Conlin Beverage Consulting, Inc.

More management wisdom

The Wall Street Journal recently ran a remembrance piece on a management philosopher, Russell Ackoff.  He was called an evangelist of the big picture… he tried to help his clients by “reimagining their challenges as opportunities to restructure.”  Something many in the beer industry should take to heart… and no, that isn’t just some cheap pitch of my services ;-)… but it is a healthy mindset to keep in both our business and personal lives.  The challenge is a fact; it cannot be changed since it is probably beyond our power to control… so why not think of it as an opportunity?  Much healthier and might even turn out to help! And if it doesn’t, what was lost? 

 

The piece notes he was an expert in conceptualizing problems and liked to say they came in three flavors: problems, messes, and puzzles, and each needed its own unique toolkit to fit.  Here is one of his great quotes which I think applies to many of our business practices…

 

“All of our social problems arise out of doing the wrong thing righter.  The more efficient you are at doing the wrong thing, the wronger you become.  It is much better to do the right thing wronger than the wrong thing righter!  If you do the right thing wrong and correct it, you get better!”

 

He was a legend as a management philosopher… but more importantly, he was a beer-guy!  He worked with Anheuser-Busch for over 30 years, beginning in the 1960s.  Sorry all you non-AB folks, but we’ve got to give him his due.  At least the author of this remembrance credits him with helping A-B achieve national dominance.  He helped A-B design a new expansion strategy that included building new breweries and warehouses based on computer modeling, a cutting edge approach at the time.  He studied A-B’s marketing strategy and came to the conclusion that increasing advertising budgets had little effect on sales… neither did taste, which he found through blind taste tests… hang on all you craft beer lovers, this was in the 1960s and 70s… although it is difficult, I will fight the urge to make some sarcastic but spot-on comment about this time frame ;-)

 

Bill Finnie, a former director of strategic planning for A-B states, “This was incredibly valuable.  It gave A-B the confidence to maintain its marketing budget flat from 1961 to 1976.  We quadrupled sales”.  According to Bill, reduced marketing costs were passed on to the consumer, making Budweiser inexpensive compared with local brands that had dominated the market through the 1950s.

 

Russell must have had some good ideas, in his 30 years of work with A-B their national market share went from 7% to 40%.  There are plenty of beer folks out there today who where on the winning or losing side of that historic transformation.

 

But for our purposes, one of his more profound breaks with conventional thinking was his proposition that to improve a system (and your business is a system), you must analyze and address it as that, a system… not a collection of parts.  Until that insight, most thought the way to address a problem (or improve an organization) was to break it down into its component parts, fix those parts, and then put the thing back together again.  Think of your organization in these terms… using this type of thought, you first break your organization into its “parts”… sales, delivery, warehousing, admin, etc., fix or improve each of them and then put the thing back together again.  Ackoff said this was folly.  This quote captures the problem with this parts or mechanical approach…

 

“The characteristic way of management that we have taught in the Western world is [to] take a complex system, divide it into parts and then try to manage each part as well as possible. And if that’s done, the system as a whole will behave well. That’s absolutely false, because it’s possible to improve the performance of each part taken separately and destroy the system at the same time.” Edward Deming

 

I’ve encountered that situation many times… some policy or procedure works great for one department, but it absolutely destroys the workings of another.  Put enough of these together and the entire organization will turn into circular firing squad.

 

Instead Ackoff developed systems thinking where improvements in an organization are driven by the design and workings of the entire system.  Innovation and improvement comes from total system improvement, not just improving certain parts.  I use this same reality in my operational consulting and perhaps surprisingly, in my brokerage activities as well.  Since I am frequently asked, yes I do help sell and purchase distributors.

 

Ackoff describes what he is talking about

 

“…the development of synthetic thinking, which provides better understanding of complex systems than analytical thinking does. Synthetic thinking is a way of thinking about and designing a system that derives the properties and behavior of its parts from the functions required of the whole. The whole has properties that none of its parts have.  Analysis of a system reveals how it works but synthetic thinking is required to explain why it works the way it does. Systems thinking integrates the two.  Analysis breaks a system down into its parts, tries to explain the behavior of these parts, and then attempts to aggregate this understanding into an understanding of the whole. It cannot succeed because when a system is taken apart it loses all its essential characteristics and so do its parts. A disassembled automobile cannot transport people and a motor taken out of it cannot move anything, even itself. Analysis, applied to systems, and therefore corporations, can only yield knowledge of how the system works, but never an understanding of why it works the way it does.”

 

I’ve often had a soon-to-be client call and ask me to come in and help them improve their compensation system or warehouse operations or whatever… I always tell them that is not possible, we must first analyze the entire system, then we can begin to address the various integrated parts.  I know more than a few thought I was just trying to sell them a bigger job, but they would soon reframe their thinking and view their organization as an integrated system, a “whole”… the first step to improvement.

 

With that, I leave you with two thoughtful quotes… the first from Edward Deming

 

“No one has to change.  Survival is optional”

 

Think about that one over beers.  You may not want to sell.  You may not want to purchase.  You may wish for all this change to go away… as Deming states, the choice is yours… your survival is most definitely optional.  And choices you make today (or don’t make), will set the course of your future for years to come.  I sometimes shake my head at people passing on acquisition opportunities… in many cases they are simply setting the stage for their exit from this industry sometime down the road… sadly, without even knowing they are doing so.

 

The second is from that management guru, Albert Einstein

 

"The specific problems we face cannot be solved using the same patterns of thought that were used to create them."

 

As you address the first quote, keep the second in mind.

 

 

 

What's Up With Values?

A question on many distributors’ minds… what’s up with values?  Some are predicting they are headed south, but on this one I am a contrarian.  As I have noted before, I had thought values would have decreased some time ago but I was wrong.  Read that last sentence again… yes, I was wrong.  As a side note and as part of my never-ending attempt to help all become better managers ;-) take that concept to heart.  All good managers and supervisors (to say nothing of spouses) should learn the high-art of admitting when you were wrong.  It really isn’t that tough and it can have an amazing affect on your relationships… often disarming arguments before they even start… plus as I remind folks in sales training, the best sell is always the truth.  And if you were wrong about something (and we all are… it is a statistical certainty), simply admit it and move on.  Analyze why you were wrong and what you can learn from it.

 

Following my own spot-on advice, why do I think values are not headed south and why was I wrong in the past?  On the financial side, profits have held up remarkably well.  Total house margin compression has not been happening, in fact in many situations total gross profit percent has increased.  After a short (but painful) run of very high fuel prices, costs are generally being contained… and the pain of these fuel costs drove many wholesalers to make changes to their service policies which were probably long overdue.  Wholesalers used this pain to become lean and meaner… and most importantly, smarter.

 

The financial side of the equation is where I got a little of it wrong, but the non-financial side is where I really missed the boat.  I thought too much about the fundamental essence of value… the present value of future discounted cash flows… and not enough about THE non-financial, but incredibly powerful and valuable aspect of beer wholesaling… exclusive territories.

 

This is like the game of Risk, it’s all about controlling real estate… and there is very little real estate available… thus the bidding process for these very rare assets continues to drive prices up, not down… and I see nothing on the horizon to change this reality.  The bottom-line is that if you want to be a significant beer distributor in the US (long-term sustainable?), you have to be aligned with one of the big two, ABI or MillerCoors… and that footprint on the ground is what drives everything.  You can leverage this legally protected distribution footprint in whatever direction you desire… but first you have to own the dang thing… once that happens, you don’t have to worry about more “normal” competition coming from anywhere but your competitor beer wholesaler… and perhaps at the fringes from the wine and spirits folks.  And the value of this legal right has shown amazing resiliency and for at least the near-term, is not heading south at all.

 

Of course once you have this distribution footprint, you can leverage it in many directions and thus define your competitors in different ways… but first you have to have the real estate.   Unless and until this is changed… and I sure would fight like hell to ensure it doesn’t… the value of beer distribution rights won’t be going south for quite some time… the assets are far too unique and far too valuable.  In many ways the sale of a distributorship is like an auction for some very rare and precious asset… there aren’t many around in the first place… they come to market only rarely… if you pass, you might never get another shot at it… and of course for a distribution business, the strategic implications of these legal footprints cannot be over-stated.  Mix that all up and it points to values remaining high, not heading south any time soon.

 

That’s my very public prediction and I’m sticking to it.

 

 

Some thoughts on Acquistions

Acquisitions… something on almost every beer wholesaler’s mind, although the present national economy and tighter credit market has a few rethinking their plans.  But the march towards consolidation and fewer distributors seems to be a foregone conclusion.  I have talked to quite a few small to medium-sized distributors who make the case this consolidation actually leads to a net decrease in street-level wholesaler performance. 

In many cases these wholesalers are correct; especially in smaller markets… having a hands-on owner/management team on the street will always have a positive impact.  And in a smaller market there are generally fewer retailers to influence and personal relationships are often more important than in major metropolitan areas.  In addition, if you sell 500,000 annual cases, each case is relatively more important than if you sell 15,000,000, and they are treated as such (and that is an on-going challenge for the larger distrib).

These distributors might have a valid point but my response is, “so what?”  That all may be true but I certainly don’t see it having any impact on the reality of consolidation.  Sorry folks, but as I’ve noted many times, our desires don’t change reality… and there is nothing on the horizon which would indicate anything to change this.  The net benefits of consolidation seem to outweigh whatever costs there might be.

So that circles us back to acquisitions… without these, consolidation has no meaning.  So do you play in this game or wait on the sidelines?  First you need to look in the mirror and decide what you want… my belief is that if you want to remain in the beer distribution business for the long-term, you have no choice but to play and to play aggressively.

Since you are already in the game you are already shouldering the risks, whatever they are.  This is true regardless of whether you’re MillerCoors or ABI (or even one of the remaining stand-alone Miller or Coors distribs).  Think of that again… whatever system-wide risks face the beer distribution industry, you already have these risks.  Period.  The only difference an acquisition makes is that you put more capital at risk.  Yes, I know… you “only” put more capital at risk.  Easy to say when one’s name isn’t on the note ;-)

But if that is the way you feel then you’re probably not in this game for the long-term, regardless of what you might tell yourself.  If you find yourself in this position I recommend you review your business and professional long-term goals.  In actuality you might be more of a seller (or holder) than buyer.

My associate Steve Cook has a great analogy for what faces many beer wholesalers. He likens it to professional sports franchises.  To win at the pro level, these owners perpetually investment spend on players, facilities, etc. to ensure they have the most competitive franchises. To succeed, these owners have a shared vision while all the time reevaluating their plans, players, resources and performance. Similarly, for wholesalers it’s about having the vision, financial resources, players, and operating models needed to sustain the franchise in the long run.  Not all owners do this in sports or beer wholesaling… but ALL the owners who want to win the title do.

So that’s one of the first questions… do you truly want to win a title and will you do what is necessary to achieve this goal?  Too many wholesalers are still fooling themselves with the old… “I’ll make an acquisition if I can steal it.”  Wishful thinking… and these folks NEVER get a deal done.  How many sports franchise owners build a title-winning team by only trying to get the cheapest talent available?  Simply doesn’t work that way.

If you are going to stick around and get larger, you have to be willing to step to the plate and get deals done.  Might you have to pay more than you “want”?  Sure… so what?  These are generally strategic deals and they need to be viewed from a strategic perspective.  This is a very large, ever-changing chess board with many players.  There is not a remote guarantee that you will achieve your goals even if you play your game well… but it is an absolute certainty that you won’t achieve them if you don’t try.

Many acquisitions are going at a price which requires a fair amount of additional capital, that’s where the folks with debt-free operations are at a substantial advantage.  They can take the cash-flow from one operation to fund another for a couple of years until the new acquisition can cover its debt load.

So looking at this landscape, what should a wholesaler do?  First and foremost, every beer distributor should focus on putting as much money as is possible to the bottom-line.  Read that again 3 times and think of it every day.  If in so much debt that it limits your ability to make acquisitions, pay it down.  But if you believe significant inflation is coming our way (and it is difficult to see how it isn’t), being in debt is not necessarily a bad thing.  Debtors “win” during times of rampant inflation.  But too much debt limits your flexibility… find the right balance for you and your organization.

Run a high-performance, high-demand organization… don’t let your personal lifestyle expand until it is consuming all of your cash flow.  Let your spouse and kids read that last one.  You have no operating and acquisition flexibility if your lifestyle consumes everything your organization generates.  Maximize your short- and long-term profitability.  Even if values decrease (which I’m not certain is eminent), ensure you pocket more money than the decrease in value.  If a strategic acquisition presents itself… get the deal done.  If not, keep harvesting the cash-flow of your organization… thus you present yourself with as much a win-win scenario as is possible… regardless of what future comes racing your way.

Next post – are values heading south?  I think not.

 

 

 

Is Change a Threat or Opportunity?

With change comes opportunity… and there is some serious change being bantered about in the beer and beverage industries.  Is my crystal ball any clearer than the rest?  In all honesty, probably not.  As I’ve noted many times before, the difference between a “good” decision and a “bad” decision is almost always how the future plays out.  If future A happens, you might look like the smartest guy (or gal) on the planet… on the other hand if future B happens, you’re the goat. 

 

So what to do?  Analyze the situation to the best of your ability, attempt to break free of all the mental chains that bind and blind you… and make your best call.  Analyze information as you gather feedback and adjust you path accordingly.  This is true in business… this is true in life.

 

And what paths people are considering!  The dynamism and creativity of the beer distribution industry continues to amaze me.  Although a minority might act like ostriches and pine for the good ol’ days, most are grabbing this change by the throat… determined to shape it to their advantage.

 

I’m involved with a number of groups who are investigating the path of mergers… ranging from the vertical integration of Miller and Coors distribs… to “simple” mergers of adjacent beer distributors… to a merger plan for the creation of a huge multi-state distributing colossus.

 

Others see opportunity in acquisitions… taking steps to create dynasties which will last for generations.  And of course others think now might be a good time to cash in their chips and to head to other pastures… and yes, I do provide brokerage services for those wishing to sell (or buy for that matter).  If you are tired of the same old folks and the same old routines, give me a call and let’s talk… there is no one out there who has actually lived and breathed the real world of beer wholesaling more than me… I help take them apart and put them back together again… I have ALWAYS lived with the real results of what I do… how’s that for a shameless plug?  ;-) 

 

As for mergers, obviously the vertical integration of separate distributors is always a profitable endeavor… on the high side you might put 70% - 80% of that new gross profit to the bottom line.  On the financial/operational side these are the ultimate no-brainer.  But of course with all mergers, the people side is where the friction generally occurs.

