Penetrating MRO
Electrical distributors have been working hard to get close to their large industrial and commercial customers, serving up their best service and painfully fair pricing, their eyes fixed on the holy grail—a partnership agreement to be their sole-source supplier for maintenance, repair and operations (MRO) electrical products.
For those among you who have been there and done that—and have found yourselves wanting more, there is a "next step." Take a look at out-sourcing and integration. On today's ultimate MRO frontier you now get so close to your customers that you get inside them and sell them more than just electrical supplies.
Supply outsourcing means a distributor takes his or her expertise in distribution logistics and offers it as a turnkey service for the customer's internal operations. Distributors can take over customers' entire purchasing, warehousing and internal distribution operations, saving them a bundle in operating costs.
Integrated supply takes distributors beyond electrical products and allows them to offer what for many customers is the answer to a prayer—a broad range of MRO supplies through a single source.
Neither of these ideas is brand new, but both are gaining popularity. There are serious costs and risks to consider before you jump into either one. But outsourcing and integration will play their parts in shaping the future of the MRO market sector because some customers love them.
Customers are constantly looking for ways to cut costs, and some have turned to integrated supply as an answer. They've seen that cutting down the number of suppliers yields enormous cost savings in reduced paperwork and increased productivity. Oversimplified, the in-tegrated supply theory says if five sources are better than 100, one source is better than five.
In response to these requests, many distributors are taking their established knowledge of supply operations and expanding the range of supplies they carry so they can offer their customers industrial, electrical, plumbing and other MRO products through one source.
While distribution operations are similar and many of the lessons learned in one industry can be applied to all, distributors that venture into integrated supply run a risk of damaging their customer relations if they don't know what they're doing. Integrated supply isn't always in the best interest of the customer, according to Don Rice, director of the Distribution Research Center at Texas A&M University, College Station, Texas.
"It's never a good idea to buy everything from one source because you lose the specialties of the various distributors," Rice says. "I'm in favor of sole-sourcing, but it's better to sole-source by product line, so you retain the expertise. You can still use single shipments, EDI (electronic data interchange) transactions and electronic payments through various systems contracts without giving up that expertise."
Several electrical distributors have addressed this problem while still attaining their integrated supply objectives by expanding their product offerings through mergers, joint ventures or consortia in which each supplier's established specialties remain intact.
This was in part the thinking behind the merger last fall of Turtle & Hughes, Inc., with Silliter/Klebes Industrial Supply Co., Inc., New Britain, Conn., says Linden, N.J.-based Turtle & Hughes' executive vice president, Frank Millard. (See "Integrated Supply," EW, June 1994, p. 42.)
Millard and his wife, Sue Millard, president of the company, saw that many of the systems contracts in their area were going to distributors that were able to supply a broader range of products, so the they joined with J.J. "Jay" Drummond of Silliter/Klebes to offer customers a competitive bid covering electrical and industrial supplies through one source.
Another recent foray into integrated supply has captured the attention of the industry. Cameron & Barkley Co., Charleston, S.C., which already had full lines of electrical, electronic and industrial products, announced in May that it is forming a 50/50 joint venture with McJunkin Corp., Charleston, W.Va., a distributor of plumbing supplies as well as electrical.
Through the new entity, to be known as McJunkin-CamBar, the two companies will be able to offer industrial customers anything they want in the way of industrial mill supplies, electrical and electronic products, pipe, valves and fittings, says M. Joel Bateman, president of the joint venture as well as executive vice president and chief operating officer of Cameron & Barkley. McJunkin-CamBar will court systems contracts anywhere there's not already both a Cameron & Barkley and a McJunkin supply house in operation, according to Bateman. The venture will have its own locations in some markets and will work out of existing facilities in markets where it's appropriate.
The key to making integrated supply work is in the processes, says James Warren, president of Cameron & Barkley. "Through the integrated supply concept, they lower costs by reducing administrative and operational activities they have," he says. "By buying from a single source, they're able to automate the process and eliminate a lot of the transactions that they normally would have with 20 or 100 suppliers. They pass those costs, or some semblance of those costs, along to the integrator, but if the integrator is smart he can reduce those costs."
Distributors have a cost advantage in handling those integration functions because, Warren says, the margins under which they work have driven them to be more efficient, because they can tap economies of scale by performing similar functions for more than one customer and because their overall productivity in this area is higher. If the process works, he says, a distributor can automate it with both customers and suppliers. "If you do that, then you can really attack the whole cost equation and the whole distribution channel to drive the cost down."
To serve customers that are not satisfied with McJunkin-CamBar's breadth, the parent companies also announced they are forming a distribution consortium to bring in non-competing distributors of other MRO products. "Together, we cover 70% to 80% of the total MRO product basket," says Warren.
