Former VP at Cleaver-Brooks Inc
- US boiler market
- Margins and pricing pressures
- End markets and new technology
Specialist (SP): That’s a very general question, so I may need you occasionally to interrupt me and bounce me back on that straight and narrow path, but for the time being, let’s just start by saying that the industry is characterised by perhaps two, maybe three major business segments. You have a very large portion of the activity boiler companies are involved with relate to comfort heating and hot-water production, so you have an enormous market that boilers are being used in to heat your apartment complex in New York City or other similar applications. You have that and then you also have a much larger, and when I say much larger I mean scale wise, there are not more units but the dollars at stake are far greater, and that is the industrial boiler market which pertains to everything from food production to manufacturing to actual power generation in what’s known as combined-cycle. Combined-cycle is you have a boiler, it generates steam, the steam drives a turbine, that turbine creates electricity, and that’s a big segment that Cleaver-Brooks has a unique market position in that they play. Then on the other end of the spectrum is a much smaller application which is typically light commercial and/or residential. Cleaver-Brooks has a very, very small offering there, but they do participate in that marketplace with some of their commercial products.
You asked the question about the impact of the pandemic. I would suggest to you that there have been impacts with the pandemic, certainly they’ve been more temporary in nature, but I’ll talk about a couple of them at a very high level, and if you want to dive in a little deeper, feel free to ask specific questions. At the very highest level, the pandemic, when it first came about, the knee-jerk reaction of most industrial concerns in North America was preserve capital, so if you were in process, if you were negotiating, if you were about to issue a purchase order, until we understood what the economic impact of the pandemic was going to be, everybody locked their cheque book in a safe and said, “Let’s wait this out”. Not that I work there anymore but I am pretty confident that they experienced a significant slow down in purchases, especially on the larger stuff, primarily because capital equipment investment would have been significantly reduced by most players as a result of the pandemic.
If you’ve heard the phrase “long COVID”, long COVID is a medical diagnosis that speaks to the longer-range impacts of COVID-19, but it’s medical. In my estimation there’s a long-COVID economic, which are the longer term impacts of what COVID has done. Right now what we’re seeing is we had such a tremendous knee-jerk reaction as a global economy to the pandemic that most industrial concerns had workforce reductions, they closed their capacity down considerably, and as we learned more and as the mortality rate has decreased and the vaccine has been introduced, the economy was still healthy. In fact, there was more income available for discretionary spending than there was even pre-COVID, based primarily on government spending. As the economy tried to wind back up again, we started to experience significant constraints due to capacity limitations. In the last 3-4 weeks the price of steel is up by as much as 20-25%, if you can get steel, and most companies who are heavily dependent upon steel for manufacturing are experiencing broken contracts or seriously extended lead times.
SP: I want to answer that question slightly differently and then if you want to talk in specific segments, I’d be happy to go into it. The pandemic, and I’ve said this to other people in other conversations but similar threads, didn’t create new things. What the pandemic did was it accelerated or exacerbated existing trends, and so if you look at it from that framework, there’s been significant exacerbation or acceleration of market trends. I’ll give you a perfect one, the global environmental awareness has ebbed and flowed and it’s been very much depending upon who was in The White House. What we’ve seen over the last several years, and this is very specific to one of the most important markets that Cleaver-Brooks serves, is power generation.
One of the mega-trends in power generation is environmentalism. The cheapest fuel you can buy is coal, and it’s the dirtiest. The more Btus you get out of it, the dirtier the fuel. Second to that is oil and third after that is natural gas. There is definitely a trend away from the heavier fossil fuels, the dirtier fossil fuels, and with the Biden administration now in place we expect to see that even further accelerated. COVID didn’t have much of an impact on that, but the change in administration really did and what we’re seeing, and no, this not just the US, this is all over the world, we’re seeing a migration away from fossil fuels. You have a lot of pressure to find other ways to create energy and boilers is one that is absolutely dependent upon fossil fuels. Fortunately for the boiler industry, there’s no easy substitute. Wind power doesn’t, solar doesn’t replace all of the power that’s created by steam turbines through combined-cycle and industrial boilers, but that’s one of the things that’s happening in the market that is creating headwind for Cleaver-Brooks.
