Introduction:
The objective of this white paper is to examine the impact of the Internet and the changing roles of traditional channels of distribution within the context of independent third party distribution networks. These changing roles directly effect over 150,000 independent sales representatives and industrial distributors representing $106 Million currently engage in the sale of engineered capital equipment. (Degli-Angeli, Sept 14, 2001) It also directly impacts manufactures that have built their business through channels of independent distribution.
This document will examine the traditional channels of distribution. Internet strategies that impact these channels will be defined along with the advantages and disadvantages that they entail. This paper will also detail evaluation tools middlemen should utilize to determine if they are indeed at risk. These tools take a close look at both their customers as well as the value they add to the buying experience.
Definitions and Background Information
A manufacturer' representative, as defined by the Manufacturers Agents National Association Educational Foundation, is an independent sales agent that in many cases represents a number of non-competing manufacturers or principals. They are commissioned agents, paid a percentage of the sale price only after the Principal has been satisfied. These independent agents afford manufacturers a professional sales force that is paid only when product is sold.
Besides the economic benefit, companies have long relied on the manufacturer's rep perform a number of functions including, the specification and sale of equipment, assistance with customers credit worthiness, warehousing of product and aftermarket support. Reps have also been a source of market information helping Principals determine what is required, what can be charged and where efforts should be concentrated. (Kirkpatrick, et. al, 1976)
These functions are especially important in the sale and support of engineered capital equipment. Examples of engineered capital equipment include, but are not limited to HVAC systems, controls, plant and process equipment. The Destruction of the Middleman
The Internet has changed all the rules and has posed a threat for many established distribution channels. At risk are the agents and distributors that man these channels. New business models such as reverse auctions, industry portals and virtual buying groups have emerged lending credence to the feared concept of disintermediation.
What is disintermediation? Simply put, it is the elimination of the very intermediaries that have enabled business to be transacted in the pre-Internet world. According to Bruce Merrifield of the Merrifield Consulting Group, it is when two parties that have used an intermediary decide to do the job for themselves. "When we pump our own gas, go to a buffet, do our own on-line e-ticket, we are disintermediating someone who use to be between us." (Merrifield, Sept. 19, 2001) Those intermediaries include distributors, retailers, wholesalers and sales agents just to name a few.
eCommerce pundits have long predicted the demise of these middlemen as a result of going direct. In some cases these predictions have become realities. Travel agents have already experienced the shortening of supply chains as airlines encourage their customers to purchase tickets directly from their web site. Many airlines have provided lucrative incentives for customers that book on-line rather than through travel agents. The reason for this online push is simple: Airlines save an estimated $15 - $25 per transaction when travelers use their Web sites. (Shattuck, Jul. 15, 2001)
This strategy has been further promoted by the creation of Orbitz, a web site jointly owned by Delta, Continental, American, United and Northwest airlines. The success of these online strategies have resulted in Delta airlines selling a record 370,000 tickets in June of 2001, their highest online sales ever. (Shattuck, Jul. 15, 2001) That translates to over $5.5 million wrung out of the process though disintermediation.
The Airline industry isn't the only sector to pick up the flag of disintermediation, so to have the Big Three AutoMakers. Ford, General Motors and DaimlerChrysler have combined their efforts and created an electronic marketplace for purchasing. Covisint, a combination of the words communication, vision and integration, (Ramirez, May 17, 2000) is a cyber exchange that will link carmakers in an electronic bazar offering everything from auto parts to mops. (Vlasic, Feb.27 2000) The impact of this eMarketplace is tremendous given the fact that Detroit automakers purchase about $240 billion annually in material, parts and services. With new partners Renault SA and Nissan Motor Co., that number will pass the $300 billion mark
These B2B eCommerce strategies do not bode well for the middleman stuck in the channel. Forrester Research has predicted $1.7 trillion in electronic commerce by 2003. But that figure represents only 10% of entire B2B market. That still leaves $15 trillion to be transacted by traditional methods. (Marshall, Aug., 2000)
The reality is that not even $15 trillion of B2B traditional transactions, meaning those not handled by eCommerce, will provide enough safe havens for the middleman. Technology and the acceptance of eCommerce as a viable method of conducting business will continue to grow. Especially if one would apply Metcalf's Law which states "the usefulness, or utility, of a network equals the square of the number of users." (Downes et. al, 1998) In other words, the more companies that turn to eCommerce, the more viable and valuable eCommerce will become.
