The Secret to Being Grainger

As a distribution industry consultant who spent many years at Grainger (NYSE: GWW), I often get questions about the company from other distributors. Typically, the questions go something like this: "How does Grainger do it? They're the biggest distributor around, they have more customers and more products and higher margins than just about anyone else, and they show no signs of slowing down. How can I be more like them?"

Sometimes, executives will give me specific examples. An electrical distributor recently told me, "One of my customers just bought 10 30-amp circuit breakers from Grainger at a 35 percent gross margin. If he'd called me, I would have sold them at a 17 percent margin. Why does that happen?"

Adding to the general confusion about Grainger: A high-priced approach is supposed to be a niche strategy. But Grainger is arguably the largest distributor of its type, it sells to nearly every type of company and offers about 1 million products. In other words, Grainger seems to be pulling off the very difficult challenge of being both the margin and market share leader in distribution.

So how do they do it? It's really pretty simple. Almost every distributor targets one of these types of segments:

• A product category (e.g., power transmission, fasteners, tools, HVACR products, PVF, building materials, office supplies, etc.)

• A customer industry (e.g., hotels and motels, restaurant equipment, mining, healthcare, janitorial, utilities)

• Or some combination of the two (e.g., selling building materials to home builders)

Grainger's segmentation is different. The company does, in fact, sell just about every type of product to just about every type of customer. But Grainger defines its target segment by a specific situation: when customers need products quickly and with no hassle. This target segment, which Grainger informally refers to as "speed and convenience," allows it to operate differently than other distributors and achieve superior results.

So while most distributors try to get a lot of revenue out of a small number of customers, Grainger wants to get a little revenue out of every customer.

When businesses or people need products quickly, they think about suppliers differently. For one thing, they accept that they will pay a higher price to have access to products they can get immediately, a concept academics call "place utility." One former Grainger president for whom I worked used the example of a vending machine in a hotel. You know that $2 is a very steep price for a can of soda, but it's worth it to you because it's fast and easy to get your Diet Coke there vs. leaving the hotel to find a very inexpensive source, like Costco. The Costco store might not be open, and even if it is, you will have to buy a whole case of warm soda in exchange for saving 90 percent. That's a big margin swing, but the "speed and convenience" of the hotel vending machine, along with the chilling of the product, which is a "value-added service," makes it worthwhile.

Think about the times you stop at a 7-Eleven. There are no bargains in the store, but you know and accept this before you walk in. Thus, if you wind up paying 30 percent more for milk, you will probably feel the "speed and convenience" benefits were worth it compared with driving to a grocery store.

Businesses function in the same way. On a regular basis, purchasing agents, maintenance personnel, warehouse managers, etc., need something quickly and conveniently. In those situations, they go to the supplier who is most likely to have all of the needed items (which is called "assortment convenience"), has the most effortless ordering system and can deliver goods the fastest. In these situations, customers are not very price sensitive, even if they are very hard-nosed buyers when negotiating traditional contracts. Thus, Grainger is often the real or perceived best choice for the customer.

The most locations

This applies to every type of product, even "commodities." The more urgently a customer needs a product, the less commoditized that product becomes. For example, very few HVACR contractors rely on Grainger as their primary source for refrigerant. It's a commodity most of the time, and HVACR distributors sell it at very low margins to try to win other business. However, if you are an HVACR contractor with a customer whose cooling is out on a 100-degree day, and you need refrigerant, you are likely to point your truck right into the Grainger parking lot. You will have a high degree of confidence that the product will be in stock, and you will be in and out of the branch quickly. In this situation, price doesn't matter, even for a commodity. It's all about speed and convenience.