How Do Distribution Companies Work?

So you’ve got a killer idea for a product and you are ready to start production so you can start making money. But before you do that, you need to figure out how to get your product from the factory to consumers and the conversation turns to distribution. This could make you wonder, “How do distribution companies work?”

Knowing how distribution companies work is essential to your business since they are the way to get your supply chain humming like a finely tuned machine. A distribution company buys products from the manufacturer and then generally resells them for a profit to a retailer or, in some cases, directly to the customer.

Picking the right one can absolutely affect your bottom line since getting your product to the consumer in the most cost-efficient way is a basic tenet of effective distribution. 

What is Product Distribution?

Product distribution in its simplest terms is the act of making goods available by circulating them through the market. Distribution itself refers to the manufacturing, packaging, delivery and transport of the product.

With many business models including worldwide sales, it is vital to set up and optimize distribution so that all links in the channel are pleased. Distributors (or wholesalers) are essential to many retailers and even directly to customers. While the biggest businesses — think Amazon or Wal-Mart — will handle their own distribution, there is a huge market to use an intermediary to get the product from the manufacturer to the consumer.

The importance of product distribution cannot be overstated. If a distributor is unable to deliver goods on the timetable agreed, multiple levels in the supply chain (retailers, customers) are disrupted and become upset. Distributors lose credibility and probably profit as well. Nailing down a productive system is key to having a successful product distribution business. 

Profitability is definitely there for the taking and the financial numbers back this up. Each year, about 300,000 distributors account for $3.2 trillion worth of commerce in the United States. To get a piece of that pie, though, there is a lot to know about the world of product distribution.

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Product Distribution Channels

A distribution channel is the flow of business that takes place between a manufacturer and a consumer, in other words, the line proceeded along during the process.

There are two types of distribution channels: direct and indirect. In a direct channel, the manufacturer delivers a product right to the customer. In an indirect channel, there are intermediaries such as a distributor, retailer or an agent.

There are four levels to the distribution channels:

• Level zero: This is the direct distribution channel involving a direct sale from the producer of goods to the consumer.
• Level one: This is an indirect channel, where one middleman sits in between the manufacturer and customer. This could be shipping directly to retail businesses, which then sells the goods to a customer or even shipping it to a wholesaler who can then sell it to the customer. 
• Level two: This is also an indirect channel, with two intermediaries between the producer and customer. So the manufacturer would sell to a wholesaler, who would then sell to a retailer. The retailer would then make the items available to the consumer.
• Level three: The third level is the same as level two, except between the retailer and customer is an agent, who brokers a deal between those two parties.

The level zero distribution channel would take the shortest amount of time, since the product is going from the manufacturer directly to the customer while the level three would take the longest because it has the most steps to go through.

What are the Kinds of Distributors?

There are three different kinds of distribution and which one you choose to pursue will depend on your overall goals.

Selective distribution: This is when a business decides to limit the number of outlets that handle its product. Because this is usually a limited-supply item, the manufacturer can set its price-point to attract a particular kind of customer.

Exclusive distribution: This chain describes a very limited amount of product produced sent to a select group of retailers. This is intended to maintain a brand’s exclusivity and this is generally executed with very high-end companies 

Mass (or intensive) distribution: This is distributing your product in great quantities in as many locations as possible. The goal of this style of distribution is to get maximum market penetration.

Depending on your aims, you’re not locked into one method of distribution for the life of your business. For example, you might start as a selective distribution outfit because your manufacturer is only able to produce a limited amount of product to hit a particular price point or it is still working to get onto more store shelves. As their business grows and their needs evolve, they might be able to produce enough of an item that consumers clamor for. As a distributor, you are now able to make the product more widely available and potentially turn to mass distribution.

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Product Distribution Strategy

Production distribution strategy (a part of business logistics) is a critical component of making it all work.

