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Distribution Methods Affect Bottom Line

Filed under Packaging & Pricing. Fact checked on May 24, 2012.

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Whether retail, wholesale or business-to-consumer, choosing the right distribution method to complement your product or service can be a boon to your bottom line.

Once you have selected and developed a unique product or business idea, correctly positioned it for your target buyers, and developed your packaging and pricing, the selection of distribution channels and sales representation is the next hurdle for successful marketing.

It's fairly easy to change many of your marketing tactics and strategies on a periodic basis. Pricing, packaging, and product mix are among these flexible choices. However, distribution and sales decisions, once made, are much more difficult to change. And distribution affects the selection and utilization of all other marketing tools.

Small businesses may have products that would appeal to many different markets or channels of distribution in a single market. However, when you have limited resources, it's often best to select a single distribution channel or a limited number of distribution channels that offer:

  • greatest ease of entry against the competition
  • lowest costs of entry compared to the competition
  • least financial risk and commitment to the trade
  • sufficient volume potential to reach short-term company goals
  • pricing levels to provide acceptable company revenues and profit margins

There are many possible distribution channels, including:

  • retail outlets owned by your company or by an independent merchant or chain
  • wholesale outlets of your own or those of independent distributors or brokers
  • sales force compensated by salary, commission, or both
  • direct mail via your own catalog or flyers
  • telemarketing on your own or through a contract firm
  • Internet marketing, selling your products online
  • TV and cable direct marketing and home shopping channels

Distribution choices for a service business are similar to many of those for a physical product. For example, financial planning services may be offered from printed material, sold at retail by consultants, delivered electronically by computer, or relayed by phone, fax or mail.

Steps for selecting distribution and sales force representation include:

  1. Identify how competitors' products are sold.
  2. Analyze strengths, weaknesses, opportunities, and threats for your business.
  3. Examine costs of channels and sales force options.
  4. Determine which distribution options match your overall marketing strategy.
  5. Prioritize your distribution choices.

This planning sequence is valuable regardless of the size of your business.

Evaluate Your Competitor's Products Distribution Methods

When analyzing your competitor's distribution methods, it is important to determine who your primary competitors are. As noted earlier, there are both indirect and direct competitors. Small businesses lack the resources to effectively compete on every front, so focus on those competitors from whom you can reasonably expect to take market share.

Example

A local one-man architect business, Life Designs, provides residential home design. Life Designs competes indirectly with all architectural design firms and home building suppliers. These include large firms who do both industrial and residential designs and suppliers of home-building kits (e.g., log houses and A-frames).

However, Life Design's direct competition is a small group of similar firms that specialize only in local area home designs and remodeling. This small one-person architectural company does not have the time or resources to compete with any firm outside his local city area at the present time. And some potential target customers may not be interested in having anyone but a larger, nationally known firm work on their home design.

Small companies should make a list of any competitors in their marketing area that could compete directly with them for the same list of potential customers. The list of competitors should then be divided into different distribution channels, if applicable.

Tip

The Life Designs architectural firm arrives at the following list of competitors broken down by different local distribution channels includes:

  • competitors who advertise in local city and county magazines, newspapers, and real-estate flyers, subdivided by home-design only firms and home-design + industrial-design firms
  • competitors who work with contractors and developers in the local county
  • the local university's architectural design department

Architectural competitors who advertise in local city media may be local, regional or national. In some cases, these competitors solicit home design business from wealthy industrial design clients they are doing work for. Other competitors have contracts to design and modify development-tract homes for local developers. And some competitors work with contractors to design home remodeling/addition projects. The local university is active in publicizing student residential design projects that result in several new home and remodeling/addition jobs each year.

The development of a list, broken down into competitive distribution channels, can also be assigned estimated dollar sales per year to create market segments. Sales estimates can be gathered by reviewing secondary research data, networking, and attending trade and association events, and by speaking with local government and business organizations (e.g., chamber of commerce and city, state, and federal housing departments, particularly the agency that issues local building permits).

Once you have analyzed the distribution methods used by your direct competitors, you need to assess your company's strengths and weaknesses, along with external environment opportunities and threats.

