What it means
Few producers can reach every customer on their own. Distribution channels fill that gap by using specialists who already have warehouses, shops or sales teams.
In return, each intermediary takes a share of the final price, so the more steps there are, the less the manufacturer keeps per sale. Channels are often described by their length.
A direct channel has no middlemen, a one-level channel includes a retailer, and a longer channel adds wholesalers or agents. A business may also use several channels at once, such as selling online and through shops, which is described as a multichannel approach.
The choice involves trade-offs. Intermediaries bring reach, local knowledge and the ability to handle storage and delivery, but they also take margin and may know the customer better than the producer does.
A direct channel gives control and data, yet requires investment in logistics and customer service. From a finance viewpoint, each channel has its own economics, including margin, working capital, returns and payment terms.
A wholesaler may pay late, a retailer may return unsold stock, and an online channel may carry shipping and advertising costs. Comparing channels on profit after all these costs is more useful than comparing them on sales alone.
A nuance is that channels evolve and can conflict. If a producer starts selling directly at a lower price than its retailers, it may damage those relationships.
Many businesses manage this by offering different products or prices through different channels and by being open with partners about their plans. Data is now a major factor in the choice.
A direct channel shows who buys, how often and at what price, while an indirect channel may share only summary sales figures. Producers that want to test new products or pricing often value this information as highly as the margin.
In practice
Real-world examples.
Example
A clothing designer sells her range through department stores and her own website. The stores take 40% of the retail price but bring large volumes. The website earns a higher margin on each sale but needs advertising to attract visitors, so the designer reviews both channels each quarter.
Example
A manufacturer of industrial pumps uses regional distributors to reach customers in countries where it has no office. The distributors hold stock and provide repairs. The manufacturer gives them a discount on list price in return.
Example
A software company sells subscriptions directly through its website and also through resellers that bundle the product with their services. Resellers bring in larger clients, while online sales deliver smaller accounts at a lower cost of sale. The sales director tracks profit by channel.
Formula
Calculation
Channel profit per unit = selling price to the channel - unit cost - channel costs borne by the producer
A producer makes a garden tool at a cost of $18. Selling through a retailer at a wholesale price of $30, with $2 per unit in freight, gives a profit of $30 - $18 - $2 = $10 per unit. Selling directly online at $48 with $9 in shipping, $6 in advertising and $3 in payment fees gives a profit of $48 - $18 - $9 - $6 - $3 = $12 per unit. The direct channel earns $2 more per unit but needs more working capital and effort.Case study
Seen in the real world.
Harbourstone Coffee is an illustrative, fictional roaster that sold 100,000 bags a year through supermarkets at a wholesale price of $6 per bag, with a production cost of $3.50 per bag. The profit was ($6.00 - $3.50) x 100,000 = $250,000.
The owner added an online subscription channel, selling 20,000 bags at $12 each. After delivery costs of $3 per bag, advertising costs of $2.50 per bag and payment fees of $0.50 per bag, the profit was ($12.00 - $3.50 - $3.00 - $2.50 - $0.50) x 20,000 = $2.50 x 20,000 = $50,000.
The online channel earned $2.50 per bag, the same as the supermarket channel, but also built a direct list of loyal customers. The illustrative lesson is that margin per bag was only part of the story, and the value of customer data and repeat orders made the extra channel worthwhile.
Watch out
Common mistakes.
- Comparing channels by sales volume alone, when margins, costs and payment terms can reverse the ranking.
- Ignoring channel conflict, when selling direct at a lower price can upset retail partners.
- Forgetting working capital, since intermediaries may pay slowly or return unsold goods.
Questions
People also ask.
What is the difference between direct and indirect distribution?
Direct distribution sells straight to the customer, while indirect distribution uses intermediaries such as wholesalers, distributors or retailers.
How many channels should a business use?
There is no fixed number. The right mix depends on where the customers buy, how much each channel costs and how well the producer can serve each one.
What is a multichannel strategy?
It is the use of several distribution channels at the same time, such as stores, a website and resellers, to reach more customers.
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