The other thing that is a significant headwind for Cleaver-Brooks is, a boiler is nothing but a steel tank. A bit of an exaggeration, but that’s really all it is. It is not an enormous piece of technology, it’s just a vessel. The technology typically exists in the burner and that’s where you determine how clean it’s going to run and how efficient it’s going to be. A major decision point in whether I replace a boiler or not, or whether I put a new firing system into that, is really a function of what are the economics of fuel savings if I were to replace old with new. I’m going to say the Arab Spring is really where this began. When you started to see the overthrow of governments and the royal Saudi family start to abandon its commitment to Opec, fuel prices began to decline and we see that today. Even to the extent where fracking is way below where it was previously and a number of major oil producers in Canada have wells that are still waiting for the per barrel price to get up over USD 60 before they reactivate. If one of the single biggest drivers in making the decision to replace an industrial boiler was the return on investment through energy reduction, a more efficient design, then when fuel prices decline, there are fewer people interested in buying boilers. There is another impact from COVID-19, fuel prices diminished significantly during COVID because nobody was buying oil, so that would have been another both near-term impact of COVID-19 as well as something that will continue to persist as time goes by. What you saw was exacerbation of a mega-trend.
SP: I think you can’t underestimate the impact of the change in The White House there. We know that Biden has stated that he is in favour of more green policy, period. That said, if you are a utility company, you have choices about how you generate power. One of those is through combined-cycle, steam-generated, but you can generate electricity in other ways. If you’re going to spend money on capital equipment, and certainly any power-generating station is an enormous capital equipment requirement, you have choices about what fuel you’re going to use or what the motive of energy is going to be. I’m going to say just about three years ago I attended an industry event and at the time the gentleman who was a lobbyist and consultant to the petrochem industry was discussing that the people who make electricity, the utility companies, had for the next five years not a single power plant driven by coal. It didn’t matter how inexpensive the fuel was, there was absolutely no interest in that any further. Then in a subsequent industry event that I participated in, I learned that the next product that is high on the list of things to eliminate from the atmosphere is the hydrocarbons that come from diesel. Under the Obama administration, the EPA was accelerating its energy cleanliness mandates. There’s just so much you can do with oil, so you’re about to lose a significant market segment, and steel production or oil production are two of the biggest customers you actually have in that industry.
For example, if you frack, you are injecting steam into the ground and that pressure that it builds forces the oil up to the top, so there’s an industry that will be further impacted by, “Fracking is a dirty word, fossil fuels are a dirty word.” Expect to see utility companies investing more in alternative energies for the long-haul. I could say, without hesitation, that the long-term impact, you can’t eliminate fossil fuels, but you could see a shift as much of 25-50% of the business that went to fossil fuels moving to alternative energies. In the long term it’s going to be a very challenging position for Cleaver-Brooks to maintain in the combined-cycle, in the heaviest end of its industrial boiler business.
SP: Their strength is their market footprint, they’ve been around a very long time, it’s a well-known brand. Again, I’m going to say more at the larger end of the spectrum, they are an established leader in the market place. If you are considering some industrial project of scale, and I’m talking about a power plant, I’m talking about an airport, I’m talking about a hospital, if that is the scale of the project that you’re considering, your engineering team and your architects, Cleaver-Brooks is one of the first names they come across in their Rolodex. That puts them in a really enviable position in terms of market presence. However, there is increasing competition and you cannot really rest on your laurels. It doesn’t really matter what the industry is or who the player is, you have to do things differently, you have to evolve, and the evolution that Cleaver Brooks has chosen as far as directional is vertical integration. Originally, they were a large domestic, so apartment buildings and large industrial, and really what they’ve done is they’ve actually integrated by acquiring and integrated by providing additional services within the various segments that they currently serve. For example, would be they now remarket and rebrand a boiler that they purchase in Europe and sell to small commercial buildings, let’s say a four-unit or as much as a 10-unit apartment complex. They won’t go much bigger than that, but that’s what that product segment was brought on board to do, they have a marketing relationship with this European company.
