BUILDING

FOR THE FUTURE

B Y

C L A R K

C O LV I N

How Building
Material Retailers
Can Adapt
to Changing
Industry

Who will be the winners and losers in the revolution that is radically reshaping
the marketing, distribution and selling of building materials? Will the expansive
dealer networks, which are broken into literally thousands of independent retail
suppliers, be able to overcome years of inertia to pioneer and execute new
concepts that will strengthen and extend the value and scope of their
businesses? Or will nimbler, more imaginative retailers get there first?
The transformation of the business
of selling building materials to professional contractors is happening before
our eyes at an incredible pace
promising to change forever an industry that has long been noted for low
margins, poor economies of scale and
extremely fragmented service
providers. Building material suppliers
have competed fiercely among themselves to drive down prices and meet
consumer needs for lower-cost building supplies. Now the survivors face
new threats from outside the industry
that might thwart all their well-conceived plans in building strong, lasting
relationships with their customers.
Financial acquirers of building material suppliers have dissected the costvalue equation and come up with new
retail concepts. Their stories have
attracted interest in the public equity
investment world. The end result has
been to persuade dozens of fiercely
independent suppliers to sell out, forcing a financial-oriented consolidation
upon the industry. This pattern is consistent with revolutions in other consumer durables markets that effectively
transferred market power from manu38

DOITYOURSELF RETAILING/DECEMBER 2001

facturers and distributors to a financial

savvy type of retailer. This also insures
that the retailer becomes the caller of
shots over the contractor customer,
instead of the other way around.

FORCES OF CHANGE
From the early decades of the 20th
century, the building materials industry
has been based on a supply-push philosophya strong bias toward filling
the stores to cover the distribution and
warehousing costs of the distributors.
The building material retail network
(that is still in place today) was largely
created as a logical extension of the
supply-push model. The retailers were
designed to hold inventory, leverage
their own private capital (without threatening the wholesale distributors control) and service and support what still is
a commodity-based, maintenanceintensive line of products and services.
These retail lumber and hardware stores
were built from the ground up by
entrepreneurs who focused on a defined
geographic area, selling a large array of
both construction and hardware lines,
catering to both contractor and the
walk-in consumer.

This distribution retail model has

been remarkably resistant to change.
Building material retailers have become
ingrained over time by a web of informal
habits and long-established customer
and vendor contacts.
Despite its longevity, the building
material supplier channel leaves some
retailers unhappy. High customer acquisition costs motivate retailers to convert
store traffic to sales by merchandising a
multitude of products that extract differential margins based on customers willingness to pay. Taking numerous bids
and sticker wars have taught contractors
to be excessively cost sensitive and negotiate from cost up, rather than from bid
down. As a result, retailers often find
themselves competing against a similar
supplier across town. This acute competition has almost wiped away retailer
profit on the sale of lumber and other
commodity-oriented building materials.
So, lumber companies often make their
profits in areas other than lumber.
The decline in profits on building
materials has forced construction, lumber and hardware suppliers to make up
the margin shortfall by looking at what
many only considered filler businesses

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before: cottage manufacturing units,

installed sales programs, etc. The problem is that a conventional building
material supplier is not necessarily positioned well to conduct all of these businesses because of their different
economics, knowledge of direct costs,
bases of competition and consumer purchasing patterns. Some suppliers, for
example, have purchased a truss manufacturing or a pre-hung door assembly
facility only to shut down those same
factories a year or two later. They go into
these ventures lured by the perception of
high margins only to find out they were
ill-fitted in terms of cost control and
management to handle such laborintensive operations.

RETAILERS STILL PART OF EQUATION

No one is suggesting, though, that
construction-oriented building material dealers will disappear. Ironically,
changes in building materials themselves are making retailers more
important. Customer satisfaction has
become a much more critical competitive differentiator and a greater influence than the materials themselves.
And it is the retailer that controls these
levers today. This explains the intense
efforts many building material retailers
have made to increase standards for
customer satisfaction.
As a result of the low-margin, highsatisfaction proposition provided by the
traditional retailer in general, the successful strategy will be to capitalize on
horizontal cost-reduction opportunities
afforded by improving the retailer
economies of scale equation by trying to
reduce costs in administration, advertising and service.

