INTEGRATED SUPPLY EVOLVES

From its early days a decade or so ago in New England factories and West Virginia coal mines, integrated supply of maintenance, repair and operations (MRO) products has had its doubters and detractors. Whether it's offered by a consortium of specialist distributors, a single distributor with broad product reach or a third-party sole-source integrator, anyone who blends the supply channels for electrical, industrial, safety, plumbing and any number of other product categories into a single stream and then tries to lock up an agreement to supply the whole lot for three to five years is bound to make enemies, just by the number of incumbent suppliers who get cut out of the action.

The naysayers have proven right on many occasions, as integrators and their customers discovered the gaps between expectations and execution. Yet contract by contract, through careful cost cutting and a flexible approach to developing new solutions to old problems, integrators have proven the case for integrated supply's benefits. It's not universal, and probably never will be, but the influence of integrated supply is substantial and is not going away.

Demand for integrated supply continues to outpace growth in the electrical and MRO markets. Integrated supply contracts accounted for $10 million in MRO product sales in 2000, and are expected to top $12 million this year, says Frank Lynn, president of Frank Lynn & Associates, Chicago, Ill., a consultant with a specialty in integrated supply. That's 20 percent growth amid an overall MRO market that is growing 4 percent to 5 percent per year recently. Clearly, integrated supply continues to take business away from traditional distribution. Some expect an economic slowdown to further boost interest in integrated supply as factories look for new cost savings from their supply chains.

Industrial customers are generally satisfied with the value of integrated supply, according to a study Lynn conducted last year. Of companies whose agreements were coming up for renewal, 75 percent to 80 percent said they plan to continue with integrated supply, though in some cases not with their original integrator.

For integrators, contract renewal is the acid test of their success. Incumbent distributors risk seeing customers dismiss the years of groundwork and hand-holding that went into creating and executing the original agreement. The incumbent supplier still has the advantage, though, as long as service levels have been first-rate, says Alan Schlecter, vice president of Turtle & Hughes Inc., Linden, N.J. “The key to the program — and it's the key to any supply business — is the service. If you have serviced the customer very, very well as an incumbent, and if you are not perceived as having increased the customer's cost of doing business, it's very unlikely that you will be replaced by another integrator.”

The first generation of integrated supply agreements has revealed a few areas of widespread dissatisfaction among customers. Foremost among them is weakness in technical support. This problem is seen most widely in the sole-source agreements handled by third-party integrators, Lynn says. A sole-source integrator typically isn't set up to offer in-depth technical support on the vast array of products under contract. “When you get outside a commodity specialty, the technical support seems to fall off,” he says.

Distributors who have established technical support capabilities are finding it a major advantage in negotiating new integrated supply contracts. Agreements that involve local distributors often have the advantage on this score.

“Technical services and product knowledge are keys to making integrated supply work,” says J.D. Sullivan Jr., chief executive officer of iPower Logistics LP, Cleveland, Ohio, a network of local integrated supply consortia. “I think that's one of iPower's strengths. We have local distributors who are experts in whatever the particular product is. That's the advantage of having mostly first-tier suppliers.”

Technical support in integrated supply should be of greater concern to manufacturers whose products are sold through integrated supply, Lynn says. Last year's study revealed that manufacturers have less influence over brand preference in an integrated supply situation.

The solution may be for manufacturers to help distributors unbundle their technical services from inventory services and offer service packages for a fee. “Something we've been pushing for a long time now is for manufacturers to pay their distributors for doing technical support in plants where the distributor doesn't write the order and doesn't deliver the product. It's a fee-for-service approach.” Lynn says. “When I started talking about this four or five years ago, distributors literally threw up on the table. They're starting to think about it now.”

What seems clear is that fee-based services have a major role to play in the evolution of integrated supply. From Lynn's viewpoint, the first generation of integrated supply agreements were based on the wrong business model.

“Integrated supply came out of a traditional distributor model and tried to incorporate the way distributors make money — on the difference between buying and selling costs,” Lynn says. “It's a buy-sell model, but this is really a service business and works best in a fee-for-service model.”

Meanwhile, the business model that everyone expected would reshape the entire MRO supply chain has not yet done so. Internet-based portals providing sole-source supply for a variety of products were widely thought to be the category-killer come to revolutionize MRO procurement, but buyers didn't warm to the services. Now many of those sites are going under.

The Internet e-commerce portals may yet revolutionize integrated supply, not by disintermediating distributors, but by serving them. The investors who financed the systems development through the stock market may have seen 95 percent of the value disappear, but the systems they paid for are still there. Built on Internet protocol (IP) technology, some of these systems include Internet-based remote inventory tracking and electronic cataloging. Lynn says they are in many ways superior to and more flexible than EDI-based integrated supply systems, says Lynn.

