Know when to hold ‘em, know when to fold ‘em

BY RICH SCHMITT
Management specialist

Should I stay or should I go? This is the refrain from a song that was popular in the early 80s by “The Clash” one of the original punk rock bands. Music history lesson aside, it is the question that some owners are asking themselves as they struggle through the current vegetative economy.

Much of the fun has gone out of their business and they wonder if selling their business may give them the capital needed to escape to the topical isle of their dreams. Some thoughts on the situation:

1. Very few wholesaling businesses are being sold at a premium. I haven’t heard of any acquisitions that are anywhere close to the huge multipliers that highlighted the industry news in the mid 2000s. Of course, they could be occurring without my knowledge but if there are any, there sure aren’t many.

2. Many, maybe most, of the businesses being sold are really the owners “cashing out.” They are trying to convert their inventory, racking, fixtures and building into cash. There is no acquisition premium or ”blue sky” involved. Operating businesses that are losing money are subject to two business rules:

• Supply and demand — When there are a lot of businesses losing money, there isn’t a lot of demand and the price isn’t high.

• Earning your keep — Acquired businesses need to throw off enough cash to pay for themselves. With losing businesses, offers may involve fractional multipliers on the good saleable inventory, pennies on the dollar for other assets and nothing for receivables beyond 60 or 90 days. Even the real estate that once seemed like a great investment isn’t nearly as shiny.

3. Wholesaling businesses are no longer the nice “hobby” businesses that they were five years ago. They’re like a hobby farm except what you keep in the barn are toilets and water heaters instead of horses and cows. In the boom years, the hobby owner could mostly pay no attention to the day to day operation, manage to make a little money and spend the winters in a more favorable climate. Many hobby owners have had to inject their own cash into these businesses or the business’ line of credit has grown in order to keep the doors open. Wholesalers that were able to muddle along marginally profitable in the boom times are suffering in this economy.

4. Some of the national and large regional wholesalers seem to have brought their mergers and acquisitions departments out of hibernation and are looking for select strategic opportunities or bargains. There seems to be some cash available for smart buys. There doesn’t seem to be any of what I called the “stupid money” that was being thrown around five years ago.

5. Each type of wholesale business has a “cruising” size where the business runs smoothly, it can survive some economic trials, the owners are getting a fair to good return on their investment and, while there is a lot of hard work, it is a good place to work. Some days, it’s even fun to work there. The company is big enough to support a few specialists for purchasing, pricing and operations. While the owner is probably still active, the business is not dependant on the owner’s 80 hours per week of blood, sweat and tears to keep the operation running. The business is also big enough to enjoy some economies of scale that make it more efficient and profitable.

For years, we said this “cruising” size was at about $10M sales for a full-line plumbing or HVAC wholesaler. To be clear, this was a seat-of-the-pants number that we developed through our observations of companies in our industry. For the past five years, we have observed that the number has increased to $15-20M. Again, nothing scientific, just observation.

This magic number varies based upon what you sell and how you operate. For instance, highly-profitable, niche wholesalers are sometimes “cruising” at a smaller sales number than full-line plumbing/HVAC wholesalers. It is good to know what the number is for your type of business and to get there ASAP if you have not already hit the threshold.

6. There is no “stopping to smell the flowers” in wholesaling. As I discussed in the last couple columns on technology, our industry is changing at a pace we have never before experienced and the rate of change is increasing.

7. Just as the internet has changed consumers’ experience and expectations, it is also changing trade customers’ expectations.

8. Again, an observation, the “power” or “juice” in the industry seems to be shifting down the supply chain in favor of the consumer.

Long ago it seemed that the manufacturer dominated and basically told the wholesaler and contractor what to sell to the consumer. Now we are seeing the consumers telling the contractors what they want to buy and what the price should be. Contractors are also becoming more demanding because they are being pushed by more knowledgeable consumers and because, they themselves, are becoming more informed and sophisticated.

9. Contractors are using more technology. Where years ago, getting a contractor to buy a fax machine was a struggle, PCs and smart phones are being used by most contractors today. One of our wholesaler customers, using our B2B webstore software, received their first B2B order from a smart phone. Not from a PC, from a contractor’s phone at a job site! It surprised the wholesaler so much that he called the contractor and asked if the order was real. The contractor’s response, “You bet, and we’re on our way to pick it up right now!”

10. Please don’t misunderstand my sense of the industry; most of the buying and selling is being done the way it has been for decades. Further, I don’t want to be a “chicken little” who gets excited without good cause. I just think wholesalers who aren’t keeping pace with their competition or the demands of their customers could be run over from behind.