Something else that they’ve done is, if you look at the demographics associated with the baby boomer population getting ready to retire, what it’s generating is there is a lack of skilled technical resources within the industry. It’s very difficult, if you’re running a complicated system, to keep it online and to do the maintenance and to keep it compliant with environmental regulations which include smokestack monitoring. The number of people that are capable of doing that is in short supply, and so Cleaver-Brooks’s response to that was they acquired a couple of companies that have those service capabilities, one in Texas, used to be called Holman Boilers, now Cleaver-Brooks Sales & Service, a second company in Illinois. What they’re really doing is they’re expanding their offering in order to generate, first, a greater degree of loyalty and, second, revenue streams from other categories that they had not previously been able to participate in.
SP: The real difference between the two of them is, there’s a technical difference, but it’s almost meaningless in this context. Firetube is you have something that is combusting fuel, and as the exhaust gases travel through the firebox and then ultimately through the heat exchanger, the products of combustion, the energy is released through small tubes, and on the exterior of those tubes you have water. That’s how you transfer the energy from the exhaust stream that’s going up the chimney into the water that’s circulating past it. That’s firetube. Watertube is different, and that is basically everything around the firebox is immersed in some type of a heat transfer medium, typically water. It doesn’t have to be water, but that liquid absorbs the heat right off the firebox. It’s more efficient, it’s much more expensive to manufacture, it is much more technically demanding. What I’m saying in a somewhat roundabout way is they have a whole lot less competition in watertube than they do in firetube. In firetube the barriers to entry are very low, the margins are very low. The number of suppliers across the globe is, I’m going to say, at least 10-fold higher because it doesn’t require a whole lot of technical expertise or large manufacturing facilities, whereas watertube, your boiler is as large as a bus and not everybody has the facilities to be able to manufacture that or the engineering to support it.
Even better than that, on that scale your customer is going to buy something, they’re going to give you a deposit for that, but it’s going to be 10, 11, 18 months before it’s finished. Your capital position really determines how much of that business you can get because very few companies can afford to finance that kind of a purchase, and so that keeps a lot of the smaller players out of larger industrial end. By the way, based on the ownership and the access to capital, that puts Cleaver-Brooks in a good place in that segment.
SP: That’s a really good question. Let me be technically precise. A condensing boiler, as you make the fire and the temperature is, say, 2,000 degrees at the point of combustion, as it travels through the heat exchanger, that energy is absorbed by the boiler and transferred somewhere else where it’s being used. At a certain temperature the combustion gases have cooled so much that it begins to get wet, that’s when the condensation comes from. Really what you’re talking about is condensing boiler is not a different kind of boiler. What it is, is it the capability of wicking heat from the combustion process more effectively, more fully than a traditional boiler does because you’re just sucking every bit of heat out of those combustion gases before they go up the chimney. As they go up the chimney they cool so much, just like the air conditioner on your automobile, that any moisture in the atmosphere begins to precipitate out and that’s what’s condensing. That’s what the condensing boiler is, it’s an extension of an existing boiler with greater efficiency that leads to a phase change of the gases from a gas to a liquid.
Clarification, yes, the industry is moving to condensing boilers fast and furious. You could not get an architect today to specify a boiler in an apartment complex that wasn’t condensing, because a non-condensing boiler suffers an efficiency disadvantage of as much as 20%. If I don’t care about condensing, I can only get up to about 80% efficiency. If I want condensing, then I can take that all the way up into the high nineties. You’re losing fuel, you’re polluting and it’s the way the world is going.
Third Bridge (TB): Is that trend deflationary for the package boiler industry?