VISION FOR THE FUTURE

Now that we see cracks in the walls
protecting the traditional building material construction supply industry, what
will the future bring? Both the underlying drivers of change in building material
retailing and trends already under way
help answer that question. In addition, it
is helpful to compare with other industries that have experience in economies

of scale evolution and look at the lessons

they learned.
Most consumer-durable industries
have undergone a substantial distribution and service evolution resulting from
changes in economics, competition or
technologies. Each one has unique circumstances, but we can see three relatively common, distinct stages in these
economies of scale restructurings:

ic customer segments through the

rationalization of logistical support
services. Functions are unbundled and
restructured into more efficient or
more appealing profit and cost centers
and formats for defined groups of customers. Customer value is further
enhanced through lower prices for
select product lines, better service or
greater variety.

Stage One:

Stage Three:

This first stage is marked by major

improvements in value delivered,
mostly reductions in cost. Usually the
cost reductions stem from strategic-

The final stage brings dramatic new

paradigms not just for the sale and distribution of products but for the entire
value chain.
1. Multiple profit centers and
formats will coexist to satisfy different market segments. Profit
centers are distinct paths between a
retailer and a customer through similar
economic entities, such as contractors
vis--vis retail customers, vis--vis
commercial customers. Formats are
distinct combinations of points of sale,
service offerings and business processes within a general profit center definition. We expect much more variation
in profit, cost centers and formats in
both an accounting and in a physical
sense and more distinct positioning in
terms of the purchase experience they
provide, thus shifting the basis of competition from products to services.
2. The separate businesses
under the roof of the traditional
retailer will be unbundled. Different operational structures will be
required to serve a variety of customer
needs and economics.
3. The cost of distributing and
marketing building materials will
be cut significantly. New formats
will instill discipline in the current system to drive out non-value-adding
cost. Supplier consolidations may
unlock substantial economies of scale
in back-office functions and purchasing leverage. Much larger savings are
possible, however, by driving out obsolete and excessive inventories; reducing investment in brick-and-mortar,
equipment and real estate, and optimizing the delivery of services.

Customer
satisfaction has
become a much
more critical
competitive
differentiator
and a greater
influence
than the materials
themselves.
oriented consolidations and rationalizations in the value chain as better
concepts or bigger players drive out
marginal or small players. The objective is the bigger players use their cost
advantage to reduce prices and often to
improve service, variety and convenience. In practice, however, these
strategic consolidators focus mainly on
increasing market share rather than the
profitability of each acquired entity.

Stage Two:
The second stage is marked by companies becoming more focused on
achieving economies of scale of specif-

DOITYOURSELF RETAILING/DECEMBER 2001

39

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4. Marketing and distribution

will concentrate on establishing
durable customer relationships.
Since customer acquisition costs are high
and going higher, it is logical for retailers
to work harder to hold on to the customers they have. We see these relationships developing on two axes: follow the
product and follow the customer.
The follow the product axis will
make manufacturers and distributors
more active in the value chain. We see
this axis as counterproductive, actually
driving down margins as well as
depleting necessary cash flows for the
retail suppliers.
The follow the customer axis means
building more direct relationships with a
targeted set of customers to define their
needs, develop tailored marketing programs and stake out unique positions.
Identifying these customers and keeping
them happy will require substantial
investments in market-understanding
capabilities that go far beyond the functional and demographic information
that most retailers rely on today. We see
this axis as the correct point of strategic
realignment of customer service.
Retailers will seek and attain much
closer contacts with consumers. We
have no doubt that someone will figure
out the riddle of consumers needs, aspirations and experiences as they relate to
building materials; the tenuous part of
this prediction is that retailers must get
there first. However, retailers today are
surprisinglyif not shockinglycut off
from their consumers.
Undoubtedly, Internet technology will
enable more effective and efficient direct
contact between retailers and their customers, as both become more comfortable with this new type of POS. If,
however, retailers fail to exploit technologies to establish meaningful relationships with consumers, more
powerful intermediaries may gain the
upper hand and end up providing material direct to both the contractor and
retail consumer end-user.
These transformations will not be
easy, and many of todays players will
fight them aggressively. But the revo40

DOITYOURSELF RETAILING/DECEMBER 2001

lution in building material retailing has

begun, and now that it is underway, it
will be impossible to stop and nearly as
difficult to contain.