 

Mergers of adjacent distributors can also make a lot of sense.  If you can close warehouses, these can also have a fairly significant financial impact.  But even where you can’t, often these mergers make sense from a defensive viewpoint… as a stand-alone 1.5 million case distributor you only have so much power… merge with a couple of your adjacent distribs and now you are a 4.5 million case operation.  Much more viable, defensible, and attractive for the long term.  And there are still synergies to be had… perhaps not $0.30 per case but if done correctly, everyone will be stronger and make more money.

 

I readily admit I am a dreamer, and taking the merger concept to the next level is extremely exciting… the colossus full state and multi-state distributor.  All it takes is vision and the willingness to do the heavy lifting upfront.  Once you begin to consider a merger and get over the only downside… that the nature of the asset changes, it is no longer solely your business… why not form larger and larger entities?  As long as the valuations are fair, no one experiences any dilution and you own a chunk of a larger and larger entity.  Regardless of where the future leads do you think you will be stronger, more viable, and more attractive to suppliers of all sorts as a stand-alone 4 million case operation or as part of a 40 million case operation?  Is it an easy path to get here?  Hardly.  But is it worth a little time and consideration?  Very possibly.

 

Next post – more on acquisitions

 

Now for something completely Positive!

I guess my Johnny Sunshine reputation is getting the best of me… because for some reason I’ve had a couple responses which generally state “can’t you say something positive for a change!”

 

And my reply is… Yes I can!  Years ago a friend was attempting to categorize my twisted mind and she finally nailed it… she said I was “positive in a negative sort of way”.  I think she got it right on the mark.  And I am positive… I am thankful for every breath I take… if I’m still kicking, I’m a happy camper.

 

First and foremost, the beer/beverage distribution business is a great, great business.  Yeah we all hear how it’s not as fun as it used to be, but it’s still pretty dang fun… and more importantly, pretty dang profitable and stable.

 

And as we all know, people are going to continue to drink beer… and someone is going to have to warehouse, sell, deliver, and merchandise the product to all those licensed accounts out there.  Until we get to the Star Trek world where matter can be transported from here to there, someone is going to have to do this.  In addition, the feds and the states are never going to tire of the tax benefits of beer… thus guaranteeing a fairly firm hand on the movement and sale of this product.  They like their tax dollars and they are not going to let anyone else in on their pot of money.

 

I often hear from wholesalers grousing about critical mass… and I can understand their frustration.  It’s like chasing a moving finish line.  You have to be at least a 1 million case distributor to be sustainable… then 2 million… then 3 million… and it seems on and on it goes.

 

But let’s get real.  I was recently talking to a high market share distributor who does around 5 million cases per year and he was concerned about his future.  My response was it would take the freaking Armageddon to create a situation where a distributor like that wasn’t viable.  In effect the entire beer distribution business would have to almost cease to exist for him to become a non-viable entity.  This is true for almost any distributor of size with an adequate share of the gross profit pool.

 

Heck, there are A LOT of small distributors out there who have no debt (that’s a huge plus) and who are very profitable… and will likely remain so for as far as the eye can see… and many more who might not be that profitable but who are still earning a pretty good living for themselves and their family.  Now might everyone’s profitability decrease?  Sure.  Might this also drive a corresponding decrease in values?  It theoretically should BUT, and this is a big but, these are very strategic assets.  This is a very long-term chess match and passing on almost any move can have serious repercussions down the road… thus it sure looks like values for most distributors will remain high… or counter-intuitively, actually increase in value… especially where there is more than one player for the strategic asset. 

 

I would have thought they would have come down some time ago but I have to admit I underestimated the strategic value each distributor has… imagine a giant and very fluid jigsaw puzzle… each piece is very important and if you pass on one, the odds are you will never get another chance at it… and the entire shape of the puzzle changes, permanently.  If you want to grow, you have to play.  Will there probably be fewer beer distributors tomorrow than there are today?  Sure.  But this is neither good nor bad, it simply is.

 

In addition, beer distributors have an incredible distribution machine whose frequency of contact at licensed retail exceeds any one else… and you already have the cost structure in place to support this.  Maybe, and this is a big maybe, in some markets someone else might match your service to large grocery chains (most likely only bottlers) but in smaller chains, c-stores and on-premise, you are the undisputed king.  This is a tremendous asset which can be leveraged in many directions.  Toss in your investment in fixed assets, technology, working capital, market knowledge, and your people, and you have a freaking astounding and powerful beast.  People are looking in every direction to leverage this asset… and many non-beer manufacturers are opening their eyes to the power of the beer distributor.  Truly who knows what the future holds?

 

Will all of this lead to change?  Of course!! Change is the only constant.  It occurs all the time, whether we know it or like it.  What is the “right” course?  That depends on the future that comes.  If the future goes one direction, a decision you made might make you look like the smartest guy on the planet.  If the future goes in another, the exact same decision will now make you look like a fool.  Don’t lose sleep over it… make you best call and move on. 

 

My goal as a professional advisor is to help analyze these possible changes and ensure you move forward with your eyes wide open… whether it is the sale of your business, a merger, an acquisition, or just a re-organization... ahem, all of which I can help you with ;-)… yes, a shameless plug for my services. 

 

Whether I agree with your decisions is not important… what is important is that you are knowingly making these decisions… not just letting things happen to you… preparing for our best bet of the future before it gets here… and having contingency plans just in case another future shows up on our door steps one day.

 

Also, please remember the nature of what I am paid to do.  When I used to do an analysis of a distributor (I generally don’t any more since I find them of little value for my clients… other than as a tool to sell additional consulting services… that’s a fact, Jack!)… Anyhow, when I’d present my report my client and their management team would often get rather gloomy… “geeze, it seems we aren’t doing anything well”.  I would remind them that they are paying me to come in and focus on problems… on areas of potential improvement.  Therefore the tone of the report is generally negative… not necessarily as a reflection of their performance… but as a reflection of the focus of the effort.  If you’re kicking butt and taking names in area X, I’ll note it.  But the bulk of my discussions will be on where you are getting your butt kick or missing the ball… thus skewing the “negativity” of the report unless you realize this up front.  As I remind them, if you want me to spend a week cruising the market, drinking beer, and telling you how great you are, I’m your man!  But generally people baulk at paying me to do this.  Guess I need to work on my sales skills.

 

The same is somewhat true on my blog.  I paint with a very broad brush and attempt to get people to think about the future… not just next week but next year and 10 years beyond that.  What information do we have today which can help us prepare for whatever comes down the pike?  How can we use this to our advantage, today and tomorrow?  And very importantly, I refuse to let people hide behind happy thoughts like that can’t happen to me or that will never happen.  I don’t know what will or won’t happen… all I can do is be as prepared as is possible for every possible future that might come my way.

 

There… are you happy?  Now can I get back to my curmudgeonly self?  ;-)

A Political Rant

For this post we are going to take a brief detour from the beer and beverage worlds to enter that most daunting of all arenas… politics.  I realize in polite company this is one of the few topics which should be avoided at all costs… and I probably should heed that advice.  But sometimes you need to scream I’m mad as hell and I’m not going to take it anymore… so damn the torpedoes and full speed ahead.  If it costs me a client or two, so be it.

 

And please don’t think I’m cheerleading for either major political party… they both have more than enough faults.  Both political parties use raw partisanship to play us as saps… to blind us to what is really happening.

 

What has brought this rant to a head?  Well last week was the annual NBWA Legislative Conference in DC, our annual suck-up to lesser men and women who have far too much power over all of us.  This is not a knock on Craig and NBWA, I think they do a pretty dang good job and sadly, ANY industry in this country had better be in DC (and every state capital)… if you are not you are a fool.  That’s just the way it is today.  In a regulated industry like ours, the imperative is even greater.

 

But I also spoke to MANY distributors who had to bite their tongues and not tell their esteemed Representatives and Senators how they really felt about what is going on in DC right now… DC currently being the most dangerous place in the world for the well being of the entire planet.  Once again, not a knock on Craig, the purpose of these visits are to accomplish the industry’s goals and Lobbying 101 says stay on target and only on target… but it sure is tough.

 

The entire episode has me disheartened and distressed... and yes, mad as hell.  The weather was beautiful so I walked about and visited many of the awe inspiring memorials.  The words of Lincoln, Jefferson, and Kennedy echoed in my mind.  The horrors of the Holocaust museum brought more than a few tears to my eyes.  The honor, courage, and sacrifice of those represented at Arlington, the Vietnam Wall, Korea, WWI and II memorials brought even more tears… and a questioning of my own worth and gratitude for these others.  That these individuals gave their all for this country, in most cases for the freedom of others shook me to my core.  It is one thing to fight for your own freedom; it is a damned sight different thing to fight and die for another’s freedom. 

 

Yet today we hear from many elected representatives that we must change the very foundation of this country… that we voted for “change” and the old rules don’t apply.  I have yet to understand how going from having 95% of the country employed to having 91.5% of the country employed (the national rate as of 04/03/09), a difference of 3.5%!!, is cause for a remaking of the very fabric of our society.  That we can spend our way to prosperity.  Churchill famously said

 

I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.

Seems fairly obvious to me.  Has any society ever taxed its way to prosperity?  Or regulated its way to prosperity?  Or borrowed its way to prosperity?  If it were possible would there ever be a country which wasn’t prosperous?  Look around.  Look at history.  Is this the case?  Why doesn’t government just send us all a check for a million dollars and then we’d all be rich?  There are realities we confront, whether we like it or not.  Just as science is a constant search for the truth, the focus of our political system should also be the search for the truth, not raw political power.  But politics and government today operate with a truth be damned-type of mindset.  Our very lives are put at risk by this arrogance.  The entire planet is put at risk by this arrogance. If you spend the time and effort you will find that every economic problem we are currently facing has government’s fingerprints all over it.  Let us never forget Tolstoy’s statement:

 

Government is an association of men who do violence to the rest of us.

 

Or that font of wisdom, P.J. O’Rourke...

 

Giving money and power to government is like giving whiskey and car keys to teenage boys

 

The old Soviet Union failed because its economic system failed.  It simply didn’t work because it contradicted reality… and reality is a pesky little thing which bends for no person… regardless of how much one might hope and dream.  China is successful because it has embraced free (er) markets.  Some have suggested that the US is heading towards European-style socialism (with some looking forward to it and some dreading it).  Both miss the mark.  Without the US being the US, European socialism isn’t possible in Europe, let alone the US!

 

Let us take a little stroll down memory lane.  At the end of World War II, the US had a tremendous transfer of wealth to Western Europe.  They have used this to luxury to build social systems which are forecast to be unsustainable in only a number of years… from handouts of hundreds of millions of dollars to unsustainable social welfare in a little over 60 years!  They have allowed this social system to become a wealth consuming beast… Western Europe doesn’t even have money (or desire) to even defend themselves!  They basically have given up having any type of effective military, instead being happy to hide under the protective cover of our military might.  Defense of the country is one of the primary reasons to even have a federal government.  Instead they fund an unsustainable social system as they race towards the abyss.

 

In the 1970’s began another huge transfer of wealth to the oil producing nations, generally in the Middle East.  A lot of these dollars were recycled back to Europe, thus helping them sustain their socialist life style.  Around the same time the Detroit automakers (and the wonderful UAW) were in the process of committing industrial suicide by their construction of some of the worst cars ever produced in this country (along with completely unsustainable union contracts).  Thus began another tremendous transfer of wealth to Japan and later to the Asian Tigers.  At least these countries used this wealth transfer to create successful, modern, and wealthy economies.  And again, a lot of this wealth was recycled back to Europe.  And this oil related transfer continues to this day… again feeding the European social disaster.

 

Take the US economy out of this equation and NONE of this is possible.  If we become European socialists, the whole world-wide equation changes… and not for the better anywhere on the freaking planet.  You probably often hear about how the US consumes a great deal of the world’s energy… what you don’t hear is how much of the world’s wealth is created here.  Medicine, technology… things that make the entire world a better, wealthier, healthier, and more peaceful place. 

 

That’s a fact, Jack.  And what of this thing we call government?  We seem to forget that words matter.  Our emotions, our opinions, our very integration with the world around us are all influenced by words.  But words are just that, words.  No matter how much one might hope, they have no influence on the real physical world.  Yet we often use words as though they represent real, physical things.  Government is such a word.  Both political parties habitually speak of government doing this or that… often in almost mystical terms; much like God intervening in our puny little lives and magically transforming reality.  Government will do this, government will solve that.  But this thing we call government is an abstraction. 

 

In this fashion it is just like a corporation, an artificial entity created by other words.  Lord Haldane’s classic quote regarding corporations says it all:

 

"My Lords, a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation."

 

This also defines the government.  This is not a moral statement but rather a physical fact. Governments don’t do anything since they don’t exist… the people who are either elected or work for governments do these things.  Again a fact.  These people are held to the same natural laws which exist for the rest of us—and they have no higher wisdom or moral authority.  In fact you could make a strong case that far too many of them are moral and intellectual inferiors.  William F. Buckley noted…

 

I'd rather entrust the government of the United States to the first 2,000 people listed in the Boston telephone directory than to the faculty of Harvard University.

 

Well I know beer distributors and I’d rather entrust the government of the United States to ANY 2,000 owners or employees than to the present band of clowns we both elect and hire to operate the government of this great nation.  The next time you read about how government is going to do this or that, replace the word with any company name, like Microsoft and see if you think it still makes sense.

 

This is not to imply that governments or corporations are static, passive things.  Far from it.  Although they are artificial entities, once created they behave much like a living entity.  They seek to sustain themselves, to protect themselves, and to grow.  A for-profit corporation’s existence is limited by profit… how effectively they can convince individuals to freely part with their money.  Government knows no such bounds. 

