03 April 2020
Delivering products and services to your customers
Whatever it is that you sell, when your customer buys it there must be some means of physically placing it in their hands.
You might ship directly to them from your warehouse, it could be sitting on the shelf in a retail outlet (a shop), or they might download it from the internet.
The decision for how you make your products or services available for purchase is called a distribution strategy.
Products and services can be (for example) bought online, in retail outlets, sold direct by sales people, mail ordered from catalogs, sold door-to-door, or sold via network marketing. The distribution strategy is a choice that entrepreneurs and organisations need to make to maximise sales opportunity.
Strategy means making a choice, and a choice is made after considering all available distribution methods and selecting the best that will create a competitive advantage over your competition.
Definition of a distribution strategy
Distribution strategy is best described as optimising the trade-off between making your product or service easier to access and purchase for your customer while minimising the cost of doing so.
Clearly if a shop that stocks Brand X is closer than a shop that sells Brand Y, the consumer has an extra reason to buy Brand X. Hence, distribution strategy is another means of achieving competitive advantage.
However, ease of purchase (or speed of delivery) is more important for some products than others. People expect milk to be available within a few kilometres of home, understand that Apple only has a handful of stores per capital city, and a laptop bought online might take a week to arrive.
Frequency of purchase is a key driver. Frequently bought low cost products like Fast Moving Consumer Goods (FMCG) need to be intensively distributed, whereas white goods (washing machines and fridges) less so.
However, as with all four P's in the marketing mix, advantage in one might over ride another. Many people happily trade the convenience of buying a dress from a retail outlet in preference for buying something similar online that might take two weeks to arrive but cost less than one third the dress boutique price.
There are a number of ways to either place the product near to customers or arrange for them to be delivered. Distribution strategies are variously grouped sometimes as...
- Direct distribution
- Indirect distribution
- Intensive distribution
- Selective distribution
- Exclusive distribution
- Online sales
- Sales agents
- Technical distributors
- System integrators
- Wholesale distribution
- Retail distribution
- Multi-level relationship selling
- Door to door selling
- Catalogue "mail order" selling
Each suits different products/services and business models.
Sell direct or via channels
The main choice for businesses is to decide between selling direct to customers or engage external firms to undertake distribution. Firms that decide to sell through intermediaries are said to be implementing a channel strategy.
Some firms will do both - selling direct to their large customers and using a channel strategy to service smaller customers. This sometimes leads to channel conflict a term that describes where one distribution method overlaps with another causing commercial conflict.
Later in this article we define each of the above, however to convey the essential concepts of Ease of Access with Distribution Cost let's start with an example of products familiar to all of us: grocery items also known as Fast Moving Consumer Goods (FMCG)...
Easier to access
Making customers jump through too many hoops to buy your product obviously will reduce the likelihood they will purchase it.
In the world of FMCG (Fast Moving Consumer Goods) the aim is to develop an intensive distribution coverage ensuring the product is available in all possible retail outlets where consumers would expect to find such products. This requires distributing through supermarket chains.
Large retail chains hold the keys to the grocery market and leverage that power to extract profits and maximise their market share. In Australia, Coles and Woolworths combined have 60% of the market. This means for FMCG, if your aim is to achieve maximum possible distribution intensity, you must deal with both.
Supermarket chains treat their shelf space like real estate and aim to maximise gross profit per linear metre of shelf space. Products needs to perform. Any product lines that fail to reach a profit threshold are kicked off.
The cost of distribution
Retail profit margins in FMCG vary considerably however, after taking into account advertising subsidies, volume rebates, pipeline fill discounts and all of the other charges the retail chains impose on their suppliers, GP margins are around 30%. This means the end consumer is paying some 50% more for the product than the price direct from the manufacturer or importer.
These are lost profits the manufacturer could be pocketing if the consumer bought direct from the factory.
However, to use Uncle Tobys Oats as an example, which are manufactured in Wahgunyah (on the River Murray in Victoria), sales would be (at a guess) less than 1% of what they currently are if consumers could only buy them from the factory (in the absence of any other distribution method).
There are other costs of distribution to pay to achieve retail distribution. Here is a typical list for FMCG...
- Retailer's margin: The margin the retailer makes (which must be taken into account when calculating the target retail price in comparison to competitors)
- Marketing/Advertising subsidies: Retailers charge their suppliers in order to fund their advertising and marketing activities.
- Promotion costs: On top of regular advertising costs, some retailers will separately charge suppliers if their product specifically appears in advertising as a featured product. They may also ask the supplier to supply promotional stock without charge ("buy one get one get one free" for example).
- Ullage/shrinkage/stock returns: After unpacking stock, any damaged products are charged back to the supplier both for the lost stock and the inconvenience. Some retailers will also charge for stolen stock and stock that has passed its use by date.