SWOT Analysis Helps Formulate Competitive Strategy

A SWOT analysis is an exercise that is vital to formulating many aspects of your business strategy. SWOT is an acronym that stands for four forces that affect your business: Strength,Weakness, Opportunity and Threat. The strength and weakness portion of the analysis looks at internal company factors that influence your ability to compete effectively. The analysis of opportunity and threat centers on the external factors, such as competitors and the external environment, that affect a company's ability to compete effectively.

You'll need to network with potential or current customers, industry associations, trade suppliers, and competitors to help answer these questions. Key questions are:

  • What are the barriers (difficulties) to entering this product category via each distribution channel?
  • How much do various distribution channels cost to successfully enter? Over what period of time is this money being spent?
  • Should we distribute our business products locally, regionally, nationally? And in what order, or through all channels at the same time?
  • Are some or all of the items we sell subject to varying product life cycles? How do our products compare to competitor product life cycles by channel?
  • What types of competitive spending, promotions, advertising, and field sales response will our business entry encounter by type of distribution channel?

Other considerations. In some categories of small business, other factors should be considered, such as:

  • ease and affordability of entering the product category
  • geographic locations of customers
  • existing competitors' market shares
  • product life cycle by channel (e.g., vending products may reach saturation in a few months, or have only seasonal distribution)
  • absolute size of competitors and their financial resources

If you enjoy working with software to analyze your business, you may wish to use the Inghenia SWOT Tool which captures the key factors for each quadrant of the SWOT analysis and provides several visual methods to interpret the results.

The following case study for Life Designs Architecture provides an example of how SWOT analysis might be conducted for a small service company.

Case Study

Our independent architect who specializes in designing residential homes, Life Designs, has a strengths, weaknesses, opportunities, and threats (SWOT) list that includes:

Strengths (of my business)

  • ability to respond quickly to customer demands and changes
  • ability to make acceptable margins on small jobs, with low overhead
  • high-quality of work and experience
  • reputation for being affable, honest, and easy to work with
  • reputation for good value of services and prices
  • appeal to customers of working directly with the architect/principal

Weaknesses (of my business)

  • very limited financial, personnel, and time resources
  • a limit of three to four projects at any given time
  • inability to sell and work on a project at the same time
  • not having a personal relationship with influential local business leaders
  • being known for a limited number of architectural design "styles"

Opportunities (in the market)

  • a growing market for new homes and more upscale homeowners moving to the area, fostered by a growing local economy
  • a chance to contract with a local developer for an exclusive agreement
  • a chance to work with the university architectural design department as a visiting lecturer
  • a chance to relocate his office from his home to a co-op business office center, with shared secretaries, receptionist, conference rooms, and computers
  • the availability of hiring independent sales reps to work with residential owners, real estate firms, and contractors

Threats (in the market)

  • a growing amount of advertising and business inroads by outside regional and national firms in the local area
  • new local zoning codes and state/federal legislation increasing the cost of new home and remodeling/addition work
  • increasing costs of building materials
  • a possible shortage of skilled building trade people in the area
  • a new competitor in the area specializing in residential home design, especially in his known "style" of design
  • economic downturns affecting the housing market in general

Match Distribution Methods to Your Goals and Resources

A small company must work harder at focusing limited resources, especially with distribution and sales force options. In some cases, the only sales force option is for the owner to do it himself or herself, as in a small retail shop, or consulting/service businesses.

Some distribution channels and sales force options may be attractive, but off-strategy for the small company. A list of all possible distribution channels and accompanying sales force options should be matched against company marketing objectives.

For example, a company selling gourmet cooking equipment has many options for distribution and sales force representation, including:

  • company retail stores, with company sales personnel
  • specialty food stores, with sales brokers
  • department stores, with sales brokers
  • hardware stores, with sales brokers
  • specialty chains (e.g., Williams-Sonoma, Crate & Barrel), with sales brokers
  • direct mail, with company personnel
  • distributors, with company sales managers, brokers, distributor sales reps

The company's products are positioned as the highest-quality cookware, used by celebrity chefs and guaranteed for the life of the end user/buyer. Target end users/buyers are upscale, well-educated, urban consumers who read upscale food magazines (e.g., Food & Wine), dine out at gourmet restaurants, drink wine, travel, drive expensive cars, and spend heavily on luxury purchases. Ideally, the company wants their products distributed through every upscale channel that caters to this exclusive target group.

