Can disties go the distance?
- 28 March, 2001 14:32
It would probably be fair to say IT distribution in Australia is currently facing its sternest test ever. However, it's not all doom and gloom. There are still ample opportunities out there and plenty of IT wholesale companies are still making money, but the glory days of booming technology adoption over the last few years has undoubtedly slowed.
Some of the players who were surviving on the low-margin, high-volume business model sustainable only in the days of high demand and market expansion are now feeling the pressure as that environment deteriorates.
Not only are the root technologies of the industry being currently commoditised, bringing the associated margin erosion, major external economic factors are also influencing the market.
The Australian dollar may be rapidly declining against IT's currency benchmark, the US dollar, making new technology more expensive, but the need for technology remains. Furthermore, the necessity for vendors to engage distribution partners to reach end users has not diminished.
Opportunity still knocks
Despite the general pall hovering over the industry at the moment, optimism is still abundant and there appears to be no shortage of new players willing to step up to the plate and have a swing at this technology wholesaling caper.
The proof is in the numbers. Channel research organisation Inform reported that it now has 41 more distributors on its database than it did nine months ago. In July last year the figure stood at 423 channel organisations that classified themselves as distributors. As of March 2001, that figure is now 464.
According to David Hancock, Inform's managing director, there have been 33 players drop off the list and 74 new ones added during this period. He said not all are necessarily new distributors - just new to Inform's database - but he did confirm that there still appeared to be plenty of organisations willing to pad up despite the tough times.
Andy Hilton, managing director of storage and memory distribution specialist Simms International, has reasonably optimistic forecasts and says there are still opportunities for resellers. He sees 2001 as being a critical period for many players and envisages further casualties and mergers, but not a full-scale meltdown.
"You can still make money in any type of distribution you choose, you just have to get the processes and methodologies of the business model right," Hilton said. "It is somewhat a case of the survival of the fittest . . . I think the strong will see it through."
Tech Pacific's Asia Pacific managing director, David Cullen, is of the same opinion. Although describing the current downturn as being the worst he has seen over five years in the industry, he also identifies it as simply being part of "natural business cycles".
"It amazes me that people are so surprised," he said. "It is part of a much broader economic pattern and strong sustainable businesses have mechanisms to manage the hard times."
Cullen believes the market peaked following Y2K and GST stimulants in September when the Olympics were held, and now there is a slump in demand. Currently there is not a lot of confidence in the market about economic forecasts and after the recent burst of upgrades.
You only have to read newspapers to see there is a negative economic outlook which instills a lack of confidence amongst general consumers and corporates who become nervous about their own situations and stop spending money.
"Retail numbers are down. [Retail] was the most buoyant during the growth peak but I think it is probably the hardest hit at the moment. I haven't seen it this hard in my time in the industry."
However, all is not lost. Cullen believes there is a turning point in economic cycles where a slowdown engenders uptake of technology-enhanced automation out of cost-shedding necessity and the need for competitive advantage. This is a drought-breaking demand spike everyone is now waiting for.
"We are not seeing that yet, but we are optimistic it will be the case," Cullen said. "There was a lot of capital expenditure in the last 18 months so the upgrade cycle has been disrupted."
To services or not to services
Inform's Hancock says that while there has been a pattern of consolidation and focusing on niches in distribution channels, there has also been an earnest attempt to swing towards services-based revenues.
"You are seeing traditional disties redefining their business strategies to deliver services," he said. "The days of simply warehousing products are gone. Five years ago this model worked, but now all but the largest companies are threatened if they rely too heavily on box-shifting as a core competency."
While Tech Pac's Cullen agrees service-based revenues are fine to pursue, he is adamant that only the right type of services should be sought. According to Cullen, many channel players are falling into the trap of delivering services where the cost of dispensing them outweighs the returns.
"There is a lot of over-servicing in the industry and I am not sure it is sustainable," he said. "There is this desperate push by a lot of distributors to provide services but the customers are not prepared to pay for it. Distributors have to reassess the type of services they are offering."
He cited rebate schemes, configuration services and freight concessions as being particular offenders as extraneous services that many operators provide at a loss.
Cullen and Ingram Micro managing director Steve Rust agree that selling on price with low margins can still work but only with critical mass.