 

Many years ago, H.L. Mencken noted the reality of government (and sadly our current situation… especially the last quote)…

 

“The government consists of a gang of men exactly like you and me. They have, taking one with another, no special talent for the business of government; they have only a talent for getting and holding office. Their principal device to that end is to search out groups who pant and pine for something they can't get and to promise to give it to them. Nine times out of ten that promise is worth nothing. The tenth time is made good by looting A to satisfy B. In other words, government is a broker in pillage, and every election is sort of an advance auction sale of stolen goods”

 

The legislature, like the executive, has ceased to be even the creature of the people: it is the creature of pressure groups, and most of them, it must be manifest, are of dubious wisdom and even more dubious honesty. Laws are no longer made by a rational process of public discussion; they are made by a process of blackmail and intimidation, and they are executed in the same manner. The typical lawmaker of today is a man wholly devoid of principle—a mere counter in a grotesque and knavish game…. If the right pressure could be applied to him he would be cheerfully in favor of chiropractic, astrology or cannibalism.”

 

"The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary”

 

Unfortunately for us all, our governments and political processes operate as though they are immune from any reality other than pure political power and the proper spin of the masses.  Today we hear how government is going to stimulate the economy.  So this abstraction called government is going to stimulate (whatever that means) another abstraction called the economy.  The economy is the sum of literally billions and billions of individual decisions and transactions made each and every day.  How do a handful of government employees plan to “stimulate” these transactions?  How do they know better than the individuals voluntarily making the transactions?  Hayek called this “The Fatal Conceit”.  It seems government can either:

·                    Take money from someone and give it to someone else, or

·                    Borrow money and give it to someone, or

·                    Print more money and give it to someone

 

I fail to understand how any of these will “stimulate” these billions of transactions which make up the economy.  

 

We seem to be in the process of voluntarily giving away the freedoms (and the wealth and prosperity these freedoms allow to be created) that our forefathers gave their very lives to create and defend.  Will future generations curse us for the damage we did?  Will they wonder how we could so casually abandon the freedoms that exist no where else on the entire planet?  Is our generation going to be the one which proves the following quote…

 

A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship. The average age of the world's greatest civilizations from the beginning of history has been about 200 years. During those 200 years, these nations always progressed through the following sequence:

·         From bondage to spiritual faith;

·         From spiritual faith to great courage;

·         From courage to liberty;

·         From liberty to abundance;

·         From abundance to complacency;

·         From complacency to apathy;

·         From apathy to dependence;

·         From dependence back into bondage

Is our time up?  Our going back to bondage will leave the world aflame.  May God have mercy on our souls is we allow this to pass.  Perhaps some late night, when all the tourists have abandoned the memorials, our political “leaders” of all stripes should sneak down and have a quiet talk with John and Abe and Thomas.  Read what they said… what they did.  Perhaps they should run their hands over the names on the Wall.  Perhaps they should weep at Arlington.  The words are right there:

“Let every nation know, whether it wishes us well or ill, that we shall pay any price - bear any burden - meet any hardship - support any friend - oppose any foe to assure the survival and the success of liberty”

“In the long history of the world, only a few generations have been granted the role of defending freedom.  In the hour of maximum danger I do not shrink from this responsibility, I welcome it”

“… It is for us the living rather to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us--that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion--that we here highly resolve that these dead shall not have died in vain…”

 

“We hold these truths to be self-evident that all men are created equal, that they are endowed by their Creator with certain inalienable rights, among these are life, liberty, and the pursuit of happiness, that to secure these rights governments are instituted among men. We...solemnly publish and declare, that these colonies are and of right ought to be free and independent states...And for the support of this declaration, with a firm reliance on the protection of divine providence, we mutually pledge our lives, our fortunes, and our sacred honor.” 

 

Re-read that last quote.   The individuals who formed this country really did risk those things.  But today, do our political “leaders”, who swear a sacred oath to this country – not to this or that political party – actually believe those words?  Or have those words simply become a suckers game?  Where the creation of and fight for political power is all that matters?  Where sacred honor is laughed at?  Where fortunes aren’t to be risked but rather to be made?  And where only those who believe such outdated sentiments put their lives and honor on the line?  Disheartening indeed.

 

For those who take the path of handing over their very lives to the lesser men and women whose only claim to greatness is their ability to get elected, I leave you with the words of a famous American patriot (and home brewer!) who did put his life, fortune, and sacred honor on the line, Samuel Adams…

If ye love wealth better than liberty, the tranquility of servitude better than the animating contest of freedom, go home from us in peace. We ask not your counsel of arms. Crouch down and lick the hands which feed you. May your chains set lightly upon you, and may posterity forget that ye were our countrymen

I for one will lick no hands.  I will not live in servitude.  I will never forget or forgive those who casually attempt to take my God-given rights away.  Nor should you.

 

Are ABI and MillerCoors Planning to Grab Consolidation Synergies?

I think I’m becoming a shill for Harry - the check IS in the mail, isn’t it Harry? ;-)  This time please have the zeros on the LEFT side of the decimal, OK?  ;-) but he reports on some interesting comments from Mike Mazzoni in his March 5^th edition of Beer Business Daily. 

 

I’ll quote Harry extensively since I think he lays the groundwork for a paradigm changing strategy… the strategy being mine, the ground work his… sorry Harry, you’re “just” a reporter… I’m a wisdom-spouting, idea-generating management consultant ;-)

 

Harry writes: (underlining and bold are mine)

 

…consultant Mike Mazzoni made a compelling case for system consolidation and why the big suppliers [MillerCoors now and ABI later] are going to push hard for it…  His rationale for consolidation?  Of course it's the money…

 

But first, a little perspective.  The ABI and consolidated MillerCoors systems control more than 80% of the U.S. beer volume.  When you add in the unconsolidated Miller/Coors house, that number increases to about 90% of the volume.  A-B distributors and MC consolidated distributors, says Mike, "appear to be at parity" on average case volume sold.  However, and this is big, he says that "while they appear to be at parity, something is going on here."  

 

MEGA-DISTRIBUTOR MATH.  That something is the "mega-distributor phenomenon, and this is really a game-changer," says Mike.  He defines a mega-distributor as a consolidated MillerCoors distributor which has been able to put together a huge high margin portfolio around the MC system.  "It's not the size," says Mike, but rather it's the "high end portfolio that they've been able to cobble together....and they've been able to use that portfolio to fuel their next acquisitions.....because they have significantly higher margins per case....sometimes 20 to 25% higher margins ."  Those mega MC distributors have been able to "reverse A-B distributors' dominance in the marketplace....that they built over the years as they grew toward 50% market share."  Mega-distributors also have "broad territories which allow for seamless execution, which is something A-B used to be able to leverage in the past."    Consequently, the ABI system is "in my view, under attack."

 

In fact, the mega-distributor model works so well, says Mike, that MillerCoors is actually going to distributors which have already consolidated and asking them to sell out to mega-distributors, "which was a surprise to me."  Mike says there are 15 to 20 mega-distributors out there who are either "solidly entrenched in the market or in the evolution stage."  Of those, the top ten control about 10% of the total U.S. beer volume, and they control about 30% more of the gross profit pool than they do of the volume pool.  "That's huge," says Mike.

 

It's huge because those top 10 mega-distributors overlap about 90 to 100 Anheuser-Busch wholesalers.  "I'm not saying that a MillerCoors mega-distributor is better than a corresponding Anheuser-Busch distributor, that's not my intent and it's not the issue.  What I'm talking about is relative scale and competitive capability."  Still, Mike says that "something is out of balance.....there's an awful lot of room for A-B distributors to catch up to be more competitive."  How did this happen?  " The bad timing of A-B's 100% share of mind initiative.  I'm not saying it was bad, but the timing was bad, because it drove the high end products that were growing into the non-AB system."

 

REACH IN.  Okay, so enough history that most of you already know.  Here is where it gets really interesting.  While A-B says it doesn't have a distributor consolidation strategy, Mike says "they should" because the resulting increase in profitability gives ABI the ability to "reach in and improve its own margins.....If I can see it, they can see it."

 

Listen to what Mike is saying… “If I can see it, they can see it.”  Repeat that 3 times.  “gives ABI the ability to "reach in and improve its own margins”… where are they reaching in and improving their own margins???  Your world my dear friends, your world.

 

Harry continues:

 

WE WILL HAVE FEWER DISTRIBUTORS.   "I believe these two companies [AB and MC] will accelerate distributor consolidation," says Mike.  In 3 to 5 years, he predicts that a third of A-B distributors will be sold or merged, and MillerCoors, which is already 70% consolidated, will consolidate another 20%, so that 90% will be consolidated.  So under that scenario we would lose about 150 A-B distributors, lose 200 stand alone Miller and Coors distributors, and get a net gain of only about 50 MillerCoors consolidated houses, because there will be several multiple acquisitions.  As for the all other distributors, they will lose some of the 350 million cases to the AB and MC distributors.

 

...AND THIS IS WHY.  Mike estimates that the entire beer distributor network in the U.S. earns about $2.75 billion in operating profits system-wide.  If Mike could consolidate 30% of the system immediately by snapping his fingers, and achieve 30% synergies on those consolidations, the operating income would go up to about $3.7 billion, or an increase of nearly a billion dollars.  Mike says achieving 30% in synergies is about average for contiguous market consolidations (buying your neighbor).

 

Let me interject here… 30% synergies is pretty dang good for contiguous or horizontal consolidations.  In many situations this is not the case.  To achieve 30% synergies you pretty much have to keep just the street-level sale, delivery, and merchandising operations.  Almost everything else goes.  This is sometimes possible but far from possible in every situation.

 

But what if, instead, you buy your competitor?  In vertical market consolidations you could achieve 50% synergies.  If you get 50% synergies, you get to about $4.2 billion in operating income, or a $1.45 bump in earnings (before interest, taxes, depreciation, or amortization, of course).  That's a lot of money.  "Over a fairly near term, there is the potential to create this kind of value in the system.  This what consolidation is all about," he says.

 

Again let me interject… although the 30% number above is fairly aggressive, the 50% synergies for a vertical (or over-lapping) consolidation is pretty conservative… often this number is closer to 70%... i.e. 70% of the gross profit of the acquired entity can be driven to the bottom-line. 

 

OH, SO IT'S A PROFIT DEAL?  "I just don't believe that the major suppliers are going go let all of that money fall to the bottom line of the distribution system...even if they reach in and only pick up half," ads Mike.  "It would be bad business."  And keep in mind, Mike reminds us, that this is a recurring benefit.  Not a one time payment.  This money is generated "year after year after year."  

 

WOULD THEY DO IT?  Mike asks why wouldn't they do it?   "You gotta ask yourself, what are they [ABI] going to do?  I believe there's a reasonable probability that they will do it.....we haven't seen anything yet, it's too early in the transition, but we do have history."

 

You each should also ask yourself… why wouldn’t they do it?  Would you if you were in their shoes?

 

As Carlos noted in my last post, InBev, now ABI has a culture of dominance and although they haven’t shown this face to their distributors (yet?), they have to their other business “partners”.  Think of 120 day payment terms… that’s 1/3^rd of a year!  You do work for them or provide some good or service and 1/3^rd of a year later they pay you!  Yikes!  ABI says no one should worry since they have a great history of paying their bills… but using that logic why not go to 360 day terms?  Don’t worry, you’ll be paid… just 12 months after you do the work… and of course since the terms you get from your business providers is probably 30 days at most, you’ll have 11 months of unreimbursed bills you have already covered.  Kind of a little hit on the ol’ cash flow.

 

So where do we stand with this and the last post?  Carlos believes AB distributors are "in denial" about AB InBev's ability and desire to transfer wealth to their own majority shareholders, largely at their expense.”  ABI has a "culture of dominance over competitors, employees, suppliers, retailers, and minority shareholders .....They run with a wealth creation agenda for the controlling shareholders..... He ends with "given the ABI that I know, it's not a partnership mentality about growing the pie " but rather a "zero sum game."

 

Then Mike comes along and makes a strong financial case for why consolidation is going to continue and why suppliers are going to try to grab a big chunk of these consolidation synergies… i.e. cold, hard cash.  Double yikes!!  If you believe Carlos and Mike, distributors are in for a little short-end of the stick time… I’d be more graphic but this is a family publication ;-)

 

So what to do?  How about changing YOUR paradigm?  If everyone else is going to try to change the game – and they are whether you like it or not -  you’d be foolish to play it under the old rules.  In fact you are destined to lose if you continue to play by the old rules while everyone else is dramatically changing the entire game.  This is simply strategy 101.

 

Carlos screams sell, and Mike says the day of the mega-distributor is here.  But what if you’re not already a mega-distributor?  What if you simply don’t want to go running towards the exit?

 

You could of course attempt to purchase other wholesalers and become a mega-distributor.  Of course you need willing sellers… and the financial strength to pull it off… not easy on either front.  And the time frame to pull this off is many, many years… probably decades.  Will the external realities you now face allow you this amount of time?  This isn’t 1980.

 

Or you can change the way you view your family business.  If you think of your business as more than solely a family business but also as a financial asset, then the path of mergers is a strong possible solution to the realities Carlos and Mike think you face.  With mergers you can create a mega-distributor in a matter of months… with mergers you could conceivably roll-up an entire state… if you have a couple hold-outs (or folks you don’t want to include), who cares?… once the thing is significantly done, they’ll have no place to go anyhow… sweet!  That’s what strategy can do for (and to!) you.  Thus there is significant value in being a “first-mover” and being involved in the construction of these mega-distributors right from the start.

 

With mergers geared toward the mega-distributor…

 

·                    Huge organizations formed in very little time… months not years in creating incredibly powerful and profitable organizations

·                    Cash-free (and tax free) transactions with little to no debt – putting those $$ synergies in the principal’s pockets rather than making the bank happy for the next 10 year…

·                    No financing limitations to growth… in fact the financial power of the entity only grows with each additional merger partner

·                    No one is forced to leave the industry… instead everyone continues to share in the financial rewards of this industry, for you and your family for generations to come… still perhaps the best financial investment out there

·                    If your suppliers want to operate from a “culture of dominance”, bring it on!  With power comes the ability to protect yourself.  Without it they pick you off one by one… pitting one against another… all while laughing all the way to the bank… and all while permanently changing the distributor’s world until the game is over before you even know it.  Two can play the culture of dominance role… and guess what, if one is going to… the other damn well had better plan to… or just get out the lubricant and ask, “please sir, can I have another” ;-) 

·                    And lastly, set a path to the golden ring, the long ball, the hat trick – you get the idea ;-) … public ownership of distributors… open up the public equity markets for both a source of financing and an exit strategy.  Yes, I can hear you now… but John, the suppliers won’t allow that!  That’s what a freaking paradigm shift is all about… changing the fundamental nature of the equation.  And you do that with power.  And the way you get power is with size and profitability… and the way to quickly build the size and power is through mergers.  Even if this objective is never achieved, the merged mega-distributor strength will still be far superior to any other option.