So let’s talk about keeping, selling or buying businesses.

Keeping — The Rules:

1. The activities that make a business more profitable, viable and fun are the same ones that “groom” it for sale and make it more valuable and interesting to a potential buyer. This means that your tactics will be the same for either scenario. So even if you are unsure about keeping vs. selling, you can move forward growing your business and getting it running smoothly. You can always change your mind as to whether you stay or go.

2. If you are under the “cruising” number for your type of company, it is critical to develop a growth plan aimed at getting your company above that target.

3. If you have lost the stomach or run out of gas, you have a limited menu of choices:

• You can ride the business into the ground. Just like an airplane your business will probably glide for some amount of time. If you were greatly profitable, it will glide for longer than if you were marginally profitable or not profitable at the start of the glide. But, as they say in aviation, contact with the terrain is inescapable. The important thing to remember is: Just as in aviation, you are in a descent and the viability and value of the company is decreasing as each day goes by.

• You can hire somebody with the fire in his/her belly to grow it and run it. Small businesses find it difficult to absorb the cost of another senior executive, especially when the owner keeps his/her salary. This can be a great option but the people dynamics can be difficult since finding the right person is always a challenge.

• You can groom it for sale…see rule # 1 of keeping your business and rule # 1 of selling your business.

4. Don’t underestimate the need to get on the technology bandwagon. Somewhere in your future, customers will begin to disqualify you if you cannot meet their technology expectations. I am not able to predict exactly how this will impact your company but I sincerely believe it will occur at some point. The key is to start building your ark before the water is around your ankles.

Selling — The Rules:

1. The same “grooming” activities that make a business more valuable and interesting to a buyer are the same activities that make it profitable, viable and fun to keep.

2. Buyers buy your team. Real estate and inventory are relatively easy to find or buy compared to the difficulty of putting together a well-oiled, smooth-running organization. While it is always important to protect your customer list, seldom in our industry, does a buyer attribute much value to the list.

3. In evaluating your team, a buyer will want strong non-owner leadership when possible. It is prudent to look at the team without the owners because long term, they want a solid in-place team that can continue if the owner becomes disinterested or distracted. If you have lost your fire, finding the right person to run the business for “keeping” may also be a key factor for “selling.”

Buying — The Rules:

1. Buy the team.

2. Discount the selling owner’s long-term contribution — they are often selling because they have not run it well or because they have lost their fire.

3. If the current team has not been successful in the current situation, it is unlikely that they will be magically transformed under new management. I recently went to a restaurant whose sign said, “Under new management.” I decided to give them one more chance but found that they had kept the same crew of disinterested, rude servers. With “truth in advertising” in mind, the sign should have read, “Under new management with the same crappy service.”

4. The company that you are buying is the way it is for a reason. This cuts both ways, good and bad. It is really tough to buy a company and to fix the bad things while not messing up the good things. Many buyers shoot themselves in both feet.

5. To assume the approach that made you successful in other markets will somehow revolutionize the purchased company is naïve. You need to really look into the nitty-gritty and determine if what you bring to the party can reasonably change the purchased company.

6. Your reputation in other markets doesn’t travel far. You will have to invest in building your brand in any new market and it takes time.

7. People don’t sell productive gold mines at a discount. Whenever you hear about that kind of deal, look harder or run for your life.

8. View every purchase more than 100 miles away as if it is a foreign country. You need to learn the language and customers of the community and must not assume that your experience applies. Many highly successful (possibly arrogant) U.S. companies have wrongly assumed that new markets in other countries would be easy to penetrate. Often to their embarrassment. The same arrogance can get you into trouble here without the nasty overseas travel.

Hopefully, these thoughts will challenge you to explicitly consider where your company is, where you are in your life plan and to make the changes that will be best for your situation.

On a personal note, many of you know that our family has been in this industry since the early 1900s, spanning four generations. My grandfather R.R., my father Joe, my wife Glenda and I, and my daughter Jennifer (Schmitt) Kemp and her husband Cory have all enjoyed the industry and especially the people in it. On June 1st, we were delighted to welcome what we hope will be our 5th generation in the industry, Carson Joseph Kemp. Jen and Carson are doing great and Cory is happy, proud and sleep deprived.

 

Rich Schmitt is president of Schmitt Consulting Group Inc., a management consulting firm focused on improving the profitability of distribution and manufacturing clients. Rich is also the co-owner of Schmitt ProfitTools Inc. (SPI), a business producing print, CD-ROM, web and palm-based catalogs as well as pricing management and analysis software for wholesalers. Go to www.go-spi.com for more information.