retail - building for the future
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The transformation of the business
of selling building materials to profes-
sional contractors is happening before
our eyes at an incredible pace—
promising to change forever an indus-
try that has long been noted for low
margins, poor economies of scale and
extremely fragmented service
providers. Building material suppliers
have competed fiercely among them-
selves to drive down prices and meet
consumer needs for lower-cost build-
ing supplies. Now the survivors face
new threats from outside the industry
that might thwart all their well-con-
ceived plans in building strong, lasting
relationships with their customers.
Financial acquirers of building materi-
al suppliers have dissected the cost-value equation and come up with new
retail concepts. Their stories have
attracted interest in the public equity
investment world. The end result has
been to persuade dozens of fiercely
independent suppliers to sell out, forc-
ing a financial-oriented consolidation
upon the industry. This pattern is con-
sistent with revolutions in other con-
sumer durables markets that effectively
transferred market power from manu-
facturers and distributors to a financial
savvy type of retailer. This also insures
that the retailer becomes the caller of
shots over the contractor customer,
instead of the other way around.
FORCESOFCHANGE
From the early decades of the 20th
century, the building materials industry
has been based on a “supply-push” phi-
losophy—a strong bias toward “filling
the stores” to cover the distribution and
warehousing costs of the distributors.
The building material retail network
(that is still in place today) was largely
created as a logical extension of the
“supply-push” model. The retailers were
designed to hold inventory, leverage
their own private capital (without threat-ening the wholesale distributor’s con-
trol) and service and support what still is
a commodity-based, maintenance-
intensive line of products and services.
These retail lumber and hardware stores
were built from the ground up by
entrepreneurs who focused on a defined
geographic area, selling a large array of
both construction and hardware lines,
catering to both contractor and the
walk-in consumer.
This distribution retail model has
been remarkably resistant to change.
Building material retailers have become
ingrained over time by a web of informal
habits and long-established customer
and vendor contacts.
Despite its longevity, the building
material supplier channel leaves some
retailers unhappy. High customer acqui-
sition costs motivate retailers to convert
store traffic to sales by merchandising a
multitude of products that extract differ-
ential margins based on customers’ will-
ingness to pay. Taking numerous bids
and sticker wars have taught contractors
to be excessively cost sensitive and nego-
tiate from cost up, rather than from bid
down. As a result, retailers often find
themselves competing against a similarsupplier across town. This acute compe-
tition has almost wiped away retailer
profit on the sale of lumber and other
commodity-oriented building materials.
So, lumber companies often make their
profits in areas other than lumber.
The decline in profits on building
materials has forced construction, lum-
ber and hardware suppliers to make up
the margin shortfall by looking at what
many only considered “filler” businesses
Who will be the winners and losers in the revolution that is radically reshaping
the marketing, distribution and selling of building materials? Will the expansive
dealer networks, which are broken into literally thousands of independent retail suppliers, be able to overcome years of inertia to pioneer and execute new
concepts that will strengthen and extend the value and scope of their
businesses? Or will nimbler, more imaginative retailers get there first?
B Y C L A R K C OL V I N
How Building
Material Retailers
Can Adapt
to Changing
Industry
38 DO•IT•YOURSELF RETAILING/DECEMBER 2001
BUILDIN GFO R TH E FUTURE
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before: cottage manufacturing units,
installed sales programs, etc. The prob-
lem is that a conventional building
material supplier is not necessarily posi-
tioned well to conduct all of these busi-nesses because of their different
economics, knowledge of direct costs,
bases of competition and consumer pur-
chasing patterns. Some suppliers, for
example, have purchased a truss manu-
facturing or a pre-hung door assembly
facility only to shut down those same
factories a year or two later. They go into
these ventures lured by the perception of
high margins only to find out they were
ill-fitted in terms of cost control and
management to handle such labor-
intensive operations.
RETAILERSSTILLPART OFEQUATION
No one is suggesting, though, that
construction-oriented building materi-
al dealers will disappear. Ironically,
changes in building materials them-
selves are making retailers more
important. Customer satisfaction has
become a much more critical competi-
tive differentiator and a greater influ-
ence than the materials themselves.
And it is the retailer that controls these
levers today. This explains the intense
efforts many building material retailers
have made to increase standards for
customer satisfaction.
As a result of the low-margin, high-
satisfaction proposition provided by the
traditional retailer in general, the suc-
cessful strategy will be to capitalize on
horizontal cost-reduction opportunities
afforded by improving the retailer
economies of scale equation by trying to
reduce costs in administration, advertis-
ing and service.
