Upcoming IP Investor Dialogues: Spirax Sarco, FAST, COST, CPRT, POOL, SNOW, DDOG - Register your interest at help@inpractise.com 

Anonymous

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:00:20} Kurt, can you share some context to when you first joined Electrocomponents?

{audio:0:00:26} Taking it back to when I joined in the summer of 2015, it was not a great time for the company. There's no question that it was chock full of outstanding people from most fronts. It was clear that the share price was hovering around £2 a share. I think there were many questions from the investor community as to the strategic and tactical directions of the company, and it had been languishing for some time. So from every respect, the company was in a place where it needed a much harder look and an approach that maybe they hadn't taken before in trying to bring in somebody from the industry to lead the business who had tremendous experience. Lindsley came on board in April of 2015. If I wasn't his first call, I was his second, trying to bring in some outside help. I'd worked with Lindsley for many years, both at the same company, and we had competed against each other. It was a tough time in many respects, but as it became clear that Lindsley was going to join the company, I think that did offer some new hope. 

{audio:0:01:46} What were the major challenges prior to Lindsley coming onboard?

{audio:0:01:52} A couple of important things were noticed right away, certainly when Lindsley showed up, and I did about a month after he was hired. The primary market for RS at the time, the UK, was declining. So the home market was not in growth; it was not good. The digital offering at the time was adequate. Certainly, it showed lots of opportunity for improvement, and I think that was something that had been a source of frustration for the company, in terms of trying to find ways to get at that and unlock the potential there. The other thing is I think the company had grown up over 80 some odd years as a UK company. And while it had expanded into western Europe, it really hadn't done a lot beyond the acquisition of Allied in the US and done almost very little in Asia Pacific, specifically in China. It was clear right away that there were opportunities to grow the company geographically and get back on track in the home court. There was a way to find opportunities to ignite the digital element of the company, which was going to have to be growing and robust for the company to be successful.

{audio:0:03:12} What exactly were the problems that came up?  

{audio:0:03:22} A couple of things. There was this kind of Coke and Pepsi thing going on with Electrocomponents and Premier Farnell. It almost appeared that the two companies were trying to find their place inside a market where they were very much the same kind of offering. As a result, it was just kind of clogging up the ability to get out there and grow, and they hadn't been able to deal with that, to separate themselves from that direct competitive comparison. Premier Farnell was not knocking it out of the park; it was a nice offering, doing reasonably well, but it wasn't anything to point to in terms of a huge success. I think the other thing is there were a number of leadership changes in the folks that were responsible for the UK, and I think they tried a number of people who didn't tap into the full potential of what was going on in the UK. They kept trying, but it just didn't stick for them. Some of that turnover, and the competitive congestion going on, added up to something that wasn't working very well.

{audio:0:04:30} It’s funny because I was reading Lindsley's earnings call from November; he seems a bit of a character in the way he communicates. He's quite a fun guy but also straight-talking and serious. It seems like he turned the business around. How would you describe his approach to Electro when he came in?

{audio:0:04:56} What you observed in listening to him, or if you've ever met him, is that he has a tremendous amount of energy. He will always be a guy who looks at things glass half full. There's always an opportunity to find a way to grow faster and be more efficient; that's how he lives his life. He's not shy and doesn’t try to cover that up. He wears everything right on his sleeve. I think part of what was important for Electrocomponents at the time was having someone like that was just a massive breath of fresh air. I think for a long time, because of the lack of performance inside the company, it had generated lots of little fiefdoms, and it wasn't a coordinated, cohesive kind of operation. What Lindsley did more than anything is he came in here and cracked the top off and made it clear that we're going to have to find ways to be better at communicating, being honest about where we are and how and where we address the opportunities we have. That spirit did open the whole thing up.

{audio:0:06:07} Could you briefly explain the differences you found between electrical and industrial product distribution?  

