The Distribution Business Model Primer
How they work, where they win and what makes them interesting investments
Over the years, I’ve analyzed a variety of distribution businesses and noticed they tend to share key characteristics that make them interesting for long-term investments. This primer lays out the general investment thesis behind distribution models, explains how they create value and highlights the metrics and risks you should track when evaluating them.
What’s a Distribution Business?
Distribution businesses are essentially B2B retailers, typically specializing in a niche market, connecting suppliers with customers. They act as intermediaries in fragmented ecosystems, streamlining procurement for their clients and creating valuable networks that suppliers depend on to access hard-to-reach end markets.
A good mental model is thinking of them as the "plumbing" that keeps supply chains moving efficiently, whether they distribute plumbing supplies (Ferguson), industrial components (Diploma), healthcare products (Owens & Minor) or electronics (Arrow, Avnet).
What Makes Distribution Businesses Attractive?
Ferguson illustrates the attractiveness of this model perfectly:
The company sits at the center of a massive network, with thousands of suppliers on one side and millions of customers on the other.
This structure creates two critical dynamics:
Low customer/supplier concentration risk: Revenues are often spread across a large number of small-to-medium-sized customers. Losing one or two customers has a minimal impact. Similarly, suppliers are often replacable and typically don’t have the best negotiating base (unless they are highly specialized).
Network effects: As a distributor scales, it becomes a more attractive partner to both sides of its network.
Suppliers want access to a large, efficient customer base.
Customers prefer the one-stop shop experience with reliable service and product breadth.
As a customer, you prefer to have one reliable partner that has a large selection of products and meets all your needs. This is called the one-stop shop strategy, where companies try to continue to gain incremental share of customer wallets. In order to deliver this the company also needs a wide distribution network with lots of branches and logstic centers. In the B2B world this is especially appealing for large, national customers or even multi-national ones with complex operating structures and processes. Having just one partner for your basic supplies in valuable, especially if its about small parts, ideally mission critical. In these situations, reliability, service quality and speed are much more important than price, leading to attractive margins compared to typical retail businesses.
Why customers stick around:
Reliability and service quality (speed, accuracy, availability of inventory) matter more than price.
Distributors often offer value-added services like inventory management, technical support, S&M tools and just-in-time delivery.
Customers are often purchasing mission-critical components or consumables where downtime is expensive.
This dynamic often results in sticky customer relationships, high retention, and attractive margins—especially when compared to typical B2C retail businesses where price competition is more intense and often the most imporant competitive differentiator.
How Distribution Businesses Build Competitive Advantages
Scale economics: Larger distributors can offer better pricing, broader product selection and superior logistics.
Local presence & density: Proximity matters—dense branch networks reduce delivery times and increase service responsiveness. Products often are low cost, but with high logistic costs.
Private label products: Higher margins and increased customer dependence.
Data & customer insights: Large distributors can leverage data to offer predictive services, cross-sell and better manage inventory.
Key KPIs to Track in Distribution Businesses
These are essential metrics to understand the health, efficiency, and competitive positioning of a distributor.
1. Gross Margin & Gross Profit per Customer/Branch/Employee (if available)
Reflects pricing power and ability to pass through supplier costs. We want to see rising margins over time.
Gross margins can vary by industry (higher for niche/technical products).
2. EBIT Margin / Operating Leverage / SG&A margin
Scale typically drives operating leverage as fixed costs (logistics, branches, tech) are spread over more revenue. Distribution businsses typically have gross margins <50%, so a prudent management of the SG&A margin is vital to deliver profitable growth.
3. Organic Growth vs. acquired Growth
Track organic revenue growth separately from M&A-driven growth. Bolt-ons make sense, as it increases product breadth, geographic expansion and elevates the negotiation power with suppliers.
Many distributors are roll-up stories (Diploma, Bunzl), so understanding integration success is key. Do they run a decentralized model or are they betting on a large central brand?
4. Same-Store Sales Growth
Indicates the health of existing locations and customer relationships. If the company gives out this information, it’s vital to see growth from existing branches.
5. Working Capital management
Inventory turnover efficiency—key for working capital management and cash flow. Distributors often need to invest into inventory to expand into new geographies and to absorb new product releases. Leveraging bargaining power (Days Sales Outstanding and Average Days Payable Outstanding) can unlock FCF in this working capital intensive businss model.
6. Return on Invested Capital (ROIC)
Measures how well management reinvested capital in the past (especially in M&A-heavy models).
7. CapEx Intensity / Branch Openings
Indicates reinvestment needs for network expansion and logistics improvements. Typically maintenance requirements are limited, with higher proportion of growth CapEx investments. We want to see organic growth and network expansion.
Most distributors are asset-light but logistics hubs/tech platforms require CapEx.
8. Private Label Penetration
Private label products typically carry higher margins and build customer dependence.
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Risks in the Distribution Model
No business model is without risks, and distribution has its fair share.
1. Disintermediation Risk
Suppliers bypassing distributors to sell direct-to-customer (DTC).
Particularly relevant if customers are large enough to justify internalizing procurement and if few large products are sold instead of many small ticket items.
2. Commoditization & Margin Pressure
In highly fragmented markets, price competition can erode margins.
Tech platforms and marketplaces (e.g., Amazon Business) can intensify this.
3. Inventory Risk
Managing inventory efficiently is critical. Excess inventory can lead to write-downs, while stock-outs hurt customer trust.
4. M&A Execution Risk
Many distributors grow via acquisitions. Poor integration or overpaying can destroy shareholder value. Culture clash can also hurt long-term growth.
5. Economic Sensitivity
Industrial and construction-focused distributors (e.g., Ferguson, Würth) can be cyclical, tied to economic activity.
6. Customer Consolidation
Large customers may gain bargaining power and demand better terms.
Consolidation among suppliers can also increase distributor dependence on fewer sources.
7. Technological Disruption
Failing to digitize the customer experience (online ordering, data services) can leave a distributor behind.
8. Inflationary Environment
Distributors need higher working capital in high inflationary environments like 2022 and might have to run at negative free cash flow for a time to absorb higher prices before they can sell the items.
Conclusion: Why Look at Distribution Businesses?
When executed well, distribution businesses can offer:
High returns on capital
Predictable cash flows and capital-light business model
Scalable growth via M&A and organic expansion
Durable moats based on scale, network and customer intimacy
Some of my favorite companies in this space have consistently outperformed due to their operational excellence, capital discipline and customer-centric models.
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Durable competitive advantages
Exceptional capital allocation track records
Attractive reinvestment opportunities
Resilient business models that thrive through cycles
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