VISION FOR THEFUTURE
Now that we see cracks in the walls
protecting the traditional building mate-
rial construction supply industry, what
will the future bring? Both the underly-
ing drivers of change in building material
retailing and trends already under way
help answer that question. In addition, it
is helpful to compare with other indus-
tries that have experience in economies
of scale evolution and look at the lessons
they learned.
Most consumer-durable industries
have undergone a substantial distribu-
tion and service evolution resulting fromchanges in economics, competition or
technologies. Each one has unique cir-
cumstances, but we can see three rela-
tively common, distinct stages in these
economies of scale restructurings:
Stage One:This first stage is marked by major
improvements in value delivered,
mostly reductions in cost. Usually the
cost reductions stem from strategic-
oriented consolidations and rational-
izations in the value chain as better
concepts or bigger players drive out
marginal or small players. The objec-
tive is the bigger players use their costadvantage to reduce prices and often to
improve service, variety and conve-
nience. In practice, however, these
strategic consolidators focus mainly on
increasing market share rather than the
profitability of each acquired entity.
Stage Two:The second stage is marked by com-
panies becoming more focused on
achieving economies of scale of specif-
ic customer segments through the
rationalization of logistical support
services. Functions are unbundled and
restructured into more efficient or
more appealing profit and cost centersand formats for defined groups of cus-
tomers. Customer value is further
enhanced through lower prices for
select product lines, better service or
greater variety.
Stage Three:The final stage brings dramatic new
paradigms not just for the sale and dis-
tribution of products but for the entire
value chain.
1 . M ultiple profit centers and
forma ts w ill coex ist to satisfy dif-ferent market segments. Profit
centers are distinct paths between a
retailer and a customer through similar
economic entities, such as contractors
vis-à-vis retail customers, vis-à-vis
commercial customers. Formats are
distinct combinations of points of sale,
service offerings and business process-
es within a general profit center defini-
tion. We expect much more variation
in profit, cost centers and formats in
both an accounting and in a physical
sense and more distinct positioning in
terms of the purchase experience they
provide, thus shifting the basis of com-
petition from products to services.
2. The separate businesses
under the roof of the traditional
retailer w ill be unbundled. Differ-
ent operational structures will be
required to serve a variety of customer
needs and economics.
3. The cost of distributing and
ma rketing building materials w ill
be cut significantly. New formats will instill discipline in the current sys-
tem to drive out non-value-adding
cost. Supplier consolidations may
unlock substantial economies of scale
in back-office functions and purchas-
ing leverage. Much larger savings are
possible, however, by driving out obso-
lete and excessive inventories; reduc-
ing investment in brick-and-mortar,
equipment and real estate, and opti-
mizing the delivery of services.
DO•IT•YOURSELF RETAILING/DECEMBER 2001 39
RETAILING
Customer satisfaction has become a much
more critical competitive
differentiator
and a greater influence than the materials
themselves.
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40 DO•IT•YOURSELF RETAILING/DECEMBER 2001
RETAILING
4. M ark eting and distribution
w ill concentrate on estab lishing
durable customer relationships.
Since customer acquisition costs are high
and going higher, it is logical for retailersto work harder to hold on to the cus-
tomers they have. We see these relation-
ships developing on two axes: “follow the
product” and “follow the customer.”
The “follow the product” axis will
make manufacturers and distributors
more active in the value chain. We see
this axis as counterproductive, actually
driving down margins as well as
depleting necessary cash flows for the
retail suppliers.
The “follow the customer” axis means
building more direct relationships with atargeted set of customers to define their
needs, develop tailored marketing pro-
grams and stake out unique positions.
Identifying these customers and keeping
them happy will require substantial
investments in market-understanding
capabilities that go far beyond the func-
tional and demographic information
that most retailers rely on today. We see
this axis as the correct point of strategic
realignment of customer service.
Retailers will seek and attain much
closer contacts with consumers. We
have no doubt that someone will figure
out the riddle of consumers’ needs, aspi-
rations and experiences as they relate to
building materials; the tenuous part of
this prediction is that retailers must get
there first. However, retailers today are
surprisingly—if not shockingly—cut off
from their consumers.
Undoubtedly, Internet technology will
enable more effective and efficient direct
contact between retailers and their cus-
tomers, as both become more comfort-able with this new type of POS. If,
however, retailers fail to exploit tech-
nologies to establish meaningful rela-
tionships with consumers, more
powerful intermediaries may gain the
upper hand and end up providing mate-
rial direct to both the contractor and
retail consumer end-user.