Internet Driven Business Models
Electronic commerce and the associated technology have given rise to many new business models that threaten tradition channels of distribution. It is important to understand these new business designs to determine what the future might hold for businesses and their channel partners.
Reverse Auctions
One of the new economy B2B models is the reverse auction. "A reverse auction uses secure Internet-based technology that allows suppliers to compete for contracts online. The auctions are conducted in real time and participants lower their prices as they see other bids." (Anon., Jan 2001) Even the United States Defense Department is utilizing this avenue to purchase materials.
In the August 2000 issue of National Defense; Arlington, reported the Naval Supply Systems Command (NAVSUP) purchased 756 recovery sequencers-major components for the advanced concept ejection seat, found in B-1 bombers and F-15, F-16 and F-117 fighter jets from HiShear Technology Corporation in Torrance, CA. The price of the contract was approximately $2.4 million. FreeMarkets Inc. of Pittsburgh, PA conducted the reverse auction. The result of the auction was a 28.9 per cent cost savings. (Kutner, August 2000)
For this particular auction, the Navy pre-selected suppliers of the recovery sequencers and, after meeting the Navy’s criteria, suppliers were invited to participate in the auctioning process. "The auction began at 1:00 p.m., and was supposed to end at 1:30. But auctions are extended when a bid is made in the final minute." according to J. J. Daunt, a FreeMarkets representative (Kutner, Aug 2000) This much different than the rules applied in e-Bay’s model in which the time frame is set and the auction is just that, a sellers auction. Another rule set by FreeMarkets included that each company need to underbid their competition by at least $5,000.00. (Kutner, Aug 2000) Where once the middleman was an integral part of bid preparation and negotiations, he has now been limited to only the pre-selection process and in many cases this function is reverting back to the manufacturer.
As an added service to their customers, FreeMarkets will assume many of the roles normally provided by a middleman. "Buyers determine their needs, and FreeMarkets works closely with them to develop a detailed RFQ-a request for quotation-that outlines specifications, order quantities and other critical elements." (Rackham, et. al., 1998)
The reverse auction has also been applied to consumer products. Priceline.com is based upon a reverse auction model that allows consumers to bid on items ranging from airline tickets to groceries and further illustrates that the B2C sector is not immune to the disintermediation of the web. Many retailers have been circumvented by Internet storefronts. In a recent study conducted by Forrester Research Company, it was determined that 70% of manufacturers have plans to sell directly online within the next five years. (Davis, Jan 22, 2001)
Marketplaces
The reverse auction is truly counterintuitive to the traditional sealed bid offering most often used by Government bodies and especially the General Services Administration. However, even the GSA as changed to accommodate new eStrategies. Beginning in 1996 the General Services Administration launched an Internet marketplace named GSA Advantage. It is here that pre-approved companies list the products, services and pricing structures that are available to Federal purchasing entities. Sales transacted on GSA Advantage totaled $5.7 million in the first year and have expanded to $383 million as of April 2001 according to Gloria Sarno of the GSA, Federal Supply Service, United States Government.
Federal buyers access the site and through the use of a search engine, locate products, services or companies that meet their needs. Once they have located the item or service required, they have the ability to place an order directly on the site. No bidding process is required and Federal entities can use purchase cards as a form of payment.
The advantage to the GSA is the reduction of expensive purchasing procedures and faster fulfillment of orders. The advantage to the suppliers listed with GSA Advantage is the lower cost of sales and a greater reach within the Federal Government.
GSA Advantage includes 5,483 Federal supply schedule vendors with 6,420 catalogs. Over 1,815,312 products and services are available to 155,296 federal buyers with credit card authority. Perhaps the most impressive fact is that GSA Advantage processes over 35,000 searches every working day and that number is growing according to Ms. Sarno.
Through this Federally owned and operated marketplace, P. C. McKenzie Company furnished an entire Gas Compression System to Barksdale Air Force base in Louisiana. This system is used to refuel natural gas powered vehicles owned and operated by the Air Force. The pricing, configuration, delivery and terms and conditions of sale were pre-negotiated. The middleman within the distribution channel did not participate and was not aware that the equipment was purchased. Nor was he aware of the project’s existence.
