The first HARDI Industry Executive Forum occurred on Nov. 7, 2006, during the annual conference in Palm Desert, CA. HARDI invited a panel of executives from Refrigeration, Controls, Equipment and Supply to address and answer questions from the membership. This condensed and edited version of the forum provides readers with insight about the HVACR industry from the perspective of top leaders. This is the first of what is to become an annual feature of the convention. John Ehlen, publisher of HVACR Distribution Business, served as moderator.
Ramesh Bhatia, president, ATCO Rubber Products
Jeffrey Irmer, vice president, sales, Americas, Honeywell Environmental & Combustion Controls
David LaGrand, president, Nordyne
Ed Purvis, group vice president, Emerson Climate Technologies, Refrigeration
EHLEN: Let's begin by having all of you give us an overview of your overall business.
IRMER: Environmental Combustion and Controls for Honeywell, or ECC, is one of six businesses that comprise Automation Control Systems (ACS). ACS is one of the four strategic business groups that make up Honeywell International. I represent one of the six ACS businesses. It is a globally-based business. In terms of sales, one half is in the Americas, and half is in the rest of the world. It is a product business based on HVACR components. About half of the Americas business is represented by our trade channel, the balance is the retail channel and OEM channel, and we sell a variety of controls products representing four lines of business. We're clearly committed to wholesale distribution and a two-step model.
PURVIS: Emerson is about a $20 billion company. The parts business representing climate technology is about $3.5 billion which makes compressor controls, electronics, valves, motors and other products. My responsibility is on the refrigeration portion of Emerson Climate Technologies. When you look at all the products we sell and the cost of refrigeration and distribution business, that's about $750 million in sales. That's a quick overview of Emerson and Emerson Climate Technologies.
LaGRAND: I'll touch on our industry, primarily referring to manufacturer's shipment of appliances and air-conditioning equipment. When we look at our industry over a long period of time, it's been a great industry to be a part of. We go back 15 years; the air-conditioning industry has grown in terms of shipment by about six percent on an annual basis. The furnace side of the business has grown by about four percent annually. Nordyne is a privately held corporation serving the residential, manufactured housing, light commercial and international HVAC equipment markets. We've invested a lot in our operational processes and our flexibility to respond to customer demand and building quality at the same time. Along the way, for the past eight years or so, we acquired some of the name brands [Tappan, Frigidaire, Gibson] that John [Ehlen] referenced, and that has really propelled our business and worked well for our channel. We've broadened our product line and now offer the highest-efficiency products in the industry, up to 23 SEER. So we've grown and we've changed a lot. The one thing I have held steadfast in our strategy is how we do the market, and we are, I believe, the only manufacturer that can be up here saying that we go to market exclusively through independent wholesale distribution.
BHATIA: ATCO Rubber is the largest manufacturer of flex duct in the world. We are a privately owned company that started about 40 years ago, and we have evolved into a large, multinational supplier of flexible duct that's sold all over the world. We have 15 plants in the United States, covering practically every metropolitan area. There's hardly any wholesale distributor who is more than 24 hours away from one of our locations. We are focused solely on flexible duct and are not distracted by any other products, any other issues. We introduce new and related products, and do the best we can to sell to our customers, who are wholesale distributors. The market for flexible duct is about one billion feet in sales in the United States. Overseas, it's about 300 million to 400 million feet. The export market and the market in other countries are growing much, much faster than in the United States because many countries are starting to adopt flexible duct. This accounts for a growth rate of about 40 percent to 50 percent. In the United States, about 65 percent of the flexible duct is used in residential construction, of which 70 percent is in new construction and 30 percent in renovation. Another 30 percent of the total sales goes into the commercial market.
EHLEN: What are the major opportunities for your company through your partnership with wholesale distribution?
IRMER: Let's consider indoor air quality, which is probably at best a 10 percent saturated market. It is a huge, huge opportunity for Honeywell and our business partners
PURVIS: If I look back at the last 20 years, I think, by and large, a lot of that progress has been made on a component-by-component-level basis. What I mean is, making motors more efficient, compressors more efficient and so on. But looking ahead, I'm very clear that the solutions there are pretty well farmed out. The step to the future are integrated solutions, the ability to optimize heat exchangers and compressors and coils, etc. That's the big focus at Emerson Climate Technologies, working with our OEMs and understanding exactly what those opportunities are and how to develop and capitalize on them. From a distribution standpoint, that means we need people who know and understand integrated systems and can teach those concepts. This requires a far more sophisticated relationship than perhaps it has in the past. I think you'd agree that value-added distribution is a huge opportunity because we need more than a simple inventory carrier in that business model.
