Resellers and Digital Transformations

1. Consolidation

Over the last 20-25 years, remanufacturing of aftermarket replacement ink and toner cartridges have transitioned from thousands of independents operating out of modest onshore premises, to a small number of manufacturers, largely concentrated in the Zhuhai area of the Guangdong province in China, mostly now engaged in the assembly of new-build cartridges.

Staples and Office Depot's plans to merge during 2015/16 were thwarted by the FTC so they have both had to continue to face the threat from Amazon, independents operating in the Amazon marketplace, and other direct competitors as independent entities. It wasn't long after the collapse of the deal that both companies announced they were exiting their overseas operations, and that both would continue with significant numbers of store closings in the United States as they hunkered down for the long haul. Then, less than a year later, Staples was taken private in a mid-2017, $6 billion private equity deal.

There are two national wholesalers – Essendant (formerly United Stationers) and SP Richards. They're both struggling to deal with market shrink and the changing competitive landscape. Essendant has experienced a fall in its share price from $45 in January 2014 to less than $10 in December 2017 with its market cap crashing from $1.8 billion to less than $350 million over the same time frame. SP Richards, a division of the much larger General Parts Company with a current (Dec 2017) market capitalization of $14 billion, would seem to be in a stronger position, at least until its parent decides it's time to shed an under-performing asset. How much longer before these two wholesalers are combined into one?

Since 2015, there has been an increasing consolidation and restructuring at the OEM level. Hewlett Packard split into two companies with the HP, Inc. portion focused on printing and supplies. Then, HP surprised the industry with the announcement of its acquisition of the printer business of Samsung, throwing its 30+ year relationship with Canon into turmoil. Then, Xerox announced, it also, was splitting into two companies with the Xerox brand to remain with the dedicated printing and supplies enterprise. The biggest shocker of all, Apex (Ninestar) announced its deal to acquire Lexmark, a deal that then closed without further ado at the end of 2016.

Consolidation of resellers has taken place but, despite this, there remain thousands of independents with this part of the consolidation process still mostly left to play out.

During the same 20-25 year period of maturing market conditions, we've witnessed the entrance of additional OEMs such as Brother and Samsung into the mainstream office products and supplies arena. Some, such as Brother and Samsung, established a stable presence while others, such as Kodak and Xerox, experienced failures and were quickly forced to exit the desktop printing space.

In the early 2000s, Hewlett Packard had around 75% market share in desktop printing but, by 2017 (excluding the Samsung deal), this share had probably been reduced to less than 50%. The new entrants eroding Hewlett Packard's market share were attracted by the prospect of profits. Despite the maturing industry, they invested to enter a market during a later stage in the business cycle when we'd normally have been expecting consolidation, not diversification. The reason for this apparent anomaly will become evident later in this paper.

2. Litigation

The office supplies industry has been a legal minefield – the OEMs have thousands and thousands of patents and these intellectual property assets have been, and continue to be, utilized as part of a strategy to defend market share. A patent is a “government-granted monopoly” issued to benefit the inventor for the term of the patent. Few would argue the patent system is not an important component of modern commerce.

However, despite the mature technology, hundreds of patents continue to be issued to the OEMs each year while (for the most part) the market is not seeing major technology advances. Remember the days when we all looked forward to the next product introduction – improved resolution, faster printing, color, etc. Well, when was the last time there was a genuine newsworthy technology advance?

Troublingly, it's difficult to see a strong correlation between the number of genuine technology advances and the number of patents issued. Creating a “thicket” of blocking patents appears to have become part of the business process, leveraging the potential for them to be deployed to protect market share.

While patent infringement cases continue to be a threat to the aftermarket, the scope was extended beyond “simple” infringement complaints. Complex legal actions, directly targeted at remanufactured products under the “first-sale” doctrine, whereby the original OEM patent rights in the U.S. were considered not to have been exhausted if the cartridge core used for remanufacturing was not “first-sold” into the U.S. market through an authorized distribution reseller.

This “first-sale” strategy was aggressively pursued by Lexmark until the matter was finally heard by the United States Supreme Court and ruled upon in May 2017, reversing the Federal Circuit on both domestic exhaustion (8-0) and international (7-1). A rare victory for the aftermarket after nearly 20 years of controversy and litigation.

3. Distribution Trends

Hewlett Packard made a bold move in the second half of 2013 announcing a major change to their distribution model. Since then we have heard the number of authorized HP resellers was culled from 15,000 or more down to 4,000 or less. The repercussions have been significant. Not only are thousands of resellers who used to be able to buy and resell HP brand product cut-off and unable to sell to their customers but, the distributors that used to sell them HP brand are no longer permitted to do so. Not only have those distributors lost the HP business but, odds are, they also lost some of the non-HP business that previously came with it.

Hewlett Packard has a “direct-to-consumer” model, including sophisticated monthly subscription plans, providing auto-fulfillment of ink in return for a monthly subscription fee. Many other OEMs are selling direct and bypassing distribution except for situations where it suits them to continue with traditional channels.

Most of the OEMs have deployed Managed Print Service programs and remotely monitor the printer hardware in their fleets. It’s ironic that, while these programs started out as “rip-and-replace”, helping the OEM maximize sales of its own hardware and consumables, they have matured to embrace remote monitoring and fulfillment of consumables onto competitors hardware. Of course, the OEM (selling the service) is not putting OEM brand supplies on its competitor's hardware inside its monitored environment. Instead, they're sourcing aftermarket product, not only providing a significant revenue boost to some aftermarket manufacturers, but also turning those formerly fierce competitors into customers and mitigating the most significant aftermarket threats.

Making printers part of the “Internet-of-Things” must contribute toward an improvement in supply chain efficiency. However, for the OEMs, it’s also allowing them to gather massive amounts of intelligence on where the printers are and how they're used. This raises questions on how the information they have may be used and what impact it may have on who ultimately owns the customer – the reseller or the OEM.

4. Market Dynamics

Demand for office products, including ink and toner, is declining and, as the market declines, price pressure occurs as resellers fight to protect their existing customer base. So, in addition to a declining market reducing the top line, there are reductions in average selling price taking place that are squeezing gross margins and compounding the negative impact on profitability. Furthermore, with universal access to the internet, it has never been easier for buyers to research alternative options and switch suppliers. Churn, or loss of customers, can have an even greater impact on the top line than market shrink and average selling prices combined.

5. OEM Pricing Model & Market Share

Office products, business equipment, and supplies is a mature market. The first all-in-one laser cartridges for desk-top printing appeared in the early 1980’s, more than thirty years ago and many lifetimes in technology terms. Ink came later in the early 1990’s. For such a mature market, it's remarkable that the OEMs retain such a dominant market share – around 70% of all monochrome and 90% of all color printing per various market analyst reports. Assuming the retail market for toner in the U.S. is $25B per year, 50% is mono, and 50% color, then $20B (80%) of the ink and toner retail dollars are spent on OEM brand product.

It’s even more remarkable when you consider the bill of material cost for a typical laser or ink cartridge. For a device like an Apple iPhone, the material cost is dissected and estimates posted on the internet within days of a new device launch, leading to envious eyes cast toward the largest and most profitable consumer electronics company in the western economy.

Of course, there’s a tremendous consumer interest in a new iPhone and much less interest in an ink or toner cartridge. However, take an OEM brand Hewlett Packard CC364X laser cartridge – available directly from Hewlett Packard, from Staples or Office Depot at $324.99. Our estimate for the material cost is around $30.00 meaning 90% of the retail price is being accounted for elsewhere in the value chain. Even Apple must be envious of the scale of the gross margin!

The same search that displays an HP brand cartridge at $324.99 also shows a compatible aftermarket cartridge at $42.99 and a remanufactured “Innovera” brand cartridge anywhere between $49.00 and $143.92!

The cost to build a new aftermarket cartridge is similar to the build cost of the OEM build of the original cartridge – probably a little more expensive because the OEM has economies associated with their higher volumes. The remanufactured cartridge cost is probably higher than the cost an aftermarket new-build. Remember, the remanufactured product is dependent on the recovery of a used “core”, and after accounting for recovery logistics costs, disassembly and rebuild with many new parts it almost certainly exceeds the cost of a new build.

Even though resellers could earn more margin dollars switching their sales from OEM brand cartridges to the aftermarket, their instinct is to preserve their top line revenue dollars as a priority over the bottom line. In other words, (with the help of OEM back-end incentive dollars) the resellers are motivated to maintain the OEM sales dollars because it supports their top line. This is despite the fact they could earn significantly more margin dollars dropping the OEM and focusing on the aftermarket product. The big-box retailers and distributors need the OEM product to support their top lines, the OEMs know they need them, hold the balance of power in the relationship, and control the allocation of margin dollars earned on the sale of the product.