{audio:0:06:29} To be simple about it, at the top is it's two totally different businesses. You have to understand that as a starting point. It’s also why you see companies that can be very good at both. When you get into what makes industrial product distribution work, especially for a high service distributor like Electrocomponents, it is very much a transactional being. Yes, there are relationships with the supplier and products sold, but it's much more of a buy-sell relationship. As a result, what you typically get is a distribution model for industrial products that is much more dependent on price, availability, and breadth of offering. So those three things will determine how successful you will be in that space. Those are the general characteristics of industrial distribution that I have certainly experienced. 

{audio:0:07:36} For electronic components, it is exactly the opposite. It’s almost entirely built on the relationships you develop with the suppliers. What I mean by that is, it is far less transactional. It's much more, I would say, strategic in terms of sharing new product technology road maps, timing, and understanding where certain products will fit in which segments, and being a lot more prescriptive about what products, where, and how those are marketed and sold. It's a much more collaborative kind of relationship in terms of how to drive success.

{audio:0:08:15} I was about to caveat what I just described. When you set yourself up as a high service distributor, as Electrocomponents has, and compare to a volume distributor, the high service guys will always be a little bit more transaction-oriented. That's simply because of the kind of folks they serve; the typically smaller to medium-sized customers who require more service in terms of the transaction itself, but still, it's built around the transaction. Why is that the case? It's probably mostly driven because of the kinds of customers that high service distributors typically deal with; smaller volume, more complex, and higher mix. 

The volume guys typically don't have to spend too much time thinking about those kinds of things. It's got a lot of nuances, the differences between the two. Yes, in some cases, distribution is still distribution. You have to have the right product, the right price, and the breadth to be competitive. But when you talk about the electronics part of the business, you have much more of an engaged relationship with the resources at the electronics manufacturers. They are also doing much the same kind of work to figure out pricing, positioning, new technologies, what segments, all of which are more of a relational kind of engagement. 

{audio:0:09:43} Is it more concentrated on the supplier side in electronics versus industrial?

{audio:0:09:49} Definitely so. One of the ways to characterize the difference between industrial product distribution and electronic component distribution is when you're in the world of electronic component distribution, the customer is certainly important. Still, the supplier is equally, if not maybe a little more important because, as the old saying goes, you can lose a customer, and that's a customer. If you lose a supplier, you potentially lose hundreds of thousands of customers. You have to find that tricky balance between how much time you spend making sure you understand and spend time with your customers and that you spend time with your suppliers.

{audio:0:10:33} How would you characterize Electrocomponents?  

{audio:0:10:40} That’s why, I think, when you get a chance to peek inside Electrocomponents, you’ll find an industrial products distribution business and a separate electronic components distribution business. While the two use and leverage many of the same marketing and selling channels, when you go and penetrate a customer and start talking about industrial products, you often enter the customer's front door and go left towards the industrial folks. When you start trying to sell electronic components, most of the time, inside the customers, the electrical engineers, and the electronics folks will be in a different part of the business. So it naturally forces that separation, and I have to tell you, endless time and energy is spent trying to find a way to get those two things to leverage each other. That's a tricky thing to do.

{audio:0:11:40} It’s almost like a different sales process completely.

{audio:0:11:43} Yes, I would say it is. When you're talking about electronic components, I think the sales process often starts with new products and new technologies, and that's how you work your way across the product life cycle over time. With industrial products, I would say that it is less about new products and technologies and more about how those customers that are buying those products are supported and served. 

{audio:0:12:13} Can we discuss the electronics side? Let’s say I’m a tier-one electronics OEM. How are the distribution agreements typically structured between the OEM and the distributor?

{audio:0:12:30} To answer the question, you have to separate high volume distribution – Arrow, Avnet, those folks – from high service, such as Electrocomponents, Farnell, and others like that. If we're just looking at the world of Electrocomponents, remembering that about 13%, maybe 14% of Electrocomponents's total revenue comes from electronic components, so the vast majority of Electro's business is industrial products. Why does that matter? It matters because when you're talking to large OEM brands of electronic components, something very important to them is driving volume. The other important thing is finding a way to grow the customer base. 

