Post Pandemic Trends for AHTD Members
By Frank Hurtte | River Heights Consulting
As we stumble our way out of the worst of the pandemic, automation distributors face several new challenges. For example, by early to mid-summer, most realized the delivery issues associated with getting products to their customers were not destined to be short-lived. This could not have come at a worse time. Further, both distributors and their supply partners had felt the impact of other pressure points on the business. To better understand these phenomena, River Heights Consulting launched a major research project to apply some metrics to the changes.
The information below is an executive summary of what we have discovered.
Major shortage of products continues
Upon launching into this situation, we wrongly assumed most delivery issues would be tied to a global shortage of electronic components as the automation industry competed with consumer-based products for electronic chips. As we pushed into adjoining industries (Electrical, Fluid Power, and Power Transmission), it became clear the shortages were broad-based and included outages in the plastics, specialty gearing, steel components, and a wide array of other products. Quite frankly, we discovered virtually no area unscathed by the supply-chain issues.
We expected to hear product issues in countries hardest hit by the pandemic, but once again, we were incorrect. Proving the supply chain for nearly everything was truly global, even North American manufacturers experienced major issues with supplying products.
Metrics on the supply-chain issues
We asked distributors to rate their experience with supply-chain and delivery issues on a scale of one to five with one being terrible and five being normal (2019 levels). The highest rating reported was two and a half with an average rating falling somewhere between one and two.
For distributors, this means a great deal of time is currently spent expediting and scouring the marketplace to locate critical parts for customers. Here, AHTD distributors have an advantage over their less technically oriented counterparts in other industries. Many distributors told us they were investing time to work with customers to engineer alternative “workarounds” for their customers. The majority were focusing these efforts on existing customers rather than using the approach to attract new clients.
Most automation distributors were not switching suppliers
Unlike reports from the electrical industry, where a meaningful percentage of distributors have switched or are contemplating switching suppliers, automation distributors appear to be holding the course with existing suppliers.
Most of the electrical distributors we talked to were contemplating switching commodity-type products and expressed feeling comfortable with the one-to-one equivalency of the products. For the most part, this process does not cross well into our industry.
Distributor backlogs continue to grow
Distributors report backlogs have reached a record high. Most report a good “normal” backlog of 60 days. At this point, the average backlog is approaching double this, and, in a few instances, distributors see backlogs at the 150-day mark.
Distributors have increased their inventories to serve customers
Despite some very long and unpredictable lead times and major league backlogs, distributors report their inventory levels as being well ahead of pre-pandemic levels. Based on distributor comments, we estimate the average distributor has escalated their stock levels by 40 percent with 10 percent of the distributors telling us they have doubled their inventories. Two distributors reported inventory levels at triple their normal levels.
Some of this is tied to holding materials where the customer has asked the distributor to ship the order once complete. This makes sense. However, the distributors with the largest increase of stock on hand tell us they are holding inventory to support specific customer needs.
Potential issues tied to the supply-chain mess
Aside from the issues tied to customer service and customer satisfaction, we see two major problems looming on the horizon:
• Customer order cancelations - Reports from a small sample of OEMs and panel builders in our industry indicate our customers are building their own inventory whenever possible. Most are also placing anticipatory orders to lock in future delivery dates. When asked what happens if the product becomes available and they don’t need it, most believe they will be able to leverage their position with their current distributor and not take delivery.
• Bloated distributor inventories cause supply chain overshoot – When manufacturer delivery dates improve, distributors will begin burning off excess inventory with the idea of returning to a “normal” level. This could create issues for our supply partners. Just about the time they adjust their manufacturing for the new higher demand, business will slow down from the distributors. This will create an overshoot, which could impact factory efficiencies. Since most distributors do a poor job of forecasting and few report future opportunities to their suppliers, this overshoot has the potential to create a new set of margin-reducing price wars.
Price increases are flowing like water out of a hose
Many of the price increases being passed along can be directly tied to supply chain issues. One manufacturer with global manufacturing facilities reported the cost of obtaining materials from Asia has increased by over 400 percent. Similar increases are also evident for products shipping from Europe.
Once these products land in North America, the manufacturers experience even more escalating costs tied to shipping to and from their facilities. For those suppliers who provide prepaid freight, the costs are even higher.
On top of these increases come some of the naturally escalating prices of raw materials. One manufacturer indicated that some of the “chips” have increased by as much as 20 times the pre-Covid cost. Similarly, the cost of plastics and various other metals have also seen much upward volatility.
What do the price increases look like?
We asked distributors how many price increases they have seen from their supply partners in the last 12 months. The majority of suppliers have switched from a single (and usually October-November timed) price increase to two per year with nearly 35 percent of the suppliers issuing more than two.
The average 12-month rolling average for these price increases falls between 9.5 and 11 percent.
Labor market cost increases
We asked distributors if they had hired any new people “since the end of COVID” which we defined as the day vaccinations were offered in January 2021. All but a couple of distributors have added people.