SP: No, actually it’s not. The problem is that the industry is experiencing deflation, it’s not because of condensing boilers. You asked a great question, what you asked was thought-provoking. There is some deflationary pressure, I’m going to change my answer to that, but explain why there’s deflationary pressure. If I had a boiler 10 years ago that was 80% efficient and I’m replacing it with one that’s 100% efficient, I don’t need as large of a boiler, I don’t need as many boilers to heat the same space, and so what you’re seeing is a significant reduction in unit demand across the entire boiler industry. There are fewer boilers being sold because the ones that are being sold, I don’t need them to be as big and I don’t need as many of them. That’s creating deflationary pressure in that market, leading to smaller demand in terms of quantities being produced. Also, because of that increase in efficiency, again efficiency upgrade as a result of being able to really cool the exhaust gas temperatures and transfer that energy into something else that you can use, because of that you have smaller boilers that are capable of doing things that in the old days, however you measure the old days, 10 years ago, 20 years ago, they’re much smaller boilers that are now capable of delivering that same kind of heat output on demand, but they’re commercial grade not industrial grade.
SP: Yes, that’s a really important question. It’s not that hard of a question, it’s a really important question and it’s actually very easy to answer. It presents, again, another headwind for the industry. I’m going to answer the question in the context of what’s happening in New York City. New York City is the oldest housing stock that uses boilers in the United States, it’s the oldest and largest. There are a couple of things that are going on in New York City. One of the things that’s going on in New York City is the value of real estate is so high. By the way, this is the single biggest geography that consumes boilers and it’s really particularly because New York City is old housing stock. If you are building newer housing stock, there are a number of things that are likely to happen in a new apartment complex that can’t happen in New York City or didn’t happen in New York City at the time that they had to make a selection of how you were going to heat that facility.
Alternative energy, or alternative technologies, for example, furnaces or independent heat-generating plants that are the size of a single apartment vs a boiler room in the basement that heats the entirety of the building. This is that trend that I wanted to get to. In New York City, the real estate values are so high that we’re seeing a competitor to Cleaver-Brooks, a company by the name of Navien has really been championing this, but all the others in the industry are starting to catch on, and they’ve figured it out and are copying it. When a tenant moves out of an apartment in a larger complex, instead of just moving somebody else in, they’re typically sending in a heating and ventilation company who will install, either under the cabinet in the kitchen or in a closet next to the bedroom, the technology is called a tankless hot-water heater. It’s capable of generating heat, and it’s capable of generating domestic hot water. It’s actually the size of a mini fridge. It’s quite small. I can tie a gas meter to that device and tell you, as the next tenant who is about to move in, that you are responsible for heating. If I’m the landlord, and I’m tired of standing outside my building, looking up and seeing, in the middle of the winter, while the boiler is running, that half my tenants have their window open, it’s very wasteful.
The icing on the cake is, when I’ve done this in every apartment that I have for rent in my complex, then I don’t need the boiler downstairs in the cellar anymore, and I’m going to actually dismantle it, I’m going to chop it up and move it out in pieces. I’m going to refinish the basement and then I’m going to build individual storage units in the basement, and I’m going to tell my tenants, “If you would like to rent additional space for all your stuff, you can rent a cage downstairs in the basement.” What we’re seeing is a tremendous move away from this monstrous machine that used to occupy the basement, and landlords figuring out, “I control my costs, as far as heating the building, I can increase my rental footprint and I don’t need an industrial boiler maintenance company,” very few of which there are available, to come in and take care of these. “I can get any old plumbing and residential heating company to come in and service that tankless hot-water heater.” I’m not running all the time. I’m only running when the person actually needs heat and turns it on for hot water or a shower or comfort heat. Big change in a geographic market, depending upon changes in the industry. Refocus. What was the question, specifically?
TB: Is there a good way to assess demand driven by boiler replacements vs organic growth from new fittings?