- Stocking cost: Most retailers will ask the supplier to fund the stocking cost when a new line is introduced to the store. This is usually taken as a discount on the first shipment.
- Pipeline stock: This is the cost of a product that is sitting somewhere in the supply chain from the end of the production line through the various steps before ending up on the supermarket shelf. These steps are for example: finished goods inventory sitting at the factory waiting to be shipped. Stock sitting on trucks travelling to distribution centres. Stock sitting in distribution centres waiting for shipping. Stock sitting in the next truck travelling to the retail outlet. Let's imagine that a box of uncle Toby's Oats takes 15 days from coming off the production line before it is sitting on the supermarket shelf. That's 15 days worth of stock that has to be manufactured to fill the pipeline. That cost has to be funded. These costs become very significant if sea freight is involved.
- Warehousing cost: Warehouses are large buildings full of racking to store product. Many have robotic systems. The capital cost of these facilities is significant and employees are required to manage and operate them.
- Freight: An obvious one, in the old day's manufacturers, used to operate their own delivery truck fleets, mostly this is now outsourced. Either way, there is a cost.
- Merchandising: Retailers expect suppliers to regularly visit every retail outlet to assist in arranging shelf displays. Some retailers (like Bunnings) do not restock their own shelves. The cost of doing that is pushed back on to the suppliers. Suppliers operate strictly monitored timetables for when merchandisers must attend each store and undertake to restock. Suppliers either employ their own merchandisers or outsource this function to specialists.
- Account Management: Retailers employ "buyers" (sometimes called category managers or similar) to negotiate contracts with suppliers. The buyer/supplier relationship operates under the implicit threat that if negotiations aren't to their liking or any other aspect of the supplier's performance is deficient, then the retail chain will no longer stock their product. This power is regularly leveraged by the buyer requiring suppliers to employ a specialist to "manage" the supplier relationship to maintain their products on the supermarket shelf as well as process the various requests from the buyer for advertising support and attend to problem-solving (late deliveries, damaged stock, invoice queries etc.). Positive aspects of the relationship are the buyer and supplier's account manager will collaborate to develop sales promotion strategies aimed at shifting more stock, discuss changing consumer trends, and buyers will look to their suppliers to develop or source new products. Both will develop an annual joint business plan to map out the strategy, sales forecasts and price agreements. The buyer can be a valuable source of consumer trend information as generally they develop considerable expertise in their category. However, some retail chains have a policy of regularly moving their buyers to other categories to ensure strong relationships do not develop between the buyer and the supplier's account manager. Makes it easier to be tough on them.
- IT Costs: Financial transactions between retail chains and suppliers are mostly done automatically. This requires suppliers to invest in IT systems that are capable of communicating computer-to-computer with the retailer. Gearing-up and maintaining such systems is another cost of doing business that may be specific to distribution. Some retailers will charge an additional cost if you are not set-up to interface with their systems, or simply refuse to do business with you.
For established brands (like Uncle Tobys for example) gearing-up to sell their product through the major supermarket chains would have taken place over decades, so they will have absorbed these costs and adapted their business model to working with retailers over a long period.
For a new manufacturer or supplier to break into the FMCG world is an almost insurmountable task. Generally, new market entrants start with the small corner shop retailers who have less market clout and build their sales slowly before making the step into the larger chains.
Web Shops - selling online as a distribution strategy
In their efforts to present their customers with low prices without compromising their own margins too much, retail chains have exerted enormous pressure on suppliers. Thus encouraging some to avoid them altogether. And now with the rise of of the online sales model, many suppliers are setting-up their own web shops to avoid the pain of dealing with the commercial brutality of the major retailers.
Development of a distribution strategy should consider the online sales option.
The main challenges of an online sales model are...
Consumers expect low prices: Without the costs of retail distribution (as listed above), suppliers have a lot of room to move their prices down often achieving an increase in their own margins while considerably reducing the selling price to the consumer. However, it's still a competitive market and with search engines, the consumer can very quickly compare offerings. Early online sales models launched with an aggressive low price model, and now the existence of overseas suppliers able to drop-ship product into Australia at low prices - the online shopper has been educated to expect lower prices.
The cost of buying eye-balls: Building a website with an online shop is just the beginning. You then need to promote the existence of the site. Maintaining a continous and effective online presence can be very costly. The cost of promotion was the big undoing of early attempts at building online shops that contributed to the Dot Com bust in the early 2000's - many Dot Coms were burning cash at high rates trying to promote their websites in order to drive sales to sufficient levels to justify their valuations. In truth, many of the Dot Com businesses were simply ill-conceived and rode the Dot Com growth bubble. However, funding advertising is a key consideration for the online model. Sometimes savings from eschewing retail distribution are instead spent on advertising.
