How private equity can add value in industrial wholesale distribution

Advancements in e-commerce and logistics offer value creation opportunities for PE investors in the wholesale distribution industry.

In brief

• Results from a recent EY-Parthenon survey illustrate how the COVID-19 pandemic has pushed the industry to finally engage with technology.
• Explore three areas where PE investments are likely to create value for specialty industrial distributors.

Private equity investors can find attractive opportunities in the enormous wholesale distribution industry due to advancements in e-commerce and tech-enabled logistics that many distributors have not fully adopted.

The sector is made up of the logistics, shipping and wholesaling companies that move every physical product under the sun from farms and factories to store shelves and supply rooms. Comprising industrial businesses of all sizes, and at roughly $7t in revenue, it is one of the biggest pieces of the US economy. After shrinking by 5% in 2020 from the initial shock of the COVID-19 pandemic, sector revenue jumped 22% in 2021, according to MDM Distribution Intelligence.[¹]

Leading distributors are making capital investments required to stay competitive in the wake of digital disruption, lingering COVID-19 supply chain woes and rising customer expectations for short turnaround times. While the pandemic has wreaked havoc on supply chains, specialty industrial distributors have remained fundamentally relevant because of their stable niche connecting customers to a broad array of products across a complex value chain.

Particularly considering supply and demand constraints, companies that are able to fulfill their core purpose of providing access to essential products are leaving behind those that cannot.

Amid the developing shakeout, opportunities abound for private equity investors ready to help traditional distributors transform into modern supply chain partners in today’s “digital-first” economy.

There are three areas where investments are likely to create value for specialty industrial distributors.

1. Enhance e-commerce and digital tools to attract high-margin customer transactions

The pandemic prodded B2B customers who were once reticent to engage with technology to adopt online buying as a core ordering method. Now, both B2B and B2C industrial customers are expecting more convenient e-commerce transactions.

Many distributors are still developing their e-commerce capabilities as online ordering grows and they find themselves increasingly competing with pure-play e-commerce platforms. A specialty distributor’s commitment and available capital to invest in digital infrastructure may soon determine if it can win in a frontier focused on e-commerce.

A recent EY-Parthenon survey of 101 specialty contractors shows 54% of consumable supply orders were made online in 2021, vs. 24% during 2016 to 2018. The jump illustrates how the COVID-19 pandemic has pushed the entire industry to finally engage with technology.

The challenge is that many companies that have set up websites to take orders have not invested in an accompanying technology infrastructure to support a digitalized and automated customer experience.

2. Expand logistics infrastructure and omnichannel sales to support increasingly complex customer preferences 

Another huge opportunity is emerging as distributors adopt new service models, including omnichannel sales, to meet evolving customer needs. Companies that emulate this strategy stand to differentiate themselves from the competition.

Changing customer behaviors are evident in the shift to online sales from in-person purchases and phone orders.

But many customers still require physical value-added services or enhanced services that support other changing customer business needs.

For example, B2B buyers interviewed by EY-Parthenon professionals note the high costs associated with using skilled employees to serve as couriers between product suppliers and jobsites. Increasingly, such customers favor distribution partners that can provide last-mile logistics and same-day delivery, whether via third-party logistics (3PL) supply chain solutions, including third-party warehousing, or urgent-need “hotshot” delivery services performed by the wholesaler.

There are also opportunities in the in-person buying experience. A leading PE-backed electrical distributor recently opened its first “open concept” branch location, adding a counter at a 12,000-square-foot warehouse to allow customers to select their own materials.

Such innovations may enable industrial distributors to capture the significant, albeit declining, share of products purchased in store, while reducing costs associated with branch merchandizing, shelf stocking and full-time counter employees.

Shifts toward omnichannel models incorporating all types of customer preferences, particularly inside sales powered by unified contact centers and e-commerce, can help distributors regain the profitability they once experienced with asset-intensive outside sales and retail branches.

3. Redefine the customer “service-value” equation

Distributors that earn a high share of industry profits are increasingly capable of fulfilling customer needs beyond the multifaceted sales and logistics infrastructure.

Another area that presents potential opportunity for PE investors is in augmenting the most valuable services a company offers to customers. This is the service-value equation, and it refers to the gross profit dollars customers pay in exchange for solutions consisting of both products and service. While the definition of value varies by customer cohort, optimal service-value equations are meaningful to customers and profitable for distributors.

For distributors, this means identifying profitable niches within a distributor’s total addressable market, and the opportunities span from sales and marketing in the front end, to operations and logistics in the back end. Examples of areas where industrial distributors can add value to outperform the competition include a broad array of support activities, such as diverse sales channels; showroom consultancy; product information and after-sales support; pickup and delivery options; sourcing; and customized solutions such as packaging, fabrication, training and service centers.