and cost position to accelerate its invest­ments in digital. Coming out of the downturn, it emerged as a digital leader in the industry, driving outperfor­mance for years to come.

What distributors can do now to keep creating value despite economic uncertainty

Each distributor must navigate the unique set of challenges in its own marketplace; no one-size-fits all solution leads to outperformance. But broadly speaking, a distributor’s responses will depend on which of the three following archetypes best fits its profile, in light of its current position during these uncertain times:

  • Poised to thrive. These companies can maintain profitability under expected headwinds such as inflation and pricing and labor cost pressures. They have strength in their core markets, a clear expansion road map, strong balance sheets, and access to cash.
  • Resolve to reform. Headwinds are putting pressure on companies in this archetype, but they have opportunities to sustain or even expand market share with careful planning and investment. Their balance sheets are strong enough to give them investment options.
  • Fight to survive. These companies are already facing margin pressures—some are no longer profitable—and their market shares are at risk or declining. With constrained balance sheets, they have few options for investment. They must act immediately to raise efficiency, strengthen execution, and bolster cash positions.

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1. Poised to thrive

With profitability under control despite pricing pressures and other expected headwinds, these distributors are less likely to face commercial or operational disruption. Most benefit from unique market dynamics and/or strong capabilities. With strong shares in their core markets, they can use their healthy balance sheets and access to cash to invest in opportunities to sustain or accelerate growth.

This is the moment for these companies to widen their strategic distance from competitors that don’t have the combination of cash and courage required to invest during a slowdown.

These companies can act now to widen their strategic distance from competitors that don’t have the combination of cash and courage required to invest during a slowdown.

Outperformers in this archetype typically make several of the following moves:

  • use programmatic M&A, such as existing sector tuck-ins and expansion to adjacent sectors, to strengthen market positions
  • increase customer stickiness by enhancing and building new services, such as value-added services, sustainability offerings, and real-time order tracking
  • activate or expand omnichannel offerings with a strong e-commerce presence and refresh their digital strategies to keep pace with evolving market dynamics
  • harness best-in-class price setting and execution mechanisms to seize surgical pricing opportunities across higher-volume and/or already profitable accounts; many will expand frontline sales teams to pursue more cross- and upselling opportunities
  • bolster procurement capabilities by identifying products that are critical for customers and recalibrate sourcing to optimize the costs of goods sold
  • put cash to good use by refreshing the investment pipeline, including some future-looking big bets and breakout opportunities
Pricing: Distributors’ most powerful value-creation lever

Pricing: Distributors’ most powerful value-creation lever

2. Resolve to reform

These distributors face a medium risk of commercial or operational disruption, with profitability somewhat challenged by inflation or other external headwinds. Economic uncertainty may tip the balance in either direction, eroding profitability and slowing growth, or creating unique opportunities to expand market share and gain a better position for the recovery. For these distributors, handling the next few months the right way could be an opportunity to rally the organization and move from good to great.

Handled the right way, a shift in the economic environment can be an opportunity to move from good to great.

Distributors in this archetype will likely benefit from balancing offensive and defensive moves. The outperformers will protect their businesses from margin and top-line erosion by setting ambitious targets. They will set up transformational programs to build core capabilities and capture quick wins, while expanding value-added services to retain and grow the customer base.

Defensive moves may include doubling down on core pricing capabilities such as inflationary cost pass-through, harnessing dynamic pricing guidance models to close gaps in pricing tools, and turning procurement capabilities into strengths by identifying products that are critical to customers, refreshing category strategies, and expanding private-label SKU portfolios. Many will equip sales reps with better insights and support to focus on sectors with growth pockets and to help solve customers’ pain points with services and cheaper offerings.

They will use cash wisely, taking a customer-centric view of inventory optimization, identifying where to expand strategically and where to reduce inventory on hand. Some will be positioned to refine their M&A strategies and opportunistically pursue sector tuck-ins at a moment when valuations are lower and fewer competitors are bidding for the same assets.

3. Fight to survive

Distributors with low margins, declining market share, and few financial resources have now reached an inflection point: some will take a wait-and-see approach as economic, labor, and supply chain challenges continue to unfold; others will take bold action now, using the crisis to pivot toward profitability and growth.

First steps could include a quick, clear-eyed assessment to understand the main challenges to the profit-and-loss (P&L) and balance sheets. This includes running the equivalent of an “investor teardown” by taking a fresh view of the business and unapologetically revealing key challenges and improvement opportunities.

Done well, this exercise can help senior leaders across functions recognize that things need to change—and that market uncertainty can be a catalyst for growth. With a deep and comprehensive analysis in hand, they can rapidly redirect resources to the highest-impact initiatives ahead of the next business cycle. They can set up the frontline sales team for success, for example, by improving price-setting processes, enabling better price execution, and maximizing selling time. They can streamline operations by focusing the category management team on the categories with the highest-value and biggest growth potential, identifying and correcting supply chain inefficiencies, and improving general and administrative allocation efficiency.

Many companies in this archetype can improve their cash positions by managing long-term liabilities, freeing up trapped cash, and exiting or divesting less profitable and noncore lines of business. Many executives in these companies tell us that audacious ideas set aside during good times can get a more serious hearing in a more challenging environment.

Every distributor should act now with speed and conviction

Economic downturns are unavoidable, and each one is unique. Our research and experience show that no one solution will fit every situation, and distributors fall into a range of archetypes within the industry’s wide array of sectors.

That said, business as usual is a losing strategy for nearly every distributor in today’s highly complex macroenvironment. Those positioned for growth should use this time to gain strategic distance from the pack. Those with clear growth potential will need to invest and build to position themselves for sustainable growth. Those facing greater challenges will have to mobilize quickly to manage profitability and defend against further decline.

We can all learn from outperformers in every arche­type and marketplace. While each one is different, they all quickly and efficiently rally their organizations and “never waste a crisis,” seeing challenging times as opportunities to drive change.

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