Distrifacturing, manusaling and distservfee

The new X-Men in industrial channels

by Scott Benfield

In this summer of the comic-strip-turned-movie (X-Men 2, The Hulk and The Matrix Reloaded), the psyche is bombarded with mutants who, largely through technological, process or relationship change, have special powers that let them thrive where others struggle.

Industrial channels are undergoing their own form of technological or knowledge-based change. The new mutants are distributors turned manufacturers (distrifacturing), manufacturers turned wholesalers (manusaling), and distributors that charge fees for services (distservfee).

Here are some common examples of the channel mutants, where they emerge, their unique abilities, and their chances of survival.

Reader beware: the mutants are growing rapidly, and their pursuit of profit does not assure that they are interested in living peaceably in the world of ordinary citizens of the industrial channel.

The impetus for channel changes
The recent history of industrial manufacturing is fraught with stories of manufacturers moving overseas (China, Eastern Europe, Pacific Rim, India) in search of a lower labor rate. Foreign direct investment is off the map in China, which until the SARS outbreak, had a gross domestic product (GDP) growth of 8 percent or more per year. 

Hundreds, if not thousands, of manufacturers closed plants in North America for the low labor rates available in other parts of the world. The net result is a depressed domestic manufacturing sector with severe unemployment and fallout in any number of associated businesses.

The globalization of mature manufacturing and the stresses on businesses dependent on domestic manufacturing are creating new and unique business models. These models are largely in their infancy but, since the manufacturing exodus shows no signs of stopping, the new models (mutants) are likely to prosper at the expense of traditional businesses.

Each of the three classes of channel mutants, however, has unique structures and knowledge needs. Each must undergo drastic changes to reach their new status.

Distrifacturing and distrifacturers
About three years ago, Benfield Consulting was called in to review a plan by an independent (non-competing) group of distributors. The plan called for the distributors to open a large central warehouse for foreign-made goods.

The distributors, assailed by cost pressure from a shrinking client base and foreign competition, were tired of paying high prices for domestically manufactured goods. Their answer was to develop a series of joint ventures with manufacturers in mainland China. The distributors would establish contact, test the product designs, sign agreements and bring the goods in at prices substantially less than those for domestic products.

Today, the warehouse has grown substantially. Through less costly products, the distributors increased their ability to compete and enhanced their margins. The idea worked so well that it is the envy of the industry and new members are knocking down the doors to get in on a good thing.

This mutation is called "distrifacturing" and the participants "distrifacturers." In short, distributors are bypassing traditional North American manufacturing, taking mature product designs to foreign shores and setting up any number of manufacturing arrangements.

Distrifacturing is not for everyone, but it can be successful with the following caveats:
• Trust is established with reliable foreign manufacturers.
• Agreements are carefully scrutinized for protection against having the joint-venture firms sell to competing distributors.
• The legalities of selling knock-off products are carefully explored.
• Group members have a written understanding of the shared costs and risks of the venture.

Distrifacturing is an extreme example for sourcing lower-cost goods. Most distributors are content to purchase from global master distributors. In certain situations, however, the direct involvement in manufacturing is appropriate. 

For one mature product, five domestic manufacturers had similar pricing structures. After the distributor group outsourced their product, two of the manufacturers went out of business and a third is reportedly on the ropes.

The losers in distrifacturing are manufacturers that have not cannibalized existing products or lowered their manufacturing costs. They also tend to be out of touch on the value of their brand to their distribution. If, as a manufacturer, you haven’t recently challenged the competitive position of your products, don’t be surprised if a distrifacturer replaces you on the shelf.

Manusaling and manusalers
Domestic manufacturers that move offshore are often bombarded with choices of manufacturing or outsourcing. Many are surprised by the technical ability and up-to-date equipment of foreign manufacturing firms.

While many manufacturers are content to wholly own or own a majority of their manufacturing, many more license their technology. This option is tricky, however, because many countries don’t protect patents and intellectual capital. We recommend thoroughly researching licensing on foreign shores.

Many manufacturers are beginning to realize they don’t need to own the fixed assets of plant, property and equipment to make a fair return. Instead, through licensed manufacturing or simply sourcing products, they can add significant value to the channel.

