Our world is experiencing some strange happenings. People and products are inexplicably in short supply. My favorite restaurant once served food until 11 p.m. and now shuts down at 9 p.m. The Kwik Shop down the road from my office never closed, even on holidays, but now shuts down well before midnight. They blame it on a worker shortage.
Lurking around the same convenience store early one morning waiting for my coffee fix, I overheard the assistant manager blaming the lack of my “breakfast of champions”—beef jerky—on supply chain issues. Suddenly, the term “supply chain” is everywhere and distributors are getting a double shot of its extra strong and fully caffeinated issues.
These very same issues and several more are hitting the world of distribution and are creating some unanticipated turbulence. Understanding the situation better can prepare us for the future. So, refresh your coffee, sit back and join me as we explore new issues that promise to make life interesting over the next year.
Supply Chain Crunch
Unless you happen to be one of the three people on the planet who has yet to experience the supply chain pain, this should come as no surprise to you—almost everything is in short supply. A few thought the supply issues would be centered around electronic components—semi-conductors come from Asia where the pandemic created the greatest impact. However, our research indicates even simple products, such as molded plastic parts, have become scarce. The same is true with motors, various types of fuses, lighting and even my personal favorite, the beef jerky mentioned above.
Several distributors reported they are spending copious amounts of time expediting orders and scouring their networks for critical customer parts. In the automation space, many distributors have increased their position in the market by finding “workaround” products; things like external communications modules that allow a stripped-down product to do the job of a feature-rich product with impossible lead times. Some have stated the ability to do this type of “engineering value-add” has opened the doors of customers served by traditional “parts-only” distributors.
Despite Delivery Issues, Inventories are Rising
Distributor backlogs are now at record levels. We have yet to find a distributor who is not experiencing this. With this thought in mind, one would assume wholesalers would be pushing their inventory levels to record low levels. Our research indicates a different scenario.
Inventory levels are now trending higher. The average distributor in our survey pool reports inventory at 40-45% greater than the pre-COVID levels. Some have purposefully adjusted their inventories up as a tool for better supporting important customers. We spoke to a half dozen distributors who have purposefully increased their stock to double and one who has tripled inventory levels.
Some distributors are attempting to predict future shortages by “grabbing” any available and commonly sold items. Others are being more scientific about the situation by asking customers to predict usage levels and placing orders today for products to meet the customers’ needs over the next 6-12 months.
Orders for non-returnable products are turning into an issue. In these cases, the customer either decides to cancel the project because the necessary components cannot be delivered in a reasonable time or find a viable workaround from another source. We have identified more than $150,000 worth of products with an unlikely chance of future sales finding their way into the distributor inventory. Unless care is taken, this is a loss for the distributor. We recommend establishing a new set of terms and conditions for the sale of non-returnable products.
Price-in-effect orders can damage the gross margin if not properly handled. In this situation, the manufacturer does not guarantee a price to the distributor on the day of the order. Instead, the cost of goods shipped to the distributor is based on the price of the product when it leaves their facility.
A Tsunami of Price Increases
After decades of annual price increases for non-commodity products, we are seeing price bumps coming multiple times a year. Most of the distributors surveyed indicated their suppliers have increased prices twice during the past 12 months with an average cumulative percentage of 9.6%.
Closing the loop with manufacturers in the electrical, automation and fluid power industries ties these increases directly to the cost of acquiring raw materials or freight costs from offshore facilities. One commented the cost of bringing in a container from Asia rose dramatically from $6,000 to $24,000 since 2019. This increase must be factored into the overall cost to distributors.
One manufacturer in the electronic space told us they had never had a price hike in nearly two decades of business, instead, counting on declines in design costs which were once the norm in the electronics industry.
The good news tied to these price increases is this: Most customers are accepting just about any price increase below 5%. What’s more, this allows the distributor to add a bit more margin for the “home team” by adding just a half point to the new margin. As we will see later in this article, we will need all the extra gross margin possible.
Labor Rates Rising: Could this be Inflation?
Our recent (and still ongoing) survey of distributors points to an acceleration of people costs. It appears to be a pan-demic phenomenon. Research indicates the costs of some positions have increased as high as 30% since 2019. Chiefly affecting warehouse, delivery, clerical and customer service departments, the issues associated with this are something our industry has not seen in at least three decades.
If your company relies on people with engineering degrees, expect their cost to increase as well. Alan Carty, CEO of Automationtechies, a recruiting company specializing in automation engineers and technicians, shared his perspective on the engineering market:
“Engineers of all kinds are no longer only needed in traditional industries like manufacturing, systems integration and distribution. The new digital economy has put companies like Google, Amazon, Deloitte and others in the market for engineering and technical talent. These companies have changed the nature of competition for those with these talents. They bring a completely different view of salary structures. We have observed a general increase for technical types of employees.”
Later in our conversation, Alan shared a resource for checking the compensation levels of entry-level people — www.collegegrad.com. We did a quick review of the findings. Here are a few sample points for an entry-level electrical engineer (listed as average entry level) and all the numbers track significantly higher than 2019 numbers:
Davenport, Iowa: $67,400
Buffalo, New York: $70,054
Chicago, Illinois: $88,500
Cleveland, Ohio: $71,800
Denver, Colorado: $80,379
Las Vegas, Nevada: $73,600
Los Angeles, California: $105,400
Based on a review of the numbers of people working in various capacities in the typical distributor, it is fair to say the typical distributor will experience at least a 10% increase in people costs. Our analysis does not include a hike in matching Social Security payments that took place in January 2021, nor do they include likely benefit-related hikes.
Why is this important? Using the latest published numbers for the NAED (Electrical) and AHTD (Automation) PAR reports, we find that people account for about 60% of a distributor’s gross margin. Looking at the NAED PAR for “Best-in-Class” Distributors, we see the number is 57%, but other groups score far lower. AHTD shows a total investment of 67% in a similarly ranked distributor. Unless distributors capitalize on profit-producing activities or find methods to improve productivity, there will be a severe profit squeeze.
What Should a Distributor Do?
Here are some points to consider:
- Review pricing contracts that require you to hold the price for more than 30 days.
- Quickly adjust price levels in your system to reflect price increases from supply partners.
- Ensure orders for specials and non-returnable items are covered in your terms and conditions so you do not end up with unsellable items in stock.
- Revisit your pricing strategy. Items in stock that are hard to get should command a bit of a premium, especially when sold to customers who are not in your top tier.
- Look for ways to increase productivity. This is especially true for the warehouse and inside sales group.
- Better manage your technical resources. Are they being used on the right accounts? Who determines where they are used? For example, an electrical distributor once said, “We have more rules tied to who gets a $40 logoed jacket than we have for which customer can use our $600-a-day specialist.”
Strange Times: A Parting Thought
I titled this article Strange Times because very few have lived through times of such dramatic change. We are told the current inflationary trends are transitory and temporary. However, the labor increases are here to stay and will impact both our suppliers and customers. This, in turn, will cause them to look for ways to become more productive or at least cut labor costs. As the proverbial “middleman,” we have an opportunity to help both sides improve their situation. And, if we succeed, we will be rewarded handsomely.