Internet marketplaces, like GSA Advantage, are continuing to develop heightening the threat for disintermediation. Flour Corporation has developed an Internet marketplace named GlobeQuip that buys and sells surplus mining and heavy construction equipment. A market, according to B to B’s Phillip Clark is valued at $70 billion. (Clark, May 28, 2001) GlobeQuip matches buyers with equipment manufacturers that have a surplus of inventory. The marketplace also helps participants arrange delivery and, through a partnering with Citigroup, Inc., can also provide for escrowing and final settlements.
According to Jeff Putman, CFO of GlobeQuip, their marketplace will reach buyers as far away as Southeast Asia and Africa. "Thridworld mining equipment buyers are increasingly using the Internet for procurement, but they are about as easy to reach through TV and print advertising as the Amish." (Clark, May 28, 2001) However, GlobeQuip’s challenge is not only to promote the site in order to attract buyers but to also attract enough suppliers to reach critical mass. That is the level in which enough buyers and sellers utilize the marketplace and make it truly self-sustaining. Not an easy task, however, marketplaces such as Travelocity and Priceline.com are well on their way to reach these levels of critical mass, landing a lethal blow to the middleman.
But not all marketplaces succeed even if they achieve that critical mass level and the investors with them. Metalsite.com, a marketplace established to move steel products had big name steel backers including Weirton Steel, Ryerson Tull, LTV, Steel Dynamics (a mini-mill) and Bethlehem Steel. Their value proposition was simple, to connect buyers with suppliers to buy, sell and trade steel. For that they charge a 1% to 2% transaction fee. But in June of 2000, MetalSite suspended operations because they had run out of operating capital. This only six months after Internet Capital spent $180 million to buy 35% stock ownership from Weirton Steel. (Boselovic, June 7, 2001) According to Bud Siegle, president and CEO of Russel Metals "the message has finally gotten through that e-commerce is not the panacea it was made out to be. There is no question in my mind that the most profitable survivors of the economic cycles will be the well-managed steel distributors, as they are the ones that have the relationships with the viable customers." (Triplett, July 2001)
Industry Portals and Manufacturer's Websites
Industry portals are another Internet strategy that has continued to develop. These are gateways that are industry specific and encourage use through narrowing the information available to accommodate their audience. Many manufacturers are listed in these portals as a means of gaining access to that specific market. Hot links to the manufacturers are included allowing the prospect to connect to the manufacturer without engaging the third party middleman.
Virtual buying groups, such as mobshop.com, have already emerged within the consumer sector and will soon be part of the B2B landscape. These are groups formed to allow smaller entities to pool their product requests and then shop for the best possible price based upon a larger volume.
The manufacturers own web site can pose a threat to the middleman as well. Leads generated here can be handled directly by the principal and eliminate the need for the middleman. Aftermarket parts are especially vulnerable to this occurrence. Most consumers refer to the nameplate on equipment they are dealing with then contact the web site of the manufacturer when they have a need for service or parts replacement. The middleman is completely circumvented in this instance and that dramatically affects his revenue.
This may also be the case when a purchaser has the need for either a replacement unit or an exact match to sit beside an existing piece of equipment. The middleman could have sold the original equipment and be completely bypassed when the customer refers to a manufacturer's web site. Protection for the middlemen
In order to protect themselves, middlemen first need to evaluate the products they sell and the areas in which they sell them to determine if they are in danger of being eliminated. In a November 1999 Fortune magazine insert by the Manufacturers Representative Educational Research Foundation (MRERF), the following list was detailed in which electronic commerce supports selling by: Delivering product information and specifications
Providing published pricing information
Collecting statistical information
Facilitating order status checking
Allowing order placement
Taking care of the "nuts and bolts" so "face-time" can be more productive
In addition, eCommerce is not well suited for:
Creating demand
Closing orders
Negotiating contracts
Analyzing competitive solutions
Dealing with exceptions
Identifying problems/suggesting solutions (Marshall, Aug 2000)
Based upon this information, Bruce Merrifield suggests that middlemen should examine and evaluate where their company is now by making three activity lists of what they do. The first is outsourced services for their manufacturers, outsourced services for their customers and services that serve both to some degree. Once this is completed they need to question which activities might be reduced more or less over time via Internet communication. "Because there is a lot of information transfer activity in the channels, this could eat into the traditional portfolio of services that rep firms provide. There will, however, be new problems that will arise from new solutions for someone to fill, and a large invisible service is the trust that comes from taking care of Murphy's Law for both manufacturers and customers." Reports Merrifield. (Merrifield, Sept. 19, 2001)
Not only should the middleman evaluate their company, but they should also evaluate their customers. In Neil Rackham's 1999 book entitled Rethinking the Sales Force, he outlines three kinds of customers. They include Intrinsic Value, Extrinsic Value and Strategic Value customers. Using these categories as measuring sticks, Middlemen can gauge where the Internet could replace their efforts.
