Laying A New Foundation

For the first time in a number of years, distributors are growing faster than their major vendors, evidence that those vendors are deriving an increasingly greater portion of their revenue through the distribution channel.

Fueling that growth is a recognition by vendors that distributors, and the solution providers they serve, are the best way to reach the resilient SMB market. But that is only part of the story. Distributors have also emerged from the tech recession with leaner, more efficient businesses, while transitioning from a product-based selling to a more solution- and services-oriented model, executives say.

Distributor revenue declined during the dot-com crash and it&s taken about two years—and not an insignificant amount of pain—to get the right model in place. But distributors have created a new foundation for growth and profitability that will allow them and the channel to thrive for many years, executives say.

“It&s very difficult. It&s still a challenge for us,” said Tom Dolan, chairman and CEO of Westcon Group, Tarrytown, N.Y. “But it&s so important for us to be efficient from a process perspective.”

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The results have paid off. Distributors& product revenue in North America increased 9.5 percent from July 2004 to June 2005, said Tim Curran, CEO of the Global Technology Distribution Council, a trade association representing the IT wholesale distribution channel.

PC and server sales, a product category that especially suffered during the downturn, increased 19.8 percent, the GTDC reported. Communication products, storage hardware, input devices and storage media also experienced double-digit growth.

According to the GTDC, growth in North American distributor product sales outpaced that of major vendors in 2004 for the first time in years. GTDC member revenue increased 15 percent, compared with 11 percent for the members& top hardware and software vendors, according to the organization. In 2003, distribution revenue increased 7 percent, compared with 11 percent for the vendors. Prior to that, distributors& revenue growth had declined for two years.

“We came out of that recession from late 2000 to 2003 and now we see steady growth—not the hockey stick of the Internet age, but it&s steady. With that and the enormous efficiencies distributors have engineered during the recession, we see profitability up as well,” said Curran.

Distributors estimate that they collectively spent tens of millions of dollars reorganizing their businesses. The changes have not only helped renew sales growth, but also gain efficiencies that have translated into healthier margins and increased profits. In its most recent earnings announcement, Ingram Micro&s profit increased 61 percent in the second quarter to $41.7 million from $25.9 million.

“There were difficult times. You had a big market falloff, HP losing market share and going direct, we had some significant head count reductions and we lost lots of revenue in the process,” said Greg Spierkel, CEO of Ingram Micro, Santa Ana, Calif. “That put a big pressure on all of us to go after costs, to get our core business as agile and cost-efficient as possible.”

Arrow Electronics and Avnet, which have traditionally provided a high level of support, have also gained efficiencies and added services. Avnet&s sales in its 2005 fiscal year ended June 30 increased 10.5 percent, while net income increased 50 percent. Arrow&s North American Computer Products group revenue increased 23 percent in the second quarter vs. the year-ago quarter.

A better grasp of its own cost structure and a focus on a solution model should result in sustained profitability, said Mike Long, president of Arrow NACP, Englewood, Colo. “We are equipping the resellers to go out and provide a total solution vs. just selling a piece of hardware,” Long said. “That is putting them closer to their customer base, but also helping them solve their customers& problems.”

The distributors& transition has been driven by marketplace demands, where a focus on enterprise customers has given way to increased attention on SMB customers. “It becomes more important for you to have a repetitive strategic selling process to reach the SMB market,” Dolan said. “You need to put a lot of opportunities in the pipeline. ... That&s driven us to reorganize our own marketing organization from the top down.”

One change is that distributors are bringing on more smaller, niche vendors to support solution sales. Westcon, for example, recently brought on a $500 product called FleXi 80/20 from a small Swedish-based developer that links to an office telephone and can alert callers whether a person is in the office and able to take a phone call.

“Frankly, a year ago we would have thought it was a neat product but we would have [had] nothing to do with it,” Dolan said. “Today we recognize that if we promote the product, we can make a whole telephone system sale behind it, pulling in $25,000 or $30,000 worth of telephony and networking equipment. In SMB, it&s our job to come up with combinations like that so our resellers have new solutions to bring to their customers.”

In some cases, distributors have redeployed significant resources internally to support solutions. Tech Data moved hundreds of technical support staff, who were trained to answer basic product questions, to handle preconfiguration and solutions integration work, said Ken Lamneck, president of the Americas at Tech Data, Clearwater, Fla.

Inquiries for simple questions were pushed to the Web, which significantly reduced first-level support calls. “It changed the workflow,” Lamneck said. “On the product management side, someone who was focused at the point product SKU level now is focused on how to help the vendor do more solutions.”

Tech Data can now focus on “soft bundling,” or grouping complementary SKUs, without having the two tied together as one SKU, he said. That allows the distributor to create repeatable but customizable solutions that can be marketed to solution providers. He said more and more vendors want distributors to include them in the bundles.

One such vendor is Xerox. The printer vendor has made a conscious effort to push more SMB business to the distribution channel in part because of the company&s own efforts to engage the SMB market, but also because distributors are more focused on building solutions, said Gary Gillam, vice president of North American channel operations at Xerox, Stamford, Conn.

“[Solutions] are a strategic growth initiative for us. The distributor&s transformation to more of a solution sell plays really well in terms of channel partners critical to us in our SMB initiative,” Gillam said. “As we bring more color and more multifunction products to market, that&s not a box-mover opportunity. That&s an opportunity for a value-added partner.”

Xerox&s unit volume of color products increased more than 70 percent through distribution in the last year, while sales of multifunction devices jumped several hundred percentage points, though from a smaller base. “A solutions model really has enhanced the role of the distributor rather than just creating supply chain efficiencies, although we are working with them there, too,” Gillam said.

Solution providers say they have benefited from the distribution channel&s rebirth and new solution orientation.

“Distributors are now starting to get a real understanding of the services model, as opposed to a SKU-based, box-moving model,” said Mike Novotny, president and CEO of InterTech, a Phoenix-based solution provider. “We&ve increased our services model because of it.”

He said distributor investments in new technologies and services has led InterTech to expand its reach to customers. “With [distributors] understanding new technologies and helping us increase our professional services offering, we&ve built a very successful business both in wireless assessment and security assessment,” he said. “As a result of distributors changing their model, we have changed ours. And it&s a higher labor revenue generator than traditional hardware break/fix.”

Can distributors rely on a solution model to drive growth long term? Roy Vallee, CEO of Phoenix-based Avnet, believes so.

With costs under control, a solution-selling model perfectly positions distributors for growth, Vallee said.

“In essence, that&s the secret sauce in distribution,” said Vallee. “The formula for success is to grow revenue while maintaining gross margin. It&s difficult to increase gross margin in a competitive hardware model. Words like productivity and operational excellence become vital—oxygen, life and death. The only way to get more profitability over time is to increase productivity.”