6. Clones Vs. Legitimate New-Build

To be accurately defined as a clone, the cartridge in question must contain the same cartridge technology (“DNA”), as the OEM cartridge but, not be manufactured, licensed or otherwise authorized by the OEM and holder of the patents. There's a strong likelihood that a clone cartridge would be found to directly infringe many patents should a legal action be brought by the owner(s) of the patents.

It has been a common misconception, amplified by those with the most to lose, that all "new-build" cartridges are clones. However, this is not necessarily the case. For an overview of the differences between OEM new build, remanufactured, and aftermarket new-build cartridges, the European Toner & Inkjet Remanufacturers Association (ETIRA) "Guide to Clones" report provides an excellent resource.

In the litigious office supplies industry, one would think clones would be easy pickings from a legal perspective yet they have continued to enter the market years after they first appeared in any scale. Availability of clones is disrupting the aftermarket, in some cases adversely affecting good business judgment and, ultimately, playing into the hands of the OEMs by further weakening a sales channel they (the OEM’s) appear to have less need for - a point we'll expand on later in this paper.

In taking no action against illegal ink & toner cartridge clones, the downfall of a diversified and independent sales channel may be accelerated.

Further complicating the controversy surrounding new-build cartridges is the difficulty to determine what constitutes a clone and what constitutes a legitimate new-build. Vast sums have been invested, primarily by the Chinese, developing so-called "patent-safe" new-builds. However, it's not possible for the average reseller to know with any certainty whether the manufacturer's "patent-safe" claims are legitimate or not. In fact, the only path for a conclusive determination would be through a patent infringement action where, ultimately, the parties either settle the dispute, or a jury decides based on the evidence presented in the Court of Law. This leaves resellers in a difficult spot with regards to what's safe to resell and what isn't.

7. Information Technology

The OEMs and the “Big-Box” resellers leverage information technology to help provide a first-class experience for their customers. Not only is the product they deliver of the highest quality, it's also delivered quickly, when promised, and the communications throughout the order and delivery process are seamless and effective. The OEMs and "Big-Box" resellers all have popular, well-recognized web-portals and are trusted to manage transactions for their customers. Each of these enterprises has deployed websites with integrated e-Commerce platforms and various value-add features. For them, e-Commerce is not a standalone strategy because their business models have been completely digitized and, through the seamless use of information technology, consumers are able to quickly and intuitively find what they're looking for and complete their transactions.

Additionally, as previously mentioned, the OEMs have deployed remote monitoring software for their managed print service programs to improve supply chain efficiency, reduce printing costs, and improve customer retention.

Small and medium reseller businesses have mostly failed to keep pace with these technology improvements and are not able to match the service levels offered by the OEMs and larger aftermarket players, thereby compromising their ability to retain existing customers and to win new ones.

The Implications

Having introduced an overview of these seven competitive headwinds confronting independent office products, business equipment & supplies resellers, it's important to consider them in light of the broader implications that result from their combination. In other words, dealing with just one of the seven threats may be considered challenging enough but, dealing with one and ignoring the other six, is unlikely to result in a satisfactory outcome. A strategy to deal with all seven is necessary.

The presence of illegal clones in the market is a significant disruptive threat and just as big a problem for the legitimate aftermarket manufacturers and resellers as it is for the OEMs. The former are forced to compete with the clones knowing they absolutely cannot adopt them for legal reasons, placing them at a serious competitive disadvantage. The OEMs are also forced to compete but, they have a huge arsenal of patents at their disposal to protect market share when they choose to do so. In other words, the aftermarket manufacturer is powerless to act but the OEMs are not.

Consolidation of the ink and toner manufacturing industry and the simultaneous consolidation of the big-box resellers of ink and toner cartridges, means the clones are unlikely to find their way into the big-box distribution channels. The remaining manufacturers who service these channels will not adopt the clones for legal reasons and, even if they did, the big-box resellers would not buy them because of the same legal issues and the damage it would cause to their OEM relationships. The OEMs know this and must be quite confident the distribution firewall (that could lead to loss of market share) is not likely to be breached.

When considering a specific competitive threat, it’s easy to overlook there may be multiple threats. So, a strategy to deal with the combination of threats is vital.

Perhaps the OEM is currently willing to tolerate the presence of clones in the market because, not only may they be taking more market share from the aftermarket than the OEM, they may also be simultaneously damaging the channel that’s selling them. Furthermore, as illustrated by recent changes in OEM distribution strategies, this is a sales channel the OEMs are demonstrating they no longer need as much as they used to. So, in the short term, the cartridge clones may serve a useful purpose to the OEM but in the longer term, when they choose to do so, they can roll out the legal big-guns to eliminate them.

We think there’s a valid argument that the presence of clones may be eroding the “legitimate" aftermarket share more significantly than the OEM share. Although the OEMs know who are manufacturing and importing them, the last seven or eight years of litigation has not been targeted specifically against these products and their manufacturers. Instead, the legal net has been cast wider with dozens of companies (including some of the clone manufacturers) sued both in Federal Courts and in actions placed with the International Trade Commission (ITC), on patents which impact clones and remanufactured cartridges equally.

Importation of clones appears to have mostly narrowed to a shadowy group of agents, who then resell the cartridges via online portals and in the eBay and Amazon marketplace. This is likely to remain the case until they're eliminated from the market.

Cartridge clones are a big threat – only the OEM has the firepower to deal with them but, so far has taken no direct action to do so!

The remaining aftermarket ink and toner remanufacturers who supply the “big-box” resellers (such as Staples and Depot) have significant customer concentration because a large proportion of their sales go through a small number of large customers. While it’s difficult for them to be displaced (who is left to displace them?), the balance of power in the relationship lies with the reseller, not the manufacturer. Therefore, the bulk of the margin dollars earned on the aftermarket product under the shelter of the OEM pricing umbrella, accumulate to the reseller, not the manufacturer.

Historically, the large number of independent resellers have been an important sales channel for the aftermarket manufacturers. Partly because of their business concentration issues resulting from the small number of "Big-Box" resellers, the independents have continued to be of interest to the remaining manufacturers because higher margins can be earned, and concentration risks reduced, with a large portfolio of smaller customers.

However, the future of this independent sales channel may be compromised by events unfolding in the marketplace causing large numbers of the smaller independents to face uncertainty. Think back to the change in distribution implemented by Hewlett Packard. Thousands of resellers that used to be able to obtain and resell Hewlett Packard branded products were "deauthorized" and most were poorly prepared to deal with the resulting challenge to their business model.

Hewlett Packard (and other OEMs) have great power in the marketplace. Those extraordinary margin dollars generate market power even though we know not all the dollars fall to the bottom line. With the need for hardware subsidies, research & development, reseller incentives (rebates), and the marketing and branding costs incurred to convince businesses and individuals to spend over $300 on a cartridge (despite high-quality alternatives being available for less than half the price), the overall margins are quickly reduced to much more modest levels.

For consumers influenced by the marketing dollars, convinced only the OEM brand will work in their equipment, and deciding to ONLY purchase the OEM brand, they can't do so from a local reseller that lost its authorization. Being forced to buy elsewhere directly contributes to the decline of a deauthorized local reseller.

The independent resellers primarily combat competitive headwinds with the price. To drop the price and still maintain margin, the reseller must reduce cost and, to reduce cost, there's a temptation to source the clones, knowingly or not. This, in turn, creates a “death spiral” of compromised product quality further devaluing the overall reputation of the aftermarket, while simultaneously playing into the OEMs branding and messaging strategy.

The opportunity for the remaining aftermarket remanufacturers to maintain, or expand, their market share through the independent resellers is compromised as clones and new-build gain traction because they're unable to compete on price or [sometimes] availability, in the event of core scarcity.

The End Game

Consider the following twelve events as if they were part of a well-considered Grand Master Plan collectively developed by the OEMs:

Failing to understand a combination of competitive threats, and to implement strategies to fight them, is not just an option for a business that expects to survive!

This sequence of events may make it appear there's a coordinated, well-planned strategy to eliminate the aftermarket. With all the competitive headwinds we've summarized, who could blame independent resellers for thinking this may be the case?

However, although it could fit well with conspiracy advocates, we don’t think a planned strategy of this nature exists at all. The OEMs are large companies, each with different strategies and objectives. Furthermore, within each OEM organization, there are bound to be cross-departmental conflicts, other strategic, and possibly legal issues which combine to mean a coordinated strategy could never get started beyond an idle chat around the water cooler.