The International Supply Consortium will operate throughout the territories served by its member companies, selling its services to large in- dustrial customers with systems contracts. It gives the distributors the power to offer customers total, integrated supply through a single source, billed on a single invoice, paid with a single monthly check, while the various members remain separate.
The motivation for the consortium came from customer requests, says Bateman. Several large systems contract customers had expressed a need for a complete one-stop source of supply for all their MRO needs, he says.
A similar consortium was formed back in 1989. Jim Coghlin of Coghlin Electric/Electronics, Inc., Worchester, Mass., created a stir with the launch of the Innovative Distribution Group, a distributor consortium that has since grown from four "shareholder" member distributors to nine, and now includes distributors of electrical, electronic, hydraulic, fluid power, air compressors, cutting tools, fasteners, paper, pipe, valves and fittings, bearings and power transmission equipment, welding and industrial supplies.
The group uses a proprietary software package to integrate the operations of its members using EDI, bar coding and combined shipments, enabling it to supply any of a customer's needs and bill it on one invoice.
Response to the group has been far beyond what he or any of the members originally expected, Coghlin says. Customers have responded favorably to the group's ability to improve productivity and reduce costs simultaneously through services such as outsourcing, he says
The general idea of out-sourcing has been around awhile. Companies have been outsourcing various human resources functions, computer/MIS programming and maintenance, trucking and other traditionally in-house operations for years, but only more recently has it hit the world of MRO supply.
The urge to outsource comes from companies wanting to trim their fat as closely as possible. In their desire to be the low-cost, high-quality producers in their chosen markets, manufacturing firms are spending more time on their core competencies and turning more peripheral functions over to companies with expertise in those fields. Some have found a bounty of savings by outsourcing their purchasing, storeroom management and internal distribution operations.
Owens & Minor, a hospital supplies distributor based in Richmond, Va., helped one hospital cut its inventory investment 80% by taking over its stockroom and filling orders with daily deliveries, according to a story in Forbes. The company also saved a large university research hospital more than $9 million over three years, then cut another $360,000 a year by buying the inventory in the hospital's 200 supply closets and selling the products back as needed.
Most of the companies offering supply outsourcing services are not primarily electrical distributors. The trend is hottest in other areas, such as hospital supplies, but that's not because it's not right for the electrical business—it's because innovative suppliers in those other businesses came up with the idea and applied it. Supply outsourcing is little more, really, than distributors taking their hard-won experience in purchasing, receiving, stocking and delivering products and offering it to customers as a turnkey service. It's an idea that can be seized by anyone with expertise in MRO distribution who has the determination and financial resources to make the project work.
The nature of an outsourcing agreement depends entirely on the customer, and every customer takes a different approach to outsourcing, say those on the front lines. The difference depends on the amount of control the customer wants to retain, plus the effectiveness of the customer's existing internal operations.
Outsourcing supply operations requires a drastic change in the culture of the "host" company and a huge leap of faith, because the customer must give up some of the control that is part of the purchasing process; but it offers dramatic savings in return. Whether a company will go for it depends on its motivation, says Tom Reid, vice president and general manager of Briggs Weaver, Inc., Dallas, Texas, an industrial supplies distributor with several outsourcing agreements to its credit.
"If they're really after big savings; if they've seen the light; if their company has been threatened; if they are convinced that they must be the low-cost producer, they'll take these kinds of steps," says Reid. "If they're just looking to see what's available, they generally won't take the chance of changing their culture to embrace this kind of outsourcing. They want to keep it where they can control it, audit it and deal with it."
No two outsourcing agreements are exactly alike, says Warren of Cameron & Barkley, which also has done some outsourcing for customers. "Sometimes we just manage their storeroom; sometimes we take over all the purchasing. Sometimes we have our people on-site; sometimes we handle it off-site. Sometimes we do it on our computer system, sometimes on theirs." Whichever way, Warren says, "if you've been doing integrated supply right, you don't have to change that much."
In a major outsourcing agreement, a distributor might buy a customer's current inventory from him and take over the whole product-acquisition process, including purchasing, receiving, upkeep of the tool crib and supply closet, and even one-time item requisitions.
The distributor typically will put employees on-site at the customer's location to handle orders. These employees function essentially as the distributor's inside salespeople in a remote location, with a computer ter-minal hooked right into the distrib-utor's system on which they can check stock and price levels and other information.
To staff that position, the distributor might hire an employee of the customer who was already involved in the purchasing process, or he might put one of his own sales trainees or inside people there. "It's great experience to get them working in the customer's operations," says Reid of Briggs Weaver.