SP: Boiler replacement has always been as much as 70-80% of the market. I’m not sure if that’s data that you’ve ever heard before, but it is the vast majority. Primarily because if your heating system in your, it’s not really a home, but in your business, in your apartment complex, is based on the boiler, you’re not really substituting a different type of heating plant because you don’t have places to run ductwork. You are confined to a boiler once all of the pipe has been installed in the building. If you are a new building, if you’re brand new, the chances are that you’re going to use fewer boilers. You may not even use boilers. You may use either a solar or partial solar or even wind, but you also have the opportunity to break the boilers down to something much more commercial. Your industrial boiler market is diminishing because even the replacement market is impacted by higher-efficiency, lower-cost alternatives to what we used to do 50 years ago.
SP: I want to answer that question in two ways. Again, the boiler itself is only a portion of the equation. The burner is also a significant element. Remember, the boiler is just a vessel. One of the bigger players that Cleaver-Brooks has been competing against all along is this company called Hurst. Hurst, actually they’re not all that far. They would trade employees, as a matter of fact. Very much the same profile of product. There are a couple of other boiler manufacturers in that same category, many of whom are migrating upwards. Weil McLain is one of the companies I used to work for, and they specifically made a decision to move from boilers in 150,000 Btus up to the five million and 10 million Btu range. They’ve introduced a whole line of products, and they’re also very well-established, for a very long time, like Cleaver-Brooks. The issue is, and this is a double-edged sword, and has been for Cleaver-Brooks, if you have a particular preference for a boiler, the chances are more than not, it’s at least a 50% chance, you own more than one boiler. If I were a university, for example, I can’t run a university on a single boiler. I have to have five or six boilers. I have to be able to flex up in peak demand. I have to be able to take units offline to do maintenance. I have to have room for failure because boilers, they do get hot and cold, and hot and cold, and hot and cold, and that expansion and contraction destroys the machine, so you rebuild them over and over again.
If I have multiple boilers, what I want is I want this boiler that I already have with this burner. There’s a great deal of value in being able to stay with what you have when you go to replace. What Cleaver-Brooks did, right or wrong, was they made a decision that if you purchased a Cleaver-Brooks boiler, it would come with a Cleaver-Brooks burner. That was some of the vertical integration we talked about. They acquired two companies, one a company by the name of Industrial Combustion out of Monroe, Wisconsin, and then another company by the name of Natcom out of Montreal, Canada. If you have a Hurst boiler, if you want to buy a Hurst boiler, Hurst will ask you, “What burner do you want on it?” You can choose a Coen boiler, and Coen is owned by the Koch brothers, big, major player in the marketplace. They’ve acquired quite a few of the players in the combustion services end of our business. You will have a choice. You can put whatever you want on it, and your buyer is interested in keeping one burner and all five of his boilers so that he has one set of mechanics that know how to work on them all.
It’s not just the boiler, but you do have some major players. You have Zeeco, you have Hurst, you have the Koch brothers, you have Weil-McLain. I’m just trying to think, it’s been a while since I’ve run through the names, but I’m going to say that, based on how many players there are in that market space, you have about five major players, Superior, Hurst, Cleaver-Brooks. There’s one that just eluded me. It will come to me when I’m not trying to think of it. There are approximately five really big players doing that industrial boiler. Indeck, that’s the name of the company. That’s who they’re competing against, and they’re quite a bit larger. Cleaver Brooks is quite a big larger than those guys. That’s both good and bad. The strength of their position is you have local representation. By the way, we didn’t talk about that, but I think you need to, if you haven’t asked One of the strengths of Cleaver-Brooks’s market position is boilers are maintenance-intensive. You may have your own staff, but in a typical hospital the staff is able to read the dials and the indicators and understand that everything is in the green, but when things get ugly, when they stop working, being able to diagnose the problem is frequently very challenging. Cleaver-Brooks’s model for going to market is they have either aligned with, or in fact acquired, major distribution points across the US, companies that are capable of not just selling the boiler but also doing the maintenance, and selling parts and doing the service on boilers that are already in place.
