Distribution Update - February 2010

By Brian Hamilton

Distributors play a vital role in the floorcovering industry supply chain for most manufacturers, retailers and contract suppliers, but they are under assault from a variety of economic forces. Not only is e-commerce eating around the edges and giving consumers a way to cut costs, but the home centers and outfits like Lumber Liquidators with their own distribution are taking marketshare away from independent retailers, and with it, the distributors who serve them. And then there are manufacturers, who are looking to enhance their relationship, grow share and cut costs.

The latter hit home in a big way last month when Armstrong World Industries, the largest hard surface producer in the industry, and CCA Global Partners announced a direct arrangement in which Armstrong will essentially use distributors only to inventory and move its products to CCA Global’s more than 2,000 retail members. These include Carpet One, Flooring America, and ProSource Wholesale Flooring stores. Armstrong, which does business with about 40 distributors in North America, will pick up all the other functions like billing and credit, and is setting up a sales force specifically to serve those stores.

This is “a calculated risk” according to Armstrong, which believes that ultimately it can sell more product with this arrangement and serve CCA members at least as well as its distributors are. It potentially can be a good financial deal for CCA Global retailers, who stand to get better pricing, and perhaps eventually some proprietary products.

But there are plenty of hurdles for Armstrong to overcome as this program rolls out over the course of the year. Chief among them is developing an effective sales force that in many cases will be supplanting long-term personal relationships distributors have had for years with some stores. Distributors do much more than sell and deliver product. They provide product training, consulting, local inventory, credit, and help when there are problems, among other services.

The distributors we spoke to—both those who handle Armstrong and those who don’t—are watching this deal closely, partly because of what it might mean for distribution in the years to come. Bruce Zwicker, CEO of the country’s largest distributor, JJ Haines, which is also the largest distributor of Armstrong products, says “We’re studying it. We see difficulties with implementation.”

Industry consultant Santo Torcivia of Market Insights noted that distribution is probably the hardest aspect of the industry to master, and that the unintended consequences of a major change like the Armstrong/CCA pact can be enormous. “If I were an Armstrong wholesaler, I’d be a little nervous,” Torcivia says. “And the risk a manufacturer runs is that they can scare the distribution base into the arms of a competitor.” One distributor we spoke to echoed that sentiment and says that eventually a major benefactor of this deal could be Mannington, which is the only other company with as broad a hard surface product line as Armstrong.

Armstrong, for its part, believes that dealing with a buying group like CCA Global is a different animal than dealing with a typical retailer. “In defense of distributors, I think buying groups are unique and you’ve got to understand what the group is trying to achieve,” says Paul Murfin, Armstrong’s vice president of sales. “With a dedicated sales team, those people will be responsible for program execution, training and merchandising. At the end of the day, it’s all about execution.” He says the agreement with CCA is more “an execution program than a pricing program.” He believes Armstrong is already doing business with a high percentage of CCA retailers but that sales are not as deep or as broad as the company would like. He also says he believes that in-store training has become kind of “a lost art” as distributors have taken on more products, and he believes his dedicated sales force will be able to handle those challenges.

Murfin wouldn’t say how many sales reps he will need to handle the program, and he wouldn’t discuss how much it might cost to implement it. However, he acknowledged that distributors aren’t necessarily thrilled about the deal, but that they understand it and will go along with it. The program with CCA, he says, is a recognition that companies need to change in today’s environment and that different customers have different service requirements.

“The single most important thing is the market is significantly smaller than it was two or three years ago, and there isn’t enough business around for everybody,” Murfin says, and that creates a lot of competition.

“A massive amount of inventory has been taken out of the system and there’s a lot of pressure on service levels. Companies with good service levels are going to prosper.” He added that being well capitalized is the key in the current environment.

