Distributor Profitability – How much margin to give to a distributor?

Assume you’re a brand or a manufacturer trying to select a distributor for your business and the terms you’ll be providing are a gross-margin of 5%, zero credit period (the credit period for the distributor is zero days from the manufacturer) and the average costs for the distributor is 2%. The distributor has to extend a credit of 2 weeks to the customers/buyers (retailers) and on average there is 2 weeks of stock that is maintained by the distributor. So, what is the ROI for the distributor?

  • Gross Margin: 5%
  • Average Costs: 2%
  • Net Margin: 3%
  • Credit offered in the market: 2 weeks
  • Zero credit from the company to the distributor
  • 2 weeks of stock maintained always in the distributor’s godown

Return on Investment = (Net Margin) * (Number of Rotations)

Number of Rotations (in the above example) = 52 weeks/(no. of weeks of investment, which is 4 in this example) = 13 rotations; (4 weeks of investment because 2 weeks of credit and 2 weeks of stock in the market)

Return on Investment (in the above example) = (3%)*(13)=39% ROI

So, how do you know how much margin to give to a distributor?

The answer depends on the opportunities to invest in that geography and to that distributor. For instance, if it is Urban City, then the options of investment for the distributor is very high and therefore one should provide a competitive ROI to the distributor and also the cost of capital is higher usually in Urban areas (say around 12% in India). But, the same is not true for Rural where the opportunities to invest is low and hence you can provide lower margin and lower ROI to the Rural distributor. Distibution is largely a risk-free business and hence a 24% ROI is decent for Urban India and one can go lower in Rural to 15-16% ROI.

What do distributors do for this ROI?

The most important activity distributors do is to reach the customer. Unlike B2B, B2C is all about reaching the customer and sometimes there is a long channel to reach the customer. Whereas B2B is more about Seller -> Buyer and hence it is more about influencing the buyer than building the distribution, building distribution is a key in B2C channels.

Distributors do call beats (touching 40 cutomers every week), maintain the servicing frequency, invests in stock for the company and increases the investment as the distributor’s turnover increases, and extends credit in the market with an objective to enhance maximum reach for your product. In India, for example, FMCG distributors always maintain 2 weeks of stock whereas Pharma distributors maintain 6 weeks of stock. So, the variables keep changing from industry to industry and so are the margins.

The typical Sales structure looks like the below:

National Sales Head/CEO3-4 Regional Heads
Regional Head4 to 6 Area Heads
Area Head2-3 Sales Officers
Sales Officer4 to 6 Company Reps
Executive2 -3 Distributor Reps

Aligning the long-termness of manufacturers to the short-termness of the distributors

Manufacturers look at the landscape for the long-term and they’re in the game for the long-term. Distributors are always short-term oriented as they’re simply trading and nothing else. However, without distribution, reaching the end customers is impossible. So, manufacturers should understand the short-termness of distributors and provide them that ROI, but at the same time repeatedly nail it in their heads the long-term objectives of the manufacturer and align the distributor to the long-termness of a manufacturer or brand.

Some brands which are very powerful do operate purely on cash basis and some brands which are new to the market do extend more credit to distributors. You may think why would distributors encourage cash! They do because sometimes they don’t have any other option. If there is a lot of consumer pull for a brand, then even if the brand gives thin margins the retailers want to stock the brand because of the volume demand in the market and thereby the distributors are forced to stock the brand. In such cases, the profit is gained from the volumes. This is why creating consumer pull is very important for any brand, it enables to reduce distributor margins as the brand has tremendous pull and doesn’t depend on push. If consumers ask for a brand, then retailers get worried and they immediately start stocking the brand and in turn the distributors are forced to stock too. This is where advertising and other brand building activities help in creating the consumer pull for the brand and make it less dependent on distributor and retailer push. Nevertheless, distribution is an absolutely beautiful and the most important essential cog in the goods distribution of all consumer brands in any B2C business in India.

Hope this is useful, thank you.