{audio:0:13:23} I can't tell you the number of meetings I've sat in with the largest electronic component OEMs in the world, and if it's not the first question, it's the second one; just show me how you've grown your customer base, both in terms of number and in terms of different types of segments. That is what’s most important to them. That all translates into reach; how does this distributor have a different or unique reach than others. When you start trying to translate that into the industrial product side of how you deal with setting up a relationship with the distributor, yes, all those things are important. Your volumes are much lower than the volume guys when you're at a high service. This automatically puts you in a place where it starts to determine and dictate pricing, return privileges, rebates, inventory swaps, all the things that are part of a negotiation that you see on the electronics side, or rather in relationships where the volume is much higher. That's why it all kind of winds itself back for a high service guy like Electrocomponents. Those relationships with suppliers are far more transactional, just buy-sell.

{audio:0:14:41} Can you give an example of products in the high service, low volume versus the more transactional higher volume?

{audio:0:14:49} On the industrial products side of the business, a great example is Electrocomponents, the makeup of their product segments and how they're driven. First and foremost – I can't remember the exact numbers – but a large portion of the revenue from Electrocomponents comes from what they call tools, consumables, and test equipment. That's typically where you've got what I would refer to as a higher-end MRO offering. It's not mops, buckets and brooms, but it's the stuff that factories need every day to keep themselves running. So it's a fantastic space for Electrocomponents. 

{audio:0:15:30} The next biggest category is automation and control. Again, many of the products that keep manufacturing equipment and factories up and running are found in the automation and control space. The third one is what they call IP&E, which is interconnect, passive and electro-mechanical. All those parts that are not necessarily on a printed circuit board but they surround an electronic product or a mechanical product to the extent that it's got electronics on it. Inside of each of those three categories, what is consistent is this focus on small to medium-size businesses that have manufacturing capability that need that support to keep their operation up and running.

{audio:0:16:21} Does it even make sense to have these two businesses together in the first place?

{audio:0:16:43} Great, great question. The short answer is, it doesn't make any sense. In the longer answer, where Electrocomponents has an opportunity, there is convergence at certain points in most industrial products and electronic components. Just like electronic components aren't sold to be electronic components, it's sold to be incorporated with other components onto a printed circuit board to create a product, much like industrial products. Rarely are customers ever just an industrial company. 

{audio:0:17:25} Regardless of where you sell your industrial products, there's a good chance some electronics are going on somewhere there. That's what we found in many of the customers. We tried to find a way to cross-sell and make sure that our sales folks, as they were walking in and the routing was to go left to the industrial guys, we were working very hard to make sure that they acknowledged whether there was a right turn to get to electronics, electro engineers, and where electronics were being developed. Because a lot of times, they just walk right past it because they're not focused on that element. Very rarely did customers not have both some kind of a mechanical thing going on and an electronic thing going on.

{audio:0:18:10} Going back to the question around the relationship with the supplier, how would you define, for example, the bargaining power of the supplier and distributing in electronics versus industrial?

{audio:0:18:23} Firstly, the bargaining power on the side of the distributor, whether it's industrial products or electronic components, really does rest in the distributor's ability to expand the customer base. Secondly, is the ability to introduce products into new segments, so not just new customers but new segments. To the extent that you can do that and do it consistently, that will give you leverage, probably unlike anything else you can do for a supplier. So the two are very much the same. The same goes for electronic components or industrial products. The only twist on electronic components is the lifeblood of any product company, whether it's a component or an industrial product, is making sure that whatever they're introducing as new products or technologies get exposed and designed in. That's the other part of how leverage could be created by distributors. The distributors can find a way to ensure they are leaning in new product and technology exposure, marketing, awareness, adoption, and designing these products into new products. This is the platform of what allows distributors to be effective.

{audio:0:19:57} What do you mean by new products? Do you mean the distributor has to actively market and sell or push the suppliers’ new products?

