The big 3 questions for QXO and the LBM Industry

QXO who? Here’s who, in their own words:

QXO plans to become a tech-forward leader in the $800 billion building products distribution industry.

It’s big news and big money – $3.5 Billion raised to disrupt the LBM supply chain. It’s vaguely reminiscent of Katerra who ultimately flushed a billion dollars down the industry transformation toilet. But this is different. QXO has more capital, more supply chain experience, more software experience, and empire building DNA. And market conditions are better, too.

Here is a table to put QXO in perspective, before they have actually done anything:

The amount of capital raised by QXO indicates this is more than a software play. You can build a lot of great software for 1/100th the capital raised. More critically for incumbents, this $3.5 Billion is a small fraction of capital on the sidelines waiting to jump in and back the right bet in the technology-driven LBM supply chain. This leads to question #1:

Question #1: Who’s lunch will QXO eat?

Everybody’s. They can acquire software companies or build their own tech. It appears they may do both. They can buy Bluelinx for cash right now (less cash this Fall as commodity and housing markets stay weak). With a fraction of their balance sheet they could dominate wholesale back-to-back commodity trading for a multi-billion dollar head start on revenue and customer engagement. Or gobble up the remaining independent lumber yard operations like a private equity PacMan. 

Two clues on their homepage substantiate the “everybody” claim. Firstly: “QXO provides technology solutions.” Second: “The building products distribution industry is highly fragmented, with approximately 7,000 distributors in North America.” That’s everybody including Boise Cascade and Bluelinx, internal vertical distribution like Weyerhaeuser’s, plus office wholesalers, The Home Depot, Lowes, pro-contractor lumber yards, and all the retail building materials locations across the US added together. That’s how you get the numbers to add up to 7,000.

They plan to generate “tens of billions in annual revenue.” There are not tens of billions in software budgets within all the companies in LBM, so they will be generating revenue by buying and selling physical products from physical locations. At a minimum, I expect them to own logistics (warehousing and trucking) based on their DNA.

Unfortunately, in our industry, most everybody will say “good luck” thinking the other persons lunch is on the menu. It’s a risky strategy for anybody with an existing stake in the channel.

Question 2: Can they execute?

The executive team has a proven record of execution in other industries. They must overcome the two critical failure points proven repeatedly in this industry. 

Failure point 1: Inefficient deployment of capital acquiring the wrong companies, for the wrong reasons, and at the wrong price. Over-ambitious acquisition strategies have sunk many companies in this industry and may drown others in the next down-turn (which is coming when?). BFS is a collection of ghost balance sheets reconstituted into a valuable company today, each ghost with stories to tell about cost structure in a downturn. Bluelinx has its skeletons of reverse stock splits and a thin balance sheet invigorated by a pandemic. This industry is full of the frugal survivors who did not spend capital, invest in technology, or even think to try anything new, only to be crowned the winner as the innovators rotated belly-up in the industry pond during the downturn. That dynamic has repeatedly reinforced the second failure point.

Failure point 2: The deeply rooted and highly reinforced good ole boy network. Insiders encounter inertia, outsiders encounter immovable objects. Money can overcome most of this, especially to acquire supply and talent, but more industry outsiders than insiders wake up each morning and say “how can technology make LBM better?”

The best news for QXO could have nothing to do with execution and everything to do with luck –  the market. No, not the trope repeated by all CEOs for the last decade of the great underbuild (that gross underbuild everyone speaks about but has yet to prove itself real in the data), but the relatively soft markets, the oversupply of many products relative to demand, and it is a huge benefit to their starting position right now. It’s likely that any purchase of commodity building products at scale has negligible downside price risk. That may hold through 2025. 

Heavily capitalized tech companies famously lose money and burn cash to buy market share, especially when that loss is high operating cost sure to decrease with scale and market dominance. Think Amazon. Principal risk, however, is another profit-devouring animal altogether. But in this market, a $1 billion investment in commodity lumber spread over the next two to three quarters might, by itself, create upside to the market and a lot of temporary friends at the mills as their over-capacity yards fill a parallel (if redundant) supply chain. Since commodities are hovering at cash break-even to mills, there is very little “principal risk” and as a new entrant you are not yet subject to analyst calls asking for the next penny squeezed from working capital in a down market mature business. Contrast this with 2021 or 2022 where poorly timed purchase contracts or material acquisitions could create operating losses and the erosion of half or more the principal investment in the commodity itself.

Frugality matters, but the commodity price tide is so low even poorly executed commodity purchases have little downside risk. That type of luck crowns commodity heroes in LBM every few years and could be primed to crown an emerging king.

Question 3: How to compete?

I am certain QXO has a well-studied thesis supported by well-compensated industry consultants and investment bankers. So this question becomes a call to action for the rest of the industry: How do you plan to compete? Wishing them luck and a happy Katerra-style meltdown is probably the default response for most incumbents, but a dangerous one. One of these days, even without exceptional execution, commodity market roulette may work against history and reward the innovator instead of the procrastinator. So here are a few things to think about.

Is your company more exciting to investors, more technologically advanced, more innovative, and better capitalized than QXO? We in the industry like to talk about the next generation of employees, technology, and career advancement, then deliver the same experience we have for the past 30 years. Katerra had its problems, but attracting talent was not one. QXO will be more enticing to top tier tech and supply chain talent than most businesses in our industry.

Is your company embracing technology? What does it mean to “embrace”, anyhow? Is an Office 365 license today’s tech-embrace baseline? Or is your company actually adopting technology to transform business processes? Or better yet, investing. Universal Forest Products is now investing like a VC (not just “embracing”), see UFP Ventures. Where do you fall on the spectrum from the nebulous non-committal embrace to venture investing? Maybe you haven’t yet made a conscious decision about technology.

Every company in LBM is now a tech company, but some are simply sheep with a wolf print hoodie and Allbirds sneakers. QXO hasn’t shown its fangs but just announced its presence and intent tromping into the LBM distribution forest. Sheep beware.

When I created Yesler 5 years ago I chose what turned out to be an even more difficult path than I imagined – create a software for the industry so the industry can control its transformation from the inside. That meant not buying and reselling the lumber, not managing the distribution centers, or calling on “the customers’ customers.” It meant building solutions for the innovators within the industry to help them do all the industry things, better. It does not appear QXO will be taking the same approach.

What do you believe about technology transformation and LBM? This industry just went from “soon” to “now”, and you should have a firm opinion about how you want to transform…or be transformed.