Because of the positioning of the gourmet cookware, the company believed that hardware stores and direct mail were not consistent with the image and reputation that they were trying to establish with their positioning. Company retail stores, while desirable, were financially risky and too expensive at the early stage of development. Distributors were also eliminated because of the time and knowledge required of distributor sales personnel, coupled with the belief that distributors could not be encouraged to learn enough or devote enough time to the product line. In addition, the estimated 35 percent to 40 percent discount with shipping expense to distributors was financially unattractive.

The company decided the best distribution channels were direct sales to specialty stores and upscale department stores such as Macy's, Bloomingdale's, and Nieman-Marcus. Their sales force consisted of three regional managers with professional cooking experience, who also did demos in stores with the cookware. In addition, the company had the extra margin available to afford this highly trained and motivated sales force since distributors were not utilized.

Evaluate Costs to Determine Most Cost-Effective Methods

Each distribution channel alternative and sales force option carries specific costs that can be estimated in most industries and categories. Obviously, financial resources and cost-effectiveness are important in considering distribution and sales force options. Put bluntly, "What can you afford, and what will give you the most bang for your buck?"

For example, Life Designs, our favorite independent architect specializing in residential work, has identified three primary distribution channels for its residential design services and estimated costs for each one:

  • Media sales: This channel is composed of competitors who advertise in local city and county magazines, newspapers, and real-estate flyers, subdivided by home-design only firms and home-design and industrial-design firms. Ad inquiries are referred by the various media groups carrying the ads. This quasi-sales force is paid on commission for referrals that turn into jobs.
  • Contractors and developers: This distribution channel is composed of referrals from contractors and developers who receive a commission from home owners and buyers. The contractors and developers are the "sales" personnel, who expect a commission and entertainment.
  • University design department: This is a closed distribution channel for architectural students and professors only. It is not open to any other architects. However, this architect's reputation may be enhanced by occasional lectures at the university.

Life Designs knows from talking with media suppliers, competitors, and contractors that the least expensive distribution channel is sales from contractors and developers. However, the frequency of sales referrals and volume of business is unpredictable. It is also somewhat out of the architect's control because the business is dependent upon many outside variables such as the economy, style of home wanted by buyers, etc.

Life Designs decides to work with two distribution channels concurrently—both media and the contractor/developer channels, since most of the spending commitment is for media. The contractor/developer channel requires personal time and some minor entertainment expenses (wining and dining the contractors). This one-man architect firm cannot spare much free time, and media spending will provide a good alternative when he is busy with a project.

Prioritizing Distribution Options Is Often Necessary

In some cases, a small business can pursue distribution via several different channels. However, most small businesses must prioritize distribution channel and sales force options over several years of growth and evolving resources for the company. For example, food supplements and vitamins are sold through a multitude of channels, including:

  • multi-level "network" organizations, with company and independent sales reps
  • health food stores, with company reps and sales brokers
  • department stores, with company reps and sales brokers
  • drug stores, with company reps and sales brokers
  • grocery stores, with company reps and sales brokers
  • mass merchandise stores, with company reps and sales brokers
  • club member warehouse stores, with company reps and sales brokers
  • direct mail, with company personnel
  • distributors, with company sales managers, brokers, distributor sales reps
  • doctors' offices, with company sales managers, brokers, distributor sales reps

It is not always possible for a company, small or large, to take advantage of all possible channels that match the marketing strategy it wants to achieve. Financial considerations aside, it may be wise to prioritize the orderly development and attack each distribution channel in order of easiest entry and least competitive resistance.

Other factors such as geographic proximity, ability and availability of management to control many different channels simultaneously, availability of experienced sales reps, marketing experience by channel, competitive strengths by channel, manufacturing capacities, and product life cycles by channel should be considered.

