Results are in, and our survey indicates distributors are cautiously optimistic about the future of the convenience distribution industry.

By Bob Gatty

For the first time in recent memory, Dr. Doom has something positive to say about the convenience distribution industry.

“I think we’ve turned the corner,” Al Bates, president of the Profit Planning Group said in September. “I think we’re doing a great job.”

For years, Bates has been warning that most distributors in the industry have been flirting with disaster, with profit margins and returns on assets (ROA) so meager that they would do better investing their money in CDs and heading for the golf course. But now – at least based on the 2008 Hershey Industry Performance Analysis (HIPA) completed by his firm – profit levels and other benchmarks like ROA are moving up as many companies have taken aggressive steps to improve.

According to this year’s HIPA report, based on 2007 results, the typical firm had a pre-tax profit of 0.5 percent and ROA of 4.1 percent, while high profit companies showed a pretax profit of 1.4 percent and ROA of 13.2 percent. Last year’s report showed a pre-tax profit of just 0.3 percent for the average company and 1.8 percent for “high profit” distributors.

Speaking at the AWMA Summit & Business Exchange in September, Bates encouraged distributors to focus on controlling payroll and fringe benefits, which he said consume 4 percent of sales for the typical AWMA distributor, compared to 3.3 percent for high profit companies. “This is a Mack truck in terms of expenses,” Bates said.

All of that was good news for the industry and for many AWMA member companies, says AWMA President & CEO Scott Ramminger. “It seems clear that many companies have paid attention to our studies and are implementing steps recommended by AWMA to improve their bottom line and position themselves for future growth,” he says.

Whether the tumultuous economy of the past several months will sidetrack these gains remains to be seen. However, an email survey of AWMA members taken just after the stock market meltdown in October still indicates at least cautious optimism among responding companies and reveals some of the strategies they are pursuing to grow profits. The 28-question survey was emailed to 254 company executives, and at press time had been completed by 35, or 13.8 percent.

While 32 percent of respondents said their pre-tax profit was about the same as the typical company identified in the HIPA report and 32 percent said it was higher, 88 percent of respondents said that their profitability level still was unacceptable, while 76 percent said it is possible to achieve improvements. However, only 35 percent felt it was possible to achieve a 1.5 percent profit margin and 12.5 percent ROA by 2009, a challenge that was included in AWMA’s 2007 report, “The Distributor Value Equation – Part II. A Mindset for Profit, Opportunities for Distributors.”

“I view this as a very positive sign for the industry, which is a reversal of the multi-year trending decline of net operating profits and return on assets,” says industry consultant Kit Dietz, who authored the report. “The profit goal of 1.5 percent profit margin and 12.5 percent ROA is just that--the goal of a reasonable profit expectation by distributors.  Although it may take a little longer than 2009, it is encouraging to see the results move in a positive direction and to see the number of distributors that are adapting their businesses to compete more profitably long-term.”

A huge problem continues to be declining profits from cigarettes, identified by 69 percent of respondents, and every company that answered the survey said they were taking steps to generate higher profits in other product categories.

“We need more sales in all categories in the store,” says Paula Glidwell, vice president, Glidewell Distributing Co., Fort Smith, AR, even though she doubts that declining cigarette profits can be replaced by selling other products. “Twenty percent of the sales can’t carry the 70 percent of cigarette sales in a c-store,” she contends. “There has to be a profit in cigarettes, the majority of sales.”

Thus, Glidewell is pessimistic about the long-term future of companies and an industry that is so dependent upon cigarette sales. “The future political climate towards cigarettes seems bleak,” she says, adding that competition from larger grocery companies, which look at cigarettes as a “loss leader”, causes serious competitive problems for the convenience channel.

Another distributor who responded to the survey said his firm is “getting squeezed by the tobacco companies. Their programs for discounts are simply unattainable, and the discounted amounts are less. We have to buy their growing numbers of brands and have to maintain minimum amounts on our shelves.”

Added another: “We, as an industry, need to stop giving product away, especially cigarettes and tobacco products.”

Even though Stephen Altman, president, Mountain-Service Distributors, Fallsburg, NY, reported that cigarette profits were increasing, his company is still seeking to generate higher profits elsewhere. “I know this isn’t going to last forever,” Altman says. “Overall, cigarette consumption is declining. We have to recognize that.”

