What You Should and Shouldn't Buy Through Distribution

What happened to specialty distribution? Ten years ago distribution companies were a rarity. Today, virtually every rep company has a distribution arm.
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What happened to specialty distribution? Ten years ago distribution companies were a rarity. Today, virtually every rep company has a distribution arm.

At first blush, it seems like a conflict of interest. Your rep firm wants you to be direct with their brands. And yet, they also want to sell products through their for-profit distribution business. But on the other hand, rep distributors offer a valuable service: products delivered same- or next day. Let's dissect the business and set up some guidelines for what and when you should buy products through distribution.

Category 1: Expensive Products with Tiny Margins. Plasma TVs and LCD projectors are the kinds of products that are perfect for distribution, and the manufacturers want it that way. Distributors for projectors and plasma TV act as the warehousing/marketing/service arm of large multi-national corporations. It's an efficient way to do business, and saves everybody money along the way.

Want to see how efficient distribution is? Go to the web site for ProjectorPeople.com. This is a company that sells projectors and plasma TVs direct to the public--and lucky you--to the trade for 5-10 percent less. This certainly proves that there's no margin in video. If you have the time, check the web site every week for a month. Surprise. Prices drop, models change and specials are announced. These are exactly the kinds of products you never want to get too intimate with. Let's face it; a 10 percent margin isn't enough to cover your warranty visits on these products. But if you were to compare these prices with those anywhere else, you'd find the distributor to be the best source. You can get the goods in a week, you can make your mind up at the last minute, and you can choose the latest and greatest model for your customer.

Low margins, high retail prices and fast-changing technology are the bywords of a product that you should buy through distribution.

Category 2: Expensive Products with Normal Margins: Six-channel amplifiers, racking systems, speakers and simple control systems are products--and others like them-that also are available through many rep/distributors. Often, these are the very same brands offered direct through the rep side of the company. Why would a manufacturer want their products sold through the rep firm and through distribution at the same time?

I can think of several reasons. First, the manufacturer has computed an internal cost of doing business directly with an account. Perhaps they have reckoned that any account purchasing less than $15k per year just isn't worth having on the books. They've determined that the cost of management per account requires it to buy in excess of $15k annually to break even. And yet, there are a number of dealers who want this company's products, but can't pony up the $15k. Instead of losing this rich source of business, the manufacturer allows a rep firm to handle the pesky stuff directly. This way, the manufacturer keeps those sales, the rep firm keeps the commissions (plus a mark-up on the sale of the product) and the dealer gets access to a product for which he could not qualify.

The benefit to the dealer is access. The cost to the dealer is reduced margin of typically 10 percent. The benefit to the rep firm is retention; without distributing the product, they would lose the sale altogether. The cost to the rep firm is capital, because the rep must buy, inventory, ship and bill products. In essence, they've taken on all the costs of a manufacturer. What's difficult to understand is why the manufacturers feel they

lose money on a small account, yet the reps feel they can earn a profit on the same dealer. A possibleanswer is that the manufacturers haven't done the math to determine if they really lose money on small accounts. It just bugs them when a dealer orders so little, so infrequently. It's also possible that most distributors break even on the distribution side of the business, but "pocket" the rep commissions as "profit." That's really not such spurious math, because many rep/distributors have become the manufacturer's largest account in the territory, permanently altering the balance of power in the relationship. (Hey, it's hard to lose a line when you buy that much stuff.)

Once a manufacturer of high-priced, high-margin products establishes a distribution policy, the dealers come to see other advantages--particularly same-day delivery, fast turnaround on defects and local technical support. Indeed, many distributors sell products on an emergency basis to dealers who are direct with the very same manufacturers--just for these reasons. Manufacturers see the benefit, too. With a local distributor in the marketplace, manufacturer's can trim costs, reducing the size of the tech support staff, reducing on-hand inventory and even reducing their marketing efforts. Long-term that's not a good thing.