FORMING A STRATEGIC RESPONSE

What, then, should a building material retailer do? Appropriate responses are
to some extent situation dependent, of
course, but we believe the three stages of
economy of scale evolution observed in
other industries provide valuable insight
into what will be required to prevail in
the retail building material industry.

In fact, first-stage economy-of-scale

evolution activities are already rampant
in building material retailing in the United States, and second-stage changes are
gradually being accepted by a handful of
retailers at this time. We expect that participants who fall behind in this evolutionary process will suffer severely,
particularly as more and more of the
value creation and consolidation in the
industry occurs downstream. The future
winners in the building material industry
likely will be the ones that drive thirdstage evolution. Accordingly, we recommend the following strategic responses
consistent with the three stages of
economies of scale evolution and the
future of the building material supplier
vision described above:
1. Aggressively and systematically pur-

sue functional, as well as, profit center

improvement, such as operational cost
savings and high margins of the existing
product lines.
2. Develop a vision of a desired endgame sales strategy and begin making
progress toward that vision, taking care
to achieve consistency between the longterm vision and short-term functional
improvement agendas.
3. Build the means to create and
capture much more of the downstream value associated with building
materialsand, in so doing, strive to

innovate game-changing approaches

to the business.

FUNCTIONAL IMPROVEMENTS
In the conventional building material
retailer network, tremendous improvement opportunities exist along two basic
functional paths: reducing operational
costs and raising customer satisfaction.
Most retailers are jumping at the latter,
forgoing the former. For example, these
players tend to select a limited number
of high acquisition specific programs,
and they typically concentrate on single
functional improvements independently
or on a single functional path. For example, thinking that a kitchen and bath
department is the cure-all for companywide lagging sales, or that focusing solely
on contractor sales will enable the com-

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pany to rid itself of unnecessary people

and product lines.
A better approach is to systematically address the whole realm of possibilities with an integrated view of benefits
within and across specific functions.
This is not easy. Even programs with
moderate scope and ambition typically
require reforming entrenched business
philosophies; coordinating several
organizational groups with individualized incentives; managing complex
and imposing logistics, and facing up
to customers resistant to change. But
retailers must recognize that new players unencumbered by these constraints are raising the bar and
traditional players must reach higher
or fall behind.
Based on our experiences and analysis, we estimate that cost reductions,
though easy to execute, will be one of the
hardest things to accomplish. There are
three reasons:
1. The consolidation and rationalization of activities to achieve economies of
scale and eliminate inefficient operations is unpopular. Large numbers of
small competing suppliers operate as
mom and pop operations.
2. The unbundling of profit center
businesses, for instance, is largely
unknown to unsophisticated business
people. To date, a retailers profit center
is often viewed as a location, not a customer type or manufacturing process.
3. Given the wide variation and the
resulting large differences in efficiency
and effectiveness in operations among
retailers, the application of best practices
for the industry is substandard. In other
words, working toward the industry
standard creates a continuing downward
spiral in industry-wide performance.
Here are some examples of potential
functional improvements:
Reduce inventory costs. Retailers can
cooperate among their different locations to pool inventory in regional centers. Also, analytical methodologies,
information-systems tools and best
practices can be used to evaluate the
retailer-level sales history to determine
the best amount and mix of materials

to hold in inventory. Finally, to

improve future demand visibility and
forecasting accuracy, retailers can use
improved information systems and
marketing techniques to track customer and sales-promotion information, marketing campaigns and
historical data on sales-promotion
effectiveness.
Leverage purchasing power. Retailers can also capitalize on purchasing
economies of scale. The economies
result from lower costs in areas such as
financing, advertising, management
personnel, payroll handling, insurance,
supplies, administrative functions and,
of course, material purchases. The
reported cost savings from these
economies alone can be as high as 20
percent of a retailers cost.
Use best management practices to
sell building materials. The traditional
selling approach for building materials
is loaded with cost (and effectiveness)
opportunities that are not taken advantage of. Sales management is often the
missing ingredient. In our opinion, the
understanding of management, as
applied to sales personnel, is one of the
largest problems of most building material retailers today.
Align manpower requirements with
profit and cost center activity. Generally speaking, even the most efficient
retailers dont separate manpower
requirements within individual profit
and cost centers, correctly understood.
Often a simple ratiopayroll to company salesdefines the standard manpower productivity level. Such
oversimplification of personnel efficiencies disguises the contribution
margin of the separate profit-generating parts of a company.
Increase customer satisfaction. Customer satisfaction and loyalty are rich
veins of potential functional improvement. Good performers end up getting
paid for what they are already doing
well, and the poor performers undertake short-lived, superficial steps to
manage the measurement. Customer
service in building material retailing is
mostly about executing the basics