 

The paradigm is going to change… that is a fairly safe bet.  You can attempt to play by the old rules and most likely lose (and like a chess match, the game might be already over before you even know it has started)… or you can grab the freaking paradigm by the throat and make it yours… or at least go down fighting with an aggressive, dynamic plan rather than a passive, “gee, I hope it all works out for me and my family” plan.  Sometimes an attitude of “just don’t do something, stand there” is a good choice… this sure doesn’t seem to be that time.

 

The choice is yours.  I sure the heck know which one I’d choose. 

 

And as a side note, I’ve heard from a couple of wholesalers who think this whole paradigm shift, culture of domination, merger push, massive consolidation forecast are all just ruses for consultants, analysts and service providers to make money ( but trust me, none of these are the non-preferred wholesalers in unconsolidated Miller Coors markets)…

 

“nah, none of this is happening, it’s all being driving by those greedy outsiders… nothing changing in my world”

 

To which I respond…………………………………………………. Have a nice day.  If you are that out of touch with your own business and the industry in which you operate, there is no reason for me to try to change your mind.  Let’s just go have a beer and we’ll see whose predictions come true… unfortunately (and sadly), I’m afraid I’ll be winning this bet.  I’d truly rather not have any of this happen (it is not in my long-term interest)… but I long ago learned that what I want has very little impact on the reality I face.  Such is life.

Is ABI Planning to Harvest Distributor Profits?

Holy Guacamole!!  And people call me Johnny Sunshine ;-)  Did you hear (or read) what Credit Suisse beverage analyst Carlos Laboy said at Harry’s Beer Business Daily Beer Industry Summit.  I’ve got a real job so I couldn’t attend… sorry Harry, I enjoy drinking on your tab ;-)  Harry summarizes it in his March 3 Beer Business Daily (a must read)

 

Harry writes:

 

“Carlos makes the case that lots of global beverage industry constituencies, from Modelo to Coca-Cola to A-B distributors to even their own minority shareholders, are "in denial" about AB InBev's ability and desire to transfer wealth to their own majority shareholders, largely at their expense.”  All bold and underlining emphasis are mine.  

 

"They challenge every industry preconceived notion with financial logic.  Nothing is sacred to that financial logic."  Carlos says they also have "exceptional strategic vision" as well as having "focusing on one thing at a time".  And he has seen them "conquer every next frontier that they have set upon to conquer" by maintaining a "culture of dominance over competitors, employees, suppliers, retailers, and minority shareholders .....They run with a wealth creation agenda for the controlling shareholders.....

 

Can you say 120 day payment terms for any company that now wants to do business with ABI?  How would you like that to be crammed down your throat?  Talk about a culture of dominance!  Harry continues:

 

WHAT ABOUT DISTRIBUTORS?    What about U.S. beer distributors, are they in denial?   Carlos says, "wake up and smell the coffee.....There are many family firms who have mis-estimated their vulnerability to ABI's wealth creation agenda."   Carlos points to Brazil where ABI went from 1,500 distributors to 200 in four years, though he acknowledged there aren't any franchise laws there, but "they still have transfer pricing on their side," meaning that they can control distributor profitability.  

 

OK folks, now read the next paragraph slowly and truly attempt to answer his challenge:

 

Carlos then looked out into the audience and asked, "What is your conviction that ABI will not challenge the old notion that this distributor system is optimal, that they won't try to transfer distributor wealth to their own shareholders, that they will not impose their dominance culture on you?  What upside are you holding out for?  What options are you pondering."  

 

Let me repeat, holy guacamole!  He might be wrong but there certainly seems to be some hard facts and logic behind his opinion.  Harry continues:

 

Later, during the Q&A when I asked Carlos if he was an A-B wholesaler, would he be a buying or selling, he said immediately, "I'd be selling.  ABI is not coming in to make you richer or add to your profit pool or, in five years, to make your slice of the pie bigger.  We'll be having this conversation five years from now and there will be a slide showing how the distributor slice of the profit pie has shrunk."   When I responded that perhaps ABI may wish to increase the size of the pie thereby giving  distributors more profits, Carlos responded that "given the ABI that I know, it's not a partnership mentality about growing the pie " but rather a "zero sum game."

 

For those who wonder, a zero sum game means a situation in which a gain by one person or side must be matched by a loss by another person or side.  A zero sum game doesn’t have a win-win situation possible.  Now Harry and AB think that ABI would be crazy to go after distributor profitability for a number of reasons… but is this simply whistling past the graveyard?  Or on AB’s part, selling the distributors a bill-of-goods to keep them from turmoil? 

 

Are past strategies an indication of future actions?  They did spend $52 BILLION to purchase A-B, about twice what the market value would have been at the time of closing… I wonder what the value of the old A-B would be in today’s equity markets?... and without a doubt, the A-B wholesaler network is a powerful and valuable asset… but as Carlos notes, why should we simply assume that ABI will view the present wholesaler situation as optimal?  This could be a fatal (or at least a very costly) assumption. 

 

Perhaps InBev paid that much BECAUSE they saw the opportunity to “harvest” an incredible annual stream of revenue from their distributor base.  Perhaps they saw this harvest as providing a tremendous annual revenue stream to help fund their future acquisitions and international growth… their own internal financing source that was just waiting to be put to their own use… all at basically no cost!  I have no idea if this is the situation but one could certainly make the case for it. 

 

And no MillerCoors distributor should be cheering this possibility… if ABI does decide to harvest distributor profitability; MillerCoors would be foolish not to follow, at least to some degree.  I’d let ABI be the spear catcher but I’d be following a few steps behind.

 

As I’ve said for over the past few years, if you are going to sell, now is the time to do it.  And this wasn’t just trying to sell my brokerage services – although Steve and I provide the best value in this industry… yes that is a shameless plug for them ;-)… it was my best consulting advice.

 

Oh but wait, that was in the past… can we do a Superman thing and go back in time?  If you know how, please call me immediately… I’ve got a few things I’d like to do differently ;-)  Unfortunately we are in the here and now and the here and now has more than just a few issues. 

 

Many wholesalers are in the game whether they like it or not.  The financial value and benefits they receive from their distributorship FAR exceeds the benefits they could reap after a sale, paying taxes, and finding other places to invest these funds.  I had a large A-B wholesaler’s CFO call me awhile back to discuss my coming in to spend a day or two discussing whether they should consider selling or not… we spoke a brief period and I told him to save the money – I’m an idiot in that way ;-),.. I seriously doubted if a sale could remotely make financial sense at almost any possible price.  He responded he was glad I said that, his analysis indicated that after paying taxes his boss would have to generate a 25% annual return to even get close to the financial benefits he was presently receiving… and that was before the various proposed increases in taxes!  In addition, this was before AB became ABI.  Perhaps the downside is beginning to outweigh the upside… for this guy I still don’t think so… but Carlos might disagree.  Unless you see Armageddon coming, lots of you are in the game.

 

And of course even if you want to sell (or buy), someone has to get financing… and that is FAR from an easy thing today.  Unless you have incredible relations with your bank, most banks won’t lend out for more than 3 years right now… money is simply too cheap and they don’t want to tie in those rates for any length of time… and there is SO much uncertainty throughout the business world that the banks don’t like doing anything that is remotely long term.  Pretty tough to make an acquisition of any size and have 3 year financing work for you.

 

So, you either race to the door… assuming someone will be there holding it for you at a price you can both live with (and finance) or you’re in the game whether you like it or not.  And what about values?  The public equity markets are down almost 50%.  Housing across the country is down significantly… do you really think values for distributorships haven’t been affected by the financial and economic situation we now confront?

 

So what to do?  Rather than looking out and seeing the adjacent or overlapping wholesaler as your next meal… perhaps you would be wise to look at them as your next partner.  In these financial and economic environments, mergers make a lot of sense.  They are not affected by the decline in values… so what if wholesaler values have dropped 30%?  In a merger it is the relative value that matters… and if each wholesaler’s value declines by 30%, the relative value doesn’t change a bit.  No one is hurt by this decline.

 

Mergers are generally cash-free transactions and are done with pre-tax money and incur little to no debt… we don’t need to worry about financing and excessive bank covenants from folks who are worried about their hides, not yours.  Mergers drive synergies, i.e. cold, hard cash to the bottom-line… sometimes a lot, sometimes less… but always some.  Mergers allow everyone to remain in this industry and reap the long-term benefits that this industry provides… it is still one of the best financial investments one can make.  Mergers allow organizations to upgrade staff across the board… creating a stronger and higher performance company.  Mergers give the new entity much more power when dealing with suppliers (both old and attracting new) and drive better purchasing power across the board.  Mergers create larger organizations where fixed costs are spread over many more cases… providing some economic protection if ABI and MillerCoors do attempt a path of harvesting distributor profitability.  Mergers can ensure that all parties have a piece of an entity which is viable for both the short- and long-term. 

 

Whatever the risks in this industry, you are already shouldering them… whether you know it or not.  Sure you can race for the door – and for some that is probably the best course of action (but you should have already done so!) – or you can do nothing.  This is always an option and it is occasionally even the best choice ;-)  Or you can seriously consider a merger.  In less than a week we can investigate a merger and discover if there are willing players and if it makes sense to continue the process… is a few days of my billing worth investigating a profoundly important corporate move?  I sure think so… but I’m kind of biased in this ;-)

 

Next post, more on consolidation and the $$ that will continue to drive it.

Broken Windows Theory of Management – Part 2

OK, for those with a short memory (like me) you might want to review the previous post on broken windows.  I was discussing how the same processes which drive the theory behind the crime fighting strategy of broken windows can also be applied to the management of your organization.  Although I prefer to take credit for these earth shattering insights ;-), in reality this is of course true since the entire theory is based on social realities… on the very nature of how we interact with other’s and our environment.

Remember that we are powerfully influenced by our surroundings, our immediate context, and the personalities of those around us.  We are acutely sensitive to even the smallest details of everyday life… whether we know it or not.  Rather than being a passive player in how these interactions take place and there influence on your employees, you can consciously work to manage this… you can consciously work to shape then. 

Consider change in your organization as attempting to start an epidemic… perhaps a “positive” epidemic… a positive emotion that jumps from one person to the next until everyone is infected.  You can do it and you can control it.  One of the rules in this is that in order to create one contagious movement, you often have to create many smaller movements first.  Small, tight knit groups have the power to magnify the positive impact… and spread an epidemic of success.  That tight knit group is you and your senior management team.

A recent client complained that his organization has a terrible habit of attempting change but having it just fritter out… nothing seems to stick.  A symptom of broken windows.

 

Another has a culture of a sense of entitlement… a broken window.

 

A culture of old beer, an acceptable amount… a broken window.

 

A culture of minor theft… a broken window. 

 

Solving the same problem over and over… a broken window

 

Not being able to make a decision… a broken window.  Remember that action is always better than inaction… action gives you feedback.  Even if you are going in the absolute wrong direction, you will know it.  Staying in one place and doing nothing tells you nothing since you don’t receive any feedback… and a year from now you will still be in the same place with the same information.

 

Don’t believe that others can drive our behavior?  Let’s think about a simple situation I bet we’ve all been in.  You and your lovely (or handsome) spouse are visiting a new city and are out taking a stroll to see the sites.  Being a fine, upstanding citizen (and in no desire to end your life on the hood of a taxi) when you first walk up to an intersection you wait for the cross walk to come on and then cross.  But then a person comes along… clearly a local yokel… takes a look in both directions and crosses the street against the light.  The light changes and you continue your stroll to the next intersection.  Again you wait for the light but LOTS of people just cruise on through against the light.  How long before you are doing the same thing?   When you’re standing there and 30 people jay walk, pretty soon you’re doing it with the best of them.  In a matter of a few minutes the behavior of total strangers has completely changed your behavior.

 

That was the situation in NYC with jumping turnstiles on the subway.  One person did it, then another and another and pretty soon you had middle aged guys in business suits jumping the turnstiles… remember the Chump School of Management I discussed in previous blogs?... well these folks thought they were chumps for paying the toll… just like sooner or later you think you’re a chump when everyone and their dog is ignoring the cross walk signals… or not taking a case or two out of the warehouse… or showing up on time… or ???

 

As a side note, this power is one of the reasons that your children’s peers are so important.  Modern research states that who your children hang out with will have a much more profound impact on who they grow to be than any impact a parent might have… why?  Because ALL behavior is contagious, it acts like an epidemic… it can be caught.  Help chose your kid’s friends very carefully.

 

Think about it in your business… how you treat your equipment determines how your employees will treat it.  It the warehouse is dirty, do you really think employees will go out of their way to ensure things are kept up?  You send messages and contagious behavior through your actions… make certain they are what you want.

 

Here are some “minor” things that cause incredible damage to your organization:

·                      Having the owner (or anyone) consistently showing up to meetings late… this is not a little issue, it is a huge deal.  You just don’t see it.

·                      Holding employees to different performance demands.

o       a driver who always is late.

o       office staff who gets away with disruptive behavior… as a side note, the office is almost always the least managed of any department.

o       I’d guess most of you have been on some sort of team in your life, a sports team or academic team.  You have a feeling for the dynamics of those that work and those that don’t.  If you want to destroy a team, hold team members to different performance standards.

·                      BS.  I always remind owners and managers that people generally have pretty good BS meters… they can tell when they are being fed a bunch of BS.  One of the most damaging behaviors you can spread is untruthfulness (don’t think you are so slick they won’t know, they will)… and if you do it, it will spread.  Companies violate this one all the time…

o       Quality is job one – yeah, until it costs the company some extra money to live up to it… remember your people are ALWAYS being influenced, whether they know it or not.

o       Customer service is number one – yeah, until it interferes with some senior person’s day

o       The list is long… don’t violate your own stated beliefs… it is FAR better to just never state these supposed beliefs than to state them but violate them when they don’t fit your immediate desires.

 

Take these ideas to heart.  Put them to use today.  Put them to use tomorrow.  Look for broken windows… in every management meeting.  As you walk around the warehouse or office.  And most importantly, when you look in the mirror.  Implement a high performance and high demand company.

