Channels of Distribution: Cost of Complexity

Not surprisingly, the more hands or “touches” that are required in the distribution channel, the greater the costs of distribution become. A retailer, wholesaler or an agent, all add to the cost structure.

There are two main reasons that Walmart is the low cost leader. The first is that its scale allows it to negotiate better prices from vendors. The second reason is that they have optimized their supply chain by examining all aspects of the distribution system and eliminating all unnecessary steps, i.e. “touches.” This allows them to carry lower inventory for shorter periods of time. Both sets of cost savings are then passed on to customers in the form of lower prices.

Let’s look at the Cap’n Crunch example again. Quaker Oats sells a truckload of the cereal to Walmart, which takes delivery of the cereal in its own warehouses and quickly, often within 24 hours, distributes it along with other products to fill a truck, to their own stores. You then buy it from their store.

Contrary to popular belief, most companies like dealing with Walmart because their efficient system is less aggravating. It also allows both Walmart and the producing company to make more money and the customer to benefit from lower prices.

Complexity has a cost. This is why selling directly through the web is simple, efficient and cost effective. All you need is an excellent website and an account with FedEx, UPS and USPS to do a good job.

Using Multiple Channels

A distribution channel allows you to sell to a customer. When you start a business, you may have only one channel, but when it becomes cost effective, you may expand to multiple channels. Below are some well-known examples to give you ideas for your business:

• Domino’s Pizza has two channels – delivery and pick up from the store.

• Apple has three channels– their website, the Apple stores and other retailers such as Amazon and Best Buy.

• The Apple stores have been a rousing success. Not only do they allow the company to sell the product, they more importantly set a tone and relationship with the customer that is crucial. Dell and Gateway, companies that made PCs some years ago, failed in this channel. It will be interesting to see how the Microsoft stores fare. Will they be able to develop a relationship with the customer as Apple has?

• Walmart sells primarily through its stores, but is making a huge effort to expand into e-commerce.

• Amazon’s key channel is its website. They recently announced they would open a retail store in New York.

• Starbucks’ primary channel is its coffee shops, but they also sell through grocery stores and Amazon.

• Warby Parker started online, but ended 2014 with 10 retail stores. They plan to double this by year-end 2015.

• A consulting company is likely to have two channels. Its primary distribution channel will most likely be on-site visits while its secondary channel may include online delivery of content, Skype, or phone conversations.

Expanding distribution channels does allow more points of interaction, but it is expensive. Brick and mortar retail stores are far more expensive than a website. Furthermore, each channel requires additional expertise. Caution is advised when expanding channels.

What does this mean for you? For the starting entrepreneur, costs are a big issue. Start with a channel where you can get the most bang for your buck. You can always add more channels later.

So what channel(s) suits your product/ service the best?

Verinder, Author: Discover The Entrepreneur Within

Written by Verinder Syal
Verinder is the Principal at Thoughtful Simplicity, an award-winning teacher at Northwestern University, and the author of Discover The Entrepreneur Within.