A reckoning is upon us in the B2B distribution industry because of new entrants like Amazon Business. Amazon's marketplace business model provides better value to the end-customer and its role in the industry will inevitably continue to expand. And, this is just the tip of the iceberg. Private equity investors: get off the Titanic now.
Amazon Already a Threat
According to analyst reports, Amazon's Business has already surpassed several billion in annual sales this year. And according to the last publicly available figures, it's growing at 20% month over month.
Further, our research on Amazon Business indicates that Amazon has already made significant inroads into key distribution industries like MRO and electrical supply. Some distributors, like Grainger, have already felt the impact of Amazon's expansion into B2B.
Grainger missed its Q1 earnings earlier this year, to the surprise of many analysts, after announcing a price cut across the board on its web products.
Since then, the company has seen its stock price decline from well a high of $250 to below $169 as of this writing. Other distributors have similarly missed forecasts or come in with disappointing margins.
As Amazon's lower cost marketplace business model makes its way into more B2B distribution segments, more of these large distributors will struggle as margins continue to shrink.
Offense or Defense - for PE, It's All Futile
Some distributors will fight back and genuinely try to bring about digital transformation by embracing the platform business model that drives Amazon's success. However, these distributors are the exception. And, many verticals do not have a large, incumbent distributor with a CEO that wants to make pro-active, yet highly disruptive, investments in a new business model.
In the verticals where an incumbent launches its own marketplace initiative, smaller-sized distributors could benefit in the short term from the added competition. Another marketplace creates more competition for Amazon and provides another sales channel for these smaller distributors. If one of these businesses is a first-mover and learns how to sell on these marketplaces, it could capture incremental revenue increases by scaling up on a new, lower-cost sales channel.
The outlook for larger distributors isn't so rosy.
Many large distributors are already trying to focus on HVAS (high-value add services) and carving out more defensible niches. This strategy is smart and will help insulate the distributor as the commoditized parts of their business start to be gobbled up by Amazon and/or other marketplaces.
However, over the long-term, all of these larger distributors will have a very difficult time replacing the revenue lost from commoditized goods with HVAS. The best-case scenario for these companies is to have less overall revenue but hopefully retain similar profit margins.
For a large distributor, keeping similar profit margins is even more challenging than a smaller distributor because it'll be too difficult to transition the whole business into a niche that can support the overhead of the business. Hence, to truly focus on niche opportunities where margins are higher, significant downsizing is in order for these companies.
The Amazon Effect
As Amazon's impact on B2B distribution becomes more widely understood, traditional investors will be less inclined to support the growth of the traditional distribution model. Valuation multiples will decrease.
With less demand and more fear about the competitive landscape, distributors' multiples will be compressed as their profit margins continue to shrink.
We saw this effect almost immediately with the announcement of Amazon's acquisition of Whole Foods. Obviously, stock prices fell for retail grocers, but so did the stock price of food distributors like Sysco or US Foods.
For private equity firms with significant positions in B2B distribution firms, the time to get out is now. Even if traditional distributors survive as HVAS providers, their value will likely never be as high as it is today.
Amazon's already had a similar impact on private equity investments in retail, as Blackstone canceled the $2.8 billion dollar sale of a mall after failing to find a buyer.
Before long, most B2B distributors will be facing the same challenges. Investors should head for the lifeboats, before it's too late.