That is a significant advantage over Indeck or Miura or many of the other companies, who their coverage is really haphazard, very regional, because these distributors are the leftovers, the second-tier distributors. All the really powerful, influential players in that marketplace are typically Cleaver-Brooks. If you’re Kellogg’s or if you’re Kraft, you don’t want to deal with 19 different companies. You want to deal with one company. I can call Cleaver-Brooks at their corporate headquarters and say, “I have a cheese factory in Atlanta, and I need somebody in there right away because it’s not working.” Cleaver-Brooks can handle the entire activity on your behalf, and there are very few companies that can do that. There is a strength there that insulates them, at the higher end, from some of the other companies that can manufacture a boiler for less money. Significantly less. We found ourselves, on a number of bids, anywhere between 30% and 20% higher than everybody else. If you have a competent technician on-hand or a staff capable of managing and running boilers, you’re actually not going to pay that premium.
SP: Yes, absolutely. Where you see it the most acutely is in the smaller products, because the volume and the absorption typically come from producing a boiler that is about the size of your sofa. Anybody can build those, and there’s a lot of smaller players. A lot of the competitors that are out there actually were, in one way or another, formerly associated with Cleaver-Brooks. They’ve taught many competitors how to be in this business. The smaller you go, the more intense the competition. It’s impractical to import a boiler that is the size of a truck. You can’t do it. You can’t put it in a container, put it on a cargo ship and take it through the Suez Canal. The competition for things that are smaller, it’s far easier for competitors to enter the marketplace and establish themselves. It’s highly fragmented, lots of very small players with exceptionally spotty penetration. It just happens to be where they happen to be, and two-thirds of the country are uncovered for that brand.
On the higher end, as I said, the strength that Cleaver-Brooks has is, first of all, the logistics of moving a massive boiler across the country are hard enough without trying to do that from an overseas location. Then, second of all, if you’re looking for all of the infrastructure that supports the sale of something that is USD 5m and takes you 28 months from the time you order it to the time that it’s actually commissioned, that strongly favours a company like Cleaver-Brooks.
SP: It’s horrible. It’s really interesting that you say that because if you look at my resume, I’m very much an industrial guy. Because I worked on heating equipment as a kid, I’m very attuned to that segment, but the other business, the other industries that I’ve served are all experiencing the same thing. There is a shortage of qualified welders, to the tune of 300,000 individuals in the United States. The number of technicians that are graduating the trade schools and are capable of becoming boiler makers, is down almost 50% over prior years. One of the most critical paths that used to spit out qualified steam generation technicians was the US Navy, because all those boats used to be steam-powered by a boiler, and none of them are now. Now they are using something that is far more similar to what you would find on a jet aeroplane. You have far more sophisticated appliances that are far more efficient. They are turbine engines, and nobody that works on a turbine-powered destroyer comes out of the Navy and knows how to work on a steam boiler, so you have a tremendous shortage.
In the next 10 years, it’s actually supposed to get worse, of people not entering the trades. You see that across any trade you can imagine. You see that even in truck driving. There’s a shortage of truck drivers to the tune of 60,000. The problem is we’re not graduating people with technical skills nearly at pace with demand. To exacerbate the problem, the products that we need them to work on are far more sophisticated, more technically complex than anything that we used to work on 25 years ago. It is something of a perfect storm.
SP: It’s very challenging to do something about that. You have to have a pool of candidates that are willing to learn. I’ve seen things done at other companies that were more proactive than what I’ve seen at Cleaver Brooks. For example, one of the manufacturers, again heavy steel industry that I was associated with, had partnerships that they were engaged with in local trade schools. They would offer, for example, to pay tuition with a fixed-period payback. “If you went to welding school, we’ll pay your way.” As long as you stay on as an employee for a period of time, your debt for that training will be forgiven. That was something that I thought really needed to be brought into Cleaver-Brooks. For whatever reason, it wasn’t in the cards. It’s now three years since I was last connected, so I don’t know if they’ve done anything different about that.
That said, what I would also say is the shortage of qualified welders has led to opportunities for competitors, because where you may want to do business with Cleaver-Brooks, their lead times are significant. Anywhere between 16 and 26 weeks was common, which means, first of all, there’s very little being built on speculation, so there is no inventory. I do know, from when I worked with United Technologies, when you have lead times that are that dramatic, for a product that might be considered a critical infrastructure piece, if you’re a hospital and a boiler goes down, you might want Cleaver-Brooks, but if that is one of just two functional machines or three functional machines, the risk of waiting for another half a year to get product is too great for many to wait and they’ll go to a second-tier supplier.