It’s not possible to go through this list of events and to intelligently build a case that OEM actions are part of a coordinated anti-competitive strategy. Instead, while there's no disputing the OEMs are all tough competitors taking advantage wherever they can, we're more concerned that segments of the independent reseller community, overwhelmed by the transformation from analog to digital, are compounding their difficult circumstances with ineffective tactics and poor decisions. Their own shortcomings are more likely to underlay their demise rather than being victims of a coordinated attack by the OEMs.

Elite business organizations are very good at exploiting opportunities as they develop in a dynamic environment. We've set out the sequence of events above in the roughly chronological order of those that have already occurred, and those that could still occur, also in a logical sequence of their potential occurrence. Let’s assume these past and potential events are not part of a grand master plan but, that as each one occurs, organizations take advantage of that event and move on. Then, the next event takes place, they take advantage and move on once again. In this scenario, it's plausible to think the end result we've illustrated could occur, not as part of a well-considered grand master plan but, as a natural progression of a series of uncoordinated events.

This is how independent resellers should view and plan for their future. Tactics and strategies must be implemented that disrupt the potential for the remaining steps of the sequence to occur. By disrupting the sequence, then the outcome can be changed and an opportunity for growth created.

Introduction

This section will explain the background of e-Commerce and how it has evolved over the last 15-20 years. While explaining the scope, the main objective is to continue developing the implications of competitive challenges facing the office products reseller community. Currently, many resellers may mistakenly view e-Commerce in itself as a headwind (for example - the threat represented by Amazon) but, instead, should be viewing it as a tactical opportunity to deploy an effective counter-strategy implemented under their management and control.

It's important to remember, the seven headwinds are all competitive threats that come as part of the territory in a free market economy. The threats are outside the reseller's control and will always be around in some form or another but, instead of leading to disjointed defensive reactions, they must lead to intelligent competitive reactions. Without embracing e-Commerce as the foundation of this reaction, it's difficult to see how the combination of threats can be dealt with and a brighter outlook developed.

Just what is e-Commerce?

The general preconception of e-Commerce by small and medium-size businesses seems to revolve around the deployment of a shopping cart site that enables consumers to make an online purchase. However, we believe a more thorough examination of successful e-Commerce establishes that the shopping cart is just the final step in an operational and digital infrastructure that facilitates online transactions. There must be compelling business reasons behind successful e-Commerce or businesses and customers would not be interested and traditional “brick and mortar” retailing would not face the threat that it does today.

Widescale access to the internet started to occur in the mid-to-late 1990s which have become the time frame now typically perceived to be the dawn of e-commerce. However, it's important to understand that the roots go way back before this. As early as the 1960s companies started attempting to improve the efficiency of transactions between their suppliers and their customers by using Electronic Data Interchange (EDI) on Value Added Networks (VAN’s).

This medium for the electronic exchange of information grew with the increased availability of internet access beginning in the 1990s and early 2000s. It’s important to understand these first, early steps in online activity were driven by early adopters seeking to obtain the competitive advantage in their respective markets that result from improvements in the efficiency of their operations. This will be a recurring point as successful e-Commerce is all about improved efficiency and performance, and not just about providing access to an online shopping cart. As these improvements occur then, so long as they are embedded in the overall value proposition and are recognized by their customers for adding value, they will be adopted and the providers will benefit with increased sales and market share.

The main elements that form the core of e-Commerce include technologies such as mobile, electronic funds transfer, supply chain management, internet marketing, online transaction processing, inventory management systems, accounting systems, data mining, shipping and tracking, and automated customer messaging systems. The deeper you drill down the more elements can be identified.

For businesses that have leveraged these elements, most of them are now taken for granted. Recall a 2014 comment from Google Chairman Eric Schmidt, that “the internet will disappear”. On the face of it, this may have seemed a ludicrous statement but, what we think he meant, is that the internet is being seamlessly integrated into our daily lives to the point where it’s no longer visible and we no longer have to even think about it. This type of seamless, information technology integration is already the case within companies that have established a strong e-commerce presence.

Providing the capability for a customer to transact efficiently on-line can only be accomplished after deploying a fully integrated information technology platform.

For their business to survive, most owners would probably agree they need to have an online (e-commerce) presence. However, deploying an e-commerce solution, without the back-office integration, is not very compelling when compared to those with integrated systems and platforms that permit their customers to conduct more efficient transactions.

E-Commerce is a broad topic covering many aspects of online transactions – not just the shopping cart. Typically, these elements of e-Commerce have been separated into segments of whom they serve. 

Some e-Commerce transactions are more relevant to certain segments than others – for example, supply chain management is typically considered an element of B2B e-Commerce but, the benefits of improved management extend all the way through to the shopping cart – i.e. inventory levels can be displayed online and there's improved management ability to keep a product in-stock and to facilitate a sale.

So, a shopping cart without connectivity to the supply chain that supports it is less compelling than one that is. The ability to further differentiate the data underlying inventory availability, in terms of where it's located and how frequently it's updated, can further enhance the value of the data. For example, having visibility to inventory in multiple distribution centers means being able to deliver faster, incur lower freight costs, and enhance the value proposition.

The background to e-Commerce: 

We're about to step back to the late 1990s and early 2000s to establish the foundation.

It is not unusual for visionary innovators to fail to capitalize on new technology. History is littered with examples of failures – railroads, automobiles, are two examples of watershed innovations that left many financial casualties before they became part of our everyday lives. During the dot-com boom, many people saw the potential for internet access and digital technology to transform the way we did business. The problem was, they were far too optimistic with regards to the pace at which the transformation could occur.

At a fundamental level, the anticipated changes were to be enabled because of the ability for information to be quickly and widely shared at a very low cost. However, business rationale went out of the window and many crazy, poorly considered concepts were funded. However, not all were crazy and the stronger ones, supported by investors with deeper pockets and longer-term vision, survived – i.e. Amazon.

For many of the failures, perhaps conceptually they may have been sound but, the infrastructure to support them and provide a better value proposition was simply not in place. The complexity involved to build out the infrastructure and “connect all the dots” was massively underestimated. A bubble had been inflated and sooner or later it had to burst. Sure enough, the technology-heavy NASDAQ Composite Index collapsed from a peak of over 5,000 in March 2000 to around 1,000 in October 2002 – a precipitous fall of 80%. It would take nearly 13 years, from when the bottom was reached in 2002, to get back to the peak level the Index had previously risen to in 2000.

Why will it be any different in 2015-20 than it was in the late 1990s? If I invest in an expensive and time consuming e-Commerce strategy, is it going to be a waste of money?

During the last 15 years, there have been tremendous technological advances and the infrastructure that's now in place forms a solid foundation for most of today’s technology valuations compared to those of 2000. The big difference between now and then is;

• Many of the ideas innovators are bringing to the market can now be supported by the technology infrastructure and,
• The benefit of hindsight and lessons learned from previous mistakes.

Furthermore, it's not only the new ideas innovators are bringing to the table that continues to transform our lives, but it's also the availability of information technology at very reasonable costs that have the potential to transform thousands of existing businesses as they choose to embrace it.

The world of commerce is changing before our eyes as the capabilities that were imagined in 2000 have now matured and are widely accessible. Sophisticated information technology systems, that used to be the exclusive domain of large enterprises with deep pockets, are now available to small businesses at reasonable costs.

One of the biggest challenges facing businesses today is to analyze and make sense of the data, and then turn it into a business opportunity.

In the late 1990s, many legacy companies were skeptical of the viability of the business models attracting private equity financing, or that the statements in the press and business circles, about “the new way of doing business” and the “new economy”, were merited.

All businesses are in business to make money. Sometimes it takes longer and costs more than anticipated but, ultimately, a business must make money or it will fail. So, despite the widespread skepticism surrounding many of the concepts, legacy companies recognized some of them had the potential to develop into threats to their existing business models and knew they had to react. Employees, who recognized these threats, framed them accordingly to their executives and secured sufficient funding to develop their own platforms to counter them.

This activity resulted in many standalone “e-Commerce” business platforms being established by legacy companies. However, just like new start-ups were destined to fail because the digital infrastructure to support their ideas did not exist, most of the legacy efforts were also primitive, poor value-add solutions.