For small companies, key factors to prioritize your choice of channels include a shorter list:

  • financial resources and risks ("How much money do we have to risk against our objectives and marketing programs?")
  • competitors' strengths and market share ("Are they big enough and mean enough to hurt us, and what are their objectives?")
  • management experience by channel ("What do we know about each channel's opportunities and threats?")
  • product positioning to target buyers ("Will the strengths of our product uniqueness help sell it to interested buyers and can we communicate our uniqueness effectively?")

Two case studies are provided to demonstrate the importance of distribution methods to the success of your business. The case study — Teddy's Flower Shop shows how creative examination of distribution can lead to revenue gains, while Alice's Dressings shows how distribution choices can evolve as your business grows.

Case Study: Teddy's Flower Shop

For a single small store with direct sales to buyers/end users, going through the exercise of deciding on appropriate distribution and sales force choices may yield new sales and volume gains.

Teddy's Flower Shop is surviving, but not growing. His local competition includes other independent florists, as well as other outlets such as grocery stores, plant nurseries, the airport, train and bus terminals. He estimated the total market was over $1,000,000 per year, based on obtaining information on wholesaler shipments into the local warehouses. He also obtained estimates of volume done by his various competitors from delivery personnel that came to his shop.

Determined to increase his revenue, Ted, the owner, conducts informal market research with his customers. He finds that most of his customers are located within a radius of a one mile of the flower shop. He also learns that many customers of Teddy's and other shops find selecting and buying flowers difficult. Flower gifts are very personal, and shoppers like to see the arrangements and attach a personal card to the gift, if possible.

Ted determined that his best target market was business people, who would make frequent purchases for a variety of occasions. This lead him to research the possibility of another way to gain sales from local area businesses within a mile of his shop, rather than relying on walk-in customer traffic. He began making notes from his discussions with customers about frequency of purchase and what kind of gift they wanted to buy for what kind of occasions. He asked about gift price ranges, and how much they were willing to spend. He asked them about their degree of satisfaction for the flowers/plants they bought for gifts.

Ted determined his mission was to "offer the highest value and most creative solutions to gift giving" to his business customers. Working in cooperation with local wine merchants, cheese vendors, and other retailers, Teddy developed gift baskets that included a fresh plant or flowers packaged with wine and/or cheese. These combinations added variety and value, and could command a premium price.

He decided on telemarketing and marketing by fax to local businesses with an expansion of gift assortments, based on his market research surveys. He estimated a budget of $1,000/month was required to cover his total marketing area for potential business lead lists, extra operators, and fax broadcast services. This extra expense required $3,000 per month in extra sales to break even (materials and overhead = 67 percent).

However, Teddy decided he could afford only $300 per month in "risk capital" for the first year. Teddy decided to pilot the idea in part of his local area to see if enough extra business could be generated in part of the industrial neighborhood nearby. He considered charging a nominal fee of $1-2 per order for the extra service in calls and faxes to help defray costs.

He also decided to pay his two high-school age children to pass out flyers and make sales calls to local businesses after school three days a week, with businesses being able to order by fax or phone.


Case Study: Alyssa's Dressings

Distribution systems may evolve over time as a business grows and changes. Alyssa's was a small, one-store family restaurant, famous locally for its delicious, unique, homemade salad dressings, such as Pomegranate Vinaigrette, Rum-Raisin-Orange Ranch, Blue Cheese Catalina.

Initially, the dressings were only available to customers eating at Alyssa's. However, customers began requesting bottles to buy. Initial sales and distribution of Alyssa's Salad Dressings were from the restaurant to walk-in customers. The product was packaged in a 32-ounce canning jar with a handmade label.

New Distribution Channels Cause Packaging and Pricing Changes

The steady stream of customers prompted Alyssa to consider other distribution options. As a result, Alyssa's Dressings were sold at a local grocery store at a discounted wholesale price, 28 percent less per ounce than the retail restaurant price. As local demand grew, Alyssa decided to have the dressings made in an independent packing facility and sold to other stores in the area, which initially raised the cost of making the dressings. Alyssa's husband, brothers, and a sister-in-law divided up initial sales responsibilities to call on local and regional stores in their spare time.