These transformations will not be
easy, and many of today’s players will
fight them aggressively. But the revo-
lution in building material retailing has
begun, and now that it is underway, it
will be impossible to stop and nearly as
difficult to contain.
FORMINGA STRATEGICRESPONSE
What, then, should a building materi-
al retailer do? Appropriate responses are
to some extent situation dependent, of
course, but we believe the three stages of
economy of scale evolution observed in
other industries provide valuable insight
into what will be required to prevail in
the retail building material industry.
In fact, first-stage economy-of-scale
evolution activities are already rampant
in building material retailing in the Unit-
ed States, and second-stage changes are
gradually being accepted by a handful of
retailers at this time. We expect that par-
ticipants who fall behind in this evolu-
tionary process will suffer severely,
particularly as more and more of thevalue creation and consolidation in the
industry occurs downstream. The future
winners in the building material industry
likely will be the ones that drive third-
stage evolution. Accordingly, we recom-
mend the following strategic responses
consistent with the three stages of
economies of scale evolution and the
future of the building material supplier
vision described above:
1. Aggressively and systematically pur-
sue functional, as well as, profit center
improvement, such as operational cost
savings and high margins of the existing
product lines.
2. Develop a vision of a desired end-game sales strategy and begin making
progress toward that vision, taking care
to achieve consistency between the long-
term vision and short-term functional
improvement agendas.
3. Build the means to create and
capture much more of the “down-
stream” value associated with building
materials—and, in so doing, strive to
innovate “game-changing” approaches
to the business.
FUNCTIONALIMPROVEMENTS
In the conventional building material
retailer network, tremendous improve-
ment opportunities exist along two basic
functional paths: reducing operational
costs and raising customer satisfaction.Most retailers are jumping at the latter,
forgoing the former. For example, these
players tend to select a limited number
of high acquisition specific programs,
and they typically concentrate on single
functional improvements independently
or on a single functional path. For exam-
ple, thinking that a kitchen and bath
department is the cure-all for company-
wide lagging sales, or that focusing solely
on contractor sales will enable the com-
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DO•IT•YOURSELF RETAILING/DECEMBER 2001 41
RETAILING
pany to rid itself of unnecessary people
and product lines.
A better approach is to systematical-
ly address the whole realm of possibili-
ties with an integrated view of benefits within and across specific functions.
This is not easy. Even programs with
moderate scope and ambition typically
require reforming entrenched business
philosophies; coordinating several
organizational groups with individual-
ized incentives; managing complex
and imposing logistics, and facing up
to customers resistant to change. But
retailers must recognize that new play-
ers unencumbered by these con-
straints are raising the bar and
traditional players must reach higheror fall behind.
Based on our experiences and analy-
sis, we estimate that cost reductions,
though easy to execute, will be one of the
hardest things to accomplish. There are
three reasons:
1. The consolidation and rationaliza-
tion of activities to achieve economies of
scale and eliminate inefficient opera-
tions is unpopular. Large numbers of
small competing suppliers operate as
“mom and pop” operations.
2. The unbundling of profit center
businesses, for instance, is largely
unknown to unsophisticated business
people. To date, a retailer’s profit center
is often viewed as a location, not a cus-
tomer type or manufacturing process.
3. Given the wide variation and the
resulting large differences in efficiency
and effectiveness in operations among
retailers, the application of best practices
for the industry is substandard. In other
words, working toward the industry
standard creates a continuing downwardspiral in industry-wide performance.
Here are some examples of potential
functional improvements:
• Reduce inventory costs. Retailers can
cooperate among their different loca-
tions to pool inventory in regional cen-
ters. Also, analytical methodologies,
information-systems tools and best
practices can be used to evaluate the
retailer-level sales history to determine
the best amount and mix of materials
to hold in inventory. Finally, to
improve future demand visibility and
forecasting accuracy, retailers can use
improved information systems and
marketing techniques to track cus-tomer and sales-promotion informa-
tion, marketing campaigns and
historical data on sales-promotion
effectiveness.
• Leverage purchasing power. Retail-
ers can also capitalize on purchasing
economies of scale. The economies
result from lower costs in areas such as
financing, advertising, management
personnel, payroll handling, insurance,
supplies, administrative functions and,
of course, material purchases. The
reported cost savings from theseeconomies alone can be as high as 20
percent of a retailer’s cost.
• Use best management practices to
sell building materials. The traditional
selling approach for building materials
is loaded with cost (and effectiveness)
opportunities that are not taken advan-
tage of. Sales management is often the
missing ingredient. In our opinion, the
understanding of management, as
applied to sales personnel, is one of the
largest problems of most building mate-
rial retailers today.
