Business Diversification: Spreading Risk, Increasing Your OddsBy Joanne Costin
Article Date: 10-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.
Dealers look in different directions for growth opportunities.
Many equipment dealers have sought to diversify their business as a way to minimize their risk, especially during downturns. And as we come off the worst recession since the Great Depression, there are signs that dealers are more aggressively looking for ways to get all of their eggs out of the same basket. Adding fuel to this notion is the fact that the construction market isn’t expected to recover for several years, and many dealer organizations are currently operating well below their capacity.
“We found the bottom,” said Ron Riecks, president of Riecks Consulting Group, “but we haven’t found the recovery yet.”
But does diversification really help to even out revenues and minimize risk? Riecks, who has reviewed hundreds of dealer financial statements during his banking career, most recently as general manager at Well Fargo Equipment Finance, Inc., and previously CIT Construction, believes this was proven out in the most recent recession.
“While everybody felt the slowdown in a very meaningful way,” said Riecks, “the distributors that were diversified – who had three legs to their business with some equality to the three legs – have done much better and come back much sooner than the ones who were not diversified.”
Industry analyst Frank Manfredi, of Manfredi & Associates, concurs. “It is absolutely a good strategy to have as many sources of revenue that aren’t linked together. The only time that it ceases to be a good strategy is if they get outside of their core competencies.”
Strategies for Diversification
When looking to diversify, dealers have a variety of options, but opportunities are largely driven by the dealer’s individual market. Diversification can be geographical, concentric, horizontal or vertical.
One way for a dealer to overcome limited growth opportunities in his or her local market is to expand into new regions. Geographical diversification can be effective, especially if those new regions have different economic drivers than the original location.
“Midwest drivers of the economy are much different than the Gulf Coast drivers,” explained Riecks. Dealers need to examine if they can get into areas where there are different economic drivers, so that if one part of your organization is feeling a slowdown the other part is not.”
RECO Equipment has grown their business from one location in Morristown, Ohio, serving primarily coal mines, to seven locations covering Ohio, Western Pennsylvania, Indiana and Kentucky. Their customers are involved in a wide variety of industries including scrap processing, construction, excavating and industrial. Most recently they began representing Liebherr in Indiana.
International expansion is also a possibility. Headquartered in Vancouver, British Columbia, Finning International Inc. has dealerships in Western Canada, the U.K., and South America (Argentina, Bolivia, Chile and Uruguay). And Hoffman Equipment, with five locations in New York and New Jersey, has an export department that offers a full range of new and used equipment for both sale and lease, technical service, and spare parts to international customers.
Selling a new product where there is a technological similarity between industries allows a firm to leverage its technical know-how for competitive advantage. This is called concentric diversification, and examples among construction equipment dealers include farm equipment, material handling equipment and power systems. To a lesser degree, trucking has also been taken on by CE dealers.
Of these industries, farm equipment appears to provide the best complement to construction equipment sales. Over the past 10 years, the value of manufacturer shipments varied the most between construction equipment and farm machinery, while power systems and construction equipment were the most similar.
For example, during 2009, it is estimated that farm machinery sales were off 5 percent nationwide, while construction equipment sales dropped nearly 40 percent.
Of course, not every dealer has the opportunity to sell farm equipment, and so they might look at other products such as mining machinery.
Or take Bramco Inc., for another example, which recently announced the acquisition of JFT Precision Fabrication, Inc., headquartered in Shepherdsville, Ky. The company offers a complete source of aggregate processing and material handling equipment and related parts and service. JFT offers turnkey systems, including plat flow design, structural design, fabrication, equipment selection and installation as well as mobile crushing, screening and conveying equipment to its customers.
Another example: When Caterpillar entered into a joint venture agreement with Navistar, it paved the way for Ransome Caterpillar to become a distributor of International trucks.
Diversification works the other way as well. In August 2008, Nuss Truck Group, with head offices in Rochester, Minn., diversified by becoming a Volvo CE dealer when it acquired of the assets of Sweeney Brothers Tractor, in Burnsville, Minn.
