The manufacturing industry is undergoing a seismic shift driven by emerging new business models. Manufacturing businesses have historically focused on driving growth through product improvement or market expansion. However, challenges, such as stagnating demand, market disruptions and diminishing returns from process improvements, have forced many to reinvent business models and transform operational frameworks.

This MDM Premium piece examines what these new business models look like, the challenges they present for distributors and how distributors can leverage strategy behind these models to benefit themselves.

The Rise of New Manufacturing Business Models

Business model innovation (BMI) allows manufacturers to directly connect with end users, expand into new services, adopt alternative revenue models and broaden core offerings.

BMI is enabling original equipment manufacturers (OEMs) to specifically:

• Evolve their customer base or customer relationship model to allow them to engage with consumers and direct purchasers
• Change the nature and range of a company’s offerings, such as expansion into services or experiences
• Adopt new commercial and revenue models (e.g., product-as-a-service)
• Expand traditional core competencies, particularly via deeper collaboration through a partner ecosystem

Challenges Faced by Distributors

While these changes offer opportunities for manufacturers, they pose critical risks for distributors who rely upon their traditional role as intermediaries.

Key challenges include:

1. Disintermediation: Direct-to-customer product sales by manufacturers can sideline distributors as they become less relevant in the value chain. Without a value proposition, they may be bypassed altogether.
2. Portfolio evolution: As manufacturers expand their portfolios to include software, services and other nontraditional offerings, they add new routes to market that may reduce the importance of distributors or bypass them entirely. For example, an OEM that begins providing performance monitoring and predictive maintenance solutions could undercut consultative selling and commoditize a distributor’s role in the value chain by specifying replacement parts to be used.
3. Margin pressure: By connecting with customers directly, manufacturers can offer competitive pricing, potentially squeezing distributor margins on the traditional portfolio. As manufacturers expand their offerings and services, they may offer distribution services themselves, further intensifying margin erosion.
4. Differentiation: Distributors that act as traditional channel partners with limited other capabilities may be at the greatest risk of disruption from manufacturers’ BMI. Simply acting as an intermediary is insufficient, but finding ways to differentiate themselves and offer services manufacturers cannot replicate is not easy.
5. Business capabilities: Manufacturers’ adoption of new business models relies heavily on technology integration, including artificial intelligence (AI), automation and data analytics. Distribution partners may face challenges keeping pace with continually evolving technology advancements. In addition, incorporating new technologies into existing systems and processes can require major investments in infrastructure, training and change management.

In an example of BMI disruption, a leading manufacturer of HVAC systems is moving beyond B2B-only sales. It sees direct user relationships as a way to increase the adoption of smart, connected features — without which the manufacturer will miss out on usage and performance data critical for new revenue streams from related services. Offerings like predictive maintenance may create significant value for OEMs and their users. For example, one provider of predictive maintenance solutions in the transportation sector touts a 30% reduction in maintenance costs — savings that illustrate why projected growth rates for such offerings are often a multiple of overall sector forecasts. However, they too may have negative downstream effects on distributors, such as longer equipment life, decreased sales of replacement parts or consumables, or other operational pressures (e.g., increased demand for just-in-time fulfillment). Even more radical BMI examples like product-as-a-service adoption could increase disintermediation for both OE and aftermarket distributors as manufacturers “servitize” their offerings and bring full lifecycle support in-house.

However, manufacturers’ BMI efforts may also create opportunities for distributors. Even when manufacturers see full lifecycle relationships with their customers as the inevitable end point of their evolution, they must also maintain focus and avoid defining core competencies too broadly. Large, well-capitalized players can build or acquire distribution capabilities if they are central to the BMI effort. However, others with fewer resources may find it more efficient to pursue partner ecosystems instead.

As manufacturers seek to expand their aftermarket-related product sales and services, distributors that can provide differentiated insights into end users and their needs will be better positioned to vie for these partner roles. But they may also find themselves challenged on profitability over time if they do not seek to offset their potentially diminished position in the value chain with other offerings for both manufacturers and users (e.g., managed services).

3 Strategies Distributors Can Employ Now

Given the changing manufacturing landscape, distributors must act now to build resiliency and position themselves for future success. Three actions can position distributors as beneficiaries rather than victims of the trend:

1. Understand the value chains in the markets you serve. Consider all links in the value chain and understand who benefits from your offerings and how. This broader perspective can help illuminate value pools and highlight the risk areas where manufacturers may be seeking to expand their offerings. It may also help distributors to identify areas to create or capture new value. For example, distributors that have already invested significantly in B2B e-commerce platforms can use the behavior and feedback from existing users to stay ahead of the curve on refinements and enhancements. These actions can increase value for their customers while raising the bar on new entrants from the manufacturing ranks.
2. Invest in areas of digital transformation to build advanced capabilities for customers and end users. Despite the up-front costs and complexity of implementing digital solutions such as advanced planning and warehouse management systems or robotics and automation, these technologies are increasingly critical for distributors’ operating efficiency and their ability to add value. Distributors farther along in their digital journeys may not only be more attractive to their customers — thanks to better stock visibility, shorter fulfillment times and more competitive pricing — but they may be better positioned as supplier partners. This is due to better management and accessibility of data valued by manufacturers. For example, a leading supply chain, electrical and distribution services provider has identified a group of preferred suppliers that invest heavily in innovation and driving end user demand and are generally profitable. To increase share with these suppliers and improve customer outcomes, the company developed an AI-driven product recommendation tool to leverage its large data lake into increased point-of-sale conversions.
3. Identify and implement your own BMI opportunities. Distributors in many markets benefit from a level of customer proximity that manufacturers see as a key driver of future growth. Viewed through a BMI lens, this situation represents a potential opportunity for distributors. By digitizing and analyzing their knowledge base, they could become an even more valuable partner for their suppliers by providing actionable intelligence as an ongoing service. Distributors may also find ways to leverage other unique attributes into BMI opportunities. For example, they may be able to tap core competencies, such as dealing with supply chain complexity to develop new solutions. This was recently done by a leading technology distributor and solutions provider that developed a “supply chain-as-a-service” offering for supplier partners.

The future of distribution lies in adaptability, innovation and strategic positioning. Individual distributors’ strategies for responding to manufacturing changes will necessarily vary by market, competitive position and other factors. However, the most successful will share a determination to quickly adapt their strategies, invest in capabilities and find innovative ways to add value within the evolving manufacturing landscape.

Views expressed in this article are those of the author and do not necessarily represent the views of Ernst & Young LLP or other members of the global EY organization.