But, there was a big difference between the start-up efforts and those of the legacy companies in that, the latter, having been forced to set up their e-Commerce initiative as a defensive measure, then started to understand what was really required in terms of integrating with their existing business platforms. Once this integration was successfully achieved then, not only could they see the path to reduced costs but, also the path for creating an improved value proposition for their customers. Once this was achieved, they found they were able to more effectively retain existing customers as well as win new ones.

So, instead of continuing with standalone e-Commerce platforms, they started to invest in their digital infrastructure to makeover their entire business model toward supporting the various elements of e-Commerce. In parallel, private equity investors restricted access to capital as they learned it was necessary for systems integration before the start-up concepts they'd been sold on could be viable. As this pause in private equity occurred, legacy companies started to rapidly move up the learning curve, developing scale, and continuing to secure access to parent funding for their development of true e-Commerce platforms. In accomplishing this, they started to develop competitive advantages.

Information, Integration, Communication, Efficiency, Superior Decision Making - Do or Die!

In truth, therefore, the legacy companies with their money and scale became the “early adopters” because the real pioneers crashed and burned. Remember, all this took place in the relatively early days of internet search. Google, founded in 1998, was emerging in the early 2000s as the dominant search engine. Few, with a basic understanding of search, would disagree that over the last 10-15 years the sophistication of search algorithms has advanced considerably. In today's search environment, with over 1.3 billion unique websites online (six-times as many as in 2010), there’s little chance of relevant organic traffic to a new website without a phenomenal new product and media publicity to drive traffic.

In 2005, with “only” 65 million websites and less sophisticated search algorithms, SEO experts figured out methods to exploit the shortcomings of the algorithms and how to place themselves prominently in search results. It was quickly understood that content (alongside pay-per-click) was a key component required to place high in search. It was also quickly understood that Google algorithms had a tough time to sort out unique content from duplicate content and, by flooding the internet with similar articles, better search results could be obtained. These tactics, especially when combined with large budgets for paid keyword search, made it possible to build a prominent online position from the ever-increasing volume of traffic and searches.

It's much more difficult in today's environment. Even if the Google search algorithms hadn’t advanced during the last ten years, the chances of organically finding a resellers website in a search environment where there are nearly 7500% more sites than there were seventeen years ago, even with 800% more users searching, is significantly more difficult. The rate of increase in the number of websites is almost ten-times the increase in the number of users.

Over time, the early adopters were able to build significant competitive advantages developing their domain strength earned through numerous factors, including the benefits of early domain registration and the subsequent accumulation of authority resulting from traffic volumes, the quality and number of links, their social media mentions, shares, etc.

The foundations for the advantages these sites now enjoy were built during times when conditions were very different. Today, without a unique product differentiator with mass-market appeal, it's much more difficult for a business to replicate what could be achieved 10-15 years ago.

On the face of things, it may seem the chances for late adopters to establish a successful e-Commerce presence is bleak. Without a phenomenal new product and lots of free, conventional media publicity to spread awareness, there’s practically no chance of becoming a highly ranked national or global site.

However, we believe the challenge needs to be contemplated from a different angle.

In the first section, we explained the headwinds facing the independent resellers in the Office Products channel. These headwinds are outside the control of the resellers and, to survive, they must figure out ways to deal with them. Establishing an effective e-commerce platform should be viewed as an essential, reseller controlled counter-strategy implemented to deal with these headwinds.

The key here is for small to medium sized businesses to develop an e-commerce strategy with realistic objectives in terms of unique daily visitors, revenue goals and, most importantly, the timeline required to achieve their objectives.

• Technology change is happening faster than ever
• Decision-making processes must evolve & adapt constantly to the changing market
• CEOs must be prepared for an era of unprecedented change
• 50 billion devices will be connected to the Internet by 2020 – a 500% increase from 2010

It should be clear, that simply launching a website and sitting back waiting for the traffic to arrive and orders to flow in is not going to work. Think about the scale of the internet, think about how many sites there are and the cold, hard fact that an individual site is just one of 1.3 BILLION sites! How can it be expected for anyone but friends and family to ever find it?

There are no boundaries around the internet and, without boundaries, a single website is about as visible as a needle in a haystack.

No one else is going to develop the boundaries so, it’s up to individual businesses to learn how to create them, how to reduce the size of the haystack, and how to appear on the first page of a relevant search. With the number of searches expected to exceed 2 TRILLION during 2017, there is no shortage but, unless a website has content relevant to what people are searching for, then none of them will ever lead to that site!

There are three ways to get traffic;

1. Pay for it
2. Earn it
3. Develop a product everyone wants, getting masses of free publicity that develops awareness and web traffic.

Chances of number three happening are rare, once in a lifetime events so, for the purposes of this paper, we'll ignore this one!

Paying for traffic can be a valuable component of a web traffic development strategy. In fact, in the beginning, it may be a necessary and significant expense. Longer term it’s likely to continue to be a component of a successful digital strategy but, over time, it should become a smaller percentage of overall marketing expense.

Earning traffic is hard. The field of traffic development is overwhelming and most small business owners simply don’t have the time or resources available to figure out what may make sense for their business and what doesn’t.

For those business owners that have invested the time to understand requirements, and then developed a strategy for implementation, they face a long, hard slog to earn relevant traffic. They're also likely to find their strategy requires constant fine-tuning because what may work well today may not work quite so well tomorrow!

Over time, due to the dynamic nature of the environment, it's likely to mean future traffic development activities will look quite different from those used at the outset. Therefore, not only is a significant investment of time required to develop an understanding of the initial requirements but, on an ongoing basis, time and resources will be required to ensure the strategy evolves alongside the changing online environment.

Why are most small businesses failing to develop any e-Commerce traction?

The scope is overwhelming and most don’t know where to start. Even though many independent resellers already have websites complete with online product catalogs and shopping cart, most haven’t put the operational and information technology infrastructure in place to support a successful e-Commerce initiative. Usually, the effort is floundering and their business continues as it was before (offline) and exposed to encroachment threats from other businesses already successfully online.

Middle Tennessee Office Products may have the best shopping cart functionality, the best product catalog, and the best prices but, NO ONE will ever know!

• One of more than 1.3 billion websites!
• The typical small business website & storefront:
  • Lacks educational content
  • Has a weak social media presence
  • Lacks a visit-to-lead conversion strategy
  • No strategy for building organic traffic and acquiring leads
• The ONLY way a website lacking these attributes gets traffic is by accident, or by paying for it

The changing business conditions:

The influx of social, mobile, analytics, the cloud, and the Internet of Things (SMACiT) is starting to have a disruptive impact.

Business models are changing and the pace of decision making has increased significantly with owners and managers having instant access to the latest and most relevant business information. Ten years ago, most business information was not accessible once away from the office, because access to desktop computers was required to log into legacy systems that needed extensive training to set up and use.

Today, while the data may still be stored on those trusty old systems, there are customized, industry-specific templates layered on top that improves the user experience and allows owners and managers to quickly access the latest business information.

Once analytics capabilities have been integrated, there is an ability to make faster decisions and, when using social and collaborative tools on the cloud, then groups of users can review this information and collaborate on the decisions.

With the increasing use of mobile devices, there's no longer a need to be tied to an office or to conventional office hours. With more and more “things” being connected to the internet, and the ability to analyze and react to the data being collected, the combination of social, mobile, analytics, the cloud, and the Internet of Things that are being adopted by the savviest businesses, it's transforming the way they protect their existing customers and how they develop new ones.

"With my 100th customer installing our data collection agent on their network I can see 3,285 printers in my downstream and know when each of them is going to run out of ink or toner. I’m so far ahead of the curve, I'm staying on the beach for another week!"

 

A fully integrated information technology system puts actionable intelligence at your fingertips 24/7 - from wherever you may be located. All that's needed is a browser and a hotspot!

The front-end of B2C e-Commerce (the shopping transaction) is a competitive fight for a finite amount of shopping traffic. Take a look at the table below. In 2014 the market penetration of internet users in the U.S. increased 7% resulting in an overall market penetration of 88%. This rate of increase cannot continue as the number of users would quickly overtake the total population. So, assuming an average increase of 2% per year between 2015 and 2020, total market penetration will be 94% by 2020. Also, assuming the number of different websites visited each day by the average user remains around 15, then the number of unique sites visited daily will only increase at the same rate as the number of users - from 4.2B per day in 2014 to 4.7B in 2020.

However, based on the on the six-fold increase in websites that's occurred between 2010 and 2017, it's not unreasonable to think that as many as 1.6 Billion sites will be established by 2020, almost 8 times the 2010 total. If this turns out to be the case, then for each site to get the same average amount of traffic as they did in 2010, the average number of sites visited per day per user would have to increase by a factor of 4, from 15 to almost 60, and the average internet usage per day would also have to increase by a factor of 4, from 1.75 (2010) to almost 7 hours per day, nearly three times the current 2020 usage projection!