Other Challenges
It’s hard to say just how many floorcovering distributors have gone out of business over the last year or two. The North American Association of Floorcovering Distributors says it lost about 20% of its members last year but gained almost as many new members, so overall membership is about flat. These businesses are generally family-owned and operated and some, like JJ Haines, have been in business for more than 100 years.

Compared to other parts of the supply chain, it’s probably easiest for distributors to downsize. They can cut employees, sell off or idle delivery equipment, adjust their inventories, and make fewer deliveries. Companies that are still in business have probably made as many cuts as they can.

“You just can’t do it the same old way anymore,” says Fred Reitz of J.J. Haines, the incoming president of NAFCD, speaking about the industry in general. He says that so far there hasn’t been a major shakeout but he knows of cases in which distributors have cut as many employees as possible, depleted their savings—partly due to extraordinarily tight bank lending policies—and have leases that they can’t get out of. “I would have guessed that more distributors would be out of business now, but people are holding on for the new rainbow.” He’s anticipating that this year could see contraction throughout the industry due to far too much capacity.

Reitz says that over the years creativity drove the distribution industry to a just-in-time model but that is changing. “Distributors are asking ‘Do I need to drive to that town five times a week?’ There’s a whole change in the supply chain from the manufacturer all the way through. It’s kind of a brand new world.” He says today many manufacturers have a week or less of inventory on the floor, which is forcing a “re-engineering” of the entire process, a development that is still in its early stages.

“Should there be more strategic partnerships where, for example, distributor A and distributor B share a truckload?” Reitz asked. “Who knows where the productivity and efficiency will come from.” Innovation is as likely to come from a large firm with more resources as a small firm that can make changes quickly.

Distributors, like everyone else in the supply chain, have seen their sales plummet over the last year and a half, and most of the top 25 saw at least a 10% reduction in sales last year. Although margins have generally held up, those margins are being generated on less expensive items as consumers have gravitated toward value products. And that’s forcing distributors to wring out as much productivity as they can from their operations.

The current environment favors the most stable players in the supply chain, as well as domestic manufacturers. Retailers, Reitz says, are more likely to line up behind distributors who will be around for a couple of years, and distributors are doing the same thing with manufacturers.

“Importing (from overseas) has almost dried up,” Reitz says. Distributors can’t afford to keep as much as several months of inventory, which is about how long it takes to fulfill an order to a Chinese manufacturer from an East Coast distributor, when you combine manufacturing and shipping time.

“The Chinese like cash up front,” Reitz says. “U.S. manufactured goods have an advantage. You only have to carry four weeks of inventory, so even if it costs more it might still be a better deal.”

NAFCD is trying to help its members survive through the downturn by offering training on topics like expense reduction and sales. This year it is also co-locating its convention with the North American Building Materials Association, in hopes that members can learn from another industry.

“Maybe the other guys have a better idea,” Reitz says. “Flooring is considered a building material, but how much different is it from a functional piece like siding?”

How They’re Adapting
Southwest distributor Swiff-Train of Corpus Christi, Texas decided a long time ago to diversify by offering its own product lines, which are all manufactured overseas. It started sourcing its own luxury vinyl tile 26 years ago, then branched out and started importing its own lines of wood and laminate. Ten years ago it needed a better LVT and that’s when its EarthWerks brand was born. It now has luxury vinyl tile and plank, hardwood and laminate branded under EarthWerks and the products are shipped all over North America, largely through other distributors. In addition, Swiff-Train has a European LVT business, and it recently exhibited at Domotex, the largest flooring trade show in the world. Nevertheless, the majority of its revenues still come from its traditional Southwest distribution business.

Each year EarthWerks also holds its own market exposition, where many of its manufacturers, such as Milliken, Mapei, and Pergo, set up booths. This year the 50s-themed show in Dallas drew about 400 retailers.

“We keep adding new products, both domestic and imports,” says Don Evans, vice president of sales and marketing. “Earthwerks, because of its pricing, is doing better than some of our domestic products.”