Other dealers such as RDO Equipment (Deere dealer based in Fargo, N.D.) and Denver-based Cat dealer, Wagner Equipment, have aggressively pursued opportunities in GPS positioning, machine control and laser technology.
Diversification strategies can focus on services as well as products. While maintenance and rental are the pillars for most construction equipment dealers, some dealers, such as Dallas-headquartered Briggs and Stephenson Equipment, based in Harrisburg, Pa., have turned safety, training and fleet management into revenue streams. Telematics may take maintenance services to a whole new level for other dealers. “Telematics is changing distributor/end-user maintenance,” said Riecks, “and it could create a whole new additional revenue stream for dealers.”
Horizontal diversification involves adding new products or services that are technologically or commercially unrelated (but not always) to current products, but which may appeal to current customers. Construction supplies are one example of horizontal diversification in the heavy equipment industry. Walsh Equipment, based in Prospect, Pa., supplements heavy equipment sales by offering construction pipe as well as highway and custom signs.
In vertical diversification, the dealership expands into the business of its suppliers or customers. For example, a dealership could decide to develop their own software versus purchasing a system from a supplier.
Beware of Business Distractions
Pursuing a diversification strategy is not without risk. Entering an unknown market with an unfamiliar product may require new skills, techniques and resources. There is always a danger that the new business will detract from the core business.
Before entering a market, dealers should evaluate the attractiveness of the opportunity, the cost of entry and determine if their organization is better off entering or not entering the business. Riecks advises dealers not to overlook an assessment of the talent you need to succeed.
“Do you have that expertise within your own organization so you can leverage your existing team to make the most out of that new diversity opportunity,” said Riecks, “or is the talent available on the team you are acquiring and do they have the reputation for knowing what they are doing in that space?”
If you are acquiring, don’t overlook the potential for cultural clash that can be very unproductive.
“All too often in an acquisition, we do a phenomenal job of analyzing the balance sheet, and the profit and loss and we figure out the pro forma,” said Wally Adamchik, a business consultant to the construction industry. “but we don’t pay good attention to the fit of the two cultures.”
Adamchik cautions that firms must have the capacity to diversify (building size, technology systems, and most important capable people), and while these things can be bought, that brings challenges.
According to Adamchik, it is equally important to understand the financials of the new business. A major diversification route for dealers has been the rental segment, and the downturn has really driven home the fact that the financials of a rental business are very different.
“We all learned that it turned down about the same time as equipment sales and dropped by greater magnitude than equipment sales,” said Manfredi. The financials of a new business could drain your current operations, he added.
Adamchik also believes dealers shouldn’t take their success for granted.
“Recognize that when you step into this new product line, no matter how you got there, that this is a new business,” said Adamchik. “And although the principles of business are often the same; the actual mechanics of running that business – the margins, the risk – are different. Approach it with a little humility, curiosity and open eyes, not overconfidence based on the success of your previous business.”
To uncover synergies between your business and a new opportunity, Adamchik proposes that dealers look at how they might leverage existing relationships or core competencies. “Dealers should ask ‘what are we really good at? What are the characteristics of my clients? Are there other things that I can do for clients that look like that?”’ said Adamchik.
What Does the Future Dealership Look Like?
As we look into the future, Riecks says he wouldn’t be surprised to see a distributor with more than one brand in the same local area. “Manufacturers have to recognize that there are only so many well capitalized distributors,” said Riecks. “It is better to be aligned with one who has multiple brands than to not have distribution at all.”
While at one time Manfredi thought this kind of compromising thinking would happen among OEMs, he now doesn’t believe it will, simply because the number of dealers has declined and the top brands are strong enough to demand exclusivity. “The top five brands have about 80 percent of the market, and until somebody comes in and breaks the paradigm, the current dealer/manufacturer model will continue,” he said.
There is one thing all the analysts agree on. The pace of diversification and consolidation will accelerate as we move from recession to recovery.
“The difference is that this slowdown has been violent enough that all things are on the table, including people who you would never think would be for sale,” said Riecks.
The eggs are coming out of the basket, but where they will end up – we’ll have to wait and see.
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