We asked for a breakdown of people, keying in on entry-level people to offset the difference between hiring a new worker and attracting one of your competitor’s key workers, which could influence the compensation level.
We asked the distributor to contrast the starting compensation of the new hire against a similar person hired in 2019. Removing the anomalies tied to distributors operating in very high cost of living cities – New York, Boston, San Francisco, and Los Angeles, here’s what we found:
Extending this further, all the distributors we spoke with indicate they have already or soon will be boosting the comp levels to others already on staff to match this new and higher compensation rate.
Based on these reports, we estimate the typical AHTD Distributor will see an escalation of people costs in the range of 11-12 percent. This presents a new squeeze for distributors.
Comparisons against AHTD PAR Report
Using the numbers from the 2021 AHTD Financial Benchmarking Dashboard, which reflects costs during calendar 2020, we see some critical, and perhaps alarming, information.
For Automation Distributors, people really are their largest investment. The typical AHTD distributor spends 67.3 percent of their gross margin dollars on people (salaries, bonuses, benefits, and payroll taxes). This number tracks a full 10 points higher than NAED distributors and reflects the nature of the kind of businesses we operate. Knowledge-based solution selling in a technical environment is expensive contrasted to a more commodity and part-oriented business.
Even if distributors ensure that all price increases are passed along to customers, there will be an erosion of profitability. Our reports from the field point to many situations where, for one reason or another, the distributor has not been able to do as such. Since increases in the cost of labor stand to exceed the immediate price increases, even in the case of full pass-through, there could still be profitability issues.
Now is the time for distributors to look for productivity gains.
A closing miscellany of thoughts
Distributors face many other challenges:
While at first glance all these points sound like good old-fashioned bad news, there is a solid silver lining to be found. If the AHTD business model is anything, it is flexible and quickly adjusts to changes in our environment. I am optimistic AHTD distributors will continue to find new and better ways to fill customer needs. Hopefully, this data will allow you to be even more nimble and quick to meet the challenges.
As we stumble our way out of the worst of the pandemic, automation distributors face several new challenges. For example, by early to mid-summer, most realized the delivery issues associated with getting products to their customers were not destined to be short-lived. This could not have come at a worse time. Further, both distributors and their supply partners had felt the impact of other pressure points on the business. To better understand these phenomena, River Heights Consulting launched a major research project to apply some metrics to the changes.
The information below is an executive summary of what we have discovered.
Major shortage of products continues
Upon launching into this situation, we wrongly assumed most delivery issues would be tied to a global shortage of electronic components as the automation industry competed with consumer-based products for electronic chips. As we pushed into adjoining industries (Electrical, Fluid Power, and Power Transmission), it became clear the shortages were broad-based and included outages in the plastics, specialty gearing, steel components, and a wide array of other products. Quite frankly, we discovered virtually no area unscathed by the supply-chain issues.
We expected to hear product issues in countries hardest hit by the pandemic, but once again, we were incorrect. Proving the supply chain for nearly everything was truly global, even North American manufacturers experienced major issues with supplying products.
Metrics on the supply-chain issues
We asked distributors to rate their experience with supply-chain and delivery issues on a scale of one to five with one being terrible and five being normal (2019 levels). The highest rating reported was two and a half with an average rating falling somewhere between one and two.
For distributors, this means a great deal of time is currently spent expediting and scouring the marketplace to locate critical parts for customers. Here, AHTD distributors have an advantage over their less technically oriented counterparts in other industries. Many distributors told us they were investing time to work with customers to engineer alternative “workarounds” for their customers. The majority were focusing these efforts on existing customers rather than using the approach to attract new clients.
Most automation distributors were not switching suppliers
Unlike reports from the electrical industry, where a meaningful percentage of distributors have switched or are contemplating switching suppliers, automation distributors appear to be holding the course with existing suppliers.
Most of the electrical distributors we talked to were contemplating switching commodity-type products and expressed feeling comfortable with the one-to-one equivalency of the products. For the most part, this process does not cross well into our industry.
Distributor backlogs continue to grow
Distributors report backlogs have reached a record high. Most report a good “normal” backlog of 60 days. At this point, the average backlog is approaching double this, and, in a few instances, distributors see backlogs at the 150-day mark.
Distributors have increased their inventories to serve customers
Despite some very long and unpredictable lead times and major league backlogs, distributors report their inventory levels as being well ahead of pre-pandemic levels. Based on distributor comments, we estimate the average distributor has escalated their stock levels by 40 percent with 10 percent of the distributors telling us they have doubled their inventories. Two distributors reported inventory levels at triple their normal levels.
Some of this is tied to holding materials where the customer has asked the distributor to ship the order once complete. This makes sense. However, the distributors with the largest increase of stock on hand tell us they are holding inventory to support specific customer needs.