Here are some questions you should ask yourself:

• How should the product be packaged? The product should be packaged in an economical way while also providing sufficient protection so the items don’t get damaged in transit. Anything that happens to the product to make it unsellable affects profitability.
• How should the inventory be managed? This is imperative because you obviously want enough product to meet demand at all times or else you’re missing out on profit. On the other hand, if you produce too much, goods will be sitting in a warehouse not making money and potentially decreasing in value over time.
• How should the orders be processed? An order has been received from a customer and it’s time to go to work. Hopefully, this is an area that has been set up with outstanding efficiency in mind because the goods must be found, loaded onto a delivery vehicle and shipped out in a timely manner. It is also a time where invoicing will be done.
• What is the logistics solution? This is as simple as deciding what kind of transportation is needed for the product to reach its destination and agreeing with the party taking delivery on a general time and place to complete the transaction. This is also a time to consider if specialized equipment is needed to load or unload the items.
• How do we communicate in the most effective manner? During this entire process, clear and concise communication is a basic necessity

For marketing your product distribution, there are generally two different strategies for product distribution — push strategy or pull strategy. Which one you choose will have important ramifications on how you advertise or promote the product:

Push strategy: This strategy involves strong advertising and incentives aimed at retailers and wholesalers with the objective they will carry your product. Then once your goods are on store shelves, customers will buy them. When a company uses this avenue, they concentrate their advertising.

Pull strategy: This strategy implements marketing directly to consumers with the hope they will put pressure on retailers to carry your products.

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How Does Wholesale Distribution Work?

Wholesale distribution takes place when a distributor purchases products from the manufacturers and then sell them to retail stores, who then make them available for consumers. This approach works best for businesses engaging in large-scale production, who don’t have the time to produce a good and then preside over selling each item directly to retail outlets or customers.

A typical chain in wholesale distribution goes along these lines:

1. The wholesale distributor buys directly from the manufacturer at a lower price
2. The distributor then stores the product in its own warehouses
3. The distributor sells the product to retailers for a higher price than it bought it for
4. The retailer turns around and sells the goods to the customer

In order to get low enough prices to achieve profit, the wholesale distributor has to buy in large quantities to be able to negotiate a further reduced price with the manufacturer. That doesn’t mean a good price cannot be bargained for on smaller quantities, but a general principle of business indicates that the more you buy at once, the less the per-unit cost tends to be.

How to Get Your Product in Stores

To get your goods on the shelves of retailers, there are some significant factors to consider.

Slotting fees: This is a one-time cost that is generally paid by the distributor to the retailer when its product is first placed on shelves. These fees were first introduced in the 1980s but are now prevalent throughout retailers. Even long-time holdout Walmart finally implemented them in 2015.

The place slotting fees are especially prevalent is at the grocery store, although they also extend to many big box stores and bookstores like Barnes & Noble.

Depending on the scope of your product placement at a retailer and the actual product, a slotting fee can be anywhere from several thousand dollars to hundreds of thousands of dollars. But like most things in the business world, slotting fees can be negotiated to a degree with the retailer. While you will face somewhat of an uphill battle since yours is not the only product vying for shelf space, it is possible to lower the cost.

The first thing to do is have a plan going in and relay that to the retailer. A strong plan will give you better footing in bargaining for the space you need. About 4 out of every 5 products end up failing, so using marketing in the form of promos or coupons can signal to a retailer that a business is serious about seeing its plan succeed.

Another way to demonstrate value to the retailer is having statistics support your vision. Showing that there is a demand for your item and proper placement will increase its viability can make it more attractive to stores. 

If you are able to get your product into the store, there is a final tip for possibly lowering the slotting fees. Track the sales of your product in stores and if the numbers are strong, point it out to the retailers, who make money when you make money.

Knowing your retailer: This can make the entire process easier when putting your goods out there for consumers. Do some research on the potential partnering retailer’s floor plans, categories and displays. Get to know the store managers of the locations your product will be (if feasible) and ask for buyer information. The retailer should be incentivized to assist you in these matters because if they sell a lot of your product, it’s good for them as well.

How to Find a Wholesale Distributor

Before you set about finding a wholesale distributor, there are some aspects of your own business you must identify to figure out what would be an exact match for your needs.

If you are the manufacturer and you’re looking for a wholesale distributor, you’re at the first step of the chain and a distributor might be the only part of the distribution channel you deal with directly.

As the manufacturer, you might have minimum order requirements, so you want to find a distributor who is willing to meet or exceed that condition.

Another important consideration is the type of product you’re looking to sell. There might be a wholesaler who specializes in buying and selling the goods you have to offer. But regardless of if you can find a niche distributor, search for a variety of wholesalers. This will check off multiple boxes for you by allowing for comparison shopping and competitive quotes.

As far as finding the wholesale distributor, it will take some effort whether it be a Google search or speaking with industry insiders to find out who they use. Competitors will not be willing to share their trade secrets. 

Another good format for finding what you’re looking for is looking for trade shows to attend. The shows are put on specifically so manufacturers, wholesalers and retailers can meet face-to-face and receive more accurate information because of the more intimate setting.