Today, Altman says cigarettes are responsible for 80 percent of his company’s dollar sales. But he knows the day will come when that won’t be the case, and he intends to be prepared.

“I was brought up that you have to make a profit,” Altman says. “Mountain-Service Distributors has never rebated a penny (on cigarettes). I maintain my margins. I don’t give things away. I watch my costs. I demand a day’s work for a day’s pay. I was one of the first distributors to jump on fuel surcharges. I pay attention more to my financial statement than to my sales report. And if I earn $100 from a customer but spend $200, I give them up. I can’t deal with customers like that.”

Like Glidewell Distributing Co. and many other distributors, Mountain-Service is looking to such categories as candy and snacks, grocery, general merchandise, beverages and foodservice to help close the gap. According to the survey, 74 percent of respondents are focusing on foodservice, 71 percent on candy and snacks, and 66 percent on beverages. Grocery is a target of 57 percent and general merchandise of 49%.

However, one distributor pointed out within the survey that finding alternative solutions is not a snap-of-the-finger solution. “Additional categories often have high incremental entrance costs,” he said.

Foodservice is a good example, Altman says. “I had to double the size of my freezer. Gross margins are higher, but so are my expenses. The cost of energy for my freezer is $6,000 a month, and that eats into my bottom line. Still, I think these programs help the retailer to boost his profitability as he struggles with shrinking margins on gasoline and cigarettes.”

That, according to Altman, is another way his company intends to protect its margins as well as its future – by providing real value to customers, helping them boost their overall profits. “Many of the programs we run out there aren’t necessarily profitable for us, but they are for the retailer,” he says. “I want our sales people to be more consultants than order takers.”

Other distributors who are determined to improve profits and strengthen their position for the future are pursuing a similar strategy. In fact, 71 percent of respondents said they have changed pricing practices and approaches to selling to focus more on the value they provide to customers – a key “Value Study” recommendation.

For example, one distributor who responded to the survey, said his company is “training our people and customers that we are consultants and business partners.” The distributor said he is “educating our customers on the need for us as their supplier to also make a reasonable profit.”

Said another: “We emphasize service, and don’t have the same high minimums as our competitors, nor the same level of fuel surcharge.”

Meanwhile, a third company said it’s important to have a “consistent program of raising prices and fuel surcharges within reason. We do not attempt to be price competitive, merely ‘sensitive’. We also offer full service: sales reps, merchandisers, category and technology support.”

Clearly, AWMA members are serious about improving their own profit positions and meeting price-cutting competitors head on. Said one survey respondent: “We have streamlined our pricing categories and have increased our margins on all categories except cigarettes. We have also reclassified our customers into appropriate pricing categories based on their purchases and cost to serve.”

One of the key recommendations of the “Value Study” read as follows: “New pricing methodologies based on ‘cost-to-serve’ must be established and implemented. These can be developed in stages and can result in significant, immediate, profit improvements.”

“As a channel, we have only scratched the surface of understanding, then applying, activity-based costing to the business,” Dietz says, adding that an initiative involving beverages in which some distributors have adjusted pricing practices to improve profits is a good example of how distributors can address the pricing of products in a high-growth category where cost-plus alone failed to cover the basic variable costs of handling low-dollar, heavy-weight, high-cube cases.  

“All distributors, could have, should have made progress in the beverage category,” Dietz says. “As the industry further develops a deeper understanding of the cost versus profit relationships of products, business processes and customers, we can then approach the business to make better decisions together to improve profitability for all channel partners to get it right for the consumer at retail and take cost out of the system together. Transparency of costs and pricing will drive this future opportunity.”

In fact, 43 percent of respondents said their competitors had also changed their approach to the market related to pricing practices and selling value. Commented one respondent: There is “less predatory pricing and a shift from ‘volume at any cost’ to ‘let’s make a profit.’”

Still, others said competitive pricing is getting even worse. “Our problem is the distributors who are set at growing at any price. Some are just plain dumb,” one respondent said. “Our competitors are lowering prices because the volume is down. To me, this is the kiss of death,” offered another. And, from a third: “As cigarette sales continue to decline, distributors are selling on thin margins, often times only earning the incentive dollars.”

What are some of the specific “Value Study-recommended” steps being taken by distributors to improve profits?