Potential issues tied to the supply-chain mess
Aside from the issues tied to customer service and customer satisfaction, we see two major problems looming on the horizon:
• Customer order cancelations - Reports from a small sample of OEMs and panel builders in our industry indicate our customers are building their own inventory whenever possible. Most are also placing anticipatory orders to lock in future delivery dates. When asked what happens if the product becomes available and they don’t need it, most believe they will be able to leverage their position with their current distributor and not take delivery.
• Bloated distributor inventories cause supply chain overshoot – When manufacturer delivery dates improve, distributors will begin burning off excess inventory with the idea of returning to a “normal” level. This could create issues for our supply partners. Just about the time they adjust their manufacturing for the new higher demand, business will slow down from the distributors. This will create an overshoot, which could impact factory efficiencies. Since most distributors do a poor job of forecasting and few report future opportunities to their suppliers, this overshoot has the potential to create a new set of margin-reducing price wars.
Price increases are flowing like water out of a hose
Many of the price increases being passed along can be directly tied to supply chain issues. One manufacturer with global manufacturing facilities reported the cost of obtaining materials from Asia has increased by over 400 percent. Similar increases are also evident for products shipping from Europe.
Once these products land in North America, the manufacturers experience even more escalating costs tied to shipping to and from their facilities. For those suppliers who provide prepaid freight, the costs are even higher.
On top of these increases come some of the naturally escalating prices of raw materials. One manufacturer indicated that some of the “chips” have increased by as much as 20 times the pre-Covid cost. Similarly, the cost of plastics and various other metals have also seen much upward volatility.
What do the price increases look like?
We asked distributors how many price increases they have seen from their supply partners in the last 12 months. The majority of suppliers have switched from a single (and usually October-November timed) price increase to two per year with nearly 35 percent of the suppliers issuing more than two.
The average 12-month rolling average for these price increases falls between 9.5 and 11 percent.
Labor market cost increases
We asked distributors if they had hired any new people “since the end of COVID” which we defined as the day vaccinations were offered in January 2021. All but a couple of distributors have added people.
We asked for a breakdown of people, keying in on entry-level people to offset the difference between hiring a new worker and attracting one of your competitor’s key workers, which could influence the compensation level.
We asked the distributor to contrast the starting compensation of the new hire against a similar person hired in 2019. Removing the anomalies tied to distributors operating in very high cost of living cities – New York, Boston, San Francisco, and Los Angeles, here’s what we found:
| Position | 2019 compensation | 2021 compensation |
|---|---|---|
| Warehouse, Shipping and Receiving people | $14-15/hour | $18-20/hour |
| Inside Sales/Customer Service | $32-34,000 per year | $41-43,000 per year |
| Production technicians | $19-21/hour | $28-32/hour |
| Product Specialist/Engineers | $65-75,000 per year | $78-85,000 per year |
Extending this further, all the distributors we spoke with indicate they have already or soon will be boosting the comp levels to others already on staff to match this new and higher compensation rate.
Based on these reports, we estimate the typical AHTD Distributor will see an escalation of people costs in the range of 11-12 percent. This presents a new squeeze for distributors.
Comparisons against AHTD PAR Report
Using the numbers from the 2021 AHTD Financial Benchmarking Dashboard, which reflects costs during calendar 2020, we see some critical, and perhaps alarming, information.
For Automation Distributors, people really are their largest investment. The typical AHTD distributor spends 67.3 percent of their gross margin dollars on people (salaries, bonuses, benefits, and payroll taxes). This number tracks a full 10 points higher than NAED distributors and reflects the nature of the kind of businesses we operate. Knowledge-based solution selling in a technical environment is expensive contrasted to a more commodity and part-oriented business.
Even if distributors ensure that all price increases are passed along to customers, there will be an erosion of profitability. Our reports from the field point to many situations where, for one reason or another, the distributor has not been able to do as such. Since increases in the cost of labor stand to exceed the immediate price increases, even in the case of full pass-through, there could still be profitability issues.
Now is the time for distributors to look for productivity gains.
A closing miscellany of thoughts
Distributors face many other challenges:
- Margin pressures created as manufacturers fight their own margin erosions in a competitive landscape. This could be particularly true if we experience a supply overshoot as mentioned earlier.
- A continued increase in the cost of labor. Across the country, Amazon is driving up the wages of entry-level people. For example, a new facility soon to be open in Davenport, Iowa is reported to pay $22.50 per hour. This changes the landscape for entry-level people.
- Continued gross margin pressures sure to be applied by online-only organizations. Their cost model is different so one would expect lower prices for the “parts” we sell.
- Escalating costs for engineering talent. In an interview with Alan Carty of Automationtechies.com, we heard the following:
While at first glance all these points sound like good old-fashioned bad news, there is a solid silver lining to be found. If the AHTD business model is anything, it is flexible and quickly adjusts to changes in our environment. I am optimistic AHTD distributors will continue to find new and better ways to fill customer needs. Hopefully, this data will allow you to be even more nimble and quick to meet the challenges.