Order fulfillment and returns: Selling a physical product online requires setting-up an order fulfillment process (picking the product out of the warehouse, packaging, labeling and dispatching). And, there needs to be a product return process. The order fulfillment process used to be a significant stumbling block but organisations have developed this expertise and order fulfillment can be outsourced.
Channel Conflict: Working with wholesale and/or retail distributors while at the same time operating an online shop may lead to commercial conflict. Distributors quite rightly know that online sales have eaten into their sales volumes. In some cases, retailers themselves have set-up their own online shops which increases their market coverage enormously, instead of just servicing the market within driving distance of their bricks-and -mortar retail outlet, they can sell to a national or even international market. This introduces another channel conflict; where a carefully selected and geographically separated retail network suddenly finds one of the retailers is selling into their patch using an online sales model and at much lower prices.
Content creation and website maintenance: Promoting products online is best achieved with content rich product information. Great photography of the product (and from various angles) substitutes for being able to touch and inspect the product (and even try it on) in a bricks-and-mortar retail outlet. Product descriptions, technical data, and even Safety data sheets need to be available. Further, some online shops now include video content particularly if there is need to explain product usage. If you are selling a significant number of products (and some online shops have thousands of SKU's) the task of initially building-up this content and keeping it updated can require teams of specialists. Some of this work can be provided by suppliers to provide images and tech data, but doubtless this will be supplied in a format that needs adjustment to fit your website layouts. The competition in the online space is becoming increasingly fierce and innovative with online retailers spending big-dollars to create more immersive and captivating online experiences to entice shoppers.
End-to-end integration and automation: one of the secrets of running a profitable online business is efficiency through automation. IT systems that you use to manage inventory, pricing, warehouse management, accounting, and order dispatch can be integrated with your website shopping cart so that a human (in theory) never has to touch the process. However, the cost of initially setting all this up and thinking through all the processes and potential wrinkles is long-winded and expensive. There are many off-the-shelf systems that on first inspection can do all of this out-of-the-box (more theory).
So, what initially seems like a good idea ("bugger the retailers, let's sell direct online") setting it up to operate at commercial scale and remaining competitive is a non-trivial exercise. Once set-up, keeping it updated and working is another beast to feed. What you save eschewing retail distribution is often spent building and driving the online sales model.
Working with distributors
The process of working with distributors to build sales is called channel marketing.
Distributors are typically independent businesses who stock and sell products (and sometimes services) on behalf of the import distributors or manufacturers they represent. There are wide variety of distribution models varying by industry, product types, and business strategy.
The distributor plays a number of important roles...
- Stocking product closer to the market:
- Promoting the product to their customers:
- Providing product information and customer service:
- Providing technical support:
- Taking sales orders and dispatching product:
- Providing after sales service and support:
Every manufacturer/importer negotiates the terms of the distribution agreement (normally a signed document) with its distributors and while they conform to industry norms and follow conventions, no two distribution agreements are the same. The terms are set through negotiation.
The main point of agreement to determine is exclusivity. Distributors are either exclusive distributors of your product or service or non-exclusive. Exclusivity means that you agree not to appoint other distributors in their territory (a territory can be an industry vertical, geographic region, or customer type) and/or you agree not to sell direct yourself into the territory.
In return, you may negotiate exclusive representation of your product; the distributor agrees not to represent any competing products or even represent your competitors at all. However, this type of reciprocity is subject to negotiation and which party has the stronger negotiating position.
The main problem with working with distributors comes down to performance which is a function of how much effort they put into promoting your product or service. There are three main approaches...
- Happy to stock your product: Some distributors either by agreement or through lack of effort simply stock your product. If customers ask for it, they will happily sell it. But, no more. If you have formally agreed to this arrangement then your strategy would be using the distributor to ensure that your product is closer to your customers enabling faster response times.
- Stock your product with minimal promotional effort: This is sort of a half-way point that results from distributors not holding-up their end of the arrangement. But, sometimes it's not entirely their fault. If you don't supply product training, promotional materials, or are not responsive to their enquiries, or don't fulfill stock orders in a timely manner, then they will put more effort into other easier to sell products. It might also be that your value proposition is a dud and even the best distributor in the world couldn't sell it.
- Stock your product with maximum promotion: a good performing distributor will go all out to develop the market using direct selling (visiting potential customers), and engaging in other market activities. This isn't purely out of good nature - after all, that's the business they are in.
Distributor agreements often set minimum agreed sales targets for the distributor to reach each year (with a year-to-year growth factor built in). The implicit threat (or incentive) is that failure to meet targets would be grounds for cancelling their distributorship and moving the business elsewhere.
Even without using sales targets as a weapon, targets at least form the basis for a more meaningful business conversation "gee, well below target this quarter - what happened? is it the market? Can we be doing more to help? etc."
As a general rule, successfully working with distributors requires a solid business relationship with commitment and effort being contributed by both parties.