LaGRAND: I'm going to come at it from a little bit different perspective by taking a look at the distribution channel as a partnership relationship. It is still a people-to-people opportunity. We want to focus on being the best manufacturer that we can be and focus on continuous improvement in our operations and all the things that we do to support distribution. What we like about independent distribution is the entrepreneurial aspect of what you [the wholesaler] bring to the party and then what the contractor does. We look at the opportunities along the lines of efficiency of communication, ordering processes and flowing inventory out to our distribution as big opportunities. But I also concur with some of the other things that have been said because tremendous opportunities exist for growth, for figuring out easier ways to put systems together, especially in the areas of indoor air quality and all of the opportunities that that brings.
BHATIA: In our case, we have a simple product. It goes in, and if the distributor does a good job [selling it], it goes out very quickly, and the profit is very high, if the inventories are managed properly. Our philosophy has been to manage all inventories and keep the investment as low as possible. We feel that wholesale distributors provide the bridge between a manufacturer and a contractor to optimize the flow of goods, and act as the ideal channel to make that happen more efficiently and for the benefit of everybody. So in partnership with distributors, we continue to provide the products that will optimize their return on investment. That's the reason why we have 15 plants in the United States We apply the just-in-time concept. Many distributors tell me that our product turns are as much as 20 per year. We believe that this is a great opportunity for us to build on and continue the relationship that we have with the distributors so that they earn the highest rate of return on the products they sell.
EHLEN: At what point in the product's lifecycle do you expand its distribution to transaction-oriented distribution versus value-added or make product distribution? As a follow-up to that, what evidence do you have to determine where the product is, in its lifecycle?
IRMER: I'm going to come at this from a little different angle. First, many of our products, particularly in our building controls and our commercial combustion controls, are always going to be what we call make-market products. They're always going to require value-added solutions, a selling capability that's going to be dictated by specific skills sets and automation training with the ability to professionally install systems. For example, a particular client needs a gas valve, and the contractor says I want to fix it. Why can't that distributor upsell that contractor, and why can't that contractor go back and upsell that particular homeowner on something else besides just fixing that gas valve, on IAQ, for example. What you've done is presented the value-added aspect back into the equation. There will always be marketplaces where commoditization can take place, yet an old professor once told me if you think your product is a commodity, then it is. So if there's anything you can do to de-commoditize that [product] such as tying it to a relationship or service level or an upsell, then that differentiates you, then that issue goes away.
BHATIA: I believe that the product lifecycle in our case depends on two things. One is internal and one is external. Internal factors are the ones that we control, where we feel that the product has matured to a point that a new product, an improved product, is needed, and that would be the time to try to develop [something new]. We basically sell out the initial product and replace it with a new one. The other product lifecycle is dependent on external factors, things like energy efficiency, code changes, government regulations, and that forces us to make changes to the product and bring in a new product. That starts off with a new lifecycle. As part of the transaction, I believe that when the product is in the very initial stage and there is limited availability, we try to limit it and increase transactions to the same distributors or the same customers. However, as the product becomes more widely known and available, then we go forward and open up more distribution and other channels.
LaGRAND: I think one of the beautiful things about the equipment business is that by the time the transaction gets to the consumer level, it's really the most customizable thing that the consumer buys for their home, and it can be sold that way by the contractor because they should be addressing the specific needs of the home and family and their requirements, and can really tailor the equipment and the accessories to that family's needs. I feel good about all our products as an industry from the equipment standpoint having great opportunities to avoid becoming plug-and-play types of commodities.
PURVIS: I agree with what Jeff [Irmer} and Dave [LaGrand] said. The only thing I would comment on would be the extent we allow our products to become transaction-based; it is not just bad for distribution, it's bad for us. Products define themselves in the lifecycle. The margins are then compressed across the entire channel, and certainly there are products that have done that. I absolutely agree that we have to recognize opportunities to upsell using service features and value-added features that make commodities out of our products.