• Align manpower requirements with
profit and cost center activity. Gener-
ally speaking, even the most efficient
retailers don’t separate manpower
requirements within individual profit
and cost centers, correctly understood.
Often a simple ratio—payroll to com-
pany sales—defines the standard man-
power productivity level. Such
oversimplification of personnel effi-
ciencies disguises the contribution
margin of the separate profit-generat-ing parts of a company.
• Increase customer satisfaction. Cus-
tomer satisfaction and loyalty are rich
veins of potential functional improve-
ment. Good performers end up getting
paid for what they are already doing
well, and the poor performers under-
take short-lived, superficial steps to
“manage the measurement.” Customer
service in building material retailing is
mostly about executing the basics
well—keeping delivery commitments
and offering conveniences. Service
advisors and computer-driven follow-
up calls will not regain ground lost to
sloppy execution.
DISTRIBUTION STRATEGY
Cost and customer-service improve-
ments are necessary but not sufficient
enough to transform the building
material retailing industry. Realizing
the full potential of these programs is
not possible without a reasonable view
of the different customer segments that
should be targeted—the appropriate
mix and level of marketing functions
needed for each segment, and the best
means of distribution.Just as specific groups of customers
have their own product requirements,
different consumer segments have
their own requirements for the pur-
chase experience. These requirements
can be effectively targeted with package
variations such as service contracts,
financing, sales incentives and different
pricing matrixes. Ultimately, the con-
sumer-segment requirements will drive
the service requirements and in turn
help determine the best cost and oper-
ating structure for the specific distribu-
tion format and customer-value
proposition of each customer type.
Creating the purchase experiences to
meet the needs of specific consumers has
two other significant implications. First is
the need for parallel accounting and prof-
it centers in a given region, each with its
own pricing and bundle of product offer-
ings. Parallel sales profit centers range
from the traditional contractor to the
commercial customer to consumer over-
the-counter sales.The second implication of serving mul-
tiple, service-based customer profit cen-
ter segments is the need to avoid
cannibalization—in other words, the rob-
bing of contractor sales to beef up retail
consumer sales, and vice versa. Here the
accurate tracking of sales, margins and
expenses are necessary. Unfortunately,
most accounting software programs in
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DO•IT•YOURSELF RETAILING/DECEMBER 2001 51
RETAILING
(Continued from page 41)
the industry are not set up to track infor-
mation by profit centers.
DOWNSTREAM VALUECREATION
The biggest winners in the building
material economy of scale evolution will
be those that drive substantial value
improvements by creating real innovation
in the retailing of building materials. In
many other industries, retailers have driv-
en and benefited from economy of scale
evolution at the expense of manufacturers
and/or distributors.
The cost-reduction potential in the
building material retailing industry is
huge. Innovative ideas that tap thispotential may well dominate the future
of the building material industry. Such
innovations can be achieved by recog-
nizing the real drivers of value and the
linkages among them. This new life-
cycle value paradigm represents one
way that a building material company
might approach the problem of creating
value through its marketing and distri-
bution activities.
ANTICIPATED CHANGES
Change and innovation are the
lifeblood of all retail businesses, but the
building material supplier industry has
been remarkably resistant to transforma-
tion. As a result, the industry suffers from
an outdated, inefficient and expensive way
of doing business.
This situation will change. Building
material retailing is beginning to evolve. At
one level the future implications are clear.
These include multiple alternative profit
centers or a greater unbundling of the
retailer’s business; increased valuethrough economies of scale; more empha-
sis on life-cycle relationships, and proba-
bly tighter relationships between retailers
and their customers. Specifically who will
win and lose is much less clear. To win,
the established retailer must shake off old
habits and practices and then visualize
and implement revolutionary ways to sell
building materials. However, if the estab-
lished retailers cannot or refuse to change,
the financial acquirers will be the new
CIRCLE125 ON PRODUCTINFORMATION CARD
dominant force in the industry; forever
changing a century of habits and practices.
Clark Colvin, managing general part-
ner at CSC Capital Partners, Ltd. is anexpert in the restructuring of building
material retailers. He has personally
restructured more than 50 building mate-
rial dealers across the United States, con-
ducting the restructuring often as interim
ceo. CSC Capital Partners is a leading
corporate restructuring, turnaround and
private investment firm in the industry. Visit CSC Capital Partners at www.csc-
capital.com for more information or call
(503) 540-0888.
April 10 – April 13, 2002
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