 

None of these things are difficult… you just have to do it.  They don’t cost money, in fact in most cases there is not cost.  Focus on those things you can actually control… and ultimately the primary thing is your organization… make it the absolute best you can.

Broken Windows Theory of Management – Part 1

In 1982 a crime fighting strategy called Broken Windows gained prominence when criminologists George Kelling and James Q. Wilson published a lengthy article on the subject in The Atlantic Monthly. Their theory holds that people are more likely to commit crimes in neighborhoods that appear unwatched and uncared for by residents and local authorities. Criminals, Kelling said recently, are ''emboldened by the lack of social control."

The crux of Wilson and Kelling's argument was that perceptions affect reality-that the appearance of disorder begets actual disorder-and that any visual cues that a neighborhood lacks social control can make a neighborhood a breeding ground for serious crime. As Kelling and Wilson put it in The Atlantic, ''one unrepaired broken window is a signal that no one cares, and so breaking more windows costs nothing."

Kelling and Wilson argued the way to fight serious crime was to not to wait for assaults and murders and then catch the bad guys, but to repair the first broken window-literally and metaphorically.  Help stop the bad guys from becoming bad guys in the first place.

Fast forward to 1993 when Rudolph Giuliani was elected Mayor of New York City on a quality of life platform… a platform of reducing crime throughout the city.  If you recall those days in NYC, many were considering the city basically ungovernable and the rampant crime pretty much unsolvable… it was just the way it was.  At that time, NYC was averaging five murders a day (1800-2200 murders a year between 1989 and 1993) and 10,000 felonies a week. Property crimes had essentially been decriminalized, with car owners displaying flags of surrender such as “radio already stolen” to prevent further break-ins. Roving packs of thugs ruled the streets and subways. 

 

Instead Giuliani and his police chiefs implemented this policing strategy, Broken Windows.  It had already been tried with considerable success in Boston and other cities. Guess what?  Rates of both petty and serious crime fell suddenly and significantly and continued to decline for the next 10 years.  On Giuliani's watch, overall violent crime was cut in half and the murder rate went down a stunning 70 percent. 

 

At its base Broken Windows is an epidemic theory of crime… that crime is contagious… it can start with a broken window and spread to an entire community.  Now most of you are probably thinking, what the heck does this broken windows thing have to do with my company?  I knew I should start blocking those dang emails! ;-)

 

Well I believe you can have a Broken Windows Theory of Management.  The same processes are occurring in your company each and every day… not crime but interactions… people choosing to act in this way or that… that behavior, all behaviors, not just crime, are a function of social context.  Broken windows says that what really matters is the small things.  You don’t have to solve all the big problems… often solving the little problems make the big ones disappear… to quickly fix problems when they first occur.

 

Not to get too psychological on you but what we consider our inner states – our emotions, our perceptions, how we feel about this person or this job or this company – are the result of our outer circumstances.  The power of situation and context is much more than most of us imagine.  And we are all tuned much more into personal cues, i.e. how someone behaves, how they act or how tense they are, than contextual cues, i.e. what someone actually says. 

We are powerfully influenced by our surroundings, our immediate context, and the personalities of those around us.  We are acutely sensitive to even the smallest details of everyday life… whether we know it or not… and in about 99.9% of the cases, we don’t know about it… but that doesn’t mean it still isn’t happening.

We often think people are who they are.  That their character is something which is struck in stone.  This isn’t the case.   People can radically transform their beliefs and behavior.

So again, how the heck does this have anything to do with my business?!  It has everything to do with your business… because rather than being a passive player you can consciously work to manage this… you can consciously work to shape it.  Let’s abandon “normal” thinking and leap outside the everyday… think about it, you can start and manage honesty epidemics… productivity epidemics… giving a damn epidemics… things that once they take hold, can and will profoundly alter the very foundation of your business… forever.

Next post – more on Broken Windows

Plenty to go around

Since I’m still in the holiday spirit I thought I’d let my warm and fuzzy side out for another stroll… always a scary and unpredictable affair.  As many have noted, the beer business changed more in 2008 than in the sum of the past 40 years.  Truly a time of astounding change.  Where will it all lead?  Who can really know?  Will things get better or worse?  The most certain answer is yes.

 

But rather than fret over things over which we have no control, why not take a brief respite and think about changing the only person on the planet which we can most assuredly change… ourselves.  I ask you to consider making a liberating leap of faith… a change in your personal and professional way of thinking… a change from a mindset of scarcity to a mindset of there is plenty to go around.  One of the speakers at last year’s NBWA convention spoke of this… and the incredible liberation (and business and personal success it can drive) in making this mental adjustment.

 

A mindset of scarcity sees the world as a very fixed and static place… where one person’s gain must almost by definition be accompanied by another person’s loss.  It is a battleground where there isn’t enough for all and everything must be fought over… with the goal being to “win”, because the alternative is to “lose”.  This mindset will permeate every action and thought one might have… whether managing employees, dealing with other wholesalers and suppliers, or even deciding where to take the family to dinner.  It is an incredibly limiting mindset… and on closer analysis in most situations it is fundamentally flawed and in no way reflects reality.

 

An alternative state of mind is simply stated as “there is plenty to go around”.  The “plenty to go around” mindset (PTGA) sees the world as a dynamic, growing, and bountiful place where one person’s gain can quite often be accompanied by another person’s gain.  A win-win world of possibilities rather than a win-lose world of constant struggle… see, I told you once you let the warm and fuzzy out, you never know where it will lead ;-)

 

In my consulting world, rather than fighting for each job instead I reach out and join hands with my associate Steve Cook, turning one plus one into a net plus four… there is plenty to go around.  Think of the beverage alcohol industry… locked in a mindset of scarcity.  The spirits folk’s primary goal seems to be to raise taxes on the beer folks.  It won’t directly help them but it will hurt the beer folks… thereby indirectly helping spirits… talk about blinded by a scarcity frame of mind!  If you lose then I might gain!!  So very limiting and in the end, so very ineffective and counter-productive.  Think of the change if the beer, wine, and spirits suppliers instead had a mindset of PTGA.  The entire regulatory, taxation and competitive landscape would change overnight… to everyone’s benefit.  But I won’t hold my breath for this one to happen.

 

But how about things we can change… the beer distributors around the country.  Very few wholesalers want to leave this industry.  This is completely understandable on a number of fronts; personal, financial, professional.  And of course everyone is a buyer and no one is a seller… which makes it really difficult to get deals done ;-)   And thus we are stuck in a scarcity mindset… a you must lose for me to win straightjacket.

 

Liberate your mind to a PTGA way of thinking… and a whole world of options materializes.  As a single example, rather than being in a death struggle to outlast the guy(s) you want to purchase… perhaps a win-win course of action is possible.  Many who have taken the leap to PTGA find that mergers are a natural response to this liberation.  EVERYONE makes more money.  EVERYONE’s business becomes stronger, more powerful and more viable… creating business entities which will survive long into the future.  EVERYONE wins… continuing to share in the rewards of this industry for generations to come.  What a concept!

 

Of course the nature of the asset changes in a merger… it is no longer solely “yours”… you now own a piece of a much larger, stronger entity.  This is the leap from scarcity to PTGA… from “I want it all for myself!” to there is plenty to go around... and we all win in the process.  Entire state-wide entities, even multi-state monsters become possibilities… with everyone winning. 

 

Concerned about jobs for your children?  Why?  These merged entities will be much larger… there will be plenty of job opportunities for all… with far superior advancement possibilities for every single employee.  Want to pay your worthless son-in-law a hundred thousand more than he’s worth?  - sorry to all the son-in-laws out there ;-)  Again, no problem… it can be taken care of.  Concerned about your position as an owner?  Don’t.  With a PTGA frame of mind, all of the principals and their desires can be taken care of… often with surprising ease.

 

Even if a merger isn’t in the cards for you… and they are not remotely right for everyone… tremendous value can be gaining with a little PTGA thinking.  It all starts with a little leap of faith… it’s all in your mind… is everything a scarce commodity or is there plenty to go around?  Your answer to this question can and will have a profound impact on your personal and professional life.  It’s just past the holidays and the start of a brand new year… a perfect time to take a leap. 

 

Well enough of that… I’ve better get back to caring for sick kittens and injured song birds… danged warm and fuzzy!  ;-) 

More on Valuations and Mergers

OK, OK, OK… the messenger really does get shot at.  The conflicts between market price and real value to the holder of the asset… and forced (not market driven) consolidation are why mergers are making more and more sense.  Don’t blame me because the actual concept of economic value doesn’t fit into your personal desires.  Here are a few points straight from finance 301 - it is a little more advanced than 101 ;-)

 

·                    The economic market value of a financial asset is set by the marketplace.  This does not mean that this value is the same for every individual on the planet.  If your personal economic value for this asset is below that set by the marketplace, you won’t move on the asset… i.e. it is a “bad” deal.  On the other hand if your personal economic value for this asset is above that set by the marketplace, you just might move on the asset… i.e. it is a “good” deal.

·                    What in statistics are called outliers, do not determine the market value of an asset, the marketplace does that.   The value of an asset does not skyrocket just because for one person on the entire planet that financial asset is worth far more than the market price.  Think about this one again.  Today, far to many values placed on distributorship rights are based on the value to some statistical outlier, not on some general market value. 

·                    Ability to pay is not the same as market value.  These are mistakenly being combined in many people’s thinking.  As an example, think about getting your home appraised (valued).  If the market value is $500K but because of some unique situation for one individual in the entire country, your house can have an economic value of $2M to him, what is the appraised value of your home?  It is $500K. 

·                    Let us use the stock market for publicly traded companies as an example.  Millions of shares of stock may be traded on any single day… some are buyers, some are sellers (it takes two to tango).  In this dynamic process a general value is determined.  For privately held businesses arriving at a value is a much more difficult task since there aren’t all these market-determining transactions.  And of course in this industry, the suppliers retain tremendous power in determining who gets the opportunity to operate a distributorship.  But still, for any proposed sale I can find 50 willing qualified buyers… these buyers will have different visions of the future, different comfort levels regarding risk, and various other variables, but their offer prices will in general be grouped in a certain range… this sets the true market value.  Now if some adjacent or overlapping wholesaler can pay far more than this market value and still make the deal work, this has no influence on the market value of this asset.  These people are statistical outliers who do not set the market price… like the home buyer above.  One person’s situation does not set the market value.  The seller might attempt to sell to this person and set their price accordingly, but this again has no influence on market value.  In fact there is really no financial reason for the prospective purchaser to pay more than market value plus $1… you can make a strong case that there is no need to share ANY potential savings based on synergies to the seller… none.  Of course this assumes a willing seller, something that might not be the case.

·                    Obviously if the economic market value of a financial asset is BELOW the financial value that the present holder of that asset (the owner) receives, then the owner won’t sell the asset.  Right?  The marketplace says it’s worth $20 but the present owner gets $30 worth of value from it… then why would the owner sell?  This is the crux of the issue facing many beer wholesalers.  For MANY wholesalers, this market value is not enough to justify the sale of the asset.  After paying taxes, the remaining dollars simply cannot produce enough economic value to equal what the original asset produced.  Therefore market value is thrown out the window and instead the selling price is attempted to be set by these statistical outliers for who the asset has much more value.  But from the buyer’s perspective, why should they pay many times the market value for the asset just because they can?  And in many situations, the seller is attempting to take ALL of the operating synergies, leaving the buyer with the worst of all worlds… paying far more than the market value but in the end receiving none of these outlier benefits… plus sitting on a pile of debt and having all the financial and operational risk on their shoulders.  But our friendly suppliers want to shrink the number of their wholesalers but market realities aren’t driving this.  That one issue is causing a lot of these problems.  Get wholesaler gross margins to an average 18% and then you’ll see market realities driving these sales and consolidations.  Just kidding guys… put down the gun!

·                    Intersection – Remember your old geometry class where you learned about unions and intersections of sets?  Hold on, this is a good concept… no reason to doze off ;-)  The intersection of 2 sets is the set of elements which are in BOTH sets.  In a venn diagram, imagine 2 circles that overlap each other to some degree… this area of overlap is the intersection of these circles… Now think of these two circles as a buyer and a seller.  Within the buyer’s circle are all those prices which they are willing to pay.  Within the seller’s circle are all those prices which they are willing to sell for.  If these circles don’t overlap, then no deal will get done… there is no intersection of these sets.  But if these circles do overlap, there is potential for a deal to get done… and it is defined by the amount of this overlap.  Now the seller will want to pull the price towards one end of this intersection and the buyer will want to pull the price towards the other end of this intersection, but all successful negotiations MUST by definition occur within this area of overlap.  Once one side leaves this area, a deal cannot be accomplished.  That’s just a mathematical reality.  Far too many brokers seem to have no grasp of this concept.

·                    Since many of these consolidations are not market driven, merging is making more and more sense.  Obviously a merger changes the nature of the financial asset but other than that, there is only upside.  Some compelling reasons to consider a merger include:

o       You “invest” pre-tax money versus after-tax money.

o       Your primary financial asset remains in the beer business, and for at least the foreseeable future, there are few business with the financial rewards and security of this industry.

o       You share in the synergies of these operations, increasing the profitability for everyone involved.  Let me repeat, everyone makes more money.

o       You don’t end up sitting on a pile of debt where only your heirs will see the financial benefits of a purchase… until then it is only the bank that rakes in the additional money (IF you find some one to finance the deal).  Or if you are the seller, you pay a pile of taxes and then try to find another investment with the upside potential of the beer business… good luck.

o       The surviving entity is much larger and thus has more power in pricing, purchasing, negotiations with suppliers and retailers, desirability to suppliers, etc..  In addition, this larger entity will offer your employees much more potential career advancement and can attract higher-caliber employees across the board.  It becomes a virtuous circle where good things only drive even more good things.

o       Your family can still participate fully in the business even though it will no longer be a single “family” business.

o       Since very few want to leave this industry (it does not make market-driven sense), it is a wonderful compromise for all involved.  You might not have 100% of what you want, but you end up with 80% of what you want and that 80% is most likely FAR GREATER than the non-merged 100%.

o       Fighting produces winners and losers, and generally both end up bloodied and battered (and often the “loser” ends up being the “winner” in the long-haul).  Joining hands and coming together only produces winners.  Something to think about over the holiday season.