Based on the history and the forward projections, it stands to reason, the vast majority of new websites will receive little to no traffic.

Most website traffic is for research and entertainment not shopping. Entertainment is outside our scope so we will ignore it.

Research, however, is within our scope as it includes internet users looking for information about a product or service before considering a purchase decision. This is an important point to understand before an e-Commerce business can be successfully developed. Once the back-end is in place, and a business has established its integrated technology platform, then the website for that business must satisfy the demand for information that’s being searched for. Unless this requirement is met, it will never stand a chance of appearing in relevant search, so it will never support a successful e-Commerce business.

If a website can be positioned as a source of authoritative information, user visits may be captured as leads that can then be nurtured through the sales pipeline until a portion of them eventually become customers.

According to FTI Consulting, (table below), e-commerce sales for 2014 were estimated at $291B (an increase of 15% from 2013) but this still only represented 10.5% of total retail sales of around $2.8T. Also, according to FTI Consulting, by 2020 online retail sales are projected to increase to over $500B and will represent around 14% market share of total U.S. retail dollars.

From this data table, you can see retail sales are projected to increase by a cumulative total of $937 Billion between 2014 and 2020 and almost one-quarter of these sales ($217B) is projected to be via e-Commerce.

The cumulative total of online retail sales between 2014 and 2020 is projected at nearly $2.8T. This is what e-Commerce is all about, a share of these 2.8 trillion dollars expected to be spent online. This is why independent resellers in the office products channel must establish their online presence so they have a chance to win a share of these dollars.

We're about to explain our view of an industry that has experienced significant consolidation and to focus on some of the structural limitations and weaknesses that develop during this process. Our objective is to identify these weaknesses and lay the foundation for strategies independent resellers may deploy to compete effectively with larger organizations.

Typically, consolidation occurs as the stronger organizations look to acquire their weaker competitors, achieve dominance through economies of scale, and ultimately, to leverage their cost advantage within an environment of reduced competition. There's a degree of inevitability to the process in a free-market economy.

Of the seven industry headwinds introduced at the start of this paper, consolidation was number one on the list. We concluded that section with the statement that the aftermarket reseller community needed to develop tactics and strategies to disrupt events that will otherwise grind toward an inevitable conclusion. The industry is consolidating and there's nothing an independent reseller can do to prevent this process. However, with knowledge and a sound strategy, the reseller can deploy tactics to take advantage of some of the inherent weaknesses that develop as an industry consolidates.

With the focus in this section on structural limitations and weaknesses, we'll move on later to explain tactics and strategies for leveraging information technology systems that help level the playing field. These systems then enable independent resellers to develop competitive advantages against much larger organizations. Understanding, and then developing these advantages, will lead to a higher level of optimism with regards to the business outlook for independent resellers.

• Business consolidation doesn’t automatically mean improved efficiency.
• Managing acquisitions & business integrations distracts from taking care of business.
• Small businesses are agile, flexible & responsive.
• Small businesses & their management team can leverage their personal presence in local markets.

What are the implications for small businesses and individuals in consolidating industries?

To help explain this we're going to provide a brief explanation of the role of money. Once we understand its role then it’s easier to understand why there can be significant negative implications in local economies that result from consolidation.

The key metric to have a basic understanding of is the velocity of money. Simply put, this is a measure of economic activity and considers how many times a unit of currency flows through an economy, and is used by various members of that economy. The faster money travels, and the more transactions in which it's used, then the healthier the economy, the richer the citizens, and the more vibrant the financial system. The velocity of money tells you how efficient one unit of money supply (i.e. a dollar) is at creating economic activity. Using “M1” (a narrow definition of the money supply including only the most liquid assets) a typical reading of the USA economy over the thirty years between 1980 and 2010 would be around eight. However, as we approached the end of 2017, it had dropped to a 45 year low of 5.5!

The money velocity metric is usually used to measure the economic activity of a nation but, for our purposes, can also be used to measure the activity of a smaller economic unit, such as a typical metropolitan area surrounding a medium sized city.

The table above presents a simplistic view of a micro-community with four thriving businesses and a money velocity of eight. 

Now let’s look at how the economic activity of this local community can be impacted by the arrival of a behemoth organization such as Walmart. Initially, this may be good for the local community – construction & infrastructure labor, employment, lower price of goods, a wider range of choices, etc. but then, over time, look at what may happen as illustrated in the table below.

The short-term benefits of a behemoth arriving in the local community may result in an increase in the velocity of money but, longer-term, four local businesses go out of business and the velocity declines from ten to one – a massive decline of economic activity in the local community.

This is a simplistic view of economic activity. Many Ph.D. theses and white papers have been written on this complex subject and we don’t want to veer deeper into economic theory. However, we do want to try and get the concept of economic activity in a local community established as a foundation for the overall argument. The discussion on whether the profits of the behemoth companies are reinvested and successfully create additional economic activity elsewhere, whether or not shareholder dividend payments create additional economic activity, or whether taxation policies on corporate profits are effective to stimulate economic activity, and if all these factors combine to help counterbalance the reduction of activity illustrated in this example, can be saved for another time. The list of potential influences on economic activity is long and arguments on costs and benefits endless.

However, just remember, over the 35 years or so prior to the Great Financial Crisis in 2008, the velocity of money in the United States averaged around eight and right now is below six – a forty-five year low and down from a peak of nearly eleven in Q1 2008. Also, keep in mind, this is a national average and it will be higher or lower in different parts of the country depending on local economic conditions.

Overall, after adjusting for inflation between 1980 and 2015 the total amount of economic activity (M1 money supply times M1 Velocity) has almost doubled in the United States from $9.5T to $18.0T. Even after adjusting for the 42% population growth that occurred over the same period, the per capita economic activity has increased by 34%. By our own definition, this substantial increase in economic activity must be good news, mustn’t it?  Perhaps, for some - we’ll revisit this question later.

There are strong economic forces that drive the trend toward scale in free market economies. The two most basic are driven, firstly by the desire of business owners to quickly expand their customer base (i.e. acquire a competitor) and secondly, to negotiate lower costs by utilizing their increased purchasing power achieved through volume. This sets off a virtuous cycle - having developed a competitive advantage, the emerging powerhouse starts to attack rival businesses and win additional customers, weakening the competition until they either go out of business or they become less expensive acquisition opportunities. Throughout this process, customers are poised to benefit from lower prices that are offered in the marketplace.

Not only is the consumer likely to experience lower prices during the consolidation process, they're also likely to experience improvements in service. As we already identified, there have been seismic changes in terms of the use of technology in business due to the deployment and widespread adoption of the internet. As businesses scale, they continue to look for ways to develop competitive advantages.

For example, consider two businesses (A and B) of comparable size in a similar industry. Business A invests in technology to improve supply chain management, warehouse management, catalog management, customer price list management, invoicing, customer messaging etc., while Business B spends its profits on a fancy office with top of the line furniture but fails to invest in the infrastructure that could improve its performance. Consequently, it requires more workers to match the performance of Business A which became more efficient through its investments. These events place Business B at a competitive disadvantage and it becomes a matter of time before the business either fails or is sold at a lower price (perhaps to Business A), than it otherwise could have been.

Now let’s look at Business C, not a specific target of Business A or B but, now also placed at a competitive disadvantage due to the actions of Business A. The owner of Business C is a smart guy and he knows he's been placed at a competitive disadvantage, but, he doesn't have access to capital (or considers it too risky) to fund acquisitions, or to employ resources to implement technology to improve efficiency and service. Therefore, over time, Business C will also fail or will be sold, perhaps to Business A. The sooner the process for the sale of the business is initiated, the more value will be extracted from that transaction by the owner of Business C.

What we see here during the consolidation cycle, is a trend toward better service and lower prices from an ever decreasing number of suppliers. Later in the consolidation cycle, the emerging behemoths realize they don’t have to continue deploying capital to acquire the remaining small businesses. They know, over time, the odds swing significantly in their favor to organically win customers they don’t already have as the smaller independents are forced to exit due to declining sales and profitability.

In the first part of the business cycle, consumers are benefiting from lower prices and improved service. However, despite this being the way a free market economy operates, there is no denying (at least in the short term) the negative impact on employment in local markets within the industry that's consolidating. In almost any acquisition, there's an expectation that synergies between the merged businesses will be sought and expenses (duplicate employment) eliminated. This, as we've previously explained, is likely to lead to a reduction of economic activity in the local market where employment is eliminated. Although consumers in that local market may benefit from lower prices and better service, there's less money in the community to be spent, so local economic activity is likely to decrease.

