Fastenal is a company that sells nuts, bolts, and other industrial and construction supplies. Pretty simple business – and definitely not sexy. How then has Fastenal stock created so much value? In keeping with comparisons to other high-flying stocks on sexier businesses (like my post on NVR) Fastenal stock has beaten both Microsoft and Apple since the 1990s!
It all came down to a certain way they decided to operate – its Competitive Strategy. There probably have been hundreds of fastener businesses that have come and gone over the past 30 years, and many probably never created much value. So what gave Fastenal their competitive advantage? What drove their staying power? And how did they compound earnings so effectively? Clearly, something must be going right to translate into Fastenal stock being such a long-term winner.
One thing I’d like the reader to do is think actually how similar Fastenal’s strategy is to Amazon’s (I think the latter borrowed some things from the former’s playbook).
First, some history to shed a light on the business.
Fastenal was actually dreamt up by its founder, Bob Kierlin when he was just 11 years old. His father ran an auto supply shop in Wisconsin and Kierlin noticed customers typically drove from store to store looking for fasteners they needed for particular jobs. If a hardware store didn’t have the right nut or bolt, the store would send the customer to Kierlin’s store, and vice-versa. Bob noticed a lot of customers had to resort to buying the part, one-off, via a special order and wait.
Kierlin and four other friends started Fastenal in with $30,000 and rented a store in Winona, Minnesota. They opened a store as a one-stop shop with thousands of fasteners for retail customer needs.
But the idea was a flop and the company almost went bust.
Instead of focusing on the retail customer, Fastenal decided to pivot and focus on the commercial customer. It turned out that price was much less of a factor than timeliness for that market segment — contractors and companies often lost money searching or waiting for a particular part. Kierlin and his partners discovered that there was a great need for a service that could quickly provide the fastener or part that a buyer needed.
In short, Fastenal segmented out its buyer base and identified what their key purchasing criteria was. They focused on industrial and commercial buyers and they realized they didn’t need to be the lowest price, they just needed to have the item in stock.
At the end of the day, you can see why this makes sense.
- Fasteners make up a small portion of project costs (e.g. building a home, building a car), but are crucial pieces in the process that can hold up work.
- If Fastenal increased price of a particular fastener by 3%, their customer probably wouldn’t even notice in their project and could likely pass it on to the end customer if needed
- Fastenal’s customers are many in size but also small in size, so they have limited bargaining power.
Fastenal further segmented based on geographic locations.
Fastenal opened its first branch in Minnesota and continued to target very small towns. Why? By targeting small towns that had healthy construction and manufacturing industries, but were also small towns that were underserved by big distributors, Fastenal could be the only game in town.
Finding New Segments
One thing a business can do to improve its competitive advantage is find new product segments. Think about Arm & Hammer expanding baking soda into a refrigerator deodorant – that was a creative decision to target a market and improved the overall market size.
In some cases, you can find new segments by broadening and you can find new segments by narrowing focus.
Fastenal actually did both.
Narrowing Focus (and Not Being Afraid to Try Something New)
This is from Fastenal’s 1996 10-K. Satellite stores weren’t a major success, but the company did expand to 71 satellite stores opened by 2001. The key was that Fastenal was focused on improving the customer relationship. Fastenal already was getting some business from these customers in smaller areas, but they wanted to make it even easier on the customer to get their Fasteners – and it preemptively did so. Sure, it would cost resources and no one else really saw the returns from doing it, but the customer sure would be loyal. Sound familiar to Amazon?
In fact, do you know what Fastenal says its goal is? “Growth through Customer Service.”
It also reminds me of Dollar General’s strategy of serving rural America. Carve out a niche where you know your customers well and others choose not to serve and that can payoff well.
In 2014, Fastenal identified a new growth driver: Onsite locations. These are sites that are not open to the public, or a wide variety of customers, but instead serve one customer at their location.
In essence, the customer (typically a very large one) might consume enough fasteners that it could source them themselves, but they’d rather benefit from Fastenal’s scale and expertise so they hire them to serve all their needs.
Fastenal had locations like these since the 1990s, but they expanded following 2014 – growing from 214 locations to over 1,100 by 2019 and represents roughly 30% of the company now.
The company really started to build a vending solution in 2011, choosing to do so while industrial activity was still weak from the Financial Crisis.