EHLEN: How important are local market facts, not opinions, about market share in your decision-making, and what are you doing to help you and us, from a wholesaler's perspective, in the collection of factual market data? I'm sure it could be useful for everyone.
LaGRAND: I'll take a crack at it. We may think of that just a little bit differently. The equipment manufacturers all participate with GAMA and with ARI, and we report our shipments, and that's good, solid data. Beyond that, it gets broken down into various levels of equipment and markets and trading areas. Our philosophy is that we'll support any ideas and things we can to provide useful information. However, I don't think share of market is just one factor in how you go to market and how you look at your competitive environment. The more important thing is to focus on what you want to achieve in the market, reference it to market share if you want, but focus on the competitive side and what activities you can be involved in with your channel partners to help drive growth.
BHATIA: The local facts that we collect are the most important factors in our decision-making process. We don't believe in opinions, we don't believe in what others are saying. We have more than 100 independent salespeople who follow [our product] who understand and study the local markets. They give us the facts. And without those facts, we do not rush into making a decision. I have been accused many times by many of our customers and some of our sales representatives that we take too long to make a decision. We do, because we want to collect all the facts, and only after we collected and analyzed them do we make a decision. This process is really important, not only for market shares but also for pricing. Some companies will react very quickly to a rumor, or say, “the price has gone down, so let's react.” We take our time. We study the information we get, and only then do we make a decision. Market facts are very, very important, and we spend our time and our resources to collect that data before we make a decision.
IRMER: A suggestion on one way we can do it is by taking a page from the electrical industry to get that information. I spent a number of years in the electrical channel, and they have a linkage with the National Association of Electrical Distributors, a HARDI equivalent. Every year at right about this time, the entire distribution community forwards sales data on specific product buckets into NAED which is disseminated back to its members. I know, for example, what the consumption rate of specific products are on an aggregate basis, what the lighting fixtures business is in the Northeast or Rocky Mountain area, or building wire, or conduits, or boxes, or switch gear. Probably 20 different product categories. Maybe HARDI can commence a movement whereby distributors tell a national board how many thermostats you buy, how many indoor air quality products you buy, etc. Generic enough to describe brackets of products where you're not giving away proprietary information. That would help us tremendously.
PURVIS: I think Jeff's [Irmer] idea is great. Because our product is very proliferated, very technical, relationships play a big part. We are committed to regional distribution. One of our biggest challenges is that we don't have all the data we need and want. We certainly exercise everything we have from demographic data to market surveys and things like that, but it's somewhere halfway between fiction and cold, hard facts. I think we have very, very little industry data. We absolutely believe the winners are the people who have the relationship and understand the product. These distributors go out from behind the counters and sell products and love the relationship.
EHLEN: Are we spending too much time selling equipment and not enough time selling the full benefit of quiet, energy-efficient air delivery systems? How are you helping distributors and contractors do that?
BHATIA: I think we spend a lot of time talking about individual parts and pieces that go into building, but we don't talk about the overall energy efficiency of the whole system. When you talk about equipment, you talk about SEER rating and about flexible ducts' “R” value. We talk about what they do individually, but not about how the whole package works. And I agree that's an effort we all should be making. From our standpoint, we are now embarked on a project with Owens Corning and several other manufacturers. We're going to study the whole house and how we can improve the energy efficiency. That is the project we have now started, and hopefully, in six to nine months, we'll have some results that can prove to us what we need to do a better job.
LaGRAND: I agree with what Ramesh [Bhatia] said. The good news is there is an awareness out there and an interest in helping the contractor feel more comfortable with new technology. We have to help him pull in all the options, configure them and make them appealing to the consumer. Contractors need to look at how to leverage their labor dollars per hour and many of them right now do not see it as being worth their investment to really try. I think there's just a lot of work to be done in terms of training and education about technology advancements.
EHLEN: Earlier in our convention, we heard about mergers-and-acquisitions and consolidation. From a manufacturer's standpoint, what will be some of the most impacting changes on how smaller independent wholesalers do business in the next five years. How do you see their role changing as you implement your global and regional strategies?