• High Cube Products – 74 percent agreed that distributors should change pricing policies to improve their return; 43 percent have instituted such policies and 23% are in the process of doing so.
• Single Pick – 20 percent provide single-pick items with no restrictions, but 66 percent do so either at a higher price or with a minimum order requirement. Nine percent are considering restrictions on single-pick.
• Sales Personnel Training – 74 percent train sales personnel so they understand which customers are profitable and which are not. Another 14 percent are considering such steps.
• Technology – 86 percent use technology for inventory control; 77 percent for warehouse management; 51 percent for category management; 43 percent for fleet management.
• SKU Rationalization – Generally, most respondents are reducing the number of SKUs, with a focus on eliminating slow movers and duplicates. 86 percent of respondents said they have taken such steps over the past two years.
• Customer Profits – 71 percent have a process to evaluate customers’ contribution to profit as well as to eliminate unprofitable customers.
• Warehouse-Delivered Snack MVE – 49 percent take advantage of AWMA’s Warehouse-Delivered Snack Multivendor End Unit merchandising program, which some distributors have said is the most effective step they have taken to boost overall snack sales.
• Expansion – Most companies responding to the survey are not sitting still. 32 percent are considering acquisitions; 57 percent, increasing category services; 54 percent, seeking opportunities outside the channel to better utilize plant and equipment; 29 percent, adding capacity to current structure.

Overall, more companies than not (55 percent) are optimistic about the future of their own operations, while 26 percent are either somewhat or very pessimistic. Forty one percent are very or somewhat optimistic about the convenience distribution as a whole, while 30 percent are pessimistic.

However, despite the profit improvements that appear to be underway, pessimism also appears to be growing. Last year the same survey revealed overall optimism about their own companies at 65 percent and optimism about the industry overall at 47 percent. No doubt this fall’s economic meltdown has influenced this attitude, at least to some degree.

“It’s not surprising that there is mix of pessimism and optimism among distributors,” says Dietz. “We are seeing a steepening decline in overall cigarette volume, traditionally the gold standard of convenience distributors. Optimism is more than likely a direct reflection of how these companies have invested in their businesses and positioned themselves to compete in a future that is less dependent on cigarette profitability and more dependent on providing total solutions for the convenience industry.”

Bob Gatty is contributing editor to Distribution Channels and founder of Gatty Edits. 

SIDEBAR

Optimism, Pessimism About the Future

As AWMA distributors look to the future, some clearly believe that despite tough economic times and a traditionally difficult competitive landscape, there is plenty of room for optimism. Others, however, admit to being much more pessimistic about the future.

In their own words, here are two such views:

Stephen Altman, president, Mountain-Service Distributors, Fallsburg, NY – “I am proud of our balance sheet and the reception that I receive when I visit my banker. I maintain my margins, and even though there are challenges, we are in a strong position. We have always strived to be the best. The quick and easy way, long-term ends up haunting you. So we make our proper margin, including on cigarettes. We try to help our retailers analyze what’s selling and help them boost their profits. When competitors come along, our retailer customers hopefully will understand that we’re more on his side than they are.”

Paula Glidewell, vice president, Glidewell Distributing Co., Fort Smith, AR – “The future political climate towards cigarettes seems bleak. Also, larger grocery companies have entered the convenience store business. After sitting on the Dot Advisory Board, I realized all grocery companies think of cigarettes as a loss leader to get the rest of the business. This model may work for grocery stores, but it does not work in the convenience sector. The traditional Candy and Tobacco wholesaler has picked up groceries and foodservice. We have typically sold all items at a lower profit margin, but made a profit on cigarettes as well. As the two have competed it has led to lower prices in all categories. Higher coffee and foodservice prices can’t cover losses on 70 percent of their sales in convenience stores, which are cigarettes.  All wholesalers talk about getting a better profit, but do not raise prices. Any additional monies they seem to get from manufacturers go into lowering the price. Even the industry analysts are okay with passing on manufacturer incentives and believe that a high sales volume will make up the difference, which it can. So the only ones who can survive with this model are the large grocers. Unfortunately, they won’t be servicing the rural Mom and Pop stores, which will just help the club stores growth (some of which are also serviced by large grocers). This model will also hurt the small manufacturers.”