Distributors Hit Rough Patch

Shortly after Kent Foster announced he would retire next month as chairman and CEO of Ingram Micro and pass the reins on to company president Greg Spierkel, the world's largest distributor made another major announcement: It would begin slashing 550 jobs in North America this spring and, like many other American corporations, outsource the work to Asia. While Ingram Micro proclaimed the move as a way to increase efficiencies and flexibility, no one would argue that the "optimization plan" is largely about saving money with less expensive labor. Consider the numbers involved: expected savings of $10 million in 2005, starting in the second quarter, as well as annualized savings of $25 million by the first quarter of 2006.

As expected, several solution providers were concerned that the quality customer service they were accustomed to would decline in the hands of low-wage workers. Ingram Micro has worked diligently to reassure its top customers within its VentureTech Network and the Ingram Micro Service Network that this will not be the case. Still, the strategy is risky in light of some of the recent troubles other U.S. corporations have had with offshore outsourcing, and resellers will remain skeptical.

Why implement such a drastic cost-cutting measure after such a strong 2004? The answer would have proved more elusive if several major distributors, including Synnex and ScanSource, had not lowered their quarterly guidance recently because of slumping sales. Along with that, others, such as Tech Data, have offered up less positive outlooks for future quarters than analysts were expecting. As a result, some distributors have seen their stock values fall and had their ratings downgraded. Perhaps most disturbing is that for the first time, some in the distribution community are admitting that sales and growth will be much less this year.

"Clearly, the market isn't growing as fast this year as it did in 2004," Spierkel says. "The IT growth rates are down from high single digits or low double digits from last year."

It's quite a change from the optimism that permeated the room at Raymond James' IT Supply Chain Conference this past December, when the leaders of IT distribution were confident the industry's comeback in 2004 would carry over to this year. Raymond James analyst Brian Alexander says that while worldwide IT spending is indeed decelerating this year, distributors are healthy and simply suffering from a few bumps after setting the bar so high in 2004.

"From a macroeconomic standpoint, there is a concern that the IT spending environment will worsen," Alexander says. "Those factors aside, the IT-distribution market is still growing, but expectations are higher after last year."

ScanSource and Synnex may be the victims of such great expectations. Both distributors are still enjoying solid double-digit revenue increases, despite lowering their sales forecasts for their most recent quarters. Distribution executives, therefore, aren't panicking and still feel the modest IT growth will keep the market moving in the right direction. But there are a few concerns. Among them are poor IT growth in Europe, which was one of distribution's hotspots last year, and increased competition and pricing pressure in North America, particularly within the broadline segment.

Europe is, perhaps, the larger of the two concerns. While many distributors have stated in recent months that North American IT demand is stable and even growing in some areas, Europe has clearly cooled off. Much of the region's growth in 2004 came from acquisitions and favorable currency exchange rates rather than strong IT demand, so the trend is hardly surprising. But with companies such as Tech Data and Ingram Micro generating an increasingly large percentage of their sales from the continent, the conditions of nations such as Germany are becoming a source of some anxiety.

"Europe might be more of a question mark, and that's driven by the GDP rates, which are much lower," Spierkel says. "It's a function more of the macroeconomic environment."

Pricing, however, is another matter. While IT demand may be stable in North America, competition is extremely fierce.

"We saw Tech Data get more aggressive in the fourth quarter earlier this year, and it resulted in them taking some share from Ingram Micro and Synnex," Alexander says. "It was a shot across the bow for Tech Data because they had lost some share in Q3 as a result of some pricing pressure."

For its part, Tech Data has simply said it is "pricing competitively and not recklessly," and points to its gross margins in North America, which grew in the fourth quarter. Alexander says he doesn't believe the heated competition among the Big Three has created a price war because the cost structure of the distributors simply won't allow it. Synnex president John Paget agrees with Alexander's take.

"It has been a highly competitive market," Paget says, "but I wouldn't call it a price war."

Still, the pricing pressure has sent margins downward for products such as systems, displays and peripherals, which has sent distributors scrambling for higher-value technologies.

Even so, there are plenty of positive developments. Tim Curran, president of the Global Technology Distribution Council, an industry advocacy group, says that the average days of inventory have decreased for its members. "We're definitely managing inventory better," Curran points out.