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Grainger (GWW) Missed Earnings – Good for Amazon, Bad for B2B Distributors

Today, Grainger announced its first-quarter results, and it wasn’t pretty.

Grainger missed its Q1 earnings projections, driven by recently announced price reductions on spot buys and online sales. Its earnings per share came in under expectations at $2.88, which was a 9% decline compared to Q1 2016. Alarmingly, operating margin declined by a full 2% YOY, falling to 11.4% for Q1 this year versus 2016.

The results in the U.S. market, by far Grainger’s largest at 73% of revenue, were particularly unsettling. While sales grew slightly in other markets, revenue was down YOY to $1.953 billion in the U.S. compared to $1.966 billion in Q1 2016. This decline comes after last year’s full-year results showed negative revenue growth in the U.S. business.

“U.S. results are all about strategic pricing actions we are taking,” Grainger CEO DG Macpherson said on today’s investor call.

In response to its poor results, Grainger today announced that it will be accelerating its price reductions across the board. Rather than rolling these price cuts out slowly throughout the rest of the year and 2018, Grainger will instead be implementing all of its price cuts this year: price cuts planned for 2018 will now happen in Q3 and Q4 of this year.

grainger 2016 revenue at risk

By its own admission, Grainger (GWW) isn’t competitively priced on nearly 43% of its revenue. Source: Grainger Q1 investor call

Along with this announcement, Grainger also slashed its full-year revenue guidance, with its new midpoint declining from $10.6 billion to $10.4 billion. Additionally, it reduced the midpoint of its guidance on operating margins from 11.9% to 10.7%. This new figure represents a decline of 1.7% from the prior year.

Why Grainger Missed

The key takeaway from Grainger’s bad first quarter is that it failed to understand how price-sensitive its customers are. Unfortunately, today’s earnings call gives no reason to think that Grainger has learned its lesson.

Grainger failed to understand how price-sensitive its customers are.

Applico predicted Grainger’s struggles in its recent webinar, The Impact and Risks of Amazon Business for Traditional B2B Distributors. Our webinar demonstrated how Grainger’s price reductions and the competitive threat of Amazon Business would likely impact Grainger over the next several years. Our middle-of-the-road model showed revenue declining only slightly to $9.68 billion by 2019, yet its earnings would decline by 56.6%. This shift in our model is driven by Grainger’s price reduction strategy and increased competition from online marketplaces like Amazon Business.

The results shared by Grainger today were very much in line with our model’s expectations for the early part of this year.

Grainger’s models predicted a much smaller response to pricing reductions than it actually experienced, indicating that Grainger’s market is far more price-sensitive than the company expected.

Grainger admitted that even with its reduced prices, it would not have the lowest available prices across the board.

In fact, it suggested that increased pricing competition from its competitors wouldn’t lead to a “race to the bottom” in prices. This assumption was a driving factor behind the company’s predicted growth over the next two years, according to Chief Financial Officer Ron Jaden.

This assumption is worrisome and suggests Grainger hasn’t fully factored in the impact that online competition and price transparency will have on its business  in the long run.

grainger (GWW) announced price reductions

Grainger predicts it will be fully price competitive by 2018. Yet its models assume that competitors won’t respond to its price reductions. This scenario is unlikely, given Amazon’s tendency slicing its competitors’ margins as thinly as possible.

If price competition does increase, Grainger won’t experience the volume growth that it predicts as a result of its price cuts. And its margins won’t improve over the next several years as its models suggest. Rather, as our model predicts, its margins will continue to deteriorate as competition and pricing pressure increases. Grainger won’t be able to shed operational costs fast enough to keep up with its more nimble and digital competitors.

Grainger Underestimates the Amazon Threat

Why are we confident in this prediction?

Grainger predicts its volume growth will come from a relatively even mix of increased spot buy business from existing large customers as well as new e-commerce business from small and mid-sized customers. While we view the former growth as likely in the short term, the latter assumption from Grainger’s leadership is much harder to swallow.

Amazon Business vs Grainger pricing data

Our sampling of Grainger and Amazon Business product and pricing data show that Grainger still has a very long way to go. For more, check out the Applico Marketplace Tracker (link below article).

The growth in these smaller customer segments is dependent on its digital marketing efforts over the rest of the year, which the company admitted it hasn’t done before due to its high web prices. If Grainger’s digital customer acquisition efforts are less effective or more costly than predicted, its predicted growth and margin improvements will not materialize or will be significantly less than its model shows.

Grainger’s predicted growth and margin improvements will not materialize.

We view this outcome to be extremely likely, given that competitors like Amazon Business have significantly more experience with digital marketing and customer acquisition. Grainger’s Q1 struggles also suggest that it is likely to find these customer segments to be more sensitive to price than it has expected.

Additionally, as Amazon Business continues to grow, its lower-cost marketplace business model means that it will be able to create increasingly greater pricing pressure than Grainger is facing today.We view a race to the bottom on prices as to be a likely outcome in the next few years. In fact, this kind of constant pricing pressure is what Amazon is known for (see Circuit City).

Will Grainger be the next one to join the graveyard of Amazon competitors?

Will Grainger be the next one to join the graveyard of Amazon competitors? The signs don’t look good.

It’s been in the company’s playbook for taking over numerous B2C industries and we see no reason that this will play out any differently in the relatively commoditized B2B markets like MRO and industrial supply.

Conclusion: Amazon at the Gates

The sensitivity to pricing and shift to online sales that Grainger is seeing are significant headwinds for its business and the market at large, factors it clearly wasn’t prepared for. Even worse, these market conditions significantly favor Amazon Business.

While Grainger would have you believe that this year and next year are the “bottom” for its pricing and margin struggles, our model predicts that this change is only the beginning of a downward spiral.

The driving assumptions behind Grainger’s more rosy projections seem unlikely to materialize. Furthermore, they show that the company still hasn’t understood the true extent of the competitive threat represented by online marketplaces.

As we have discussed in our white paper, “The Best Defense is Offense: How B2B Distributors Can Dominate with a Marketplace,” Grainger and other B2B distributors need to combat the Amazon marketplace threat with their own digital transformation initiative. They need to embrace the marketplace approach and invite third-party sellers to sell alongside the distributor’s own e-commerce efforts.

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