Franchise or commodity: testing a distribution business

Distribution businesses report similar-looking numbers across very different competitive positions. Thin gross margins, high asset turns, and returns on capital that can be respectable in both cases. The reported figures do not separate a business customers cannot easily leave from one that simply moves boxes cheaply.

Test one: what happens to price in a downturn

A distributor with switching costs holds price and loses some volume. One without holds volume and loses price. Both look like a revenue decline in the headline; the composition is the signal, and it is usually disclosed in the volume commentary.

Test two: revenue per customer over time

A franchise deepens. If the same customers buy more categories year after year, something is holding them — inventory availability, technical support, integration with their own systems. If revenue per customer is flat and growth comes entirely from adding customers, the business is winning on price and will keep having to.

Test three: working capital in a squeeze

This is the most revealing and the least discussed. When supply tightens, a distributor with real supplier relationships gets allocation and can hold inventory for customers. One without gets rationed.

The signature is visible in the cash flow statement: inventory rising ahead of revenue during a shortage, then converting. That is a business being trusted at both ends of the chain.

Putting it together

None of the three is decisive alone. Two out of three, sustained across a cycle, is usually enough to distinguish the two business models — and the distinction is worth several turns of earnings.