Core CompetenciesThe architectural paint business is different from other sectors of the coatings industry. No matter what distribution channels you use, and how they might change under the influence of the Internet, architectural paint demands the following four common core competencies.
- Price/performance optimization of formulations
- Excellent logistics giving high product availability
- An understanding of consumer marketing
- Cost control
The emphasis on these competencies varies from channel to channel, and each channel has its special requirements, but these four competencies are always essential.
It can be argued that the fundamental difference between architectural and industrial coatings is the role of technology. In industrial applications, the technical performance of the product is often the key competitive differentiator. Many OEMs find that only one coating company can formulate a product that gives acceptable application properties on their paint line, combined with the appearance and performance they require. This means that an industrial paint company can build niche businesses based on technology. These niches have excellent margins. Three examples of this type of business are automotive cationic e-coat, steam- and solvent-resistant coatings for dry cleaners’ coat hangers, and heavy-duty coatings for compressed gas cylinders.
In the architectural segment, this type of technical differentiation seems nearly impossible. Raw material suppliers will provide formulations with the performance, appearance and application properties that the market requires. The role of R&D is to reduce product cost by cutting back on properties that are not required for a particular application. A good example of this type of R&D effort is eliminating spatter resistance from formulations that will be sprayed in new tract housing. This allows considerable cost reduction by eliminating an unnecessary application characteristic without affecting the appearance and performance of the dry film.
Since the facts about the product are not a major differentiating factor in architectural paint, the coatings company must compete on service, customer perception of the product, and price. That is what drives the requirements for the other three core competencies. Excellent logistics are necessary to provide the product availability that allows one to compete on service. Marketing to the consumer and the applicator is necessary to stimulate demand, differentiate the company’s brands, and support margins. Cost control is essential in every part of the supply chain to enable the paintmaker to make profits while competing on price. Even Benjamin Moore, with its superb brand name and excellent pricing, has found it necessary to close plants and cut cost out of its supply chain.
Requirements of Each Distribution Channel - Company-Owned StoresWith stores, the major requirement is the ability to operate a retail network. This has multiple implications. First, there is the strategic requirement to locate stores in the right places in the right cities. The paint company must understand the demographic factors that drive store sales, and the type of location favored by the subsegments of the contractor market that they will target. Location decisions are vital because they make or break profitability, and cannot be changed until leases expire. Once the stores are in place, they must be operated effectively. That means sales effort, service, professional products and pricing that will bring the contractors in. In retail, it is certainly not true that if you build it they will come. The right contractors (the ones who pay their bills) have to be wooed.
Running stores intensifies the pressure to control working capital. The paint company using this channel owns all the inventory in the supply chain. In addition, contractors are notoriously slow to pay. Depending on store size and operating ability, inventory and receivables can run anywhere between $90,000 and $200,000 per location. In fact, one of our clients is finding that their growth is restricted by the working capital needed to expand their stores network.
Independent DealersSelling through dealers imposes a different set of requirements. First, you must be able to identify the strong dealers who will grow, or at least stay in business. Second, you must be able to get your product on their shelves. We expect that two types of dealers will survive the next 10 years. The first type is the well-operated, well-financed, contractor-focused, independently owned specialty paint store. The second group is the dealers in towns, with stable or growing populations, that are still too small to attract additional competitors. Although their volume is low, prices to these customers can be kept high. The desirable customers can only be identified by knowing the local market, visiting their premises, and by doing research through references such as Dun & Bradstreet, the Better Business Bureau, and perhaps the local Chamber of Commerce.
A crucial problem with dealer business is getting the product placed. There are virtually no new dealer stores opening, and established outlets are usually unwilling to change brands. In a market survey for a Canadian client, we found that dealers in their target market had been buying from their current paint suppliers for an average of 26 years. There is not enough natural turnover to allow growth; shelf space must be taken from competitors using one of two approaches.
One approach is to have a brand or promotional activity that will increase the dealer’s sales. To use this method, you must have superior marketing. Even with a superior brand, it will be necessary to buy out the dealer’s current inventory. Clearly, this is only economically viable if you keep the account for many years.
The other approach is to take a second brand position. As a second brand, your product must offer the retailer a benefit that the main brand does not provide. The most common benefit is lower wholesale price. This allows the dealer to increase gross margin, or to sell the second brand at lower prices in direct competition with the big boxes.
The risks inherent in buying business in the dealer channel is only one example of the tendency for selling and administrative costs to run out of control in this channel. Indeed, the two leaders in the dealer channel, Benjamin Moore and PPG, have higher SG&A per gallon than leading companies with their own stores. This tendency is confirmed by our studies of clients operating in both stores and dealer channels. Our work with clients strongly indicates that, if done correctly, it can be cheaper to sell through your own stores than to a dealer. The winners in the dealer channel have the ability to control selling costs. They direct sales effort to the right accounts, set appropriate freight policies, get good mileage from every promotional or advertising dollar, and above all avoid weak customers and the associated failure costs.
Mass MerchandisersThe mass merchant channel demands particular competence in four areas. The first is identifying strong customers. Despite the growth of the channel, many of the big boxes are suffering. In this channel, the coatings company can only grow if its customers are growing. In addition, supplying a failed home center will result in large write-offs, which will be very difficult to absorb given the low margins on this business. The only way to identify these strong customers is quantitative analysis of trends in their financials, backed up by first hand observation of traffic, merchandising and inventory turns, in their stores.
The second, and possibly the most difficult, task in dealing with big boxes is getting shelf space. Dealers make this difficult by being conservative. The big boxes do it by being selective and exorbitant. They recognize the value of access to the customer flow that their locations produce, and the power this gives them. They also need products, or marketing expenditures, that allow them to maintain their sales per foot of retail space. As a result, the paint company can only get shelf space if it has a strong national brand or if it provides substantial co-operative advertising money. Both these factors lie behind Home Depot’s decision to replace Williams Holdings and Duron with Glidden. The contract PPG signed with Mongomery Ward in the 1980s also illustrates this point. PPG committed to supply the Pittsburgh brand, and also to provide advertising support that worked out at more than 50% of first year sales.