{audio:0:20:05} Absolutely. If I’m going to you as a customer and I represent a number of leading brands, I’ve got a whole host of new products and technologies that I want to make sure that you’re aware of. As your team is designing their new products, they’re thinking about what components I’m going to pick and what products I’m going to incorporate, and you want to make sure that they're fully aware of what's coming down the pipeline. It also works on the back end of the product life cycle. As products go obsolete, part of your job as a distributor is to make sure when replacement parts are needed because of obsolescence. There's a very clear list of manufacturers with the products and technologies that can be swapped in where obsolescence occurs.

{audio:0:20:52} How does the pricing work in industrial versus electronics? 

{audio:0:21:00} We could spend a whole half a day on pricing, but for the most part, on the industrial side, you're more or less a price taker. You'll get a price sheet from your OEM – your manufacturer – and you won’t deviate from that. There may be specials based on volume, new customers, and new segments, but beyond that, it's pretty straightforward, pretty prescriptive. 

{audio:0:21:29} There's probably a bit more room to negotiate cost and price on the electronics side. Still, you have to remember that most manufacturers and suppliers have a stable of distributors; a couple of high-volume guys, a couple of medium-sized guys, and a couple of service guys. They make sure that they manage their business that way intentionally, and they're not going to start upsetting people by giving different pricing to different folks. What they typically do is find a way to create a baseline. But again, based on volume, exposure, access, new technologies, design-in wins, that's where distributors can come back and say hey, let's talk about rebates, return privileges, longer-term contracts – the things that allow for a little bit of preferential treatment – but it's earned.

{audio:0:22:27} On the point of Electrocomponents versus Arrow, in terms of high service versus volume, what exactly is a service they provide that defines it as high service versus what Arrow would provide?  

{audio:0:22:43} Between high service and volume, the everyday kind of application of that, there really isn’t a lot of difference. What defines those two things differently is the reach. When you've got high service, you’re typically going to have many, many customers, but buying at an average order value that's very, very small, as opposed to an Arrow, for example, where you'll have a lot of customers because of the size and shape of Arrow, the high volume. Still, you're going to have relationships where the order values are much higher, not just because of the difference between industrial products and electronic components, but rather because you can move a higher volume of product when you're an Arrow than you do when you’re an Electrocomponents. So it's natural that order values are going to reflect that. 

{audio:0:23:37} In terms of the basics of distribution, do I have the right products on the shelf at the right time at the right price? That's kind of the ticket to the game. When it comes to things like true extended breadth to the product line, you will find that the volume guys probably have access to a much greater breadth just because they're moving much more product. The other thing is the high service guys are going to make sure that it is a one-stop-shop, it's an omnichannel; it doesn't matter whether you want to buy digital, at a brick and mortar shop, whatever. You can get it as you like it.

{audio:0:24:20} You can see the turns difference from Arrow to Electrocomponents. I think Arrow turns their inventory eight, nine times a year, and Electrocomponents is two, two and a half; completely different.

{audio:0:24:35} Exactly, that's a great example of what it means to have a lot of product available, but also it limits the ability to have significant breadth. It's just too expensive.

{audio:0:24:47} Back to the point where you mentioned how the suppliers have typically a few distributors that do different work for them. Who would you say is the real competitor to Electrocomponents?

{audio:0:24:56} I think the high service business in segment gets most competitive by geographic segment. I could give you a list of folks that Electrocomponents is competing with within France, which is different from Germany, which is different from the UK. There is some overlap, but a lot of what you do in high service is getting in there and servicing local, really local companies. The big guys, the volume guys, don't get to that depth in terms of local customers.

{audio:0:25:27} Then Arrow would serve your Fortune 500 maybe, and Electrocomponents would serve the much smaller company.

{audio:0:25:34} Exactly. The way we used to talk about it is Electrocomponents and high service really do kind of address that fat part of the middle of the market the curve where there is the most, but draw the curve differently in terms of volume and dollars spent. That's where the bigger guys like Arrow are going to spend most of their time.

{audio:0:25:55} Back to the pricing point, I’m curious how you look at the gross margin for Electrocomponents. It’s declined sustainably over the last 20 years, with a 51% gross margin in 2002, down to 42%, 43% today. What are the main drivers of that, in your opinion?