The business models Cullen sees working are ones that are broad-based with very low-cost ratios, or those which target a specific niche and include high margins and value-added services revenues. Of these, the survivors will be the ones that can "best manage the costs of doing business", Cullen said.
"Pure broad-based distribution can survive so long as there is critical mass and low costs," he added. "The model won't work for smaller players. Unless there is good margin in smaller operations there is no ability to reinvest in the business and that is crucial to long-term viability."
Rust said the current situation is nothing new to IT or business of any sort. "We have seen this all before," he said. "It is part of a cycle. Overly optimistic manufacturers have created an oversupply situation because they overestimated demand."
Rust added there is now a slowing of spending because of consumer nervousness about the state of the economy, and this is filtering through the industry.
"I remember in the early 1990s there was a similar major downturn and IT bounced back very quickly," Rust said. "IT is now such a critical success factor in the function of any company, and because it delivers the ability to cut costs out of doing business, it will be looked at more as a solution to a problem than an unnecessary expense."
He added that there has to be an element of "deep pockets" and "weathering the storm" in the low-margin, high-volume model. Ingram Micro is currently focusing on minimising costs and maximising channel reach. Rust speculates the current low margins have to drive some box-shifting companies out of business and believes the current patterns of consolidation amongst existing players will continue.
In the immediate future Rust foresees some of the badly-performing companies slipping off the map, while some of the good companies will be acquired for their revenues and customers.
It's a bit of a cliché these days, but Rust says there is a lot of truth in the often-uttered statement that distribution channels need to get big, get niche or get out.
"It is still a valid business model to operate on small margins, but you do have to be big," Rust said. "The other model that appears to be working at the moment is specialisation in parts of the market where there are many value-adding opportunities.
"Any distributor which doesn't fall into the category of either specialisation or scale is going to find it difficult to survive.
"Critical mass disties will be able to ride out the storm because their long-term business models allow for this type of cycle," Rust said. "As some of those who are playing the [scale] game drop out, the disenfranchised customers will go elsewhere, which compensates the survivors.
"In theory, the survivors of a shake-out will be stronger, leaner and meaner as well as being much more customer focused."
Rust said Ingram Micro's reseller surveys are showing the channel fundamentally wants to purchase product that is immediately available and priced competitively.
"Secondary to these cores, they want to deal with companies that make it easier for them to do business," Rust added. "They want services that help them take costs out of the way they do their business and they want to be helped out with their image amongst potential customers.
"Unless a distributor is able to supply these sorts of services and support, they will find it difficult to survive."
Contrary to popular opinion, two areas of the IT market which appear to be in a better position than others to weather the storm include storage and portable devices.
Felix Wong, managing director of specialist distributor Advanced Portable Technologies (APT), also subscribes to the theory that there is still opportunity for all sorts of distributors despite hard times, providing they can get the model right.
"Distributors have to ask themselves what their value-add proposition is and how they differentiate themselves in the market place," Wong said. "The challenge is then to get the right balance between what price the market will bear and how much added value you can throw in for free.
"In tougher times, such as now, the real trick is adding value without increasing your costs," Wong said.
Simms' Hilton agrees that there is a right way and a wrong way to deal with the industry's downturns. His company has hedged against its core dependence on memory products by building up a storage solutions portfolio. The company's skills in a highly complicated and high-value section of the market have allowed it to continue to grow as memory prices and profitability plummeted in recent times.
"If you don't read the market right you can end up in very dangerous territory," Hilton said. "It comes down to management. It's like setting your sails into a storm. There is a way to do it and survive, but if you get it wrong it could be all over very quickly."
Exchange rate woes
Wong was also quick to point out that perhaps the single biggest negative impact on distribution channels currently is the diminished value of the Australian dollar.
In an industry that recognises the US dollar as its default currency, watching the Australian dollar plunge to all-time lows, and below the psychologically significant 50-cent mark, has added an extra degree of volatility to the market.
"It complicates the whole distribution game, adding another factor into the equation," APT's Wong said. "Three years ago, I never had to worry about the exchange rate when conducting business.
