Are These Industrial Distributors Under Siege?

Last April, Amazon.com launched AmazonSupply, offering more than 500,000 parts and supplies for business and industrial customers at competitive prices. A year later, a study by Acquity Group showed that close to half of business-to-business (B2B) buyers have bought from AmazonSupply. But In the face of this formidable new competition, industrial distributors like W.W. Grainger (NYSE: GWW  ) , HD Supply Holdings (NASDAQ: HDS  ) and WESCO International (NYSE: WCC  ) , are rising to the challenge.

The race is not over yet
The industrial supply market is still relatively underpenetrated, especially among big clients. The same Acquity study showed that only 13% of corporate buyers with a budget in excess of half a billion dollars are buying directly from a supplier's website.

AmazonSupply has something to fight for, but the other industrial distributors are also moving online. E-commerce already contributes 30% of Grainger's 2012 revenues. Moreover, existing industrial distributors have an edge because of their multichannel sales approach. If you're a corporate buyer, you have the flexibility of dropping by a branch, calling a friendly salesperson, or ordering online.  

HD Supply understands that people value convenience, and the next best alternative to e-commerce is buying from a store located in your neighborhood.  It has plans to open more branches and distribution centers closer to both its customers, to capture a greater share of the local market.

Small and big customers
Grainger is focused on bigger clients, with large and medium customers accounting for about 95% of its sales. Large customers provide a steady flow of business, are less likely to default on payments and most importantly are not the target customers of Amazon Supply. Even so, Grainger is not giving up its small customers without a fight. It has investments in pure online distribution channels, including Japan-based MonotaRO and U.S. based Zoro Tools, to compete with AmazonSupply.

It is not just about price
If you were a potential customer choosing between AmazonSupply and the other industrial distributors, price wouldn't be your sole consideration. You'd want to be sure that you could get most (if not all) of the products you need from a single supplier. An attentive and knowledgeable sales person, who could give you tips on the most suitable products, would definitely be helpful as well.  Hence, it is no surprise that 32% of buyers ranked customer service and convenience ahead of price in the Acquity survey.

Just as supermarket retailers have driven customer loyalty and margin expansion through private-label products, HD Supply's proprietary brands generate higher margins than their third-party counterparts and help to build stronger customer following. These products accounted for only about 7% of HD Supply's fiscal 2012 sales, implying significant room for growth. 

While there are customers who are fine with 'click & go', many other clients prefer some form of hand-holding. Grainger has increased its sales force from less than 2,000 in 2010 to close to 2,500 this year, with plans to increase that number to 4,000 in the foreseeable future.

To serve customers better, WESCO initiated its "WESCO One" strategy to become an integrated industrial distributor. Plans under this strategy include combining operations in selected geographies to meet the needs of regional customers; and allocating more corporate resources and salesperson attention to those who really need them. 

Cold calls and the like 
There is an element of passivity associated with starting a website and waiting for customers to turn up. AmazonSupply has done reasonably well, but the traditional demand generation and lead qualification models that companies like WESCO adopt are still very much relevant.

Since 2011, 30,000 calls per year to WESCO have generated 40,700 actionable leads and $185 million in first-time orders. The first call rarely ends with a done deal. WESCO also has the support of 600 sales support personnel and the reach of 475 branches to meet customers' needs and queries.

Conclusion
While AmazonSupply is a potent force, large industrial distributors have their fair share of experience competing with local distributors practising low-cost strategies. The incumbents' multichannel sales approach and focus on customer service and product availability will continue to serve them well in their battle with AmazonSupply.

Of the three stocks discussed, Grainger is valued at a premium to its peers with a forward P/E of 20. In contrast, HD Supply and WESCO International trade at 12-13 times forward P/E. This valuation premium is justified in my opinion, because of Grainger's limited exposure to small customers, which are the most vulnerable to the threat from AmazonSupply.

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