Making margins

Ezy Infotech is the entity that acquired certain assets of eSys Group earlier this year, including its PC assembly and distribution businesses. With 1,400 employees in more than 25 countries, the company remains an important player in the global market. Vikas Goel, advisor to the board of Ezy Infotech - and a well-known face in the IT channel - reveals where the company sees opportunities for growth and explains why the distribution sector is on the cusp of massive change.
Making margins
By Andrew Seymour
Tue 08 Dec 2009 04:00 AM

Ezy Infotech is the entity that acquired certain assets of eSys Group earlier this year, including its PC assembly and distribution businesses. With 1,400 employees in more than 25 countries, the company remains an important player in the global market. Vikas Goel, advisor to the board of Ezy Infotech - and a well-known face in the IT channel - reveals where the company sees opportunities for growth and explains why the distribution sector is on the cusp of massive change.

Contract assembly for IT and consumer electronics has become a larger part of the group's business in recent years, and you now have manufacturing facilities in Asia and the CIS. Is that the case in Dubai as well?

Yes, what we do is assembly or disassembly depending on which country [the product] is going into and the logistics requirements for those countries. We have cemented our footprint quite a bit in terms of product line and physical presence in countries such as Sri Lanka, Bangladesh and Pakistan. Those three countries typically get clubbed as the Indian subcontinent, but they consist of 500 million people and they are huge, growing markets.

In India, of course, we are in quite a dominant position, especially for our own-branded goods. What we have done with the strategy globally is moved higher up the value chain into high-margin products, whether it's software, own-branded products or manufacturing.

Where does distribution fit into your IT portfolio these days?

We have consolidated distribution to a certain level - US$700m to US$800m - and we are not consciously pushing it beyond that, but what we are doing is pushing our manufacturing and other businesses higher so that the average margin goes up.

In distribution, the fundamental problem during the last one and a half years has been credit exposure. The insurance limits on the customers are being withdrawn everywhere, whether it is Latin America, the Middle East or Eastern Europe, so your ability to give credit is limited. And if you can only give X amount of dollars to a certain customer, it is better for you to give credit on products which give you higher margins.

The components business is typically only a 3% or 4% margin business, and the systems business is 4% or 5%, but when you get into solutions, software or your own-manufactured products, you are talking about double-digit margins. Our average gross margins from, say, 2006, when we were a purely components distributor have grown from 3.5% to 7.5%.

What about the Middle East? Are you still committed to serving the region?

Yes, we are definitely fully committed to the Middle East market and, in fact, our local Dubai operation - in line with our global strategy - is focusing on the components distribution portfolio to the extent that it was previously, but we have also expanded more into own-branded products and manufacturing, including contract manufacturing. We do that for a couple of major MNC brands. Apart from that, we have focused quite a bit on the CIS and adding a footprint there, as well as Egypt. We have a joint venture in Uzbekistan, where we are one of the largest components distributors and the largest PC supplier. With Uzbekistan we are also getting into Turkmenistan.

A lot of other distributors in the Middle East have expanded into the Saudi market over the years, but that's not something Ezy Infotech, or the eSys Group before it, appears to have done. Why the reluctance?

We didn't want to waste resources in a market that is already saturated. The credit cycles are much longer, everybody has payment issues over there and every distributor is sitting there and fighting with one another over cents and pennies.

If you want to be a significant player in Saudi, it requires, let's say, 10 X of resources. But you can be a significant player in the smaller markets with 1 X of resources - so a tenth of that. It is better to be a king in 10 countries than a marginal player in one country. When you deal in Saudi you may make 3% on a product, but when you deal in CIS or the African countries the margins we are talking about are 5% to 10%.

There is a perception that the contract manufacturing business has suffered more than distribution in the downturn though. What are your thoughts on that?

You have to pick and choose your battles. If you are doing contract manufacturing in China or Taiwan then all the big boys are there and you won't be able to compete with them if you don't have economies of scale or any niches. In Europe, the situation is tight, operating expenses are going up, there are taxes and the product margins are low.

Now, in the Middle East we are uniquely positioned because there is no other contract manufacturer; we are pretty much the only ones with a decent IT factory. The second thing is our ability to manage the logistics by combining distribution with contract manufacturing. Our ability to club distribution - which is essentially logistics and financing - along with the manufacturing gives us the edge over everybody else.

The other benefit we have is being very capital rich, our bank debt is almost zero, 100% equity, and we don't have any long-term debt or external investors or partners. It is one of the best balance sheets in distribution. How does that help you?

Leveraging on this balance sheet, we can pick and choose our own battles. We can decide what kind of business we want to do or what kind of margin profile we need to be in, unlike other distributors that have to rely on vendor credit lines and keep rolling them over.

The moment you are not dependent upon the bank or the supplier credit line, you can choose the products that you want to sell and how you want to sell. Alternatively, Intel distributors, for instance, need to keep paying Intel every 30 days and they need to keep buying and selling because Intel's credit line has become a part of their working capital.

Do you expect the distribution channel to go through much change in the coming months given the pressures that are being felt across the market?

We expect distribution to undergo a fundamental change and it will depend upon the country because there are numerous pressures right now. Overall demand has suffered and average selling prices have come down dramatically. Traditionally, the price drop used to be compensated by volume growth, but now the volume is constant or lower and on top of that the liquidity has taken a big hit.

It is not just your ability to get capital from your banks or suppliers, it is about your customers' ability to get capital from their banks and their suppliers. When they have a liquidity crunch, it is invariably passed back to you. The insurance companies have, on average, withdrawn 50% of cover on customers, which is reflective of the risk profile in the downstream customer base.

Which markets or territories have been most affected?

In Eastern Europe it was very dramatic. There was the currency impact as well as the cash flow issues, so a lot of distributors went down over the last six months. In the Middle East, because of lack of transparency and the relaxed legal systems, it typically takes a while before the problem occurs. I feel that distribution over here will end up getting consolidated into fewer companies that can manage their risk profile much better.

The margins over time should get much better because the current margins in the business are clearly not sustainable. Whoever has deeper pockets to sustain this downturn will emerge victorious.

Are vendors taking enough action when it comes to helping the channel?

It varies from individual to individual, but on a generic basis the fundamental problem with vendors is that when there is a problem they are always late to recognise it because their sales targets and Wall Street targets are all fixed.

They do not want to acknowledge the problem and keep pushing the distributors. They are often the core reason why a distributor goes down because they inject a lot of inventory when the market is not able to take the goods or the demand is not there. The second thing is that when vendors start seeing the problem, the finance people typically have a knee-jerk reaction of cutting credit lines.

The way the vendor credit line system works is that because they still want to do the business, they end up injecting more resources into the financially stronger, more credible distributors - it could be the Ingrams in the US or somebody else - and the weaker ones start bleeding even more. That's essentially how they end up pushing consolidation.

You have business interests in a number of industries. But do you still have a passion for IT and IT distribution given your background in those markets?

To be honest, as an entrepreneur I am very passionate about anything new that I pick up, such as textiles for example. I am deeply into that. Ask me anything about that anywhere in the world - costings, products - and I would know about it. But with IT distribution I have the emotional tie-up in the sense that it is like your old girlfriend - you can't let go and then she keeps coming back to you!

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