{audio:0:26:16} I think there are a couple of things going on. As customers have become more sophisticated and have more options, there is a natural tendency to start driving down pricing and its effects on gross margin. The other part of this that is a huge driver is the whole digital element. It's only been in the last 10 years that people could do all their business online. More importantly, I think they're just starting to catch up to that for the industrial customer, who is typically a little less sophisticated when it comes to the digital elements of how you run your business. We probably should go back more to 10, 15, 20 years, maybe, but the adoption by the industrial side is taking a little bit longer but it is happening. I think that's creating some efficiencies that weren't necessarily reflected in cost to goods sold in the past. Those are the two biggest drivers that I can think of, and I think they will continue to be important. 

{audio:0:27:22} So when you mean the customer has other options, what other options do they have exactly? Do you mean Amazon? Where else can they buy this stuff?

{audio:0:27:32} If the price isn't an issue – keep that to the side for a second – the emergence of the broker community has had an enormous impact on how products are available and how that affects pricing. I think the way that products are designed now, or at least the evolution of design, has moved from fewer things that are truly unique to more things with a lot of common parts. A lot of the uniqueness comes from how the firmware, software, and functionality are developed inside of a product, and that has caused a convergence to more commonly used products and components. That’s a fantastic question. I could go on for a long time on that, but I think that probably sums it up.

{audio:0:28:30} Getting to those two points, could you elaborate more on the broker community? What does that mean, what impacts has it had? Are they digital brokers? Or do you mean they’re traditional, physical brokers?

{audio:0:28:47} Physical. Basically, you need a product, or you want a product, you tell them what you need, and they'll go find it for you. It will be the most expensive route that you'll ever take to get a product or a component, but it's available, and you can find ways to do it. As that broker community has evolved and developed, both on the electronic component and the industrial product side, you find that as that's built up, brokers used to be expensive to use as a source because the broker industry and business have continued to evolve. There are options, and it has competitively converged into a space that isn’t quite as expensive.

{audio:0:29:27} These brokers would then go to the suppliers themselves, or they would also go to the distributor?

{audio:0:29:32} Yes and yes. A broker's job is to find the part wherever they can.

{audio:0:29:37} Why would a customer use this channel?  

{audio:0:29:41} It’s typically an unscheduled demand, an emergency situation where the line is down, and your normal supplier or distributor doesn't have the part; the extreme stuff that often happens in smaller to medium-sized companies that maybe aren’t as sophisticated in how they plan. They are forced into the space to keep their lines running and keep the products being manufactured, to tap into some of these sources. 

{audio:0:30:11} I would never call Electrocomponents a broker, but one way to look at what Electrocomponents does as a high service distributor is that I would say, in some cases, they're kind of one step above a broker. They’re highly transactional, they will have services wrapped around it, holding product, in-factory stock, all the things that they do to try to make it easier to have products available, but it comes down to very much a buy-sell relationship.

{audio:0:30:43} If I’m a small, medium business in the UK, I will have Electrocomponents and Farnell accounts, but I'll have a couple of brokers maybe if I need some stuff that these guys can’t fulfill.

{audio:0:30:58} If you're trying to manage your sourcing from end to end, that's exactly what you'd do. The challenge is that in the broker community, you have to be very careful because you want to make sure you know where your parts are coming from, and the broker has to be able to give you that assurance. You can buy anything from anywhere, but often it's not going to be what you buy or what you expected.

{audio:0:31:18} I didn’t expect there to be little broker communities actually in this market. The whole proposition of the distributor is like this one-stop-shop. I can give you everything, always available, so it's interesting that a broker community seems like it's flourishing. 

{audio:0:31:37} Right now, the broker industry is exploding because of supply constraints and what's going on, especially on the electronic component side.

{audio:0:31:49} What can Electrocomponents do about that?

{audio:0:31:50} Great question. Tricky, but I think part of what anybody wants to do is not have themselves associated with being a broker. Brokers build their business in a very special way. It's a unique circumstance and very, very transactional. There’s no hint of relationship inside there because you usually only pull the lever for a broker when it’s an emergency. That happens, but you like to go back to your original distributor supplier and get them to try to help you and get them to go out and find product. At the same time, the objective is to find a way to keep your people on the factory floor working and the lines running, and if you have to pay a little more for a part, that's going to be small in comparison.