"Even if you are operating on margins of about 10 per cent - and that is often very optimistic - a fall in the exchange rate can have a dramatic affect on pricing and profitability."
"There are way too many mid-range distributors focusing on desktop technologies."
Worse before better
The majority of distributors ARN spoke to agreed that things will get worse before they get better, and that there is more consolidation around the corner.
"I wouldn't want to be starting from scratch at the moment," Simms' Hilton said. "I think pretty well all angles of distribution are covered in Australia at the moment. If you are not already in the niche you want to be in right now, it could be too late."
Inform's Hancock also feels the channel has not yet hit the bottom of the downturn and expects some distributors will take drastic action if some sanity doesn't return soon.
"Distributors are in a particularly precarious position," he said. "Vendors already have relationships with the end users and so do the resellers. Distributors are in the middle and run the risk of being eliminated from the equation.
"It is all very well for distributors to be loyal to their channels, but if it comes down to survival - and in some instances I would suggest it does - I think [distributors] will have to compete with their channels on service. They have to stay afloat as well, even if that does mean upsetting their partners."
Mark Roberts, CEO of newcomer Server Bits (a recently launched subsidiary of the Queensland-based Coretech), agreed it is a not ideal conditions at present but said he has managed to grow the business "almost on a day-by-day basis".
Server Bits imports and distributes server components and white-box servers catering to the local integrator market. Roberts said starting a business in tough times is a good test of the business model.
"Many companies became fat and lazy in the good times and some are now finding it very difficult to reel in their costs and carry out a proactive sales model," according to Roberts. "When starting out in such an environment you have to manage costs and outstanding debts very closely - factors which are fundamental to business success."
"I think distributors catering to desktop markets are going to struggle - there has to be further consolidation - there are way too many mid-range distributors focusing on desktop technologies.
"I would say many more will go," he said.
Roberts concedes that when companies like Cisco and Intel start laying off large numbers of staff, there are obviously some speed bumps ahead. Nevertheless, he remains upbeat.
"I would agree it is a tough market, but in some areas more than others," Roberts said. "I think servers are still going well, driven by [the affordability of] new technology and software.
"My business is growing but our initial forecast of 40 per cent growth has changed to 15 per cent. The good thing for server technologies is that when end users face hard times, they spend more on hardware that offers efficiency and cost-effective benefits.
"[In distribution] getting big is not the answer. Some of the bigger guys tried and failed in a sometimes spectacular manner. The answer is simple in distribution. Fulfilling your promises to the dealer channel is going more than half way to keeping them onside."
Renato Catalan, sales and marketing manager components distributor Achieva, also reports revenue growth in a tough market, but concedes it has slowed over the last two quarters. He claims the two secrets to sustaining Achieva's place in the component market are achieving critical mass and building a quality channel.
"Survival is based on who has the strongest channel as opposed to the strongest vendors," Catalan said. "We feel that the market for white-box components is stagnant, but our reseller channel is strengthening.
Catalan also sees the best long-term opportunities for distributors in focusing on either volume or value-adding based business models. "Achieva is leaning towards volume," he said. "We are moving to create services, but we still move a lot of boxes.
"We keep margins up as high as possible by distributing brands whose demand is not controlled by price. Other companies have many products, but we focus on a few strategic partners.
"It is all about how effectively distributors reach their channels. That is what the quality vendors are looking for and what we are aiming at."
Still the one
Tech Pac's Cullen firmly believes that, despite the tough climate, resellers should not sell themselves short.
"Distributors should never undervalue the service they provide to vendors and ensure they are getting the margins that are warranted," he said. "Vendors have to get their products to market and they don't have the resources or customer intimacy that is required.
"A healthy channel is still the best way for them to do that. Currently there is not enough margin on a lot of products. It is my expectation that vendors will have to increase margins."
APT's Wong also feels the channel is crucial to vendors' go-to-market strategies.
"Some of the very big guys are showing a tendency to want to go direct and they may be able to pull it off," Wong said. "But if you look at IT as a whole, vendors are going to continue needing channels to get their products to market.
"In some cases, vendors that are wanting to sustain growth or enter the Australian market are going to have to build much closer ties to their channel partners or risk being left out. Channel companies are still the preferred technology providers of most end users."