What is going on with beer values?

What is going on with values for beer brands?  Recently in the trade press there has been an on-going discussion of distributor and brand values.  If you are a regular reader of Harry’s newsletter (and you should be), you have been reading about this.  Let us pull back a little and examine this from a bit more distance.

 

In order to take advantage of these once-in-a life opportunities, many brand transactions are becoming overvalued (sounds like the sub-prime mortgage debacle). In many cases these consolidations (both vertical AND horizontal) should have been done a long time ago for a variety of economic and supply-side reasons… and yes, supplier strategy has changed significantly in the past 15 years and has sadly left many wholesalers holding the bag.  A true statement but the past is just that, past.

 

However, the affected wholesalers always thought they would be able to go out on their terms.  As a result many wholesalers are NOT willing sellers. Because of these extraordinary forced circumstances, the intent of some valuations take on an entirely new meaning.  Those wholesalers who are forced to sell hope there is some retribution in the end.  And the buying wholesaler “gets” to pay a premium to execute the transaction to remain in good graces with the brewery who reassigns significant earning power to them… or at least for the present owner’s heirs since for many of these deals, only the bank is going to be seeing any increase in profitability for the next 15 or so years.

 

It is easy for client support professionals engaged in these activities to lose perspective. The focus can easily move to self-serving.  For the selling wholesaler, turning a Lose proposition into a Win by receiving extraordinary value justifies the transaction. Additionally, the buyer feels pressure to execute the deal at any cost.  As a result the surviving wholesaler is stretched to the financial max by awarding all the economic synergies to the seller through the asset purchase.

 

In addition, IMHO (that’s in my humble opinion for you none texters) my buddy Andy Christon (and Joe) works aggressively to keep prices high.  I might be wrong but it sure seems Andy (and Joe) are almost always on the selling side, and don’t really give a damn about whether the thing actually works for the buyer.  I’m both a financial and operational guy and work with many buyers.  Whether it works for the purchaser is a big deal for me… I’m not happily whistling to the bank at the end of the deal, I’m in the trenches trying to make certain the planned synergies actually come to fruition.

 

Let us take a look at some of the issues happening right now in this wave of brand and wholesaler consolidation:

 

·                    In many cases brokers get in the way of getting a deal done.  Deals are going to arbitration in Colorado and California (and probably more).  They set the seller’s sights on some incredibly high number… generally to get the job… and thus poison the deal.  I’ll bet in almost every situation, the seller is going to regret going to arbitration and will actually lose money off the deal…  What I have found is that in many of these deals, especially with a fairly sophisticated wholesaler, is that they have the in-house expertise to model the deal.  They don’t need someone to give them a “value”, they can calculate that.  They don’t need a broker to find a buyer, the potential buyers are all easily identified… often being just one distributor.  What is needed is a facilitator, someone who works to get a deal done for both sides.

·                    Golden Cases – God bless Andy for being creative in selling his services but please.  ALL cases are golden.  This economic theory is completely flawed on closer examination… regardless of where Andy has sold the concept.  Fixed costs and even many variable costs go up in stair steps.  These steps come in all sizes… from very small to very large.

Think about your business.  You don’t get to purchase one tenth of a truck, you have to buy the whole dang thing.  Same is true with employees.  Thus you get a general stair-step function where volumes (or account base) can increase a certain amount with almost no increased cost, but when a threshold is crossed there is a rather abrupt increase in cost… completely exceeding the relatively small volume which pushed it over the limit… much like the saying of the straw that broke the camel’s back.  Some of these costs can be rather steep, like a new warehouse.  Should those few extra cases which force you into a warehouse expansion be allocated the entire cost of the new warehouse?  If so, you’d be better off decreasing your sales than getting these extra boxes… yes I know, a foolish and quite plainly wrong analysis.

 

So I guess the pitch for a Golden Case is that as they are magical cases which only reside on the flat side of the stair graph.  The riser part of the stair, i.e. the step up in cost, all belong to some other non-magical cases.  The golden case theory seems to make sense from an operational view-point... you can add a certain number of cases and have almost no increase in cost… thus these cases can be very valuable, operationally.  Or from the opposite view-point, if you subtract a certain number of cases you might have almost no decrease in cost.  This is an operational reality which holds true for EVERY CASE YOU SELL.  But from a value view-point, ultimately they all can’t be golden cases… Going back to my crusty MBA finance professor, talk about measuring with a rubber yardstick!  Sometimes these cases are golden and thus have a tremendous multiple, in other times these exact same cases are not golden and thus have a much lower value.  Every freaking case can’t be golden but this flawed analysis sets them up to be. 

 

This golden case analysis takes a relatively simple operational reality which is true in most businesses and attempts to extend it to the value of specific brands.  Heck, Andy is now taking this thinking even further and stating that if the removal of a brand makes the company not viable, the value of those brands is the value of the entire distributorship!  So if 10,000 cases from a certain supplier is keeping my head above water, the true market value of those brands is the value of my entire company?!  Think of this from a supplier perspective… this thinking and attempting to codify it into law may cause tremendous damage to the entire three tier system as incredible values are placed on almost any brand… thus effectively tying the brands to the present distributor forever.  This will not bode well for the three tier system.   

 

·                    Multiple madness… it depends.  Again we are getting a very superficial analysis and not very deep thinking.  Yes you can pay very high multiples for some craft or import brands… why? 

o       Growth potential… many of these brands could see 50% to 100% increases in volume.  So a 5 or even 7 times multiple in actuality is much less.  The infamous pay-back period is much shorter than the GP multiple might imply.  Look at Corona numbers; does any one think they are going back to 20% growth days any time soon?  What does flat to down volumes (and potentially shrinking margins) mean to the multiple?  A freaking lot!  Look at Coors versus Miller.  In many markets one can reasonably expect Coors to increase in volume, perhaps for some time.  Can you say the same about Miller?  Of how about A-B?  If you’re sitting on 70 share, do you really think this is going to increase?  It is much more complicated than pulling some multiple (whether EBITDA or gross profit or whatever) out of some body orifice and saying someone else paid this over there so it must be the value over here.  Wrong.  Yes, as a broker it will get you the contract but in the end it screws up the deal because it never gets done.  Or the broker uses the pie-in-the-sky to get the contract and then actually sells the thing for much less.  The seller might not be too happy but the broker is ;-)  And of course the seller leaves the industry so they won’t be around to bad mouth the broker regardless!  

o       The case volume is relatively low.  You might not want to, but you can pay a high multiple for a small volume.  This is not the case as the volume increases.  If Corona is 10% of a deal is much different than if it is 50% of a deal.  It simply doesn’t work to pay the same multiples, the deal won’t cash flow.  Also from a risk factor, a deal with 50% Corona is MUCH riskier than one with 10%.  It’s just the way it is.    

 

There is more at stake than most realize.  It was the wine industries inability to deal effectively with these needed transitions that led to a weakening of their wholesaler relationships.  We need to reward loyal wholesalers for their commitment while maintaining the ability to improve its business model.  Everyone needs to be part of the solution.  Take the high road to a successful transaction… hire a facilitator who knows all the implications for both the seller and the buyer.  Make your transaction a win/win.  Each transaction is unique and has its own personality and idiosyncrasies… applying general rules and values is not in everyone’s best interest.

 

 

 

 

 

 

 

 

How to improve your operations

OK, you’re not going to merge with anyone or jump on the shared services bandwagon (see the 2 prior posts)… then what?  Or I guess, even if you are ;-)

 

Simple.  Build and operate the most efficient and effective organization you possibly can.  Here are some things to think about in no specific order.

 

·                    The world changes… are you allocating your payroll dollars appropriately?  This is especially true in your sales area.

·                    Flat, flat, flat… the flatter the organization the better.  Look at your management levels… do you really need them all? (sorry folks) What is the ROI on some of these positions?  Do you have $75K level people doing $30K level work?  It is much easier to manage an organization like this but it is rather expensive.

·                    Build better managers.  We promote “doers”, people who are great at getting things done.  You know the type, you give them a task and never think about it again since you know they’ll get it done and get it done right.  Then we make them managers… where they have to accomplish tasks through others.  This is not what has made them stand out… this is not the personality trait where they have excelled… in fact in many ways it is in contradiction to the very things which made them superior.  That’s the reason many managers and supervisors in this industry don’t truly manage at all… they help.  They think their job is to help their people accomplish their daily tasks… and they do so by physically helping them, rather than managing them.  Help your managers make the profound transformation from being a doer to a manager.

·                    If it doesn’t help sell beer, why are you doing it?  Ask yourself this one every single day.

·                    The office is almost always the least (worst?) managed department in a distributorship.  There often aren’t great payroll savings here (but there might be), but a lot of operational friction can start here.  Make certain that all departments work together seamlessly… that each department’s actions support and smoothly integrate with the other departments.  Often one department does something in a certain way, not knowing it causes great headaches for another… and a simple solution is available if they just communicated about it.

·                    Getting too specialized in delivery is generally a poor ROI move.  Specialization in sales has a better chance of generating a positive ROI but be careful here too.  Some wholesalers have gone a little overboard with this… make certain the benefits exceed the costs.

·                    As an analogy, the past years in beer distribution has been like going from playing high school ball to college ball to pro ball.  How many superstars in high school can play at the college level?  A lot get weeded out when everybody else is pretty darn good too.  And how many college stars can play at the pro level?  Look around (and in the mirror)… is your team ready to play at the pro level?  If not, get it in gear and start down a path towards that goal.  Train, coach, help your people get better.  And where this isn’t possible, replace them with someone who can play at the pro level.  These things aren’t moral issues, just the essence of building a winning pro team.  Keep your high school team if you desire… but I’ll bet on the pros every time.  Just as I’ll bet on the beer drinkers when it’s 3^rd and 10 over the milk drinkers (I stole and modified that last one from the old Miller Lite sports quotes)

·                    Get rid of stove-pipe thinking… that’s when each department focuses solely on their own little world and don’t communicate beyond their stove pipe.  Force cross-departmental communication and integration.  Your organization is a system.  No part of a system is more or less important… in fact the concept doesn’t even make sense when thinking of a system.  You need to ensure the entire system works.  A great example of the truth of this system thinking is the space shuttle Challenger… that’s the one which exploded soon after takeoff.  It was a very complication system with a total cost of hundred’s of millions of dollars.  Yet it exploded and killed everyone on board because a five dollar O-ring failed.  Ask those dead astronauts what’s the most important part of a system… they all are.

·                    Don’t be afraid of change… embrace it.  This is a mindset, not just a slogan… help it spread throughout your organization.  Now don’t go mindlessly chasing change but try to wake every day and see the world (and your organization) anew.  If something can be done better, then do it.  One caveat here though… don’t be constantly changing the design of your organization.  Employees don’t handle constant change very well… once every 3 - 5 years or so take a hard look at your organization… the rest of the time spend your efforts improving the execution of what you’ve got.

·                    Look in the mirror – are you consistent?  Nothing destroys management and employee commitment more than owners and senior management flip-flops… or bull****.  Make certain you don’t say one thing but down the road when this creates some conflict, you take the easier path.  And as a side note, from my experiences whether in management or even child rearing, most of the time the easiest choice is the wrong path.  Quite often, tougher choices today make for much better results tomorrow.    

·                    Take good and make it better… take great and make it greater.  Never be satisfied.  Except with your sharp dressed and black hearted management consultant ;-)

Does a duopoly lead to shared services?

I’ve written about shared services before and many are giving them another look.  First let us take a stroll down Economics 101 to discuss why they might now make more sense than in the past.

 

In economics, a market for a good or service is defined by many features and a primary feature is the number of competitors (sometimes thought of as sellers or producers) in that market.  On one end of the continuum is perfect competition… I won’t get into the details but for our thinking just assume a lot of producers, each kind of doing their own thing... so to speak.  At the other end of the continuum is the famous monopoly… only one producer.

 

Beer distributors (and our friendly brewer partners) operate in what is called an oligopoly.  It is a definition of a market’s structure.  In general an oligopoly is a market in which there are only a few producers and each one can influence prices and affect competitors.  That is a key feature of oligopolies… because of their limited number each oligopolist (that’s you!) is aware of the actions of the others. The decisions of one firm influence, and are influenced by the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants. This causes oligopolistic markets and industries to be at the highest risk for collusion… or so the lefties and big government types claim ;-) 

 

From my experiences, generally the opposite is true… competition between sellers in an oligopoly is often quite fierce.  Everybody knows what everybody else is doing… and no one is going to let the other guy get the upper hand.  Look at this industry when wholesalers compete on service… I”LL be here two times a week!  Well then I’LL be here three!  Well then I’LL be here 7!  Well I’LL lose more money coming to see you than my competitors will.  No way… I’LL lose even more.  It is difficult to gain any competitive advantage because the other players are generally aware of what you are doing and if financially and operationally possible, they can match you.  You all have lived this in servicing retailers, pricing, weekend pulls, special events… you name it.

 

But in most markets (and at the major supplier level), this oligopoly has changed or is changing to a special type of oligopoly, a duopoly… a duopoly is a market structure where only two producers exist in one market.  And this change is what might make shared services deserve another look.

 

Think about the differences… imagine a market where one dominate player has 50 share (or higher), the next perhaps 30, and the next the remaining 20 share… and even perhaps a fourth small player.  In this type of market structure, although each player might be aware of what the others are doing, the largest player has significant dominance… think average cases per stop which drive significant profit advantages.  Frequency of service to retail, frequency and quality of delivery, frequency and quality of merchandising, quality of workforce, number of feet on the street, special events, level of compensation, benefits, rolling stock, warehousing, technology … all are areas of potential competitive advantage for the larger player.  Why would this market leader be willing to go to shared services?  They have advantages the other two competitors will have a difficult time matching.  In fact if they are wise, they have advantages the other two competitors have no way of matching.  This was the general market structure in the US for the past few decades.  And I think you have to admit, A-B distributors were laughing all the way to the bank.

 

Of course during this time period shared services might make sense for the two (or three) smaller players, but quite often they are too busy fighting over the crumbs to get along.  In addition, each wanted to purchase the other so why would they join hands and help keep the other guy in business?