• Initially, consumers benefit as prices drop and service improves.
• Toward the end of the cycle, prices may increase and service may deteriorate.

Up to this point in the consolidation cycle, we've been explaining the advantages accruing to customers through reduced prices and improved service. We think the arguments and evidence to support these benefits of consolidation are quite compelling and overall constitute a net benefit to society, as evidenced by an inflation-adjusted aggregate increase in economic activity of 34% over the last 35 years. However, it's also widely reported that a significant shift in the distribution of total wealth has also occurred over the same time frame, with the top 10% of U.S. households now holding around 50% of total wealth versus 40% in 1990.

The point here is, that although there may have been a 34% increase in economic activity, the bulk of the benefit has gone to the top 10% of U.S. households. Furthermore, most of the benefits have accrued to the financial sector and the C-level executives of the behemoth companies. Consequently, the bottom 90% of households have benefited very little from the overall increase in economic activity.

It must also be questioned whether the price and service benefits of scale continue to take place over a longer period and especially at the later stages of industry consolidation. We think the answer necessarily must be that they will not, or at very best, will be on a significantly reduced scale.

Observations:

• The benefits of consolidation to consumers tail-off the further the progress into the cycle that has taken place
• Today's consumers have access to far more information and are better informed of alternative solutions

Furthermore, we believe there's a great deal of evidence to show the advantages of scale, so far as the consumer is concerned, are negative long before most realize.

• All corporations, public or private, are accountable to their stakeholders. The drive to maximize profits is inexorable and reduced employment and/or lower wages are a prime target.  For example - we have all experienced the frustration of outsourced call centers and automated inbound telephone systems. Reduced costs, maybe, increased customer satisfaction, we don’t think so.
• The value of the relationship between supplier and customer is frequently overlooked these days. The fact is, there's rarely a personal relationship between the behemoth companies and all but their very largest customers. So, often the relationship is instant chat, shopping cart, and offshore call center. Do customers prefer a more direct relationship with their suppliers and, if they could, would it result in a more loyal customer?  We think so. Can the behemoth companies provide this? No, mostly they can’t.
• Large corporations do not move quickly, processes and procedures must be followed, legal due diligence followed, etc. and product development cycles that used to be measured in months are now measured in years. There's no longer any such thing as a simple change.
• That state-of-the-art legacy ERP system has become a boat anchor with a hundred custom programs hanging off it that are constantly breaking and incurring expensive resources to maintain and fix.
• The brick and mortar, essential for business fifteen years ago, may be developing into an ever-increasing liability. Administration of all the hard assets (buildings, inventory, equipment, etc.) place additional demands on management and add to the overhead expense.

In a consolidating industry, there’s a great deal of evidence to show the advantages of scale from a consumer's perspective, are negative long before most realize!

Implications:

• Large enterprises respond slowly and neglect customer service.
• Despite economies of scale, layers of overhead must be added to manage complexity.
• Smaller, more flexible organizations can take advantage

Despite the creep of inefficiency, reduced customer service, reduced relationship management and increased overhead, the behemoths retain a significant advantage of scale through lower material cost. Also, and perhaps more importantly;

• They have the hooks of their accumulated technology integration with the customer base
• The power of their brand developed during long periods of profitability alongside a lasting ability to influence consumer spending habits.

Beyond price, these last two factors provide a degree of protection for the behemoth despite the slowdown in realized benefits of scale. However, if the smaller more flexible business owners are astute, this still represents a window of opportunity during which advantage may be taken of emerging chinks in the armor.

It’s not a window that will stay open forever. Although we don’t see much evidence yet in the Office Products vertical, there are numerous behemoth organizations in a variety of other verticals starting to conclude scale is not everything and there's a great need to introduce focus, flexibility, and speed. They're motivated by the appearance of intelligent, fast-moving, independent businesses encroaching their customer base with improved business performance as they deploy newly developed competitive advantages. These competitive pressures are forcing the behemoths to think carefully about their futures as they gradually figure out how to respond.

What happens to the money in a local market when businesses are acquired or go out of business?

This really depends on the reaction from the business owners and employees impacted by the arrival of the behemoth in the local market. If they give up and start to draw benefits then economic activity in that market will decline. However, what if they learn from the experience and set up a new business in a different category where there is no behemoth?

It’s quite possible that a new business, in a new category, will thrive and overall economic activity will improve. Not only will the community continue to benefit from the lower prices the behemoth introduced but, if the displaced businesses start over and keep the velocity of money at the higher level, then everyone will benefit. In this new cycle, a business owner will be mindful of what happened the first time around and, aware of the potential threat from larger enterprises, will implement strategies that result in a sustainable competitive advantage over time.

The 2015-20 time frame is very different to conditions back in the early 1990s and now, even small businesses can now operate with much higher levels of sophistication and efficiency then they could 25 years ago. When combining some of the advantages of small business such as higher levels of flexibility, focus, personalization, minimal use of capital alongside deployment and utilization of information technology then, all that remains to be determined is whether these factors are sufficient to outweigh the advantage in material cost (before overhead) that are enjoyed by the behemoth. If they are, then the small business owner may develop its own competitive advantage and start to take back market share.

• Money does not have to leave local economies when big enterprises arrive and take over.
• The tools are now available for small business owners to equip themselves to compete effectively with much larger competitors.

To revert this discussion back to the framework of office products let’s take a quick look at Office Depot and Staples.

The Big-Box Retailers - Staples and Office Depot

As we know, Staples attempted to purchase Office Depot during 2015/16 but, ultimately, FTC regulators prevailed with their objections, and the creation of a behemoth with combined annual sales of nearly $33B was prevented. According to their then CEO, Ron Sargent, Staples believed there were over $1B in savings to be extracted from the combined entities. However, to achieve the synergies there were two inescapable facts – one, time and two, money.

It was projected to take at least two years and a significant cash outlay (we've assumed $500M) to achieve the synergies. Think about the costs to close the unwanted stores and to eliminate duplicate headcount. Think also about the vast amounts of management time required, and the subsequent distraction from day-to-day business activities, to manage the cost reduction process after the deal closed. Finally, think also about the reduced economic activity in the local markets affected by the store closings and headcount reductions.

By January 2018 (two years after the originally projected closing date), if all had gone well and management had executed flawlessly, the combined entities were projected to generate an additional $1.0B of EBITDA, in theory, $2.4B in total.

However, two or more years is quite a time span and execution is rarely flawless, so this time frame would have been a unique window of opportunity for those independent resellers, who were up for the fight, to exploit. Day one after closing, with a projected debt to EBITDA ratio of five (after adding the $6.3B acquisition cost to the balance sheet and leaving no room for additional borrowing), the combined EBITDA on $33B in sales would have been $1.4B or 4.4% of sales.

This relatively high, post-close, debt to EBITDA ratio would not have provided for much flexibility had there been hundreds (perhaps thousands) of competitors chipping away at that $33B in annual sales. Chipping away that is, at the same time as key members of the management team would have been distracted with the task of achieving the synergistic cost savings committed to the investors.

We already have some benefit of hindsight that amplifies just how difficult a task the merged entities would have faced.

Less than two years after the originally hoped for close date, and from the most recently published financial statements, we were able to see the combined sales of the two entities decreased by nearly 15% (from $33b to $28B), a decrease that almost certainly would have put the planned $1.0B in synergies out of reach. If we assume, instead of $1.0B in synergies, that only $750M was achievable because of the decline in sales, and that it still cost $500M to achieve these synergies, the potential combination appears it would have been weaker than the two independent enterprises originally were.

Now, we never really got the Staples / Depot deal in the first place. We never thought it would result in a financially stronger enterprise than the two independent businesses. We didn’t understand how financing a huge deal with all that debt made sense and questioned if it was being driven by executive egos and the financial and legal community seeking large transaction fees and prospective interest payments on the debt.

However, we had still hoped the deal would be approved because we felt like it would open up an opportunity for the smartest independent resellers of office products and equipment to take advantage of the managerial distractions and loss of talent that was likely to have taken place in the combined entities.

Then, when the deal collapsed, we thought to ourselves that combined or not, Staples and Depot are vulnerable. Maybe, they would have been more vulnerable had the deal moved forward, maybe not. We’ll never know. However, the fact remains, as independent entities, they continue to cut costs and to retrench. Stores are being closed, overseas operations are being sold off, and their outlook remains challenging. So, the opportunity for smaller, independent resellers to target the customers of Staples and Depot remains, regardless of the busted deal.