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How Do Distribution Companies Make Money?

The way a distribution company makes money is simple. The company buys the product at a lower price from the manufacturer and sells it at a higher price to a retailer or customer.

In order for a product distribution company to do the work it does, a Gross Profit Margin of 10 to 15% needs to be attained by the wholesaler. To achieve the 15 percent, the product generally needs to be sold to the retailer at about 18% more than the distributor originally bought it from the manufacturer for. Although distributors can make money from serving smaller customers, the best way to make more money is to sell in as great a quantity as possible in each individual order.

A simplified example would be a product has a Manufacturer Suggested Retail Price (MSRP) of $50. The manufacturer sells it to the wholesaler for $30 and the wholesaler turns around and sells it to the retailer for $40. The wholesaler and retailer each make a $10 profit per item while the manufacturer presumably makes at least that much.

Actually “auditing” your own customers can reveal financial realities that are surprising. A rudimentary representation of this is using two cases:

In the first case, you buy $3.9 million in goods and sell them for $4 million. You realize a profit of $100,000. In the second case, you buy $350,000 in goods and sell them for $500,000. You realize a profit of $150,000.

Those examples are just meant to illustrate that volume is not always king. A smaller customer who might be a small fraction of your business could possibly be worth more to your business than a larger client. Still, the heavy volume customer would also be important as it helps you pay operating costs.

To truly make money, you will need to scrutinize every aspect of the business. Saving money on things as small as your telecommunications (internet, phones) or office supplies can improve your bottom line. Going over your own business with a sharp eye, even if it is a time-consuming endeavor, can improve your long-term outlook. From time to time, it is important to review each part of your operations to see if there are cost-saving measures to implement or time-saving measures that can also increase overall productivity.

Something that will also help a distributor make money is being able to prove that your product is actually worth buying. Unless you’re in the unlikely scenario where yours is the only company in the world that sells a particular item, you will have competition — likely from a myriad of sources. For a wholesaler to want to buy and then sell your items, you will have to demonstrate its usefulness and value. Some questions that could be on a wholesaler’s mind include:

• Will the retailer be able to sell your goods quickly?
• Is there demand on the retailer and customer levels? 
• Will it be more profitable than a competitor’s? 
• Are you able to meet the wholesaler’s demand?
• Do you appear to have a good business model?

While you may not be asked these questions outright by a wholesaler, you’ll have to show that you have the right answers through your plan and actions. 

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How Do I Start a Distribution Business?

There are two types of ways to start a distribution business of your own: you can either start one from scratch or buy an existing distribution business.

The pros to buying an existing one include more limited risk in failure since there should already be a solid business plan in place. While there will be a large upfront cost in buying an existing distribution business, if it is already a profitable business, a new owner should theoretically see profits much sooner than starting its own business from scratch.

Also, the business selling you its distribution center could provide you with its list of clients or add value in the form of help getting you set up or offering advice.

In order to run a successful wholesale distribution business, there are several aspects that need careful attention:

• Money: Whether it’s reinvesting your own money, dipping into your savings or taking out a business loan, you will need capital to get the business off the ground. If the business is brand new, it could be anywhere from six months to several years before a profit is realized.
• You need accounting/bookkeeping: Whether you handle this or hire someone, having a budget and financial accountability is a must.
• Knowledge of the product: Hopefully the distributor starting out is working with items they have some familiarity with or are passionate about. If neither of those are the case, you’ll need to have at least a working knowledge of the goods you’re trying to sell. If you know nothing about the product, how will you be able to promote or sell it to a retailer?
• A person or people proficient at sales: The fact of the matter is a wholesale distributor will be selling the products it purchased to retailers and will need a sales force able to move those goods to retailers. A large sales force could be cost-prohibitive but whether it is just you or someone associated with your operation, there has to be a front-facing employee to deal with retailers and sell them on the merits of the products you’re distributing.
• Storage space: Whether you need a storage unit or garage for small businesses or warehouse space for mass distribution, a wholesaler has to plan on storing the product it buys until it can sell it to a retailer. Figuring out the right amount of space and location for the operation will be crucial to potentially keeping costs down and also getting the items to customers as quickly as possible. 
• Applicable licenses: You will need to be licensed as a business, first of all, and then licensed as a wholesaler so you don’t pay double taxes. Also depending on what kind of products are being sold, you might need additional federal licenses in order to buy or sell.