The mass merchants also make heavy demands on the supply chain. Clearly, at the prices big boxes pay, successful suppliers must have exceedingly low costs. Secondly, the mass merchants require excellent delivery performance, which they enforce by fines. Providing this level of service is exceptionally difficult as the mass merchants have exceeding erratic demand patterns. These erratic demands are driven by their internal inventory management systems and by promotions. Thus, excellent planning and a flexible low-cost supply chain are among the core competencies suppliers to the mass merchants must have.
Table 1 provides a summary of the characteristics, risks and crucial success factors for each distribution channel.
Steps in Determining a Distribution StrategyWhen developing and implementing a distribution channel strategy, we recommend a six-step process, based on our years of assisting architectural coatings clients in this area.
1. To start, form a channel of distribution strategy team. This team approach is essential. Using a knowledgeable and experienced outside consultant can contribute an objective viewpoint, creative thinking, a strategic process, and industry knowledge, but the client is the expert on the company, its capabilities, and customers. A team approach generates a better strategy and greater commitment for implementation.
2. The first task of the team is to understand your target markets and how your company is positioned in those markets. The data needed is listed below.
Sales, growth rates and market share broken down by the following.
End customer — DIY, small contractor, medium contractor or national contractor
Pricing, gross margin and actual profitability by channel
Sales, growth and profitability by outlet or customer
Market shares and growth rates of key competitors
Customer satisfaction levels derived from the unfiltered voice of the customer
- The key growth drivers for each channel and region, e.g., population growth and aging, penetration by home centers
Specific risks inherent in the business, e.g., a particular customer in financial difficulties or some 10 year leases on stores with shrinking sales
3. The next step is to assess your company’s core competencies. The only way to do that is to measure your own performance in the key competencies against solid benchmarks. Figure 1 shows how a client’s stores network compared with national benchmarks.
The figure shows that the client had lower SG&A costs than benchmark, a clear source of strength. In three other core competencies, sales, growth and receivables, performance was close to benchmark. However, there were two clear weaknesses.
Inventory control is a relatively minor issue, but gross margins, at roughly 71% of benchmark, were clearly impacting profitability.
Poor gross margin was a complex issue. We were able to measure the contributions from formulation, manufacturing cost, pricing and purchasing. The main factor was formulation. The paint company needed to develop cost/performance optimized formulations for the middle and lower price point contractor products.
4. When you have the facts about the market opportunities and your own strengths, you can then analyze the available alternatives and pick the strategy that maximizes the reward:risk ratio. The following two main tools can be used for this analysis.
The opportunity evaluation (OE) sheet to assess individual ideas, and
The SWOT (Strengths-Weaknesses-Opportunities-Threats) chart for overall assessment.
To measure the potential of a particular strategy, for example, developing a dealer network in outlying towns or establishing stores in a particular metropolitan market, an OE sheet should be developed for every major customer or potential location included in the strategy. OE sheets are too complex to explain in a general article. They show the projected sales and profit figures for each opportunity, assess investment requirements and risks, and project the financial impact. Figure 2 is a simplified OE sheet for a hypothetical store. An OE sheet for a real store is based on factual cost and market data determined from historical performance, market studies, demographic analysis, and discussions with commercial real estate agents. It would also contain a detailed action plan for capitalizing on the opportunity.
Summarizing the opportunity sheets allows us to calculate the total impact of the strategy on the business, the risks involved, the investment and the resources required.
SWOT charts are well understood, so we will not discuss them further. They are an excellent way of assessing the fit between core competencies and the requirements for the successful execution of a strategic plan. E-commerce is clearly an opportunity and threat that should be evaluated on any company’s SWOT chart.
5. The next step is to present the distribution strategy to the senior management team for discussion, modification and ratification. The objectives of this step are to get formal agreement on a distribution channel strategy, and commitment to all the implementation actions.
6. The final stage of the process is implementation. The necessary actions will already be specified on the OE sheets. They will include such activities as the following.
Final selection of store locations
Manufacturing, inventory and physical distribution planning
Recruitment of stores, technical or sales personnel
Making the sales calls on the targeted accounts
Cost performance optimization of the formulations for the products they need
Closing the sales, delivering the product and banking the profits
ConclusionChoice of the right channel strategy involves multiple factors including volume, growth rate, gross profits, the risks inherent in each channel, an objective measurement of the company’s core competencies, and some reasoned consideration of the impact of the Internet. The complexity and interaction of these factors explain why there is no simple “one size fits all” distribution channel strategy. Every company needs to assess its own position and determine the unique strategy that suits it best.
There are few questions that are more important. The right choice of distribution channels gives access to growing segments of the market at profitable prices. It almost guarantees profitable growth for the decade to come. The excellent results Sherwin-Williams, Benjamin Moore and Valspar have achieved are a matter of public record. To an extent, those results have been achieved by pursuing definite distribution strategies and developing the necessary core competencies.
The wrong choice can saddle a paint manufacturer with falling sales, failing customers, lost contracts, excess inventories, liabilities for leases on closed outlets and a host of other costs.
These two articles have examined the structure of the architectural paint market, recent trends, risk factors and the core competencies required to supply the three main channels successfully. We have also outlined the process we recommend for developing the optimum channel strategy for your company.
For more information on distribution channel strategies, contact Orr & Boss, 44450 Pinetree Dr., Suite 103, Plymouth, MI 48170-3869; phone 734/453.3033; fax 734/453.4320.