Forex Magnum


This Distributor Is a Bargain


Generally speaking, it’s costly for producers and customers to interact with each other.

Imagine an industry with five producers and five customers, with all the producers selling to all the customers. If there were no distributors, each customer would establish a relationship with each producer, totaling 25 relationships. These relationships must be nurtured, which consumes resources and time.

If we insert a distributor into the middle, we now only have ten relationships if each customer and producer deals only with the distributor. Scale this up to an industry with thousands of products, customers, and producers, and it’s easy to see the value a middleman brings to the table.

Distributors often have a few other points in their favor. For one, they are typically capital-light and generate high free cash flows through an economic cycle. Also, they don’t suffer from a lot of technology or business model risk. In a fast-changing economy, longevity should count for a lot to investors. Finally, past a certain critical mass, many distributors benefit from at least two sources of economic moats: network effects and scale, which reinforce each other.

This can be a pretty potent combination. Industrial and electrical distributors—companies like Anixter (AXE), Grainger (GWW), Fastenal (FAST), and MSC Industrial (MSM)—distribute industrial supplies: tools, electronic equipment, wires, cables, screws, lubricants, and basically anything that’s required to build or fabricate something. These firms are a vital part of our industrial supply chain, serving millions of businesses, both in America and abroad.

Because the customer base is so large and heterogeneous, they often carry mammoth product lineups. Anixter, for example, has about 450,000 unique products in stock, selling to over 100,000 customers. A heavyweight like Grainger carries twice as many products and serves several million customers.

This dispersion of products and customers is a big point in the distributors’ favor. For example, a machine tool maker with 100,000 small customers would find it impracticable to build a direct-sale presence to each of these customers. On the other hand, if you were a small general contractor, buying from several hundred suppliers, it would also be uneconomical for you to contact each of these firms directly.

There are a few big reasons that the industry remains highly fragmented:

Even after consolidating for the past decade, industrial and electrical distribution remains extremely fragmented. Depending on whom you ask, the top ten players control perhaps 20% to 30% of the market. This is a testament to how sticky some of the customer relationships are in the business. On the other hand, this suggests that the growth runway for the largest companies is very, very long.


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