What it means
A company may sell straight to customers through its own website or shops, or it may rely on intermediaries who buy, store and resell. Many businesses use a mix.
The choice of channels affects price, reach, brand image and profit. Every intermediary needs to earn a margin, so the more steps between maker and customer, the less money the maker keeps per sale.
A distributor might buy at a 20% discount from the wholesale price and a retailer at a 40% discount from the shelf price. The business must be sure that the volume gained from a channel justifies the margin given away.
Channels also affect cash flow and risk. Selling through a retailer may bring a large order but long payment terms, and the retailer may return unsold stock.
A direct online sale brings cash quickly but requires the company to pay for marketing, shipping and customer service. Channel conflict is a real issue.
If a manufacturer sells at a lower price on its own website than its retail partners can, the partners may stop promoting its products. Finance and sales teams need consistent pricing rules and clear agreements on which customers each channel can serve.
Managing channels well means measuring each one separately. Revenue, gross margin, cost to serve, returns and payment days should be tracked by channel, so the business can decide where to invest.
Often the biggest channel by sales is not the most profitable once all costs are included. Technology has changed the choices available.
A small producer can now reach customers through online marketplaces, social media shops and subscription boxes that did not exist a generation ago. Each new channel brings fees and data that finance teams must learn to read and compare.
In practice
Real-world examples
Example 1
A craft coffee roaster sells beans through its own website, local cafes and supermarkets. The finance manager reports margin by channel and finds the website earns the highest margin per bag, while supermarkets deliver the biggest volume.
Example 2
A software company sells through reseller partners that keep 25% of each licence. It decides to keep large customers in-house, and uses the partners for smaller accounts where its own sales team would be too costly. Margins are reviewed twice a year to check the split still makes sense.
Example 3
A furniture manufacturer opens a showroom and sells online. It prices both the same, because lower online prices would upset its showroom staff and partners. It offsets this by offering free delivery on online orders above a set value, which the finance team has costed at $45 per order.
Think of it
Think of distribution channels like plumbing pipes in a house. The water represents your product, and the taps represent your customers. You can run a single direct pipe from your main tank to your kitchen sink, or you can install a complex network of branching pipes to supply every room.
Formula
Calculation
Manufacturer's net revenue per unit = Consumer price x (1 - Retailer margin) x (1 - Distributor margin)
Suppose a product retails for $100. The retailer keeps a 40% margin, so pays 100 x 0.60 = $60. The distributor keeps 20% of that, so pays the manufacturer 60 x 0.80 = $48. With production cost of $30, the manufacturer earns 48 - 30 = $18 per unit, a 37.5% margin on its $48 revenue. Selling directly at $100 with $15 of delivery and marketing costs would give 100 - 30 - 15 = $55 per unit, though it would need to build its own customer reach.Case study
Seen in the real world
Fernhill Outdoors is an illustrative, fictional maker of camping equipment that sold 80% of its goods through two large retail chains. Its owner worried about depending on them, because the chains controlled shelf space and pushed for deeper discounts every year.
The finance manager analysed the margins and found that retail sales earned a 28% gross margin, while the company's own online store earned 52% after delivery costs. She proposed redirecting marketing money towards the online store and building a stronger direct channel.
Over two years, the illustrative company grew its online share from 10% to 30% of sales. Total profit rose even though some retail sales fell, and the company had more bargaining power in its negotiations with the retail chains.
Watch out
Common mistakes
- Judging a channel only by sales volume, without allowing for the margin given away, the marketing cost and the cost of returns.
- Letting different channels set conflicting prices, which damages relationships with partners and confuses customers.
- Depending too heavily on a single channel, so that a change in its terms or the loss of the partner threatens the whole business.
Questions
People also ask
How many channels should a business use?
There is no fixed number, but it should use enough to reach its target customers while keeping each channel profitable and manageable.
What is the difference between direct and indirect channels?
Direct channels sell to the customer without a middleman, while indirect channels use intermediaries such as wholesalers and retailers.
How do channels affect pricing?
Each intermediary needs a margin, so the price charged to the end customer must be high enough to leave the manufacturer with an acceptable return.