CHAPTER FOURTEEN

The U.S. Economy’s Power Shift

POWER IN THE ECONOMIES of developed countries is rapidly shifting from manufacturers to distributors and retailers.

The phenomenal success of Wal-Mart, which made the late Sam Walton one of the world’s richest men in less than twenty years, was based squarely on the chain’s controlling the operations of its main suppliers. Wal-Mart, rather than the manufacturer—a Procter & Gamble, for instance—controls what should be produced, in what product mix, in what quantities, when it should be delivered, and to which stores. Similarly, in Japan, Ito-Yokado Company controls the product mix, the manufacturing schedule, and the delivery of major supplies, such as Coca-Cola or beer, for its 4,300 7-Eleven stores.

In hardware a few very large distributors—many of them owned by the independent retail stores they serve—actually design the products (or at least write the specifications for them), find a manufacturer, and lay down manufacturing schedules and delivery times. One example is Servistar, a Butler, Pennsylvania–based company, which buys for 4,500 stores across the United States and is owned by them.

The chains of hypermarkets that have come to dominate food retailing in France and Spain similarly control the product mix, manufacturing schedules, and delivery schedules of their main suppliers. And so do the discount chains that take a growing share of the U.S. market in office products. In the United States, the freestanding community hospital is no longer the principal customer for health-care products. Buying is now done by chains—for-profit ones, such as Humana; voluntary ones; denominational ones, whether Catholic or Lutheran. They set the product specifications, find the manufacturer, negotiate price, and determine manufacturing schedules and delivery.

Distributing is increasingly becoming concentrated; manufacturing, by contrast, is increasingly splintering. Thirty years ago, three big automakers shared the U.S. market. Today the market is split among ten—Detroit’s Big Three, five Japanese, two Germans. But thirty years ago 85 percent of all retail car sales were done in singlesite dealerships; even three-dealership chains were quite uncommon. Today a fairly small number of large chain-dealers—no more than fifty or sixty—sell two-fifths of all cars in the United States. Yesterday’s dealer handled only one make. Today’s chains may sell GM cars in one dealership, Toyotas in the dealership across the street, and BMWs in a dealership in the next town. They have little commitment to any one maker but go by what their customers want.

In the mid-1960s Servistar (then called American Hardware) bought less than $20 million a year and had 600 member stores. Today it serves 4,500 stores and has an annual volume of $1.5 billion. Twenty years ago, each of the current 7-Eleven outlets in Japan was an independent “mom-and-pop” store. Mom and Pop still serve the customers, but they have become franchises: 7-Eleven runs the store, decides what merchandise it carries and in what quantity, buys it, stocks it, does the display, finances the store, does its accounting, and trains its people.

These large distributors are becoming less and less dependent on manufacturers’ brands. Thirty years ago, only two very big American retailers successfully sold their own “private labels”: R. H. Macy and Sears, Roebuck. The largest American food retailer of that time, the Great Atlantic and Pacific Tea Company, tried to emulate these two. A&P’s private labels were superior value. But the public refused to buy them, which all but destroyed A&P. Now private labels are flourishing.

The independent stationery store in my neighborhood carries only national brands. But the only national brands carried by the recently opened local outlet of a stationery discount chain are goods that require service, such as computers and fax machines, and they account for less than half of the store’s volume. Increasingly the retail chains use cable TV to promote their own brands; they no longer depend on the manufacturers’ advertising on over-the-air networks.

What underlies this shift is information. Wal-Mart is built around information from the sales floor. Whenever a customer buys anything, the information goes directly—in “real time”—to the manufacturer’s plant. It is automatically converted into a manufacturing schedule and into delivery instructions: when to ship, how to ship, and where to ship. Traditionally, 20 percent or 30 percent of the retail price went toward getting merchandise from the manufacturer’s loading dock to the retailer’s store—most of it for keeping inventory in three warehouses: the manufacturer’s, the wholesaler’s and the retailer’s. These costs are largely eliminated in the Wal-Mart system, which enables the company to undersell local competitors despite its generally higher labor costs.

The moment a 7-Eleven customer in Japan buys a soft drink or a can of beer, the information goes directly to bottler or brewery. It immediately becomes both production schedule and delivery schedule, actually specifying the hour when the new supply has to be delivered and to which of the 4,300 stores.

We would not have needed the computer to do what Wal-Mart and 7-Eleven are doing. More than fifty years ago, Marks & Spencer, the British retail chain, integrated market information and the manufacturing schedules of its suppliers and created the first just-in-time system. In the mid-1960s, O. M. Scott of Marsyville, Ohio, a producer of grass, seeds, fertilizer, and pesticides, built real-time market information into its manufacturing system. Both almost immediately attained industry leadership. But once the computer is there and provides instant market information, the integration of this information with manufacturing production and delivery becomes inevitable.

Since I first said it in my 1954 book The Practice of Management, it has become commonplace to assert that results are only in the marketplace; where things are being made or moved, there are only costs. Everybody these days talks of the “market-driven” or the “customer-driven” company. But as long as we did not have market information, decisions (especially day-to-day operating decisions) had to be made as manufacturing decisions. They had to be controlled by what goes on in the plant, and they had to be based on the only information we had (or believed we had)—on manufacturing costs.

Now that we have real-time information on what goes on in the marketplace, decisions will increasingly be based on what goes on where the ultimate customers, whether house wives or hospitals, take buying action. These decisions will be controlled by the people who have the information—retailers and distributors. Increasingly, decision-making power will shift to them.

One implication of this is that producers will have to restructure their plants for “flexible manufacturing”—the buzzword for production organized around the flow of market information rather than around the flow of materials, as in traditional manufacturing. The more we automate, the more important this will be. General Motors largely wasted $30 billion on automating the traditional process, which only made its plants more expensive, more rigid, and less responsive. Toyota (and to some extent, Ford) spent a fraction of what GM spent. But it spent the money restructuring production around market information—on “flexible manufacturing.”

There is another important implication. When, during the past ten or fifteen years, companies began to organize themselves internally around the flow of information—we now call it “reengineering”—they immediately found that they did not need a good many management levels. Some companies have since cut two-thirds of their management layers. Now that we are beginning to organize around external information, we are learning that the economy needs far fewer intermediaries. We are eliminating wholesalers.

In the U.S. hardware industry, for example, the new distributors such as Servistar are doing what three levels of wholesalers used to do. In Japan, 7-Eleven has eliminated five or six wholesale levels. And this trend has only started.

Physical distribution is changing too. In many industries the warehouse is becoming redundant. In others it is changing function. One medium-sized supermarket chain now handles half its merchandise without any storage; it goes directly from manufacturer to store. The other half still goes through a warehouse. But it is not held there; it goes out within twelve hours, soon to be cut to three—in transportation parlance, the warehouse has become a “switching yard” instead of a “holding yard.”

This also means that the economy needs less and less of the financing that for two centuries provided banks with their safest and most lucrative business: short-term lending on inventory. The sharp drop in the demand for such money explains in large measure why banks in developed countries are seeing their commercialloan business shrink, even in boom times, and why they have been trying to compensate by rushing into dubious real-estate deals and loans to Third World dictators.

But the biggest implication is that the economy is changing structure. From being organized around the flow of things and the flow of money, it is becoming organized around the flow of information.

1992