SP: There is one thing that I think probably needs to be, if you want to understand their position in the marketplace. I will tell you that I’m a pretty technical person. I understand how the products work, but that is not my greatest strength. My greatest strength is understanding distribution models. That is, for me, one of the things that I’m most concerned about, not just for Cleaver-Brooks but for many other market participants across a wide range of industries. In particular, what I’m talking about is the vast majority of Cleaver-Brooks’s go-to-market model is dependent upon independent businesses that are typically family-owned. They are out there promoting Cleaver-Brooks products. The analogy that comes to mind is the hardware store or the auto parts store. If I dial back the clock 30 years, there was an auto parts store in every town. It was quite small. It was privately-held. Same thing with a lumber store. If you fast forward, the Home Depots and the AutoZones have pretty well, through consolidation, wiped out all the independent players.
Cleaver-Brooks’s model is dependent upon approximately 30 families, with, I’m going to say, one exception, and that’s Cleaver-Brooks Sales & Service. That was the former Holman Boiler company that they bought and staked out a position in Illinois and Texas. If you then look outside those two territories, quote, unquote, what you’ll see is, again I’m using broad strokes, you will see several groups of greybeards, men who are 50 or 60 or maybe even a little bit older, who are milking it but they’re not growing it. If they could sell it, and they found somebody who would pay them what it was worth, they would probably sell it and ride off into the sunset, but based on the margin profile, the lack of human resources and technical resources that are required to create a profitable model for that, many of these players do not have an exit strategy. If my distribution model is dependent upon 30 companies across the United States, most of whom are owned by very close-to-retirement age individuals, I’m a little concerned. By the way, this is not limited to Cleaver-Brooks. This is an observation I’ve made in a number of different industries that I’ve served, but I think Cleaver-Brooks is especially vulnerable to it because if you do a distributor profile and you look at how it’s owned, who are the principals, there’s not a lot of them who have a succession plan. They don’t have succession plans, with very few exceptions.
SP: Yes, there is in fact an evolution that you should expect, and it’s very predictable. The purpose of the sales organisation, from a theoretical point of view, is they are diffusers of innovation. We’re here to tell you about something you don’t know about, that you should know about. Once a market reaches maturity, then competitive advantage accrues to the companies whose logistics profile is the most robust. It’s going to be more price-sensitive because there’s more competition, and you have to shed overhead. In this case, you could talk about the distribution channel as overhead. They take anywhere between 30% and 50% margin on what they buy from Cleaver-Brooks onto themselves, and it leaves huge gaps, geographically, throughout the country. Ultimately, the most efficient logistics platform for Cleaver-Brooks would be some kind of direct selling routine.
They’ve migrated that way a little bit. If the sale gets made to an electrical plant, a power plant in a distributor’s territory, Cleaver-Brooks will hold the paper. They’ll write the invoice, and when everything is done they’ll credit the distributor for their active participation, and that that is the hook that keeps you involved and servicing that customer for a good long time, because I’m paying you to be engaged. That Cleaver-Brooks distributor couldn’t have done that job if they wanted to. They just don’t have the cash reserves. Very rarely would they have access to capital on that scale. The problem is, as these guys reach retirement age, there’s nobody to come in and acquire their businesses. When I say nobody, I mean most of them don’t have that in place. The only alternative that I see for Cleaver-Brooks is either acquisition, acquire your distribution channel, or you lose it. If you lose it to somebody who sells another brand, that’s a bad play. I think, ultimately, for Cleaver-Brooks to maintain their position over the long haul, they’re going to have to figure out how to deliver not just a manufactured product but all of the infrastructure that supports that product, from installation, service, to long-term parts availability and support. That will be challenging. Not impossible, but that will be challenging.