No matter how executives of the national companies spin their quarterly results, their companies are the "big dogs" on the porch, driving the market up and down. The independent operators are not trying to weave golden parachutes because each day independents are operating with "no nets." So, the profit equation is more important than some manufactured quotient that divides market share by the square root of market potential with a factor of the company's EBITDA. For independent operators, the only number that matters to them is the bottom line and whether it is red or black.
One of the national companies wrote about giving up market share to earn a margin of 20.9%, and based on its own bottom line losses, it is 8.4 points short of profitability. I understand these are crude calculations, but a 20.9% margin in Florida will accomplish one thing for someone in our industry: bankruptcy. The cost of doing business is too high in Florida for anyone to make any money at a gross margin of 20.9%. Another major company came out with its report, and if you take its previous public comments on current sales and their reported losses for this year, it would have to improve its gross margin in excess of 23%.
In both cases, these companies have been keenly aggressive in trying to garner market share at any cost. But at some point, their investors will demand a return. Say tomorrow both of these large corporations are pressured by their investors to make reasonable returns. Each of them will be forced to make significant increases in their gross margin--raise prices. Their market share will tumble because an overall low price strategy does not work, as it creates no loyalty or pull through buying habits. Every time a leading national company bottoms a market price, it is achieving nothing but its own demise.
Many look at the strategies of the big boxes in the retail building supply industry and try to link similarities to the professional supply industry, but other than selling some like merchandise that's where it ends. At the big boxes, managers have thousands of products they sell daily in which they are not matching prices or being shopped. They have a product mix that allows them to build margin, and there is a real factor principle that works. In addition, a great location, easy access, and actual in-store service levels can create habit forming customers who automatically buy from a location because of convenience. Those conditions do not exist in the professional supply industry.
The root cause why so many national supply companies have failed in the past three decades is that they are not patient and their executives do not operate their companies for the long term. Too many times, a national company will come into a new market and try to bury the price so it can immediately get market share. Then it will try to find the best salespeople in the market to pimp them out to the company's side. These quick-fix solutions cost thousands of dollars, but do not lead to long-term stability.
When entering the market, national companies should establish their brands, create their service niches, and begin the slow, methodical process of winning customers by the strength of their organization. They should attract salespeople by character and benefits of their organization and not with the dollars they are willing to throw around. Bribing and coercing salespeople to join your team will only work as long as the agreement is in force. After that, your "superstar salesperson" will find a new partner to dance with.
The current economic downturn has been brutal to everyone in the professional supply industry and it's exposing the weaknesses of many strategies for all companies. The low margin strategy to build market share is a disastrous strategy, which exposes survival vulnerability that should have long been addressed by investors. Any investor in the professional supply industry who believes a company can sustain market share when it abandons a low -margin strategy should call Bernie Madoff for investment advice. Bought market share is good as long as the price is right.
If you want to see how strong an organization in this industry really is, look at its gross margin. Those who can achieve positive cash flow with a higher gross margin understand that bills are paid with gross margin dollars from profitable sales. The success of every supplier in this industry is contingent on stopping the buyer from dictating price. This can only be accomplished if the "big dogs in the marketplace begin using a profit equation with a profitable margin.
Don Magruder is the Vice President of Ro-Mac Lumber &Supply in Central Florida, and is also a former chairman of the Florida Building Material Association. This article originally appeared in FBMA's Dec. 17 newsletter.