Manufacturers face a rather cyclical issue of whether to take more sales direct, and less through distribution.  Manufacturers need to do their homework before making this decision.  The 3 questions and profitability equation offered in this article help examine this issue.

Manufacturers sometimes feel they are “paying” distributors too much money for too little effort. This is especially true in the following examples:

Scenario – Manufacturers are drop shipping to customers

Manufacturer Response – Part of the distributor discount is to pay for them to inventory my product and they aren’t even doing that

Scenario – Manufacturers identify new sales opportunities and then turn the business over to distributors
Manufacturer Response – I’m already doing all the selling; I may as well just take the order

Scenario – Manufacturers provide all the post-sale customer support
Manufacturer Response – I still must have a technical staff to answer customer questions that the distributor should be answering

In order to know if you can or should take more sales direct, you will have to do some homework. There are three questions you need to answer in order to gain the insight needed to make this important (and often irrevocable) decision:

1. How much money would I save if I took more sales direct?
2. What would happen to my remaining sales through distribution?
3. Would customers even want to buy from me if I tried to sell them directly?

What do I save?

In our work at Indian River Consulting Group, we have developed a formula that allows you to measure increased or decreased profitability by shifting to more direct sales. The Direct Profitability Equation has both positive and negative profit contributors.

Positive Contributors

Depending on your discount and pricing schedules, most manufacturers will realize a price increase by selling directly to a customer. The end-user price will be somewhat higher than the distributor price. This is identified as (Pr) in the Direct Profitability Equation.

If you are paying rebates to distributors, the amount of rebates associated with the volume now going direct will disappear. Of course, if you are paying end-user rebates, those have to be added back in. This is identified as (Re) in the equation.

Negative Contributors

One of the many values that distribution provides for its customer base is financing or terms. Selling direct means extending those same terms to customers which leads to an increased cost of capital. It also leads to a need for increased levels of inventory to meet customer availability demands that are presently being serviced by distributors. This also results in an increased cost of capital. We refer to this as (Cc) in the equation.

Hand in hand with extending terms to end users is increasing bad debt expense. Bad debt for distributors is almost always higher than for manufacturers. Manufacturers are much stricter about who they extend terms to and do not allow accounts receivable to increase much. Therefore, bad debt (Bd) will no doubt negatively affect profitability.

Not only is there increased bad debt risk in selling more customers direct but there is also an increased credit cost associated with more credit activity. Customers are notorious for simply deducting what they think is the proper amount to offset a return, mis-shipment, mis-order, etc. Distributors often do the same to manufacturers, but end users will cause an even greater reduction in top line revenue or increased expense (direct costs). This will also impact personnel costs for increased credit department activity and sales rep time spent resolving issues (indirect costs). Increased costs resulting from credit activity is identified as (Cr).

All of the previously outlined costs are hard costs that can be identified with some work. Upgrading your sales force and the expense associated with that is a bit more subjective. Our experience in talking to thousands of distributors and dealers over the years tells us time and again that about 20% of your sales force needs to be upgraded. Sometimes this is such a critical issue that even if customers were interested in buying direct, they won’t buy from your salesperson. The costs associated with upgrading the sales force include severance packages, recruiting, hiring and training new people (Sf).

The Direct Profitability Equation

The equation is the easy part; the hard part is finding accurate data. After determining all the savings and additional costs described above, use the following equation to determine the savings you would realize by shifting a desired amount of sales direct:

$ales shifted * [Pr + Re – Cc – Bd – Cr – Sf] =
$ increase (or decrease) in bottom line profit

In a recent project, we measured the increase to bottom line profit to be about 5% BEFORE the impact of distributor retaliation.

Distributor Retaliation

Trying to accurately measure the impact of an angry distributor on revenue is difficult at best and anecdotal at worst. The reaction by a distributor to news that one of his vendors is going to try to take large accounts in his territory direct will certainly be strong verbally, but it may or may not be as strong monetarily. We have anecdotally measured retaliation that shows the amount of business that will go elsewhere ranges from the low teens to as much as a third of the business. The seriousness of the retaliation depends on several factors:

• Is your brand preferred by and asked for by end users, so whether the distributor wants to or not, he will have to continue selling it?
• Are you an important line to the distributor, or are you one of many tertiary lines?
• Does the distributor make a reasonable amount of money selling your line, or are his margins already razor thin?
• Have you discussed this with the distributor, explained your position, identified which accounts you will take direct, etc.?
• Do you have a partnership relationship with your distributors or is it an adversarial one in which there is little trust?

Even if it’s difficult to measure, do take the retaliation factor seriously because it is easy to negate any savings from taking more business direct if there is an overall decrease in business.

What if I build it and no one comes?

It’s not uncommon for manufacturers to think that any customer of a reasonable size would jump at the opportunity to buy direct. It’s a matter of pride, of ego, to say you are big enough and important enough to buy direct from your suppliers. Customers also might believe they will get a better price, better availability, better service, etc.

But in today’s economic world where more and more people are trying to cut the number of suppliers, manufacturers are finding the above assumption is not necessarily true of their end users. Adding a direct relationship with a supplier is almost like adding another vendor; it certainly is another source for a product even if it is the same product they are already purchasing. And then there are all the other value-added services of a local distributor: same day/next day delivery, extended terms, bundling of lots and lots of products, local customer service and local market knowledge. In a recent study, we found that the percentage of end users who were even interested in pursuing a direct relationship with a vendor was less than 25%. This number is lower than many might think.

Consider Carefully

Make sure you take the time to complete your homework before you get too caught up in the issue of the moment. Gather the data, calculate the profitability equation, consider the impact of retaliation, and be realistic about your end users. The potential for added profitability may well be realized, but some of these less obvious factors may negate any increases. For further consideration and discussion on this and other channel marketing issues, please contact us at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it .