 

Fast forward to today… and our duopoly.  Now due to consolidation, the market structure is two dominate competitors.  Yeah the A-B guy might have more market share (but often not by that much), but when you think about the gas that runs the machine – gross profit dollars – often the MillerCoors distributor has a bigger chunk of this pool than his A-B competitor.

 

In our new world, basically anything one can do, the other can match.  They might choose not to, but if they want to they can.  This changes the entire competitive dynamic.  In today’s world, most distributors run quality sales, delivery, merchandising, and warehousing operations.  Although everybody feels their team is better than the other guy’s (and sometimes they are actually right!), generally what each takes to retail is not too different from the competition.

 

In this situation, shared services might just make a heck of a lot more sense than it did a few years back.  Chain power isn’t going to go away and you will be merchandising these stores at a high frequency, whether you like it or not.  Why not a shared merchandising force?  The same could be said for delivery and warehousing.  You can still fight like heck on the street in the sales arena but share services where the competitive reality is at a draw… and is likely to remain so for the foreseeable future.  In these situations there is no competitive impact with shared services since there is no competitive advantage either side holds… the competitive impact of sharing is zero but the cost savings can be rather substantial.  Worth a look?

 

We often bring the past with us in our day-to-day thinking.  Don’t let your past 40 years of competing in a certain way determine the correct way to address the future… the market structure has fundamentally changed and this will drive change.  It might not seem like much, but it truly is a profound change.  Shared services aren’t for everyone but for some, they may deserve a second look.

Even more on mergers

You’ve heard it before and it is true… this industry has experienced more change in the past 12 months than in the decades before.  And the amazing thing is that it is not yet remotely over.  Many of these changes are driving interest in mergers to a record level.  So let’s think a little about mergers…

 

First, those unconsolidated Miller and Coors houses.  Obviously if it were easy in these markets, something would have been done a long time ago.  There is a reason why so many Miller and Coors distributors have consolidated… it simply makes sense.  And along the same lines, there is a reason why they haven’t consolidated in other markets.  Generally the reason is that neither party was willing to “give”… i.e. sell.  The A-B guy has loved this situation and has been laughing all the way to the bank.  Please read that last sentence again.

 

So what to do?  I think there are at least four options:

1.                  Neither side give… basically playing a game of chicken on who ultimately will get the brands.  I’ve never liked the game of chicken because with strong and/or stubborn players, generally both sides lose… see A-B laughing all the way to the bank above.  But it is an option… and one which MillerCoors could live without.

2.                  The Miller distributor purchase the Coors distributor.

3.                  The Coors distributor purchase the Miller distributor… points 2 and 3 make sense but as I mentioned above, it would seem if this were going to voluntarily happen, it would have already occurred.  And yes, if I’m the purchaser I want to purchase all the brands… none of this crap where you try to sell only the major and keep the imports and crafts and compete against me.  Can you say non-compete?  No one worth his salt is going to buy without this clause in the contract… get over it.

4.                  Both parties accepting the reality they face and instead seeking a win-win compromise… and in many cases this compromise is a merger of some sort.

 

Let’s look at the four options in greater detail… I believe the worst course of action for both parties is probably the game of chicken.  Of course you might win, but then again you might lose.  Long, drawn out lawsuits… if you haven’t had the “pleasure” of a business lawsuit you don’t know what you’re missing.  You’ll blow through $50K in the first two weeks… plan for hundreds of thousands in legal fees… the magic million dollar mark is easily attainable.  And again, you may just lose.  This is kind of the nuclear option… to be used as the last resort. 

 

Either party purchasing the other… as I mention, if this were going to happen it probably would have happened some time ago.  But if you want to give this one last shot, you’ll have to make a high offer.  Don’t waste everyone’s time trying to get a low-ball deal now… step to the plate and give the other party a reason to take the money and run.  Of course even with a high offer there is no guarantee the other party will accept it – this is often about far more than money… but you have to start with a premium offer.

 

Or the fourth option… both parties looking in the mirror and saying I want to stay and I can’t force them to leave… therefore what can we do that will work for both of us? Ahhh, that magic word… compromise.  80% of something is much better than 100% of nothing.

 

There is a study on the analysis of strategy with nicely captures the reality these unconsolidated markets face… the Prisoner’s Dilemma… (note much of the following has been liberally plagiarized).  A guy named Tucker first came up with the Prisoners' Dilemma to illustrate the difficulty of analyzing "certain kinds of games." His simple explanation has since given rise to a vast body of literature in subjects as diverse as philosophy, ethics, biology, sociology, political science, economics, and, of course, game theory.  It’s an interesting area for reading.

 

The Prisoner’s Dilemma can be stated as:

Suppose two burglars, Bob and Al, are captured near the scene of a burglary and are given the "third degree" separately by the police. Each has to choose whether or not to confess and implicate the other. If neither man confesses, then both will serve one year on a charge of carrying a concealed weapon. If each confesses and implicates the other, both will go to prison for 10 years. However, if one burglar confesses and implicates the other, and the other burglar does not confess, the one who has collaborated with the police will go free, while the other burglar will go to prison for 20 years on the maximum charge.

The strategies in this case are: confess or don't confess. The payoffs (penalties, actually) are the sentences served. We can express all this compactly in a "payoff table" of a kind that has become pretty standard in game theory. Here is the payoff table for the Prisoners' Dilemma game:

		Al
		confess	don't
Bob	confess	10,10	0,20
	don't	20,0	1,1

 The table is read like this: Each prisoner chooses one of the two strategies. In effect, Al chooses a column and Bob chooses a row. The two numbers in each cell tell the outcomes for the two prisoners when the corresponding pair of strategies is chosen. The number to the left of the comma tells the payoff to the person who chooses the rows (Bob) while the number to the right of the column tells the payoff to the person who chooses the columns (Al). Thus (reading down the first column) if they both confess, each gets 10 years, but if Al confesses and Bob does not, Bob gets 20 and Al goes free.

So: how to solve this game? What strategies are "rational" if both men want to minimize the time they spend in jail? Al might reason as follows: "Two things can happen: Bob can confess or Bob can keep quiet. Suppose Bob confesses. Then I get 20 years if I don't confess, 10 years if I do, so in that case it's best to confess. On the other hand, if Bob doesn't confess, and I don't either, I get a year; but in that case, if I confess I can go free. Either way, it's best if I confess. Therefore, I'll confess."

But Bob can and presumably will reason in the same way -- so that they both confess and go to prison for 10 years each. Yet, if they had acted "irrationally," and kept quiet, they each could have gotten off with one year each.

Now I’m not claiming the unconsolidated Miller and Coors distributors are like criminals, it’s just that the decisions they face are much like Bob and Al.  There are many iterations of this game, going in all directions.  For our Miller Coors distributors, they get to “play” the game many times over… it’s not just a one-time affair.  This makes the benefits (and warm fuzzies) of cooperation even more enticing.  I believe if most of these wholesalers made a decision table like the one above, they would quickly see the tremendous upside to cooperation… and this cooperation is spelled by one word… merger.

 

How this merger might work, protecting each parties interests, various individual’s roles… these and a hundred other things will need to be decided, but they can be decided down the road.  The first step is opening your minds to the concept of merger… and the multi-interactions and ability to communicate which tweaks the strategy of the Prisoner’s Dilemma.  Give me one week and we can quickly determine if a merger will work in your specific situation with your specific merger partner(s).

 

Other types of mergers… There is also a great deal of interest in mergers all across the board… small guys wanting to get bigger… large wanting to get larger… horizontal mergers (overlapping territory)… vertical mergers (adjacent territory)… you name it.  The interest in these types of mergers is in many ways like the Miller Coors discussed above… wholesalers who are analyzing the landscape and expected future operating environment and coming to the conclusion that some degree of compromise is a wise and necessary business decision.

 

If you’re a 1.5M case A-B wholesaler… are you big enough to be long-term sustainable?  Think about the Prisoner’s Dilemma… sure seems a course which should at least be examined would be some sort of compromise where you become long-term sustainable.  Or perhaps you’re a 4M case distributor… is there a possible model where you could become part of a 20M case operation?  With all the benefits and power that come along with it?  The problem always comes back to “that other SOB won’t sell”.  Of course don’t’ forget that you’re the “other SOB” from the other guy’s perspective.  So do we play chicken with all the risks that entails?  Or do we at least consider a win-win compromise which sets all parties up for long-term success and sustainability?  I can tell you a lot of folks are reconsidering their feelings on this subject.  And of course all suppliers LOVE mergers since in the end they get a larger, stronger distributor who is not sitting on a mountain of debt.  They really love that aspect and supplier approvals should not be a concern.  This lack of debt ain’t a bad thing for the merger partners either…

 

If you are interested, I can get us a long way down this road in a week’s time.  I start with confidential one-on-one interviews with all parties… discovering their goals, ideas, objectives, concerns, lines-in-the-sand.  After that we get together as a group and discuss if there is any reason to proceed… our first go / no go decision (and there will be many more in the process).  In this process I don’t represent any one distributor’s interests but I represent ALL distributor’s interests… all of the parties become my client and in effect I work for this yet to be formed entity.  Do we always move forward?  Heck no.  In fact in many cases after the initial interviews it becomes apparent the merger can’t work with the parties various demands.  At least these fundamental conflicts are then out in the open and all parties can decide whether to change their minds… or to let the thing set for now.  Either way, a great deal of value can be gained in a relatively short time.

 

Is a merger for you?  Heck if I know.  But in many cases they make tremendous sense… everyone wins and in situations where no one wants to leave, they may be the only real solution… other than sitting back, playing chicken and just seeing how it all works out in the end.  If it were mine, I wouldn’t willingly choose the chicken option.

The Concept of Value and Other Whimsical Things – Part 3

Continuing our voyage to value, don’t ever forget that purchasing anything in a market economy is basically participating in an auction… whether you are aware of it or not.  This is true whether you are buying or selling a distributorship.  Even the employment market is basically an auction… you desire a certain skill set and the market (the auction) tells you what the price of this skill set is as of today in your specific geographic territory.  It might change tomorrow but as of today this is what it is.  And just like an auction, you can always overpay but other than those few times when you are lucky and can find a deal, you can seldom underpay.  And when do you find a deal?  Generally when there are few, if any who want to purchase what you are bidding on at that time.  Just like buying or selling a distributorship. 

 

Although this is a rather crass example, it is a great illustration of this real-world economics in action.  I had a friend who was in the Army stationed in San Diego in the late ‘60s.  All the Army guys hated it when the Navy made port since it drove up the price of… well let’s say it drove up the price of certain commodities… and even after they left town it would take some time before these prices decreased back to more “normal” market prices.  Economics always works, whether we like it or not – unless of course that thing we call government intervenes but that’s a rant for another day ;-)

 

This factor (no, not the Navy… the reduction in potential purchasers) is one of the concerns of the recent MillerCoors contract… it certainly seems to shrink the pool of potential purchasers substantially… thus potentially lowering values by a significant amount.  Whether this truly comes to fruition is another matter entirely.  There still are A LOT more buyers than sellers and this always puts upward pressure on price (see the Navy above).  Distributorships are fairly unique entities and there really aren’t that many around – i.e. limited supply.  Throw in all the other non-financial considerations I’ve talked about in the beginning of this article and it is difficult to truly decide which directions values might go.  If you are considering selling or buying, my attitude is just get the deal done.  Waiting to see what the future may or may not hold is generally a poor strategy.

 

In fact it seems that in many situations, the ultimate determinate of value is becoming can you get the deal financed?  Even though the buyer and seller might agree to the value, if the deal requires debt, the bankers might hold the cards.  In theory the value of any financial asset is not determined by the means used to purchase it.  An asset doesn’t have value A if it is purchased with no debt, and value B if it is purchased with debt.  A crusty old MBA finance professor used to call this attempting to measure with a rubber yardstick.  But unfortunately the real-world occasionally raises its ugly head and slaps what is “right” about the head and face.  Maybe availability of debt financing doesn’t have anything to do with value, but it certainly does have a lot to do with ability to pay… and if it impacts everyone’s ability to pay, then it must impact ultimate value.

 

Since few folks have ten’s of millions of cash laying around just waiting to be used to purchase a distributorship… and government subsidizes debt… i.e. you can deduct your interest payments, this leverage makes purchasing any significant asset with some degree of debt a wise financial choice.  Therefore the banker does come into the picture… both from a willingness to lend perspective and from a cash-flow perspective.  The banker could give a hoot about whether you overpay for an asset, but they very much want to ensure the cash flow is sufficient to cover the debt payments and not strangle the company it the process… at least until they get all of their money back ;-)

 

In summary, what have we discovered about value?  That it is a very fluid and flexible concept which is impacted by a great many factors… some are hard facts and some (many?) are very soft and emotional.  This isn’t to say that getting a valuation done for your company is a bad idea - come on!  I do them so of course they are a great idea!  ;-)… in fact the valuation is often the first step in many transactions… it’s just that as a “consumer” of this product, a valuation, you should be aware of the nature of the concept of value so as to maximize the value it brings to you.

 

As a completely off the wall side note… I had a crazy finance professor in my MBA studies who taught a class on investments.  And he began the class with asking what seems to be a very simple question… what is the difference between gambling and investing?  Or is there one?  It’s not as clear as one first might think… his belief was that they are a continuum.  Most would agree placing a bet on a complete game of chance is gambling.  But what about a person who studies dog racing and places bets based on the “superior” knowledge.  The prof liked dog racing over horse racing since those pesky jockeys can easily influence a race.

 

One could make the case that because of this superior knowledge, this is closer to investing than gambling.  Just think, instead of telling your wife you’re off to the track or betting on your favorite football team… perhaps perceived as a bad thing, you should be telling her that you are investing… of course a good thing!  ;-)  Reading the sports pages? … Investment prep work.  Weekly poker games? … investment in action!  What does this have to do with value and buying and selling distributorships?  I’ll leave that for you to decide ;-)

 

 

The Concept of Value and Other Whimsical Things – Part 2

Continuing our voyage to the meaning of value, let us think about some of the non-financial aspects of what a distributorship is “worth”.  Although it is fundamentally financial in nature, people’s desires or expectations for a return on investment are different.  Perhaps you want a 15 year pay-back, and I’m happy with 25 years.  Is there a strategic implication for the deal?  Does it ensure my organization’s long-term viability?  Are there operating synergies?  What is it worth to continue the family business your grandfather started?  What is it worth to have your sons and daughters continue in the business?  What is it worth to be the beer-guy in town with all the perks that come with it?  What is it worth to have a nice cash-flow friendly business?  What value – both economic and non-economic - does my family (and extended family and friends) take from the business and is it remotely possible to replace this value?