wellkeeping delivery commitments

and offering conveniences. Service
advisors and computer-driven followup calls will not regain ground lost to
sloppy execution.

DISTRIBUTION STRATEGY
Cost and customer-service improvements are necessary but not sufficient
enough to transform the building
material retailing industry. Realizing
the full potential of these programs is
not possible without a reasonable view
of the different customer segments that
should be targetedthe appropriate
mix and level of marketing functions
needed for each segment, and the best
means of distribution.
Just as specific groups of customers
have their own product requirements,
different consumer segments have
their own requirements for the purchase experience. These requirements
can be effectively targeted with package
variations such as service contracts,
financing, sales incentives and different
pricing matrixes. Ultimately, the consumer-segment requirements will drive
the service requirements and in turn
help determine the best cost and operating structure for the specific distribution format and customer-value
proposition of each customer type.
Creating the purchase experiences to
meet the needs of specific consumers has
two other significant implications. First is
the need for parallel accounting and profit centers in a given region, each with its
own pricing and bundle of product offerings. Parallel sales profit centers range
from the traditional contractor to the
commercial customer to consumer overthe-counter sales.
The second implication of serving multiple, service-based customer profit center segments is the need to avoid
cannibalizationin other words, the robbing of contractor sales to beef up retail
consumer sales, and vice versa. Here the
accurate tracking of sales, margins and
expenses are necessary. Unfortunately,
most accounting software programs in
(Continued on page 51)
DOITYOURSELF RETAILING/DECEMBER 2001

41

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(Continued from page 41)

the industry are not set up to track information by profit centers.

DOWNSTREAM VALUE CREATION

The biggest winners in the building
material economy of scale evolution will
be those that drive substantial value
improvements by creating real innovation
in the retailing of building materials. In
many other industries, retailers have driven and benefited from economy of scale
evolution at the expense of manufacturers
and/or distributors.
The cost-reduction potential in the
building material retailing industry is
huge. Innovative ideas that tap this
potential may well dominate the future
of the building material industry. Such
innovations can be achieved by recognizing the real drivers of value and the
linkages among them. This new lifecycle value paradigm represents one
way that a building material company
might approach the problem of creating
value through its marketing and distribution activities.

ANTICIPATED CHANGES
Change and innovation are the
lifeblood of all retail businesses, but the
building material supplier industry has
been remarkably resistant to transformation. As a result, the industry suffers from
an outdated, inefficient and expensive way
of doing business.
This situation will change. Building
material retailing is beginning to evolve. At
one level the future implications are clear.
These include multiple alternative profit
centers or a greater unbundling of the
retailers business; increased value
through economies of scale; more emphasis on life-cycle relationships, and probably tighter relationships between retailers
and their customers. Specifically who will
win and lose is much less clear. To win,
the established retailer must shake off old
habits and practices and then visualize
and implement revolutionary ways to sell
building materials. However, if the established retailers cannot or refuse to change,
the financial acquirers will be the new

dominant force in the industry; forever

changing a century of habits and practices.
Clark Colvin, managing general partner at CSC Capital Partners, Ltd. is an
expert in the restructuring of building
material retailers. He has personally
restructured more than 50 building mate-

rial dealers across the United States, conducting the restructuring often as interim
ceo. CSC Capital Partners is a leading
corporate restructuring, turnaround and
private investment firm in the industry.
Visit CSC Capital Partners at www.csccapital.com for more information or call
(503) 540-0888.

April 10 April 13, 2002

Anaheim Convention Center
Anaheim, California

The Marketplace for

Specialists in Hearth, Patio,
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For Registration Information and Forms Contact:
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