{audio:0:32:39} Can’t Electrocomponents buy the brokers? Just roll them up? 

{audio:0:32:43} You could, but the broker business model would be very difficult to have side-by-side with a business trying to find a way to develop relationships with suppliers. Brokers don't have relationships with suppliers. All they do is they want to find a part, and it doesn’t matter where it is to make that transaction happen.

{audio:0:33:10} The broker business model is very special, and I would be very careful trying to figure out how to incorporate that into another business.

{audio:0:33:18} Back to the second point of what’s been driving gross margin. You mentioned more commoditized components and, potentially, more of the value in industrial and electronic components becoming more of the software or the intangible on top of that component. Have you seen any material changes in these products over the last 20 years that would suggest that, potentially, the components in the products that companies like Electrocomponents are moving are just becoming much more commoditized, therefore more pricing pressure?

{audio:0:33:56} I'm not an electrical engineer, but I've spent enough time around them. My sense is that the days of trying to create differentiation within the electronic component elements of a product are less than they were years ago. What I mean by that is the speed and capacity for processing are rigid, and a bit prescriptive, and the real magic in an electronic product happens in how the firmware is built and then the software on top of that to provide an application that then becomes unique. Speed and capacity, in terms of processing, have become a little less important.

{audio:0:34:44} Did you see pricing objectively change from the suppliers?  

{audio:0:34:55} The answer to that is absolutely yes. Let's take a couple of big guys like TI and Intel. In the past, they relied on the distributor to help them understand their new product technology roadmaps to the point where they could actually go into a customer and represent them properly and be in a position to help that customer make a design-in decision with that particular component. 

{audio:0:35:29} Over the last 15, 20 years, the big suppliers like TI and Intel have finally just decided, we’ll do that. We'll now take responsibility for that kind of field application engineer function that distributors had spent a lot of money and time and generated a lot of extra margin from suppliers doing in the past. There’s been a bit of a turn; part of it is based on the fact that I don't think the distributors were successful in truly designing in components for suppliers. We could talk all day about that. But I think the suppliers are speaking with their actions. They’re looking at what they’re paying distributors to help them design new products and design in components. They’re not terribly happy with that and are now deciding to take that responsibility for themselves. That takes a fairly significant chunk of the margin opportunity away from distributors now, and it's just gone.

{audio:0:36:32} That’s the high margin service part.

{audio:0:36:35} Exactly. You can see a typical component sale going off at a gross margin of high single digits, but if you can prove that you as a distributor were responsible for that customer designing in that particular part, that high single-digit then goes to 15, 16, 17, 18 points of margin. It's happening now. TI made that decision a couple of years ago. Intel has done it, and a bunch of other folks are doing it. Now, distributors have to find another way to make up for that.

{audio:0:37:13} There are effectively just becoming more commoditized, just moving more products.

{audio:0:37:18} As they say, big box to small box.

{audio:0:37:21} How would that work, historically, in terms of the pricing? Suppose you're Electrocomponents and you design in this component with a customer. Would you go back to the supplier and prove that, saying, look, this customer has purchased this component. I have some kind of service element, or I deserve a service revenue on this because I've effectively made them purchase it and design it in. Is that how the agreement would have been struck?

{audio:0:37:48} It is. It's a very old and tried and true process for validating a design, what they call a design-win. All tracked, all carefully captured by both supplier and distributor; it's a process where that gets demonstrated, and the documentation that supports it gets put to the supplier. They end up paying the margin on that. Sometimes, that's not a one-time thing; that can be over the life of the product sometimes.

{audio:0:38:23} So it’s almost like a consultant as well, effectively.

{audio:0:38:29} It’s a nice piece of recurring revenue and margin. When I ran the Americas for Arrow, my largest expense in terms of payroll was the 120 field application engineers that I employed and paid. They’re very expensive people because they're very good, and these are engineers that can sell. That's a tough mix to find in and of itself. When you find them and they're really good, they're expensive. But what’s happened recently is the suppliers like TI and Intel have just decided that they don’t want to pay for that.