“The smarter e-commerce guys are beginning to recognize that they have an electronic information network capability that can be offered to manufacturers and distributors as a service, and very nicely fits with integrated supply,” Lynn says. “They're beginning to offer these services on a subscription basis. Instead of a front-end fee and a licensing fee, these guys are saying, ‘We can sell this like wireless service or cellular service — $1,000 a month for ‘X’ amount of time on my system.’ That's making it very easy to buy.”

Based on this technology, Lynn expects some suppliers to adopt what he calls “integrated supply lite,” a bare-bones solution that may appeal to medium-sized customers. A typical integrator doesn't mess with facilities that buy less than $3 million a year in MRO goods, Lynn says. But that's still a sizable facility, typically employing more than 1,000 workers. Integrated supply lite would provide some of the purchasing advantages of consolidated billing, standardized products and better management of inventories, but without the in-depth onsite storeroom management services, Lynn says.

The portals may be fading, but the Web still has an expanding role to play in integrated supply. Web sites with personalized content such as electronic catalogs with the customer's standardized products, part numbers and contract pricing are the next level of Web-based service, says Schlecter of Turtle & Hughes. “That's going to be the way to go, where customers have us customize a system that they really want to use to eliminate paperwork and transactions. But it's only going to be for items they buy frequently, like a glorified systems contract over the Internet,” Schlecter says.

The importance of information systems in integrated supply would be hard to overstate — they're a major barrier to entry and can make or break an integrated supply agreement. M. Joel Bateman, executive vice president of Cameron & Barkley (CamBar), Charleston, S.C., says his company's commitment to the constant development of better supply chain technology has been a major factor in the company's record of integrated supply successes.

Information systems are certainly critical for addressing the ever-expanding range of services such as vendor-managed inventory (VMI) and other advanced inventory and storeroom-management services. Spreading demand for such services across multiple sites within a company is the biggest single change in integrated supply over the past few years, says Bateman.

“Initially, storeroom management was not a factor in integrated supply, but over the years this opportunity has grown significantly as a desirable part of our integrated supply contracts, and I think this will continue to be the case,” he says.

Bateman expects that demand to expand beyond national borders, a trend that would fit well with the long-term plans of CamBar and its new parent company, Hagemeyer North America Inc., Atlanta, Ga. A subsidiary of global distribution giant Hagemeyer N.V. of the Netherlands, Hagemeyer North America also has acquired Vallen Safety Supply Co., Dallas; and Tristate Electrical & Electronics Supply Co., Hagerstown, Md., two industrial supply players that greatly expand CamBar's ability to offer national coverage.

“Of even more importance, however, is Hagemeyer's presence in Europe and Australia,” says Bateman. “I see integrated supply moving to a global initiative with our customers over time, probably sooner rather than later.”

While one group of large customers is looking for the efficiencies of national and possibly international coverage, others are moving in the opposite direction, shifting to regional rather than national programs in pursuit of the better service and technical support that proved troublesome in early integrated supply agreements. Schlecter of Turtle & Hughes says he's seeing many customers move away from national contracts because of local service issues, complicating factors such as rep territories, and labor issues. Schlecter also sees many customers moving from sole-source integration back to a more commodity-based purchasing that integrates a group of specialist suppliers.

The variety of products and services requested by the customers is growing as well. Sullivan says iPower Logistics has seen strong growth in demand to include a more diverse array of services under the agreements. These include not just product support and inventory management but services such as “critter removal” and watering plants.

Early integrated supply agreements often required the integrators to buy storeroom inventory from the customer. That trend seems to be reversing itself because large industrials have lower borrowing costs and freer access to capital, says Lynn.

The lessons learned since industry's first immersion in integrated supply have made everybody — customers, integrators and suppliers — more realistic about what to expect from an integrated-supply program. A lot of distributors felt some serious pain when it came to delivering on their commitments regarding cost savings, service levels and expenses. The experience has made all parties wiser about integrated supply's possibilities and limitations.

“We know what we can do, and we spell it out for the customer, but any program that is new requires a lot of hand-holding,” says Bateman. “If they work with us as a partner in developing and rolling out the programs, it is more likely that the final result will be close to the expectations.”

Integrated supply remains a specialized business with different infrastructure and operational requirements. It seems likely to continue to take some business away from traditional distributors. Indeed, right now the most significant limit to the growth of integrated supply may be the difficulty in finding people with the right mix of project management, customer service and industrial supply operations knowledge to manage integrated-supply agreements, says Lynn. “The big sole-source integrators are doing as many of these agreements as they can handle, and could do more if they could find the people.”

Integrated supply will continue growing because it has a lot of benefits for the customer, and for the distributor as well. It's a powerful differentiator for any distributor in the MRO market, but it's not a game for everybody. “This type of agreement raises the bar,” says Bateman. “The number of competitors who normally can handle or are interested in these types of agreements is much more limited than it is with the normal everyday business.”