It's generally a bad idea to buy high-priced, high-margin distributed products. First, you rely on high-margin products to offset your labor, engineering and administrative costs. You certainly don't make money on plasma TVs, and you can't charge your customers your true labor cost. As a result, you use the margin in product sales to run the business. You lose at least 10 percent of margin every time you buy products through a distributor, which is more than most companies make in net profit at the end of the year. Another way to look at it is that you happily hand over your company's net profit to your local rep/distributor every time you buy a high-margin, high-priced product from them.

ut you say you're a small fry. You can't buy enough to go direct. Perhaps you're such an "artiste" that you would simply die if you couldn't choose just the very best product for each custom job you design. Unless you're selling less than $150k annually in sales, you should be direct with all high-priced, high-margin products. It's just time you learned some discipline, focus on fewer brands, and order enough to be important to one manufacturer. (Note to reader: if your company sells less than $150k per year, put down this magazine and get a job.)

But there are exceptions to the rule. Use the distributor for need-to-have-now emergencies. Losing 10 percent in margin may be a lot better than sucking up Blue Label charges to have a 25-pound package shipped cross-country.

Category 3: Low-Priced Products with High Margins: Cable, IR devices, connectors and surge protectors are the as-required products in your installations. Most distributors are flush with the little bits and pieces you buy for pennies and sell for a lot more. And there's a good reason why: these are the parts that should be stocked and sold by a distributor.

Just look at any other industries, like the alarm, HVAC and plumbing businesses, which support distributors. If you've ever visited one of these distribution centers, you'd find that they carry thousands upon thousands of SKUs. Often they have a good/better/best selection for each part, available from several vendors.

The beauty of distribution is that a distributor adds true value to the sales chain by keeping lots of little, hard-to-find things available quickly. So should you buy low-priced, high-margin products from a distributor? The answer is "sometimes."

There's another way to look at these products. Let's use the unflattering word "commodity." In its truest sense, a commodity is a product made by one company that can be easily interchanged with one made several others. For example, 14/2 direct burial cable. That's a commodity. When you buy commodities, you're on the floor of the Chicago Exchange playing the spot market. It's fun. Buy low-priced products with high margins at the best price possible from an extremely short list of reputable suppliers.

Let's say you use a 1,000-foot roll of Cat-5 every two days. And let's say a roll is $200. That means you buy about 10 rolls ($2,000) of Cat-5 every month. With that information, you should look for a good supplier of 10 rolls of Cat-5. Your local rep/distributor may have the best price, considering freight costs. Or a national distributor like Capitol Sales might get your attention. Or you could consider buying directly from a wire manufacturer. In fact, you might want to contact a vendor in Taiwan to supply you with a shipment every few months in the color you want, with your spiffy logo imprinted every six inches. (Look to AsianSources.com for a list of Asian suppliers.)

From an economic standpoint, our industry doesn't need so many distributors of low-priced, high-margin products. The key to commodity sales is low price. And the magic to low price is high volume. Splitting the business among hundreds of distributors is inefficient and drives prices up. Because markets don't like inefficiency, over time, smaller distributors who sell low-priced, high-margin products will likely vacate the category. Do your part. Buy the least expensive products from the best suppliers.

Category 4: Low-Priced Products with Low Margins: VCRs, DVD changers and 2-channel receivers have to offer them because your customer needs them. And yet, you're buying them for only a few dollars less than MAP. Here's a case where you should buy them direct in order to squeeze out every last margin dollar you can get. Plus, these items are typically offered by one of your electronics vendors. Therefore, buying a DVD changer from your receiver vendor just makes good sense on a number of levels. The aesthetics match, the IR codes are shared and every purchase counts toward your annual goal. Buy these units through distribution only in emergencies.

A final note to those on the brink of losing direct status: if you've been a loyal, yet insignificant direct customer, and you've been told that your purchase history dictates an unceremonious bump down to the distribution level, don't go willingly. First, find out why you can't maintain your direct status. Most companies require a minimal amount of annual purchases to stay on direct. So if you aren't making the minimum because you're buying similar products from a variety of vendors, focus on one and stay direct. You need the margin.

If you just don't buy enough of that particular category to stay direct, find another brand that'll support you. There are a lot of manufacturers out there who want your business and will tolerate a smaller account like yours.

Ira Friedman is president of Bay Audio in San Diego, California.