{audio:0:39:06} Looking at the gross margin again, 52% to 43% in the last 20 years, obviously this is even when RS PRO has been growing, which is much higher margin as well. So the gross margin of the core business would be down even more than that if you didn't have RS PRO. It seems it's a huge change fundamentally in the value add that these businesses are providing to suppliers.

{audio:0:39:31} It is. Going back as long as you want, I think the refrain around the executive leadership table, beyond the core business, is how do we find ways to add value that allow us to create new profitable growth services. For distributors, it's been very difficult. All you have to do is look at the history of some of Arrow's decisions. While they might make sense strategically, additional revenue is captured, and profitability often doesn't line up completely. Trying to think about how to do something more than the right part, right time, right price has always been a challenge for distribution.

{audio:0:40:20} How do you think they could solve that problem?

{audio:0:40:26} Let’s use an example. A fantastic space that Electrocomponents recently moved into within the last three or four years, with a couple of acquisitions, is trying to find a way to help large industrial companies deal with the long tail of commodity products that they have to buy and use every day, but they don't want to have their own people doing it, because it's too expensive. They put a big old fence around that bucket of parts that are that long tail – sometimes that can be $50, $75 million of business – and they say to a distributor or a company, here, take this and please manage it for us. Here's the schedule of when I need it, here's the pricing that I expect to pay. Anything you can do better on pricing is yours to keep, just make sure these products are here when I need them. 

{audio:0:41:21} Then there's a whole thing about whether it has to be the same supplier, or it can be a different supplier. Electrocomponents decided to venture into that space. Not distribution, a little bit of it, but it's more an expertise of having a system and a routine that allows to take that long tail, put a fence around it and just take it away and manage it for that company.

{audio:0:41:46} It’s almost like an outsourced service.

{audio:0:41:49} Exactly. But I think the value add, when it comes to high service industrial distribution of products, usually comes down to how accessible or easy it is for me as a customer to buy the product. That's why Electrocomponents, for example, spends a lot of time talking about how they are omnichannel; buy anywhere. If a part isn't right or doesn't work, the next day, boom, you get another one. All of that kind of service that gets almost put into the space, that's just every day taking care of your customer; well, it's not. Those are valuable, value-added bits that companies like Electrocomponents are very good at.

{audio:0:42:38} Any other ways to add more value beyond, as you said, having the right product, right place, right time?

{audio:0:42:46} I'll jump right to the private label part of this if that's okay. That was one of the key drivers, creating a robust and recognized private label offering. At the time when I was at Electrocomponents, we believed that was very important. Why is that important? In the world of buying products and supplies, to you and me in our daily lives, there's always this kind of tiering of at least three: good-better-best. 

{audio:0:43:21} When you talk about the best, you talk about the leading brands with all the features, functions, and capabilities that you would ever need or even not need, but you have to pay for. If you want a branded product, you're paying for those features and benefits whether you need them or not, and you're also paying for building a brand for these guys. But most of the time, when you're dealing with small to medium-sized guys that are just trying to keep their businesses running, they don't need all the features and benefits of a brand-new product. They start looking for the next available options that we call the value space, somewhere between the high end of good, and better. That's where most folks were comfortable if they decided to not need the brand but wanted something else. That's the space where they would go.

{audio:0:44:20} What we tried to do, and I think it's still a tremendous opportunity, is to find a way to carve out that high end of good and all of the better space and create an offering and a brand in there that industrial folks can trust. They understand that this is a value play, they're not getting all the features and benefits, but they're getting a high-quality product that does the basics. It was amazing how attractive that became and grew as we started to tighten up the whole story around RS PRO. Whether you're talking about private labeling or own brand, which are two very different things, I believe both are enormous, untapped potential for any distributor.

