Adam J. Fein: Why revenue growth will get tougher

Total revenues of wholesale distributors have grown by an unusually high nine percent per year in the past three years. Revenues in the first quarter of 2006 were up 10.3 percent versus the first quarter of 2005. Sectors as diverse as industrial products, pharmaceuticals, and plumbing/HVAC all registered double digit growth. 

Top-line revenue growth comes from increased volume, higher prices, or a fortunate combination of both factors. While robust economic growth has boosted unit volume, many wholesale distribution executives must also recognize that unusually high commodity price inflation has made revenue growth much easier in many sectors. Wholesaler-distributors are going to have to work harder for real growth, requiring a more strategic and focused approach.

THE INFLATION GROWTH BOOST
Think back to the economic environment just a few years ago. Excluding highly volatile food and fuels, prices for intermediate products in business-to-business transactions declined throughout much of 2002. Then-Federal Reserve Chairman Alan Greenspan startled financial markets in early 2003 by stating that the threat of deflation “though minor, is sufficiently large that it does require very close scrutiny and maybe—maybe—action on the part of the central bank.”

Deflation wreaks havoc with the income statement of wholesale distributors, who are “paid” for providing services to customers and suppliers in the supply chain in the form of gross profit. Product price deflation translates into fewer gross margin dollars to pay for the value that these services actually provide. 

Today, the situation has reversed dramatically as a commodity price bubble creates inflationary pressures. The price index for intermediate goods (excluding food and fuels) increased by 7.3 percent in June 2006 versus the previous year. Prices of certain core commodities have literally skyrocketed.

• Steel mill products increased in price by more than 60% since mid-2003. Although prices began to decline in the second half of 2005, prices remain relatively high by historical standards, due in large part to China’s commodity-intensive manufacturing activities. (China’s imports of all commodities have risen more than tenfold in the past 15 years.)
• Oil trades above $70 per barrel versus $32 in late 2003, triggering price increases throughout the supply chain and in derivative products. For example, prices for plastic pipes and fittings are now growing at 20 percent per year.
• Prices for building materials such as lumber products spiked in 2004 and remain above historical levels. Inflation for concrete products remains high as demand continues to exceed supply.

But as we all know, trees do not grow to the sky. There is a practical limit to how much business customers can pay for materials and supplies. Many analysts believe we are in the midst of a speculative bubble in commodities. The Federal Reserve is aggressively ending the “easy money” era through higher interest rates, suggesting a slowing inflation rate or more moderate economic growth. 

VOLUME GROWTH STRATEGIES
If the growth in commodity prices does ease, then the revenue-enhancing benefit of product price inflation dissipates. It will become harder for wholesaler-distributors to show top-line revenue growth, making volume growth more important as a source of revenue growth.

There are two well-understood strategies for a wholesaler-distributor to increase the volume of product sold:

In a forthcoming Pembroke Consulting research study sponsored by Lawson Software, we found that seven out of ten wholesale distribution executives view current customers to be their most important source of growth over the next five years. When we split the sample into four industry groups, we found some clear differences in the specific growth strategies by which wholesaler-distributors plan to expand sales with current customers.

Wholesale distribution strategies for increasing revenues from current customers in the next five years

Data show percent of wholesale distribution executives rating the strategy as "Most Important" for increasing sales to current customers

Source: Pembroke Consulting/Lawson Software study of wholesale distribution growth strategies
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These findings illuminate important differences in the wholesale distribution industry. Most distributors of building materials, contractor supplies, and foodservice distributors expect to grow by increasing sales of their current product categories. These distributors sell to primarily local buyers such as contractors or restaurant operators, making account penetration among customers with stable needs crucial.

In contrast, industrial distributors are being forced to redefine their value at the same time that their traditional manufacturing customer base reinvents itself through outsourcing, offshoring, and lean production. These distributors need to cross-sell additional product categories to get a bigger share of spending from the surviving industrial customers. Trends such as integrated supply and strategic sourcing encourage a business-broadening strategy. Distributors of consumer products, which face retail customers bypassing the traditional wholesale distribution channel, also plan to look outside their core product lines for growth.

Yet as I point out in a previous column on profitable growth, it will be virtually impossible for a wholesaler-distributor to pursue either strategy without the rich data and analytic tools available from a sophisticated business system. Inside and outside salespeople will also need new competencies and skills in order to execute either growth strategy. In the coming months, I will explore how technology can help a wholesaler-distributor to both retain with its most valuable customers as well as identify the right cross-sell opportunities. 

Wholesale distribution executives should analyze the relative contributions of volume versus price growth to their company’s recent top-line revenue growth. An over reliance on inflation-boosted growth may signal that a slowdown is coming.