The popularity of Alyssa's Dressings caused Alyssa to consider the possibility of selling large pallet quantities to distributors in other states. The distributors needed another 25 percent discount from wholesale price, along with free shipping. Sales brokers were also recommended, at 5 percent commission on net distributor sales, since the family could no longer call on everyone. A separate company would have to be set up to market the salad dressings. And this enterprise would require full-time management.

Distribution Channels Are Key to Pricing, Packaging Decisions

In this case, a separate business, new distribution channels and sales representation grew out of Alyssa's initial one-store restaurant. Alyssa's restaurant was initially able to sell the salad dressings at $5.00 per 32-ounce jar (15.6 cents per ounce) directly to customers. However, once a decision was made to sell Alyssa's Dressings as a shelf-stable item in grocery stores, the bottles were changed to a standard 26-ounce size to compete with other dressings sold in this size.

Alyssa was concerned that grocery consumers, unfamiliar with the restaurant, would not pay over $3.99 retail per 26-ounce bottle when competing brands ranged from $1.29 to $2.69 for the same 26-ounce size. Wholesale prices were 28 percent less than retail, at $2.89 per bottle. However, the cost of ingredients was substantially more than competing brands, at $1.00 per bottle, and packaging and processing costs added another $0.50 per bottle. Profits were reduced from restaurant sales per bottle, but still acceptable (i.e., from $3.50 a bottle, or 11 cents per ounce, to $1.39 per bottle, or five cents per ounce), since the total amount of sales and profits were expected to be substantially greater through grocery sales.

Further research with marketing experts in the industry and sales brokers indicated a further 40 percent reduction in delivered distributor price (including brokerage commissions and shipping costs). Alyssa would net $1.73 per bottle at delivered distributor price with brokerage commissions of 5 percent, leaving an unacceptable gross margin of only 23 cents per bottle (13 percent), even at the higher retail price of $3.99 per bottle.

Alyssa finally decided to upgrade the bottle and label to a unique, tall, triangular, Italian glass bottle and cork, with gold and black labels and recipe hang-tags by a local design studio. She sold the dressings directly to upscale specialty and grocery stores. Distributors would not be used. Specialty brokers were hired to aid in selling directly, at a 10 percent commission on net sales. The premium pricing was also retained in this non-elastic, low-price-sensitivity market segment, with the new bottles retailing at $4.99 each. Final net factory sales per bottle were $2.69 after deducting 10 percent brokerage commissions, with net factory profits of $1.10/bottle. Specialty food stores took a 40 percent gross margin, but paid for shipping.

Packaging and pricing decisions are intimately related to distribution and sales force decisions: Alyssa's restaurant could have made several different distribution decisions, with different packaging and pricing results:

  • Sell the salad dressings only from the restaurant in 32-ounce jars with handmade black and white labels at $5.00 each. This distribution and sales decision requires the least amount of extra resources, spending, and risk. This also provides the smallest potential sales return.
  • Sell the dressings directly to all consumers through mail order or other marketing channels with family members handling both marketing and sales. This distribution and sales decision is a variation on selling only from the restaurant and may require additional resources to manage and grow, but it delivers better returns than selling only to local restaurant customers.
  • Sell through DSD (Direct Store Delivery) distributors. This distribution and sales decision requires financial resources, management time, personnel, higher margins, and spending support, but may be the fastest way to grow the business.
  • Hire brokers for store and/or distributor sales. This sales decision depends upon scope of operations and geographic and distribution channel expansion plans.
  • Combine several distribution channels simultaneously. This distribution and sales decision calls for the largest amount of resources, time and personnel, with the objective of growing the business as fast as possible.
  • License the formulas and restaurant name to another manufacturer and receive a 4 percent to 5 percent royalty on net sales. This distribution and sales decision is also low-risk, with low-resource requirements. The long-term potential return is much higher than selling out of a single restaurant.
  • Sell a different size bottle or jar directly to stores only, as Alyssa finally decided to do. This distribution and sales decision preserves higher gross margins and eliminates discounts to distributors and possibly sales commissions to brokers, but requires more financing, management personnel and time.

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