Manufacturer-Owned Distribution: Justifying The Ownership Of Captive Channels
Introduction
The relevance and rationale surrounding manufacturer-owned
distribution channels has always been of interest within Frank Lynn
& Associates' executive network?and the topic
regularly evokes engaging discussions within our ongoing workshop
series. While few manufacturing executives will admit it, the
ongoing level of interest in the subject is directly related to the
lack of control they feel they exert over the operations of their
independent distribution channels. Manufacturing executives,
accustomed to the high level of managerial control exerted in
sourcing, logistics, and production, are often sobered by their
lack of direct control over independent market-facing
resources.
"If only we could get our distribution channels to . .
." (insert your largest market-facing problem here) ". .
. we could optimize our entire sales and marketing motion and
provide complete integration with (insert your current operating
platform here?SAP, Oracle, PeopleSoft, etc.) and the rest
of our internal operations!"
If this battle cry sounds familiar, it's likely that
you've heard the follow-up argument?one that almost
always includes support for acquiring formerly independent
distributors and rolling them up into a best-in-class,
manufacturer-owned distribution enterprise. Such discussions
typically describe an enterprise that would be "run like a
real business", "operated on a single business
platform", "provide a business model demonstration for
the industry," be "accretive to our earnings," and
ultimately function "in the best interests of the
manufacturer."
Such talk sounds impressive around the water cooler, but do
these arguments provide manufacturers any real justification to
acquire their distributors? To develop some perspectives on the
issue, Frank Lynn & Associates analyzed a sample of
manufacturer-owned distribution enterprises across a number of
industries?assessing the initial and ongoing
justifications for ownership, the underlying economic model, and
the alternatives open to manufacturers before and after the
acquisition(s). While we have divided the arguments into three
categories?economic, operational, and
strategic?most successful acquisition plans incorporate
an expansive view that encompasses justifications from all three
perspectives.
Economic Justification for Manufacturer-Owned Distribution
Channels
Economic analyses, if supported by sufficient current state /
future state scenarios and internal hurdle rates reflective of risk
levels, can provide sufficient "stand alone"
justification for distribution acquisition decisions. Frank Lynn
& Associates' research, however, finds that pure economic
arguments supporting the ownership of distribution are relatively
uncommon. Simply put, the business models that support typical
manufacturing and distribution concerns are quite different from
the perspective of virtually every financial measure. In most
cases, economic analyses and justifications are used to understand
the financial "downside" that accompanies an
operationally- or strategically-justified decision to acquire
distribution.
The economics associated with distribution
businesses?as they would be run by the manufacturer's
organization?are expected to be accretive to earnings and
do not conflict with any financial covenants. Such justifications
are quite rare, particularly because distribution businesses
typically operate on much slimmer gross margin and EBITDA lines
than manufacturers. Within manufacturing firms that own captive
distribution channels, the disparity between the financials
inherent in the two business models is a frequent topic of
discussion among shareholders and the analyst community. Wall
Street loves to complain about manufacturers who tie up assets in
operations that drag down overall earnings.
Some of the strongest economic arguments are found in industries
where a preponderance of value?across the entire raw
material-to-customer value chain?is created in the
distribution channel. Such scenarios are typical in industries that
rely to a great extent on the ongoing sale of consumable products
and on-site services, primarily because the revenue model is
weighted in favor of post-sale activities. Companies competing in
this "razor / razor blade" market typically pursue a
business model that leverages the lifetime value of an account, and
as such, use value chain analyses to justify the move into captive
distribution. In these industries, manufacturer new product
development decisions are evaluated from the perspective of value
capture over the entire life of the product, incorporating
manufacturer and distributor income from services, consumables, and
aftermarket parts into the overall decision making process. In many
cases, distributor margin over the life of the product is several
times greater than the margin reaped by the manufacturer in...
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