According to Rackham, an intrinsic value customer appreciates the product itself. They already understand the product and how it is applied. In effect, they view the product as a commodity item and the driving purchase motivator will be price. They know what they want and focus on how to minimize the cost. They believe that salespeople simply add to the cost and therefore would rather not deal with them. In this same vein of thought, they are more apt to expedite their own orders by logging on-line. The intrinsic value customer is most interested in the reverse auctions and supplier marketplaces made possible by the Internet. They are, without a doubt, the worst customers for a middleman to deal with given the threat of disintermediation.
The extrinsic value customer is the opposite; they require and expect support from a salesperson. Therefore, the consultative sales approach works best. They rely on the supplier to first understand their unique problem and based on that understanding, provide solutions. They realize that the cost for this level of service will be higher but price is not the motivator in the transaction. Solving the problem is. But the middleman must be cautious as the extrinsic value customer will quickly transition to an intrinsic value customer when he or she believes they know all there is to know about a product and how it is applied.
The golden ring for the middleman then is the strategic value customer. It is this type of customer with which a middleman can form a partnership based upon a solid working relationship, not price concessions. Both the buyer's and the seller's organizations blend together with shared goals. These relationships often carry across to the highest levels of the customer's company and are very hard to establish. It is within this sector that eCommerce tools will aid rather than hurt the middleman. As an additional tool, middlemen should refer to the Coakley Field Activity Pyramid. (Please refer to Appendix A) Tim Coakley of the rep firm Coakley, Boyd and Abbett introduced this graphic illustration to demonstrate four levels of sales activities against the backdrop of technology. The first and lowest level is literature fulfillment. The second step in the pyramid is basic information gathering and budgetary pricing. These two lower levels are the areas in which a middleman is most likely to be replaced by technology. Level one and two fit well within the description of Rackham's intrinsic value customer.
The third level details live technical inquiries, quotation against competitors, problem solving and order closure. This step requires a higher level of interaction between the customer and the middleman. Therefore, level three meets the criteria of an extrinsic customer according the Rickman. At the third level, technology is deemed an enabler, assisting the middleman in the accomplishment of his job to satisfy the extrinsic customer. But, as Rackham points out, the same technology that supports the middleman can also push the extrinsic customer into the category of an intrinsic customer. Technology that once enabled can also be employed to disintermediate the process. At the top of the pyramid is the realm of the strategic customer, those customers that are willing to form a meaningful alliance. It is at this level that the technology of the Internet does not threaten the middleman, but instead reinforces his efforts and value. It not only strengthens the middleman but also the strategic customer and ultimately the alliance that they have forged. For those middlemen working on the bottom tiers of the Coakley Pyramid the Internet is a large and real threat that can and will push them out of the channel. When Bruce Merrifield was asked where these agents could turn for help he responded as follows: "If you were making clipper ships in the early 1870's when steam ships finally got traction for trans-Atlantic shipping, you would have been better off to start making steam ships instead of "getting help". If you are in a channel in which there are good structural reasons for why both manufacturers and the distributors/retailers/dealers will stay fragmented, and then you just have to keep selling the total sales/service cost reduction that you provide. As some old activities melt away look for the new ones that will inevitably rise and fill those needs for a cost that is less than what the two players will value and pay for in some way." He ends his response with "All easier said than done". (Merrifield, Sept. 19, 2001)
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