Then, in June 2017 private equity firm Sycamore Partners announced they had agreed on a deal with the Staples board to privatize the business is a $6.9 billion deal. The last set of financial statements we have for Staples as a publicly listed company are from July 31, 2017, prior to completion of the deal in September 2017. However, assuming $6.0 billion of the acquisition cost ended up on the privatized company's balance sheet, it looks to us as though, without the injection of additional equity, the private company will be far more constrained in terms of its debt leveraged balance sheet than it was as a public company. Just compare Staples post-privatization balance sheet with that of Office Depot as of Sept 30, 2017, and it should be clear which business is likely to have the greater flexibility!

Finally, in the most recent development as of the time of writing in December 2017, Office Depot completed the $1.0 billion acquisition of Compucom in a bold move to transition its revenue towards service-based income from its historical transaction-based business. Time will tell whether or not this initiative will be successful but, the important point to understand is how Depot has used a portion of its debt capacity to take an initiative that it's less likely Staples can now take, or that the combined entities (should the FTC not have intervened) could have taken.

What we've attempted to demonstrate with these details on Staples and Office Depot is to show how vulnerable we believe they are toward intelligent competition. Staples doesn't appear to have any capacity on its balance sheet to do any strategic deals so we have to assume its top line will continue to decrease by 7-10% per year. If that proves to be the case, then it's likely to turn out to be a challenging investment by Sycamore. However, they (Sycamore) have a lot of experience in retail and they cannot have gone into this deal blind to the risks. They must have a plan that we don't yet understand.

For Office Depot, they still appear to have some room to maneuver and they clearly have a strategic plan. To execute is going to be a challenge and they must move quickly to stem the ongoing loss in sales and the negative impact that has on EBITDA and debt coverage.

Summary:

Perhaps unsurprisingly, small businesses are usually poorly equipped to deal with the sophistication of a large, well-capitalized competitor that can out-perform smaller entities on many levels of competitive activity.

The most common defensive measure of the independents in these circumstances is price reductions. Given the likelihood, on an “apples-for-apples” basis, that the small reseller's product cost is higher than the behemoth then, in the face of competitive pressures, profitability is reduced or a lower cost (perhaps lower quality) alternative product is sourced to try and protect margins. If a lower quality product is chosen to support a lower price, then a risk is simultaneously introduced of a future customer loss due to poor product performance.

There are always exceptions to the norm and there are numerous examples of resellers in the Office Products industry that have excelled in the current business environment – growing sales profitably and with favorable outlooks for continued independent growth.

In our opinion, conditions exist for profitable growth in this vertical but, to take advantage of them, the under-performers must look towards the successful resellers and examine what they're doing that's making a difference? Can their tactics be emulated? Are there other strategies and tactics that can be deployed in combination with what they're doing to create a competitive advantage?

We believe there are opportunities to do so and we’ll start to focus on them in the next section of this paper.

Our objective is to link the challenging conditions facing independent resellers in the office products and equipment vertical with a strategic road-map for helping overcome them. Following our road-map will help resellers develop sustainable competitive advantages over large enterprises that currently dominate the industry.

However, first and foremost, it's important to understand there is no silver bullet that makes this objective easy or leads to overnight success. The path toward developing a modern business, equipped to compete effectively with organizations with far greater resources, is lengthy and involves a great deal of hard work with new, and probably unfamiliar, business development techniques required.

Owners must think back to their early years struggling to develop their office products and equipment dealerships. For most, this was not easy and required fortitude, resilience, and sacrifices. This cycle must now be repeated as mature, traditional, and declining businesses are reinvented for the modern age.

Significant rewards can await those that are successful – not only in terms of sales and related profits but also in terms of increased enterprise values and improved economic activity in local markets.

The Foundation

No objective to build or restructure a business will succeed without a plan and the most vital part of that plan is a commitment to base it off a strong foundation.

Our focus is that the foundation simply must be the development and deployment of an integrated information technology platform. Think back to the subject of e-Commerce where we dealt extensively with the argument that it's is more than just a shopping cart. How it’s a complete integration between information technology systems and operations that, collectively, improve the customer experience and reduces the operator's cost. Think back to the third section where we explained competition, and that the “winners” in a consolidation cycle emerge from those that invest to improve their operational efficiency, achieve scale and reduce cost while providing a superior customer experience. No plan to improve a business outlook will succeed unless these requirements are met.

So, what’s needed from a software perspective to establish the foundation for a business to thrive in the 21^st century?

Most businesses already have their back-office accounting system, a website and some form of an online catalog and shopping cart. Most don’t have CRM, integrated email marketing, effective social media strategies, blogging capabilities, or the ability to create and deliver high-quality marketing collateral. However, to successfully transform from the analog to the digital age, it’s necessary to develop and deploy all these capabilities. However, it’s not enough to simply add on a CRM application, start blasting email marketing messages, and to write a blog.

Each of the components of an information technology platform must be integrated so they can seamlessly communicate with each other and the marketing effort must be planned to establish a clear strategy with specific goals.

This infographic illustrates examples of six software applications that may be utilized by a reseller to operate a modern 21st-century business. Some of them will be familiar to readers as they're already widely used – i.e. QuickBooks, PayPal, and GoDaddy. QuickBooks for back office, financial, etc., PayPal for the merchant account to process online payments, and GoDaddy for hosted websites. The other two components may be less familiar, Power E-commerce for the product catalog and shopping cart and HubSpot for digital marketing and Customer Relationship Management (CRM).

Of course, collectively, these are not the only software options available for building an integrated technology platform but they're what we'll be using as examples to explain our thinking.

The argument we're going to develop is two-fold.

• First, these are world-class applications available at a reasonable cost and second;
• Second, deployed without integration is far less effective than as a fully integrated information technology platform.

Large enterprises have invested millions to develop their “integrated” information technology platforms. Quite often they're now weighed down with the legacy costs of having implemented global Enterprise Resource Planning (ERP) systems that require expensive teams of specialists to maintain. Their complicated systems usually compromise flexibility and the ability for rapid change.

For smaller, independent resellers that intelligently implement their software applications and integrate them so they electronically communicate with each other, they develop the power of an Enterprise Resource Planning system without having to invest large amounts of capital, human resources, and the time that larger enterprises had to. Furthermore, within an integrated software platform built on the elements we've identified, the reseller retains the ability to stay flexible and responsive to market conditions.

The responsibility for developing, improving, and maintaining these types of software-as-a-service (SAS) systems remain with the developer, not the subscriber, and is a feature that saves expense in the longer term. There are many competitors in the market for each of the software components we're explaining and, because of this competition, each of the developers is continually driven to enhance their products or to risk losing their subscriber base. Subscribers directly benefit from this competitive environment and avoid the problems associated with ties to legacy mainframe systems. Furthermore, they can be sure the ongoing software development and enhancements are being written by world-class developers at the forefront of the information technology and e-commerce fields.

By implementing and integrating these (or similar) software applications, businesses can operate more efficiently, provide a higher level of customer satisfaction, and become fully equipped to operate in the 21st-century business environment.

Information Technology is the foundation for a successful 21^st-century business and a Digital Business Transformation can only be launched from a solid foundation!

In a study of over two-hundred office products reseller websites we conducted during 2015-16, it was apparent the most widely recognized software applications (back office, rudimentary website, etc.) were already widely deployed. It was also evident that less recognized applications (such as CRM, online catalog and product management, and digital marketing) were not. We found almost none of the resellers we studied had fully integrated information technology platforms supporting their business. The study also determined that average site traffic (unique daily visitors) was very modest – i.e. less than 100 and, in most cases, less than 20 per day. Very few of the websites had anything in terms of high-quality content or effective, integrated blogging and social media strategies.

The conclusion we formed was that very few of the resellers were effectively leveraging information technology to help operate their businesses. It was also apparent that almost none of the businesses had effective content or social media strategies designed to develop traffic to their sites. Without having deployed integrated software solutions and implementing digital marketing strategies, these businesses are not equipped to compete in the 21st-century business environment.

The longer it takes independent resellers to recognize these deficiencies and to implement improvements to correct them, the more likely larger enterprises will implement strategies to minimize their own weaknesses that smaller competitors currently have a small window of opportunity to take advantage of.

A suite of software applications has been identified to establish the necessary information technology platform on which to operate a digitally enabled business. The infographic we created was designed to illustrate that software deployed without integration reduces the potential value of a system that could otherwise be realized.