When a customer's employee needs a part, he or she places the order directly with the distributor. The customer can specify as part of the agreement the spending levels allowed for each employee or department and the approvals required, so there's no need to go through a purchasing department. The distributor buys it, delivers it to the person on the line, gets a signature from him, and bills it all on one monthly statement.
"The ideal situation of course is where the requisition deals directly with us, and we deliver it directly back to him, bypassing the receiving department," Reid says. "That cuts out all the steps, so to them it looks like a paperless transaction. Then we give them a monthly report of everything we've bought for them, how much we charged them for it, et cetera."
Reid says the process can save the host company $50 to $100 in paperwork costs for a single product. It cuts out all the invoices, all the packing slips, and the many checks they have to cut when they buy from several sources. "It reduces overhead by a lot more than (the customer would save on) the cost of the merchandise by beating down the poor distributor 5%," Reid says.
The big savings for the customer come from reductions in inventory, personnel and paperwork, but the exact figure varies. "We haven't been at it long enough to develop any models where we say, 'Man, if you do this with us, and do it like we want you to, you'll save this much,'" Reid says. "I'm not sure we'll ever have the data to say that."
The actual savings depends on how much control the customer turns over to the distributor; how sophisticated and efficient its systems were to begin with; and how they make use of the arrangement. According to Reid, most customers are looking for savings of 25% to 30% in their total procurement costs, which is sometimes possible. Five percent to 10% a year is no problem, he says.
Of course, the functions of purchasing, receiving, inventory and transportation don't go away, they're just shifted to the distributor. But since outsourcing is basically a more aggressive version of a sole-sourcing agreement, the distributor has the processes well-established. By leveraging his economies of scale and experience in handling products in a low-margin business, the distributor can provide the service at a lower cost.
Another, less invasive, version of outsourcing involves siting a distributor warehouse near enough to a customer's location to eliminate the customer's need to stock its own MRO supplies. The Timken Co., a Canton, Ohio-based manufacturer of alloy steels and bearings, chose to keep many of its existing internal processes in place, but to outsource its inventory needs by having its suppliers move in next door. Sacks Electrical Supply Co., based in Akron, Ohio, was the first company to move into Supplier City, a real estate development owned by Timken where its major suppliers have warehouses just two minutes from the customer's Faircrest steel plant.
The seven suppliers in Supplier City commit to having certain crucial products available on a moment's notice, so Timken doesn't have to stock them. In case an emergency occurs during off hours, authorized Timken employees have the keys to the Sacks Electrical Supply building and the security codes to get into the warehouse.
To be a part of Supplier City, suppliers have to meet Timken's delivery, stocking and performance requirements. They also must provide 24-hour emergency service. Sacks Electrical Supply has committed to 15-minute delivery times for a range of stock items that are crucial to Timken's operations. Timken is linked electronically with its suppliers, allowing it to download purchase orders complete with its own bar codes for products it needs. The arrangement also allows its suppliers to check inventory levels at the plant.
For all that commitment, Timken is under no obligation to purchase any or all of its supplies through the Supplier City sources. "The only reason it makes sense is the large volume of business," says Jules Altshuler, president of Sacks Electrical Supply. "We did it because Timken was a major customer of ours, and moving into Supplier City meant they would become an even larger customer." Since joining Timken's Supplier City, Sacks Electrical Supply was acquired by Willcox & Gibbs, Inc., New York, N.Y.
While the requirements for admission to Supplier City are intense, the outsourcing agreement is just an extension of the distributor's existing MRO capabilities. "These are all things we do for other customers as well," says Altshuler. The Supplier City location is Sacks Electrical Supply's only operation in Canton, and the company serves all its customers out of that location.
Though outsourcing can be a valuable service and a first-rate cost-cutter for customers, it's by no means cheap or easy for the distributor to get started. Reid of Briggs Weaver offers some caveats to companies thinking of getting into outsourcing for the first time. "Existing customer inventory can be a problem. If the customer has lots of inventory and wants the distributor to buy it; that requires cash," Reid says. "It takes more cash to get started than you think; there's more ramp-up time. It generally takes a larger distributor to make it work--one with the financial resources to deal with the unexpected costs. If you're undercapitalized or you're not willing to use your cash for this kind of investment, you're going to run into nightmares."
Outsourcing requires that distributors leave their traditional ways of looking at their business behind. "Ten years ago we were pretty much into general factory supply," says Reid. "Now we've got coffee and sugar and creamer in the warehouse. We stock Nike shoes for a plant that has a clean room, and Wella Balsam shampoo for a plant that deals in caustic materials and has employees shower after every shift. We've got Windex by the pallet-load. We'll stock anything they want."
"We used to be a company with products, and we added services to the products," Reid says. "Now we're a company with services and we add products to the services."
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