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IT distributors: The only people adding value to the world economy

More than just middlemen...

Take Acal as an example. It has a total equity of £50m-odd, upon which in 2010 it made a lovely loss, while in 2011 it made £1m. By our yardstick it doesn't matter what its margins were, nor even its profits. We care about whether profits are greater or lesser than an 8 per cent return on total capital employed. For Acal, that would be £4m and clearly it failed. However, two years' results isn't really enough to judge such a thing. And one company isn't enough to judge an entire sector either.

Avnet, on the other hand, shows the following returns over the past five years: over 10 per cent; over 10 per cent; whacking loss; over 10 per cent; and then another 10 per cent. So it is by our particular measure adding value; it is earning more than its cost of capital.

If we look at Arrow over the past five years we see: well over 10 per cent; whacking loss; 4 per cent; 15 per cent; and then 16 per cent.

Ingram Micro gives us this intriguing little snippet: “Full year return on invested capital was 10.4 per cent, exceeding our weighted average cost of capital of 9 per cent.”

Which is very nice and gives us an idea that our near arbitrary 8 per cent cost of capital isn't far off. However, “invested” capital is not the same as total capital. If you have a chunk of capital that you don't know what to do with and are keeping in the bank at 1 per cent then your total return on total capital can fall below that cost of capital. And to be fair to Ingram, it has only failed our 8 per cent test twice in the last five years.

Northamber (PDF): Ooops! Using a slightly different set of numbers (but which ought to be the same as percentages) net earnings per net equity both per share, seems to have had returns over the past five years of: 3.6 per cent; 1.5 per cent; 0.2 per cent; 0.6 per cent; and minus 0.4 per cent. So it didn't really manage that return over the cost of capital that makes an economist beam with pride.

But just looking at individual companies isn't going to tell us whether the whole sector is adding economic value or not. Some companies might just not be doing very well in the face of competition while others are doing just fine. What we'd really like to to see the average return on capital for the whole sector. Which, through the magic of low friends in low places I can provide – if only for this most recent year.

For the 36 companies which my low friend considers to be the electronics distribution sector, this gives us a return on capital of 24 per cent. This is well above either our arbitrary 8 per cent or Ingram's admitted weighted average cost of capital of 9 per cent.

At this point the economist entirely loses interest in the subject under discussion. Why a certain activity is adding value to the economy is completely uninteresting: we know that people do all sorts of weird things and the very reason that we don't try to plan an economy is because no one centrally can work out why they do what they do or what value they gain from having done so.

We can, as we have done, work out that the activity itself is adding value: profits in a competitive market are higher than the cost of capital. This boils down to the fact that someone, somewhere, is willing to pay more for these services than they cost to provide. This is the very definition of adding value. Excellent, well done and that's all we care about.

Unless you'd all like to tell me why it is that distributors add value to you? ®

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