Successful systems integration results in the value being greater than the simple sum of the individual parts and is the enabler for significantly higher levels of performance.

The software systems deployment and integration initiative are one of the most difficult elements necessary for modernizing a business. Although integration may not be easy, it should, largely, be a one-off investment of time and resources and, once completed, only incur modest ongoing maintenance and improvement expenses.

A business operator’s objective should be to establish an integrated software platform to;

• Efficiently provide as much information as possible to existing customers and;
• Attract new traffic (leads) to its website and strategically nurture those leads to turn them into customers.

On the face of it, these two objectives seem to be straightforward, commonsense objectives.

However, to be able to accomplish this, two different objectives must be met. An existing customer may be visiting a website to place an order. It's important these visitors are able to quickly navigate to a log-in, access the product catalog, place the order, and efficiently get into, and out of, the website. But, for a new visitor not contemplating to place an order, the objective is fundamentally different.

First, we'll deal with the operational requirements necessary to satisfy customers and then, second, we'll explain the “front-end” requirements necessary to handle the challenges associated with attracting new visitors, converting them to leads, and nurturing them to the point a portion are converted into customers.

The Back Office:

• Customers expect to be kept informed & it takes too long to keep them informed using manual processes.
• Customers don’t have any patience for dumb mistakes – invoicing errors, etc.
• It must be easy to conduct a transaction.
• An integrated back-office information technology platform is necessary to stay competitive and for effective communications.

Let’s assume a website has been deployed with a shopping cart displaying a comprehensive product catalog, open pricing, and is fully integrated with the resellers accounting system and online payment processor.

Let’s take the position of an existing customer who’s used to sending in orders by email. Of course, it would be preferable for the reseller that the customer places its orders directly online because it saves admin time and eliminates the potential for a missed email in a crowded inbox. However, the customer may not be willing to enter its own order in the resellers portal, because it has already been keyed once into its back-office system. This is okay! Nurturing customers and encouraging them to use a website for informational purposes is much more important than who keys the orders into the portal. There's no need to start thinking an e-Commerce initiative is failing just because existing customers may be unwilling to use a portal to re-enter their own orders.

Remember, the objective is to improve the overall experience for customers and, well-organized, online product catalogs with comprehensive search capabilities, are likely to save customers time compared to the old-school alternatives requiring a phone call (or not) to ask about product availability.

From an operations perspective, once an order is placed the customer must receive an order acknowledgment, immediately it’s picked a copy of the shipping notice must be sent, immediately the freight carrier provides shipping and tracking information, it must be sent to the customer. Immediately the order ships an invoice or credit card transaction confirmation must be sent. These electronic communications may need to be sent to different personnel at the customer, such as purchasing or accounting, so all these different contact details must be set up and maintained in the reseller's system to ensure the right people are informed at the right time of the order status. This is what large enterprises do and what their customers take for granted. Smaller businesses must achieve the same standard to level the playing field.

Once the reseller has set up its information technology platform to accomplish this then;

• Firstly, it can use the time that's saved for higher value activities (such as winning more customers).
• Secondly, it will make fewer pricing and other related administrative mistakes.
• Thirdly, it will efficiently keep its customers informed of their order status.

These factors improve customer confidence and satisfaction as well as providing comparable performance to larger enterprises.

All the purchase order and invoice transactions must be integrated with the accounting system avoiding the necessity to be re-keyed. The accounting system also must be integrated into company bank accounts and, at each month-end, financial statements produced and bank accounts reconciled.

• There are too many places it can go wrong when manual processes are involved
  • It's too time-consuming.
  • Distribution of critical customer communications fails to take place.

The Product Catalog

A customer or prospect must be able to quickly see and understand what's available for sale. Within the office products and equipment industry, there's a massive array of products with big-box resellers offering more than 500,000 items. Such an extensive product line requires an army of resources to manage, resources that are outside the scope of a small business.

However, the dilemma is, for a smaller business to compete effectively with larger enterprises, it must offer a similar, wide range of competitively priced products or, it risks the lower value proposition appearance (weakness) associated with only being positioned to cherry-pick both prospective, and existing customers needs. If it limits itself to offering a more manageable, but a narrower range of higher volume products, it plays into the hands of larger enterprises, and their knowledge that customers prefer a single-source (one-stop-shop), for all their office products, equipment, and supplies.

The only way to cost-effectively offer such a vast catalog is to partner with a third-party e-Commerce solutions provider. Enablers of these platforms have developed partnerships with all the major players in the office products distribution and manufacturing industry that are leveraged to build a catalog of over 500,000 office products. With all the product and search attributes, product compatibilities and cross-referencing, images, specifications, and keywords already populated into their databases, a reseller is able to leverage access to the leading industry experts to manage the product catalog on their time and at their expense.

These tasks resellers cannot manage by themselves and are able to realize significant savings by effectively outsourcing the work. In adopting this approach, resellers can offer a catalog of products, equivalent to the best the largest enterprises offer, without having to employ the resources to individually manage them. In so doing, they cost-effectively equip themselves to deal with the “one-stop-shop” objections that may otherwise be raised by their customers and prospects.

Other features, such as individual customer log-ins are enabled, thereby facilitating price list management, access to order history, etc. This ensures accurate and reliable customer pricing management, eliminating potential mistakes, and the time that's taken and loss of goodwill incurred to fix them. Today, most large enterprises have an advantage in this area but, in the future, much of that advantage can be eliminated.

Operations

How else can a small business operator leverage information technology to improve its customers and prospects experience as they do, or consider to do, business?

Let’s contemplate a scenario where a business integrates a third-party e-Commerce solution and establishes accounts with multiple vendors (manufacturers and distributors) within the platform. This approach can provide access to inventory in more than 100 distribution centers throughout the USA and Canada. Whether a resellers business is local or national, it's covered and there's no longer a need to stock its own inventory to fill customer orders. No inventory equals no risk, and no inventory equals less requirement for working capital. Furthermore, the product can be delivered to its customers anywhere in the United States within one to two days.

Perhaps a local business has previously stayed away from a premium customer prospect in its local community because it has multiple locations scattered across the United States and utilizes centralized purchasing. Previously, without an integrated technology platform, a small local business was unable to reliably service their requirements so the business defaults to a larger enterprise. Well, in the scenario we've just described that’s no longer the case and a major objection to doing business can be removed.

In becoming a member of a third-party e-Commerce “eco-system”, not only do resellers benefit from having the product catalog managed for them, but they also have visibility to on-hand inventory for all items at the distribution centers. Furthermore, not only will the reseller have visibility to this information, but its customers can as well, becoming another feature that elevates the value proposition to one comparable with much larger enterprises.

Summary

Let’s recap for a moment on the capabilities that have been explained and the improved value proposition from resellers adopting this strategy. Within this scenario, a comprehensive integration develops between a vast product catalog, an accounting system, and a fully enabled customer messaging system is established. This meets, or even exceeds, the capabilities of most larger enterprises and equips the independent reseller to do business with prospects that may have previously been considered to have been out of reach.

In this fully integrated scenario, a comprehensive technology platform exists for taking care of customers. However, despite these accomplishments and, as we're about to explain in the final section of this paper, there’s still a lot of work required to take full advantage of the platform and to leverage its potential for the purposes of developing new customers.

• Deploying an online catalog from a comprehensive series of vendor data feed permits a business to outsource the product management.
• This reduces overhead expense as the enterprise can now leverage the expertise of the industry suppliers.
• Customers can see real-time information on product availability, pricing, specifications, compatibilities, etc.
• New products are automatically added.

If a website, as we strongly argue it should be, is developed and deployed as a key component of a longer-term strategy to build a successful and profitable business, then it needs to include content that's of value to its visitors and that's capable of being leveraged to earn organic traffic over time. It must start the process of building the loyalty and the trust of visitors that can later be converted into profitable sales transactions. Here, in the final section of our paper, we're about to explain traffic development and what we consider to be the most challenging element of an e-Commerce strategy.

To build traffic, a website must be marketed to its target audience. The only way to accomplish this (without relying exclusively on paid traffic) is to create content that's of value to that audience. Remember, there are 1.3 BILLION websites and relevant visitors, with the future potential to become customers, are unlikely to stumble on a website by accident and magically convert.

There are no silver bullet, overnight success stories in the field of content and traffic development.

Independent resellers must be prepared for one to two years of foundational effort. Although positive evidence of their efforts will start to be apparent within a few months, it will take 18 - 24 months for all the hard work to really start to pay off.