Distribution in the Age of Amazon
Midsize distribution companies are finding ways to stand out, using high-touch customer service and defensible niches to remain competitive.
Amazon has transformed the shopping experience and redefined expectations for delivery, but its reach extends beyond consumer markets. The e-commerce giant is disrupting the commercial sector, too, transforming product distribution and raising the stakes for smaller companies hoping to hold on to their business relationships.
It’s no small feat, but some middle-market distributors have found ways to thrive despite the threat Amazon poses. To compete, they need high-touch customer service, a hard-to-disrupt niche and the ability to add value to their customers’ businesses. For companies that can do all three, private equity firms are eager to acquire them and help them expand their reach. But that also means remaining a step ahead of Amazon’s growing empire.
“We’ve done a lot more research on Amazon than we would have probably expected to as a middle-market firm,” says Corey Whisner, a partner at Chicago-based Rotunda Capital Partners who has been investing in distribution companies for more than 15 years. “There’s a lot we feel like we need to understand about Amazon’s value proposition for business customers.”
There’s no question the e-commerce giant has cornered the consumer market. Seventy-two percent of U.S. households with annual income above $50,000 use Amazon Prime and 44 percent of online shoppers say they check Amazon before making a purchase, according to a Marist consumer trends poll released in June.
For commercial buyers, Amazon offers industrial parts and the ability to buy in bulk. Customers benefit from its speedy and reliable delivery, made possible by one of the most efficient logistics platforms in the world. Prime users get most items delivered in two days or pay a nominal fee for next-day delivery. But there’s a downside to that hyper-efficiency.
“The No. 1 thing that keeps people away from Amazon is that they can’t pick up the phone and talk to someone for personal support,” says Whisner, who adds that customer service is one of the key value drivers for distribution companies. If customers can call a distributor to discuss their specific service requirements with a person, or if they see that product support is available, they are more likely to choose that distributor over Amazon even if it costs more, he adds.
J.B. Dollison, managing director at Houston-based investment bank Crutchfield Capital, says companies that have built a strong inside sales force can capitalize on the demand for personalized support. By establishing relationships with buyers over time, members of the sales team make personal connections that aren’t possible for Amazon.
“If a salesperson knows their customer’s business needs, they can make suggestions about parts or services. Buyers respond if they feel like a distributor is adding value,” Dollison says. “If a customer is spending on specialty parts and there’s a problem, they want to speak to someone knowledgeable for a resolution. They don’t want to play trial and error by returning parts and trying to pick products blindly.”
“What we’ve seen over the past five to 10 years is that distributors are putting more resources behind improving their technology, improving the speed of delivery, because customers are used to two-day shipping now.”
President, Gemini Investors
Beyond offering superior customer service, operating within a specialty niche can make a distribution company stand out and help insulate it from competition. “We’re looking for companies that aren’t technology-dependent and also have a clearly defined market,” says David Gershman, partner at Coral Gables, Florida-based private equity firm Trivest Partners. “Everyone has access to online ordering. We’re looking for a company that isn’t likely to get disintermediated by tech or easy delivery.”
One of Trivest’s portfolio companies, North Star Seafood, is a specialty seafood distributor focused on the South Florida market. In addition to improvements to on-time delivery during Trivest’s ownership, the company made changes intended to increase the value proposition for both suppliers and customers. It invested in updating its refrigerated facilities, acquired several competitors, and worked to improve relationships with fishermen and chefs at local hotels and restaurants.
Another example of a specialized distributor with a competitive edge is Phoenix Aromas and Essential Oils, a portfolio company of Wellesley, Massachusetts-based Gemini Investors. The company supplies flavor and fragrance components—a business that requires a deep understanding of agriculture and chemistry.
Phoenix Aromas has relationships with suppliers all over the world, allowing the company to offer its customers consistent sourcing and supply, says Gemini Investors President James Goodman. The ingredients it sells are critical for products across a range of consumer industries that often have fragmented business networks. Investing time to establish relationships with customers in a variety of sectors has been paramount to Phoenix Aromas’ success. Goodman says the fragmented market, along with the company’s specialized products, has created a long runway for organic customer growth.
Despite strong interest from buyers and investors, distribution companies are also somewhat insulated from the global M&A boom that has consolidated many sectors and put new limits on the prospects for price-multiple expansion. Many of the companies served by middle-market distributors operate in fragmented industries or specialty markets where there aren’t many competitors to buy, making major consolidation unlikely in the next five to 10 years.
Indeed, GPs say these companies present an attractive investment opportunity because the specialization required to corner a market can also keep out competitors. Specialty parts distributors are one example. In addition to making or sourcing parts, these companies also have a high level of knowledge and relationships in their given industries, making it difficult for an outsider to disrupt the business or start picking off customers.
The Amazon Effect
Even if a niche focus has insulated a company from being disrupted by Amazon’s broad product offerings, the e-commerce giant is likely impacting its business model in other ways.
“What we’ve seen over the past five to 10 years is that distributors are putting more resources behind improving their technology, improving speed of delivery, because customers are used to two-day shipping now,” Goodman says.
Shoppers’ expectations have created new ways for private equity firms to add value. Trivest’s Gershman and Rotunda’s Whisner both say that when they begin working with their portfolio companies’ management teams, areas like digital strategy, transportation speed and guaranteed delivery are all high on the list for improvement.
Using technology to ensure on-time delivery is important, of course, but there’s much more private equity firms can do to help distributors get to the next level, Gershman says. “We’re working with companies on giving salespeople mobile apps that they can use in the field to make orders, for example. We’re looking at their digital strategy. These are all part of the sales relationship.”
Whisner adds that the Amazon effect has also contributed to the myth that distribution companies are low-margin businesses. That’s often the case for companies in sectors that rely on volume and focus on consumer goods, but it isn’t true for more specialized distributors, he says. “We just don’t see that in our companies. They’re providing a critical service and businesses are willing to pay.”
It’s important during the diligence process to understand how margins are made, particularly when investing in a distribution company, says Goodman, whose team also considers a company’s prospects for adding new customers. Most of Gemini’s portfolio companies have profit margins in the high teens, a level he believes is sustainable. “We think those margins are defensible. We’ve passed on other higher-margin distribution companies because we just don’t see the profit being defensible over the long-term. It’s a question of value-add.”
This story originally appeared in the September/October 2018 print edition of Middle Market Growth magazine. Read the full issue in the archive.
Bailey McCann is a business writer and author in New York.