PURVIS: I think the demise of the small independent wholesalers has been forecast as long as I've been in the industry, and it hasn't happened. I think that you probably know better than I do why that has happened, and we talked about the relationships and local presence and local knowledge. It's harder to be a small player. One thing I think distributors need to do to succeed is become better at supply chain management. I think we have to get a lot better at information technology, tracking and managing inventory, knowing good inventory from bad inventory, the value of inventory, knowing who your customers are, what they buy and therefore what they're likely to buy in the future. I think we've scratched the surface in operating an efficient distribution channel and, frankly, I know that because of [other] large distribution channels who are more advanced in this area than we are today.
LaGRAND: I think there is certainly a place for the local and regional distributors, and it has to do with the strengths of the relationship that you had with your customers and the value-added levels that distributors provide. We also see a lot of trends, not only through HARDI, of sharing information.
BHATIA: I believe that a smaller independent wholesaler has a very important role to play in the marketplace in spite of all the mergers, acquisitions and all the consolidation that has taken place. I think that the relationships the small independent distributor cultivates with the contractors and with the builders are hard to overcome. A lot of business at this level is done through relationships. Smaller distributors are not [constrained] by corporate philosophies or overhead and are able to react a lot faster. As a company, we try to help the local distributors by providing them with quicker service and improving the turns and getting the product to them on time. I think that smaller, independent distributors have a great future over the next five to 10 years, and they will continue to play an integral role in the business.
IRMER: Part of our business is only delivered to the marketplace via the small regional distributors, particularly on the commercial side. This will always require much training and investment, and these are barriers to entry for the big multinational chains from getting into the commercial [distributor] business. Distributors clearly provide a value-added sale and not just an off-the-shelf approach, so smaller, regional niche distributors will continue to succeed. I don't see this changing in the short term or the long term.
EHLEN: Is it possible that foreign manufacturers of HVACR equipment and components could have the same impact on domestic manufacturers as occurred in the steel and automotive industries?
LaGRAND: We have certainly seen it from a components standpoint and have seen components (companies) move production to lower-cost countries to take advantage of lower labor costs. We have a lot of respect for manufacturers of equipment from outside of North America and what their capabilities are. Currently, there are some obstacles. Mainly, the latest are the logistics of bringing larger equipment products into the market because of the freight cost and the working capital associated with the amount of time that it's in transit. The other thing is that since we've had a highly customizable system, which means you have to have all the right parts or sections all show up in the same place at the same time, it provides a barrier for competition coming from outside of North America.
PURVIS: We are a financial company, we analyze everything, and we try to take an analytical approach to this. It [the logistics issue] has happened in affiliated fields so we need to be a little paranoid. We need to be real careful and there's been a couple of people who tried. On at least two cases, they have come to distribution and said we'd like to partner with you, we'd like you to distribute our products for us, and then within a year turned around and set up their own distribution. Distributors really need to be careful about [choosing] long-term partners.
IRMER: Honeywell is a global organization. We keep competitive on a global scale because we serve the global marketplace, and we gain scale from building products in North America and around the world. The same goes for engineering. We have engineers across the globe on a platform basis and then accommodate regionality as it relates to the individual market.
BHATIA: It's possible that there could be some foreign products coming into the United States for uninsulated flexible duct. For insulated duct, we don't think there is a possibility of any products coming from overseas in the near term, because of the strict standards that we have in the United States. I don't know anybody in the world who can pass those tests that U.S. manufacturers can. I think the freight costs from overseas are quite high. In the near term, I don't see any problem or danger. In five or 10 years, there is always the possibility of imports.
EHLEN: For the future growth of your company, how important is the implementation of information technology between your company and your distributors? In your opinion, who should be the driver of the technological innovation?
IRMER: We all need to get even better at leveraging information technology across our businesses. We need to work together with distribution in implementing technology to be the weapon that keeps driving the value relationship. We can cement the relationship of wholesale distribution by being a lot easier to do business with, with technology a critical enabler.
PURVIS: We have a long way to go in information technology. We tend to come to some distributors and ask them to tell us how you want to communicate, tell us how do you want it sent, how do you want to receive it. The more the better.
BHATIA: I would add that there has to be an information exchange between the manufacturer and the distributor as to what is the most appropriate technology that can help both sides. It's not just manufacturers coming up with something and forcing it down the throat of the distributor, or vice versa. There has to be good information, how to help each other and how to get it down to the distributors.
T.S. Peric' is the editor of HVACR Distribution Business magazine. Contact him at [email protected].