 

I’ve been told more than once, “John, I’ve got more wealth than I could ever spend.  My family is set for generations regardless of what happens to this distributorship.  I’m not leaving no matter what.  If it goes down in flames I’m still OK.”  Kind of hard to argue with that!  ;-)  I’ve encountered this thinking when purchasing too… “yeah I know I’m over-paying but I’ve got my reasons (son or daughter or long-term viability or whatever) and my family and I are protected even if it goes south.”  I like those folks when I’m on the selling side!  ;-)  The price doesn’t matter to them as much as getting the deal done… the infamous; no one will remember what we paid 30 years from now.  And there is some truth to that statement… unless of course the debt payments bring the entire thing crashing down.  In that case no one will remember what you paid since you will be long gone and someone else will own the dang thing.

 

I was recently on a project (attempting to complete a complicated merger) and the owner was somewhat disparaging one of the other parties, as in it’s all about the money to him… nothing else.  My response to this was “great!  I can deal with money-driven issues… those are relatively easy.  It’s the emotional side which causes the problems.  The emotional side is where logic is thrown out the window… and that makes the situation much more difficult to navigate to a successful win-win conclusion.”  And the emotional side can and does have a tremendous impact on this thing we call value.  This is true from both a buyer and seller’s perspective.

 

“Value” is also impacted by the nature of the marketplace.  Valuing a pure financial object, say a share of Cisco common stock, is relatively easy since the market does it for you.  Millions of shares of stock trading daily in millions of transactions will quickly determine the value.  The marketplace will speak and set the value… regardless of any individual’s wants or desires.

 

When you have an asset which is traded much less frequently, arriving at a value is much more difficult.  Some of you may have experienced this in trying to get rid of an old warehouse… it’s difficult to arrive at an appraised value when nothing similar has been sold in the area in the last 10 years.  Obviously beer distributorships fall into this second category.  Even though the pace of deals has increased to a record level… record pace is still very few for decisively determining “value”.  Throw in differences in state laws (and market share/relative strength, demographics, population trends, etc.) and the very few get even smaller.

 

Uniqueness of an asset also makes valuing much more difficult.  A handful of territories around the country are true gems… there are few other places which present the demographic mix, population growth, etc. that these gems do.  How does this impact value?  I’ve known people whose primary (in some cases sole) consideration when looking to purchase a distributorship is do they want to live there.  Once again, ‘I’ve got more money than I can ever spend and my quality of life is the most important factor”.  I can’t argue with it. 

 

And of course the ultimate determinate of value is what someone is willing to pay for it.  That’s where the rubber meets the road.  You might think your house is worth $1M, but if no one will pay more than $500K for it, then that is its value in the market today… regardless of yours or my wishes.  And one of the primary factors of this (in many cases the only factor) is how many potential purchasers are in the market.  Is there only one person in the entire world which makes sense to purchase this asset?  If so, the price might be less than desired… of course then again, how bad does this party want the asset?  How important is it to them?  It could lead to a stupendous “value”… especially if the potential seller does not have to sell the asset.   Let me emphasize again, just because there is only one buyer does not automatically mean the value will be low… it might be or it might not be.  Or there may be many people interested… and perhaps the direction the deal goes sets the chess board for years to come… if not forever.  In that case you are almost assuredly looking at a high value.

 

I’ve been involved in 2 recent Miller deals.  In one the price was just over one times 12 months gross profit (happily I was on the buying side of this one) and in the other the price was just under five times gross profit (and happily again, I was on the selling side of that one).  Since I hate politicians who claim credit when things go well (generally through no action of theirs) and then blame others when things go bad (generally because of their actions), I won’t claim any great credit in either of these deals.  In each situation the amount paid was right for those specific circumstances… for both parties.  As I joke with my clients, I won’t take any credit… all I ask them to do is to look at their financials or business situation and compare pre-Conlin with post-Conlin… there is always an amazing correlation to good things ;-)  And with that bit of self-promotion, I’ll end this post until the next… a continued discussion of value.

The Concept of Value and Other Whimsical Things – Part 1

The concept of value is a topic for which many trees have given their all, yet there remains much confusion.  First let’s rid ourselves of the fantasy that there really is some fixed, determined value for anything… there is no value god who magically comes along and determines the proper value for this and that… although some financial consultants will try to tell you (and sell you) something different ;-)  Neither they, nor even I, have the keys to this secret vault of value.

 

Rather the concept of value is very fluid, influenced by many factors.  In most situations diamonds have a much higher value than water… but if you are dying of thirst this value equation might just change dramatically.  Although that is an extreme example, it makes the point that many factors determine the value of anything and these factors can change dramatically… often in a relatively short period of time.

 

The value of any financial asset is the sum of expected future cash flows discounted back to a present value.  This is a relatively easy calculation for a pure financial asset, like a CD or bond or some such instrument… although it is still open to significant subjective inputs.  What will be the expected inflation rate over the respective period of time?  Government T-bills are often used as a proxy for this number.  These are used since they are assumed to be risk-free… although as the recent financial melt down shows, even the concept of risk-free is more subjective than many had thought.  And this aspect, the relative risk factor is the other part of the discount rate… discount rate = expected inflation rate plus a risk factor… i.e. if the expected inflation rate is 3% and the risk-factor is 5%, the discount rate is 8%.  Using a relatively simple formula, you use this discount rate to determine the present value of these future cash flows… the process is kind of like calculating reverse inflation.

 

But alas, again there is no risk god who magically determines the correct risk factor… and differences in this risk factor will have a significant impact on the present value of these cash flows.  And using this same process for non-pure financial assets, you usually must also determine a terminal value.  Conceptually these future cash flows go on in perpetuity but rather than attempting to calculate future cash flows years and years out, some terminal value is place on the asset and this value is discounted back to a present value.  Of course what this terminal value should be is also open to considerable flexibility.

 

There are of course other proxies for discounted cash flow… but fundamentally they all are based on the same premise… that the economic value is based on discounted cash flows… kind of even makes sense if you think about it.

 

Some of these proxies might be some multiple of gross profit dollars, i.e. this is worth 4.2 times trailing 12 months gross profit.  The advantage of this proxy is that the multiple is easily transferred from one distributor to another… you all have gross profit dollars and multiplying it by some number isn’t too dang tough ;-)  That’s the reason I like it.  This proxy is good for just general conversation  (is it a “high” deal or a “low deal) and for sellers.  Sellers don’t give a hoot about how the buyer is going to make it work, as long as they get their money.  Buyers on the other hand have to make certain the deal actually works in the real world and thus they might make offers of X time 12 months gross profit, but that’s not how they arrived at the value.

 

EBITDA (earnings before interest, taxes, depreciation, and amortization) is also used to measure worth.  This proxy is commonly used to compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.  But there is no absolute standard on what items companies can include in EBITDA, thus it is not completely transferable from one company to the next, or even for the same company from one financial period to the next.

 

As many finance wizards will warn, EBITDA does not represent cash earnings… it is a tool to measure profitability, but not cash flow. EBITDA ignores the cash required to fund working capital and the replacement of capital equipment… and in distributorships these may or may not be significant.  But this method is still a useful proxy for value, as in it is worth 14 times EBITDA.

 

EBIT (earnings before interest and taxes, also called operating profit) is also used.  It too eliminates the effects of financing and accounting decisions but includes the non-cash items of depreciation and amortization.  There are many other EB…’s that can also be used, each with its own strengths and weaknesses.

 

You could even just look at payback period… i.e. how long will it be before I get my dang money back?  This of course ignores the time value of money and the timing of “getting my money back”.  It makes a big difference if you get 90% of your money back from an investment in the first year… or if you get 90% of your money back in year 15.  But it is sometimes useful to think in a payback period fashion, but only for broad brush stroke type discussions.

 

Heck, some folks even talk value as X dollars per case.  But again, this might work from a seller’s perspective, but the buyer needs to build the operational and financial model prior to “backing into” a number like this.  Regardless of how you choose to look at it, the value of a financial asset is still going to be determined by future cash flows discounted back to a present value.

 

But of course this is only the beginning.  There are many other factors which influence value.  My vision of the future and yours might be very different.  I might forecast tremendous population growth, you a flat market.  I might envision margins going up, you see them falling rapidly.  I might envision a strengthening of my state’s franchise laws, you might see them crumbling in the next few years.  I might expect market share growth, you a shrinking market share.  In fact we might disagree on every internal and external factor which can influence a distributorship in a respective territory.  This will have a tremendous impact on the value we assign to this distributor and its distribution rights.

 

And of course distributorships are not just financial assets, they are much more than that.  But since I have been told repeatedly that I am long-winded (and this from friends!), you’ll have to wait for the next post to read more on non-financial aspects of distributor value.

Bringing a knife to a gun fight

Well the convention in San Fran was a good one.  Pretty darn good attendance for a non-trade show year… the fear and concern were evident throughout the place.  So with that in mind, here is a little rough love… er, I mean tough love ;-)   Please don’t shoot the messenger.  I hate the sight of blood… especially my blood.

 

Since it seems everyone and his dog asked me about the MillerCoors contract, here’s my quick read of the situation.  You may have heard that old joke which ends with “I hate it when someone brings a knife to a gun fight”.  I hate to break the news to you but in some ways it is more like you are bringing a plastic spoon to a gun fight… OK, maybe you’ve got a plastic spork ;-)  Had to throw that in there, gotta love the spork.

 

So, being the black hearted mercenary consultant that I am, here’s what would happen if I were on the other side of the table… and thank goodness for all that I’m not.  First, of course it depends on which state you’re in.  State law is almost always going to trump those parts of the contract which are in conflict with the law.  This doesn’t impact the remainder of this contract, it’s just that generally state law wins… except perhaps in the arbitration versus federal or state court aspect.  But the bad news here is that this breaks against the wholesaler and perhaps sticks them with arbitration regardless of the state franchise statute.

 

Next, please get rid of the silly (but quaint) notion of fairness.  Of course we might talk this way but in the end why would I be concerned with fairness?  The whole concept of fair is extremely situational.  What is fair always depends on which side of the issue you are on… fair to one party might be considered getting seriously screwed by the other.  Thus, fair is determined by power and the willingness to use it… please see the plastic spoon example above.  You A-B folks will want to keep this in mind as A-B InBev begins to implement their changes.  If nothing else it prepares you for unhappy events.  Ignore the happy talk; this is ultimately about business and nothing else.

 

Some were surprised MillerCoors took the parts of their separate contracts which were more in their favor and built the contract around them.  Why would this surprise anyone?  And if I were InBev, I would be following right down the same path.  For any wholesaler who gets an attitude and chooses not to aggressively represent my products, I’d have one word… good-bye… or is that two words?

 

Obviously MillerCoors plans to take a much more active role in consolidation of “their” network.  From their perspective it makes absolute sense.  And it gives them the ability to toss some pretty nice bones to those wholesalers who earn their good graces.  Power and the willingness to use it.  I’m guessing the A-B folks will be learning this lesson too, real soon… actually I think they may already know it pretty well ;-)

 

Now a lot of folks talk about not signing the contract… again you are bringing a plastic spoon to a gun fight.  To those who refuse to sign I’d have a very simple response.  Either sign the contract and get over it and move on, or sell your business… we’ll even bring you a willing purchaser.  Two simple choices.  I just don’t see how your plastic spoon is going to win this one.  This doesn’t mean don’t fight… I’m cheering for you but betting against you. 

 

And don’t ignore the economic statement of what willing purchasers means.  I’ve had wholesalers explain that the supplier(s) can’t do this or that because it would put them out of business.  My initial black-hearted response is so what?  What does that have to do with anything (other than of course your individual business).  From a strictly economic perspective, the marketplace is telling you that this industry is still very desirable, regardless of your wants and desires.  There are still a lot more buyers than sellers… this is an economic statement.  When there are no buyers or only buyers at a steep discount, then and only then will whining about your profitability be economically justified.  Sorry, but from a solely financial viewpoint, that’s the way it is.  For those in doubt, check out the last few weeks from Wall Street… that’s what it looks like when the markets make a bad economic statement against a company or industry.

 

As I was sucking down free beer in the MillerCoors hospitality reception, I talked to many wholesalers about the recently concluded MillerCoors meeting… how it went, what was said, the general feel.  Obviously just a little tension in air, on both sides of the podium… some tap dancing.  To be expected.  But I do tip my hat to the MillerCoors folks.  The top dogs made themselves available for the entire reception… no running and hiding… a touch of class.

 

If I ran the meeting here’s how it would have went…

 

“There has been a fair amount of grumbling about the recent MillerCoors contract.  We believe it is both fair and equitable.  We have no intention of changing anything in it.  For those who don’t believe they can sign it, we hold no animosity.  For those who have no intention of signing it, please form a line to my right and we will gladly start the process of finding you buyers for your businesses.  Let us part as friends.  That, or sign the contract and get over it.  We look forward to working with our remaining distribution partners today, tomorrow and far into the future… now let’s get on with the meeting and selling beer…”

 

Sorry guys and gals, I’m on your side and everyday I work to make wholesalers stronger, better, and more successful.  I don’t just write this wisdom (this is just marketing), my real job is being the management consultant to the beer distribution industry. 

 

Remember I started this post talking about a little tough love… and I hope I’m wrong about everything I just wrote, but this black hearted mercenary doesn’t think so.  I just don’t think your plastic spoon in this gun fight is going to be enough.  Power and the willingness to use it.  And for you A-B folks, I’d have to guess the same prospects are racing your way.  And they call me Johnny Sunshine ;-) 

 

Oh but wait.  As my regular readers know, I am a strong believer in the power of connectivity… the amazing transformation which can occur by the simple act of reaching out and joining hands… from many, one… E Pluribus Unum.  Can these single plastic spoons come together and form an army of spoons?  Together can the plastic spoon battalions win the gun fight?  Can the spoons stick together or will short-term interests turn spoon against spoon?  Or will the individual spoons sit on the sidelines and just be glad (for now) it’s happening to someone else and not them?  The entire power situation can profoundly change by using this collective power… power and the willingness to use it… now it’s up to you.