As a distribution industry consultant who has spent many years at Grainger (NYSE: GWW), I often get questions about the company from other distributors. Typically, the questions go something like this:
"How does Grainger do it? They're the biggest distributor around, they have more customers and more products and higher margins than just about anyone else, and they show no signs of slowing down.
Sometimes, executives will give me specific examples. An electrical distributor recently told me, "One of my customers just bought 10 30 amp circuit breakers from Grainger at a 35 percent gross margin. ? "
Adding to the general confusion about Grainger: A high-priced approach is supposed to be a niche strategy. But Grainger is arguably the largest distributor of its type, it sells to nearly every type of company and offers about 1 million products. In other words, Grainger seems to be pulling off the very difficult challenge of being both the margin and market share leader in distribution.
So how do they do it? It's really pretty simple. Almost every distributor targets One of these types of segments:
- A product category (eg, power transmission, fasteners, tools, HVAC products, PVF, building materials, office supplies, etc.)
- A customer industry (eg, hotels and motels, restaurant equipment, mining, healthcare, janitorial, utilities)
- Or some combination of the two (eg, selling building materials to home builders)
Grainger's segmentation is different. The company does, in fact, sell just about every type of product to just about every type of customer. But Grainger defines its target segment by a specific situation: when customers need products quickly and with no hassle. This target segment, which Grainger informally refers to as "speed and convenience," allows it to operate differently than other distributors and get superior results.
So while most distributors try to get a lot of revenue out of a small number of customers, Grainger wants to get a little revenue out of every customer.
When businesses or people need products quickly, they think about suppliers differently. For one thing, they accept that they will pay a higher price to have access to products they can get immediately, a concept academics call "place utility." One former Grainger president for whom I worked using the example of a vending machine in a hotel. You know that $ 2 is a very steep price for a can of soda, but it's worth it to you because it's fast and easy to get your Diet Coke there vs. leaving the hotel to find a very inexpensive source, like Costco. The Costco store may not be open and even if it is, you will have to buy a whole case of warm soda in exchange for saving 90%. That's a big margin swing but the "speed and convenience" of the hotel vending machine, along with the chilling of the product, which is a "value-added service," makes it worthwhile.
Think about the times you stop at a 7-Eleven. There are no bargains in the store, but you know and accept this before you walk in. So, if you wind up paying 30 percent more for milk, you will probably feel the "speed and convenience" benefits were worth it compared with driving to a grocery store.
Businesses function in the same way. On a regular basis, purchasing agents, maintenance personnel, warehouse managers, etc., need something quickly and conveniently. In those situations, they go to the supplier who is most likely to have all of the needed items (which is called "assortment convenience"), has the most effortless ordering system and can deliver goods the fastest. In these situations, customers are not very price sensitive, even if they are very hard-nosed buyers when negotiating traditional contracts. Thus, Grainger is often the real or perceived best choice for the customer.
This applies to every type of product, even "commodities." The more urgently a customer needs a product, the less commoditized that product becomes. For example, very few HVAC contractors rely on Grainger as their primary source for refrigerant. It's a commodity most of the time, and HVAC distributors sell it at very low margins to try to win other business. However, if you are an HVAC contractor with a customer who is cooling is out on a 100-degree day, and you need refrigerant, you are likely to point your truck right into the Grainger parking lot. You will have a high degree of confidence that the product will be in stock, and you will be in and out of the branch quickly. In this situation, price does not matter, even for a commodity. It's all about speed and convenience.
Okay, so we've defined Grainger's target segment, and we've talked about the nature of products needed urgently. Here are some of the ways Grainger deliver value for "speed and convenience" purchasers:
The most locations. Grainger has more than 600 stocking branches in North America. Sometimes customers need things extremely quickly, even the same day, and Grainger is the closest and fastest alternative more often than other distributors. Additionally, through its severe distribution network, Grainger can probably deliver a greater assortment of goods the next day than any other supplier.
The most inventory. Grainger carries massive stocks of inventory. In its "2009 Fact Book," it claims more than a billion dollars on hand. Of course, this was offset by a relatively high gross margin of 41 percent. Like every distributor, Grainger has to choose between service levels and inventory turns and, in the speed and convenience business, you choose service levels.
The best catalog. In some types of distribution, paper catalogs are still essential because they are the fastest and easiest way to look up many types of products. Grainger's catalog is particularly fast to use, adding to customers 'tender to pick it up instead of competitors' books. The Grainger catalog enhances the company's ability to handle "speed and convenience" transactions faster than competitors.
The easiest to use website. Sometimes, the fastest and most convenient way to purchase something is by using the keyboard that's right in front of you. If you are a business buyer, you already know Grainger is more likely to have what you need quickly vs. other distributors. You also know that Grainger.com is a particularly well-designed and easy to use website. Grainger has always been an e-commerce pioneer; the truth is that they are still in the lead.
Let's wrap up by getting back to the question of how Grainger can be one of the largest distributors while implementing what seems to be a niche strategy. Actually, it really is a niche strategy, but the niche is awesome in the extremely fragmented industry that makes up MRO. Every single business needs products quickly and conveniently and thus becomes a relevant target for Grainger's value proposition. In an industry the size of MRO, which Grainger estimates at $ 125B in its 2009 Fact Book, they hold less than a 6 percent market share. So even in this "niche," there's a lot of room to grow.
Remember that "convenience" is also part of the equation. Sometimes even when customers are not in a hurry, it's just more convenient to buy from Grainger. The company is more likely to have the product on hand, it's clearly listed in their catalog or website, and they provide very friendly and competent service. All of these considerations make customers care less about price and more willing to buy from Grainger.
So there's really nothing mysterious about what Grainger has done. The company has succeeded by serving "speed and convenience" needs for decades. What has changed over the last several years is the company's willingness to focus on what it does best and get out of areas that do not leverage its core competencies. This is the result of extremely high quality leadership that is likely to find new ways of enhancing its capabilities. That means Grainger will probably get even tougher in the future and expand its market share gradually but steadily.