{audio:0:45:12} I’ll wait for the question, but I anticipate it in advance. Why would suppliers accept that? Why would supplies have their product on a shelf, and you're seemingly just competing with them? Most of the big brands understand their value in their ability to offer leading features and benefits and the comfort of knowing that you're buying a branded product. That's very, very intrinsic. That's important to many people. Many people will just say, I'm a brand person, and that's all I buy. 

{audio:0:45:48} However, as the option of a value brand of solid quality and performance starts to emerge in the industrial space, more of those decisions to move away from a brand become easier. The best examples we can use is what’s happened in the retail space for you and me over the last 25 or 30 years. I’m old enough to remember when you walk into a grocery store, and at best, you could see a private label thing of paper towels or tissues. You walk into a place now, and it's loaded with private label options everywhere.

{audio:0:46:31} Is there a limit on the potential mix or maximum penetration of RS PRO as a percentage of Electrocomponents revenue?

{audio:0:46:41} Seven years ago, when I first joined Electrocomponents, this was the path my team and I went down; trying to understand the extent of the opportunity. What we found was there seems to be a natural limit at around 25% or 30% of revenue for any distributor to have private label or own brand be a part of the mix. Why is that? I don’t know. When you look at the two examples that I used in pulling RS PRO together from a branding perspective, it was Costco. 

{audio:0:47:22} I’m sure you’re familiar with Costco; if you are, I'm sure you're familiar with Kirkland Signature, that's their private label brand. Kirkland Signature today, I think, represents about 25% of all of Costco’s revenue, and it’s been 25% for some time. It grows slightly and comes back down, but it’s always at about that place of 25% or 30%. So that was one really interesting data point. I talked to people at Costco when I was doing all this research and never got a good answer as to why. It wasn't intentional; they weren't trying to limit it because the profitability is 1% to 2% on a third-party OEM branded product and probably 25% margin on their own brand, so why wouldn't you grow the hell out of that? It has to do with that relationship with your suppliers and your brands. Because the thing that's important about private label and own brand is they don’t exist in a mixed environment without leading brands. You need a leading brand to set up a private label or a brand offering.

{audio:0:48:36} What’s the difference between a private label and own brand?

{audio:0:48:37} Costco offers a Kirkland Signature Scotch, and that Scotch is provided or manufactured by Macallan. The Macallan bottle is next to the Kirkland Signature Scotch, and the difference is the price.

{audio:0:48:59} They’ll use the same manufacturer. They'll have a relationship with the brand to take product off their manufacturing line, rebrand it Kirkland Signature, make a couple of tweaks that don't make a difference so they can call it something different, and off you go. Own brand is where Costco would go and work directly with a supplier, say in some other company, to manufacture a bottle of Scotch for them, and they put the Kirkland Signature brand on it.

Former President at Electrocomponents

Electrocomponents, RS PRO & B2B Distribution

ECM is facing gross margin pressure as suppliers have more bargaining power and take back ownership of servicing end customer

The broker community is pressuring ECM competitively by sourcing product more efficiently during tight supply  

Potential competitive risk if Arrow can find a way to get into high-service distribution 

RS Pro has room to expand to 25% of total sales which will drive gross margin 

Former Global Category Manager, Electrocomponents

Electrocomponents: Industrial Procurement & Supplier Development

Electrocomponents, Bechtle AG, & B2B Distribution

ARROW ELECTRONICS INC

Electrocomponents PLC

Founded in 1937, Electrocomponents (ECM) is a UK-listed industrial and electronics distributor that provides MRO components, automation and control, and technical electronics products to businesses globally. The company is a high-service distributor that aims to provide value-added service beyond simply selling components that an Arrow Electronics would focus on.

Over the last 10 years, the company has faced gross margin pressure and lower conversion of gross to operating profit that has dampened FCF growth. Lindsley Ruth, ECM's CEO, joined in 2015 and has reorganised the business to focus on value-add services to drive organic growth in addition to multiple acquisitions. ECM has compounded FCF per share at over 10% for 20 years and still has opportunity to expand globally.

ECM is part of our global B2B distributor coverage to understand what drives a sustainable competitive advantage in this business. 