They would give a customer a vending machine, essentially for free (estimated to be a $10,000 value), but in return it would essentially become a “mini-branch” at the customer’s site. The machines were also available to the customer 24/7 – not just when a supply room is staffed. It also helped the customer track consumption data, in some cases improving their ability to see which of their plants were consuming more or less of certain parts.
Early on, Fastenal learned that it actually cut customer consumption (2011 conference call):
As we talked about on the Amazon review, if I were to distill differentiation with a buyer into two factors it would be: cut their cost and/or improve performance.
In this case, Fastenal cut the costs for its customers buy reducing spend, but it also differentiated Fastenal as a solutions provider. It also resulted in a share shift as customers looked favorably at the vending machines (quid pro quo) and Fastenal “locked” the customer into purchasing from them.
The company now has 105,000 vending devices in the field and generate $1.1BN of revenue.
Fastenal decided in the mid-90s to test out new products. If a customer came into the store for fasteners, they might want to pick up something else why they are in the store. Convenience outweighs price.
In 1995, threaded fasteners were ~70% of sales. By 2000, it was just 51% of sales. Now, Fastenal has 9 different product categories it sells and targeting further product diversity:
The company also decided that in some cases, it made sense to manufacture tools for a customer. This would be rare, but in some cases it would pay off royally (and gain customer loyalty).
In one instance, a Ford plant’s assembly line was shut down by a breakdown that required a few dozen special bolts. Ford’s regular supplier told the company it would have to wait until Monday—three days later. “Meanwhile, it’s costing them something like $50,000 an hour to have this line not operating,” Slaggie [one of Fastenal’s founders] said in the March 11, 1992, Successful Business. “They called us and the part is an oddball, something we don’t have in stock. We had them fax us the blueprint for the machine and we determined we could make it…. We had them finished Sunday afternoon.”
Doing some simple math, $50,000 a day is $1.2MM in cost… for 3 days that would cost the company $3.6MM. Fastenal could make a part and charge $50,000 for it, and I’m sure Ford would pay for that all day… I have no idea what Fastenal charged in this case, but you can see why Fastenal created differentiation here as a service provider.
Decentralized. By the time Fastenal stock became public, they put out some interesting color on how they decided to manage new branch openings:
By reading the company’s filings, you can tell they first want to train their employees to understand the business and industry and then give them the power to make decisions on their own.
I’m a relatively cynical person, so I wonder to myself how the employees could possibly know more about what to stock than people who have been operating the business for 20+ years. Two words: Smile & Dial.
Putting it together
I could go on about Fastenal — there is a lot I didn’t touch on about how frugal the company chooses to be — but its performance as “just a fastener distributor” has been truly amazing.
I opened this series saying that I was tired of the terms “asset light” or “high margins” being used to say why a business is “good”… instead, you need to understand what the company has done to make its business sustainable and why they will create above average shareholder value in the long run.
Here are some summary financial metrics for Fastenal compared to other distributor peers.
What jumps off the page to me is (i) its gross margins for a distributor, (ii) its EBITDA margins and (iii) EBITA / Assets (a proxy for ROIC).
High Gross Margins: Its high gross margins relay to me that they truly have targeted their customer in a way that isn’t just based on price – otherwise I think the margins would be much lower.
EBITDA margins: Its EBITDA margins are high, which makes sense given the gross margins. But the delta between gross margins and EBITDA margins is nearly 23% of sales — meaning they spend 23% of sales on selling costs and general and administrative expenses. That’s definitely in the upper half of the group and tells me that they are spending a lot on service for the customer.
EBITA / Assets: One might look at this comp set and say, “hmmm, Fastenal’s metrics are good, but its FCF conversion (rough proxy using EBITDA – Capex over EBITDA) isn’t great because capex is so high.” That’s ok for me – when I look at EBITA / Assets, what Fastenal earns on every dollar of capex it spends is much higher than what I could go out and earn! It also will likely lead to above-average sales growth.
I hope you’ve seen from what I’ve outlined above that Fastenal is very similar to Amazon – relentless focus on the customer. But Kierlen also appreciated hiring the right people and giving autonomy, as shown in this interview I found with some hard-hitting reporters.
“I admit things I never knew how to do well – I admit I was never a good sales person, so I hired a good salesperson.” In some ways it reminds me of Steve Jobs (though it was later learned he had a tendency to micromanage), he did have a great quote:
“It doesn’t make sense to hire smart people and tell them what to do; we hire smart people so they can tell us what to do.”