In a recent show of hands in a product manager seminar composed of Fortune 1000 companies, more than 70 percent of the participants admitted to sourcing products that they did not manufacture or for which their companies did not own proprietary product designs. They also confessed to increasing this source of income significantly over the past several years.

In the not-too-distant past, many manufacturers shunned NIH (not invented here) products and invested little time in ancillary parts and piece aftermarkets. With the explosion of global manufacturing, many traditional manufacturers are finding significant profits in providing a wholesale function by sourcing and bundling products with similar applications.

We’ve dubbed this mutant "manusalers" and the mode of business "manusaling." Manusaling exists because of the cost advantages of foreign manufacturing and the ability to lower channel costs by bundling more SKUs and smoothing transaction costs over larger orders.

It is doubtful that manusalers will replace the traditional roles of merchant wholesaler or buy/sell intermediaries. Instead, it is more common to find manusalers using their knowledge of the industry and foreign contacts to source unique items that augment their existing product line and fit within their existing distribution channels.

Manusaling will probably not replace the core business of creating new products that increase productivity. It will, however, become a more common practice, and many manufacturers will look to do more with ancillary products where they can add value.

Manusaling is a quite different business from manufacturing and lest a reader become too excited over the future cash streams, we caution manufacturers to check their ranks for the knowledge and processes that prove successful to be a top notch manusaler.

Product development in manusaling is more of a purchasing function. The product manager should establish a market need for the product, but the actual development resembles a purchasing relationship.

Pricing is quite different from traditional product pricing. In proprietary manufactured products, pricing is predicated on break-even volume using unit contribution. In manusaling, pricing will need to be accompanied by an analysis of activity costs specific to the product line/customer. 

The pricing goal is to maximize margin above and beyond activity costs. We caution manufacturers that have existing, proprietary, product-driven activity cost systems. Most manufacturing activity cost systems use characteristics unique to the product for activity drivers. In manusaling, activity drivers are lines, invoices, types of transactions, etc. Just because, as a manufacturer, you have an existing activity costing system, doesn’t mean it is appropriate for manusaling.

There are many winners in manusaling. Manufacturers win by additional revenues without being tied down to fixed cost burdens. Traditional wholesalers win by having more products to fill out an order. The largest potential losers are manufacturers that take their products for granted and insist on proprietary manufacturing or have an NIH mentality. There are numerous sources for most mature industrial products. Don’t be surprised if you find a new competitor that doesn’t manufacture but simply sources a competitive  product and lowers channel costs for competitive advantage.

Distservfee and fee-basing services
Much has been written about fee-basing services and the need to unbundle and reform the service bundle. Much of this writing, thought and experimentation focused on industrial distributors, whose primary customer base is under tremendous cost pressure. Too many distributors don’t match their services with customer requirements and give the associated price breaks for different service bundles.

Too many distributors are trying to justify their full-service and full-cost bundles without properly exploring whether or not their customers want all of the services and associated costs. 

These are the same distributors who say, I can’t get my customers to pay me for my current services, much less add more. Some distributors just don’t get it, and we implore you not to fall into this trap. Simply put, if you are over-servicing, then reform service bundles, delete non-value added services and lower the price.

Industrial manufacturing customers will require that you streamline, outsource and unbundle services to stay competitive. Some services are required to compete while others can be deleted or developed for fees. In our seminars on fee-based services, we teach a list of close to two-dozen service categories.

For the few distributors that offer fee-based services, there are several consensus commentaries:
• Services are profitable and deliver 30 percent or more profit than the typical product sale.
• Services require different sales skills and traditional product sellers don’t do well in fee-based roles.
• Services require a documented development process to maximize success.

Distservfee wholesalers will become more common in times ahead. Some distributors will specialize in low-cost service offerings (transactional) while others will become much more conscious of service costs and experiment with varying price/service bundles to maximize account sales.

Final thoughts
Channel mutants of distrifacturing, manusaling and distservfee will become increasingly common. The cost pressures of low-wage countries, flexibility offered by the global economy and aided by Internet technology and e-commerce will ensure new models of business.

Those who explore these mutant opportunities post haste will be the “firstest” and get the “mostest.” Those who don’t will likely suffer the depressed margins they have experienced of the past three years.

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