Torcivia of Market Insights says the Swiff-Train diversification strategy is a good model for distributors. He noted that a good number of wholesalers in Canada have their own legitimate brands. “I think it’s a smart move,” Torcivia says. “When things turn around, the smart (distributors) will be investing in these kinds of things. It takes them away from being an appendage of a manufacturer who has life and death over them.”

Overall business was down about 6% last year for Swiff-Train, Evans says. The firm keeps a tight rein on its inventory, and spent much of last year getting all its products on barcode for improved tracking. Its EarthWerks strategy requires the company to keep a lot of inventory but because of its relationship with manufacturers it gets advantageous pricing. The company has also added people to its credit department and is watching its receivables closely.

J.J. Haines, based in Glen Burnie, Maryland, distributes throughout the East Coast, Southeast and parts of the Midwest. It began making changes for a downturn more than two years ago, and today sees the opportunity to gain marketshare. While cutting expenses where it could in areas like transportation, it also put a warehouse in Columbia, South Carolina in 2007, bought Orlando, Florida distributor Wheeler in 2008, and now is adding a warehouse in Atlanta.

Haines works hard on its service and has embraced technology in a big way. It’s online around the clock and it has B2B software for its largest customers so that invoicing, ordering and other functions can be done electronically. It also has something called the Haines Loyalty Club and helps members, among other things, put up websites. Every few months it surveys its customers. It even publishes an installation newsletter.

“Service is more important than ever,” CEO Zwicker says. “Every order is life and death and consumers are almost paranoid about getting what they want on time.”

In the face of “soggy demand” for products, a trend that Zwicker believes will be the norm for the foreseeable future, manufacturers need to raise their prices, Zwicker says.

While acknowledging that it will take a brave company to do so, he says “I think we’re at a pivotal point in floorcovering and I think this will be the pivot. Our job as distributors is to enforce the price.”

Distributor Elias Wilf of Owings Mills, Maryland, also saw the downturn coming back in 2006 and began right sizing the company. CEO Jeff Striegel says he made sure all the warehouses were on the web, re-evaluated its freight system, renegotiated its leases, and installed optical scanning, all of which cost a fair amount of money but allowed the company to streamline operations. In addition, the company had a number of employees who specialized in certain areas. That changed so that many of the specialists became generalists.

“With the systems and technology in place, since 2006 we’ve had a 40% reduction in operating costs,” Striegel says. “We track error rates and with all the reductions, our efficiencies and accuracy improved. We now have five errors per thousand orders.”

Recognizing that his dealers are struggling, Elias Wilf has lowered prices and offered more programs. Striegel personally visited his 18 largest dealers during the last couple months of the year to show support.

Striegel, like Zwicker, also expects the pain to continue for a while, especially since he believes the commericial market has yet to hit bottom and a rebound won’t hit commercial flooring for another two years. The only area where he sees a chance for a reasonable upturn is at retail, but again, it will only be as good as the confidence of consumers, who will react to everything from employment numbers to political developments.

Striegel, like Reitz, also expects a fairly significant shakeout this year. With laminate manufacturers operating at 40% capacity, and engineered hardwood manufacturers at 32% capacity, something has to give, he says. There’s too much excess capacity.

“Little distributors, unless they have a specific niche, or are in particular geographic locations, or are in some way a specialist, are probably not going to make it,” Striegel says. A lot of the small, generalist distributors are using everything to stay alive, including credit cards and home equity.

“How are they going to fund the business when the economy comes back?” Striegel asks. “More companies go out of business coming out of a recession than going into one.”

The distributors that make it all the way through the downturn are likely to be in good position to prosper. While retail forces, like the growing influence of the home centers and e-commerce, are changing the landscape, there will always be a need for independent distributors, especially for the smaller manufacturers.

“In the end, a brand’s position in the store rests with the reputation and service of the distributor as much as anything,” Torcivia says. “There are a lot of other variables, but it’s difficult to find alternative ways to supplant them.”

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