Tips for Wholesale Distribution Business

Outside of knowing the basics about distribution, there are some factors to consider when trying to set out on your own.

Try to manage costs: This might seem like a no-brainer but there are many factors to consider as a wholesaler in achieving a profitable bottom line.

You are solely responsible for the cost of warehousing the products and shipping them to the retailers. This is pretty important since locking in warehousing costs is relatively easy, but fuel costs fluctuate at a daily rate. So if you’ve locked in a price to sell to a retailer but your fuel costs increase, obviously less profit would be realized and it can negatively impact the cash flow of the wholesaler.

Figuring out a strategic location to store your goods is essential to operations. A wholesaler wants to strike a balance between finding a cost-effective warehousing solution with it being close enough to where the majority of the product will eventually be delivered to. This will make the distribution process more efficient and hopefully cut down on having to use more trucks — and more fuel — than necessary. Many cities have industrial centers with ample warehousing that is located in a way to make it easy and fast to disperse product. This might also be a good fit for your business.

Inventory management is suddenly very important. The distributor is now the owner of the product the minute it’s unloaded from the truck into the warehouse and any damage or loss is now theirs to deal with. Putting measures in place to quickly yet safely process orders can have a huge effect on costs.    

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Maintaining rapid turnover of product: This is vital for several possible reasons. If you have a warehouse of items and can’t move them, money is not being recouped and your fixed costs are also not disappearing. Also, a product that has a limited shelf life or is prone to spoilage needs to be moved or you could lose money by having to dispose of the items.

Also, the MSRP of a product could decrease after a period of time. This would in turn be sold for less to a retailer, meaning a hit to profit margins or even a loss for the wholesaler. Also the opposite could happen. If the cost of goods rises too much at the retailer level, customers might stop buying the item. The wholesaler would then be unable to move the product it purchased, which would also leave a warehouse full of less desirable items.

Implement an inventory management system: The days of manually writing down or recording data should be over. It is hard to process and keep track of, and unless you’re making copies of the same forms, it’s more difficult to quickly disseminate information.   

The vast majority of people own smartphones, which can be hooked up to company WiFi, to quickly manage inventory in real time and send the information to many parties in a matter of seconds. Even if your employees balk at using their own phones, you can provide inexpensive, lightweight tablets that will provide the same function. While the outlay for a multitude of tablets could be a large upfront cost, the much improved efficiency and tracking of inventory could soon recoup the initial investment.

Make customer service a priority: Today’s marketplace is wildly competitive and it might not be enough to just offer the lowest price on an item. In fact, that might not even be possible. But one aspect you can truly control and allow your business to shine in is through excellent customer service.

Customers that do not feel properly valued will eventually leave. Offering a great experience for the customer by engaging with them in a seamless and contemporary manner will go a long way. Also being extremely responsive is crucial to engendering goodwill while simultaneously putting the customer’s mind at ease and immediately fixing any hiccup in the supply chain.

Without a customer — in this case the retailer — you have no business. So make it your business to treat them as important as they truly are to your operations.

Quickly filling orders: This might seem like logistics 101 but it truly matters to whoever your customer is. You need to be able to quickly fill and ship orders to the retailer so they’re not held up on their end.

Again, you might feel like you have the best system in place from start to finish but analyzing each step to spot any inefficiencies can keep the product stream flowing. The old saying “time is money” really comes into play here. If you can ship items faster to the retailer, you can move more product in the same amount of time and therefore realize a greater profit.

Leveraging business relationships: If you’ve managed to successfully do the previous two things, this tip will be easy to achieve. Theoretically, you’re now known as a fast shipper that quickly provides solutions for any problems that arise. You’ve built strong relationships with your current customers, who would be more likely to recommend your services to other retailers if asked.

Even with all the advances in marketing, word-of-mouth marketing is a passive way to generate more business. You’ve already done the good work with your current customer and it may have gotten you a fantastic lead to more customers with no additional cost to yourself. 

Product Distribution Consulting with R+L Global Logistics

As you can see, the business of product distribution is no joke. There are many different aspects that need to be carefully planned and accounted for at every turn. With all this new world to discover, let R+L Global Logistics help guide you through the process.

With over 30 years of experience, we can offer solutions to many of the facets a distributor faces in making sure its business thrives. From warehousing to kitting to transportation, there are so many ways R+L Global Logistics can partner with you and help your time as a wholesaler be less of a headache and more profitable.  

Ready to take the next step? Contact us today to learn more about distribution companies, wholesale business and what we can do for you. 

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