How to maximise profits and savings in Supply Chains!

“In science one tries to tell people, in such a way as to be understood by everyone, something that no one ever knew before. But in poetry, it's the exact opposite.” Paul Adrien Maurice Dirac.

I have spent about fifteen years working in and out of a channel model industries, it is a fascinating experience, and ironically few people working within the model understand its mechanism and why it exists.

Confusion about the model exists at all levels. Examples include the Original Equipment Manufacturer (OEM/Vendor) or Vendor who is looking for Resellers to "take their product to market", the Distributors and Resellers that wish to charge high margins for logistics, or other undifferentiated and over distributed value adds, etc.

The reason I have written this piece is to help clarify the model and make it easier to understand for those who are new or from outside of a channel model.

• OEMs/Vendors create great solutions (Products and Offerings) and generate demand
• Distributors provide a shared resource model to OEMs/Vendors and Resellers
• Resellers offer convenient high customer service experiences for End-Users

The common misconception is this is a linear model working left to right or top to bottom from OEM/Vendor to End-User, but this is not the case.

It 's hard to know where to start. While I was working at a reseller and training some graduates the common question was, why doesn't the manufacturer (aka OEM/Vendor) sell their products direct to the end user? It is a superb question, but the best place to start is with the End-User!

End-Users have numerous and complex requirements and problems. An OEM/Vendor invents a new offering through research and development that they believe solves the End-Users problems and is competitive enough to take market share. The OEM engages in market making activity (advertising, PR, etc.) that stimulates demand for their offering in the end-user community. Very few Vendors/OEMs can fulfil an End User's requirement entirely. Also, end users often seek "best-in-class" or the best "product-market-fit" for each requirement. The result is most End-User's purchase the offerings of multiple vendors.

Resellers capture the demand that OEM/Vendors generate through market making activity. There is much contention around the value that is added by Resellers, but ultimately it comes down to Customer Service and OEM/Vendor aggregation or providing a "single source supplier" solution. Typically Resellers value-added-services are logistics, stock-holding, price comparison, product information, professional services and expertise.

Distributors provide a shared resource model to the OEM/Vendors and Resellers. The distributors provide the same services as Resellers and provide them to the Resellers. The Distributors provide a shared resource model to the OEM/Vendors, where OEMs can share warehouse space, account management teams, operations teams, etc. within a region or country with other OEMs. Having a small number of distributors, supplying a large number of resellers reduces the management overhead for OEMs.

If we consider the question of why don't manufacturers sell direct? It is obvious that the OEM can provide all the value added services that the distributors and resellers provide. They can build or provide logistics operations, e-commerce portals, product support services, product experts, account management teams, finance teams, credit control services, etc. They can also go to the trouble of building this globally to the demands of today's global marketplace, so why don't they? Well, some do! However, it is about risk, efficiency and simplicity.

It is risky for an OEM to build all this infrastructure because it is expensive and what happens if your product is not as successful as you planned? What do you do then? In the Direct model, lots of money gets wasted on sales, logistics and operations that could be spent on research and development or building better products for the future. The beauty of the shared resource model is that for a relatively small fee you can keep your options open or close them down.

Another concern is carrying enough products. Few products exist in a monopoly, and no OEM makes everything a customer needs. Typically, products are a member of a family of the goods that exist in a category. An example could be a product like a Personal Computer (PC). This product is a member of a family called End-User-Computing which is a part of the larger category called Information Technology. The End-User will probably purchase hundreds of different products from various OEMs within the category of Information Technology.

If an End-User wants to buy a product, they will seek a company that can supply them. A problem occurs at this stage for a buyer who needs to buy fifty to hundred different products, from various manufacturers, publishers or service providers. If we consider buying direct, the buyer has to deal with a lot of different suppliers, and they have to get answers to many questions. For example, what's the best price for this product? Is the product in stock? Where can I get product knowledge? Whom can I speak to about the product? What happens if something goes wrong? How do I get customer service? Can I get credit terms?

The buyer for the end user, faced with complexity, seeks an aggregated experience. A solution where they can buy everything and get answers to all of the questions mentioned above simply and quickly. When you look at consumers the same is true, hence the popularity of supermarkets, superstores, price comparison websites and online marketplaces such as Amazon, eBay and the like. Buyers will ultimately seek a convenient single source.

As an OEM/Vendor, if you use the channel model (shared resource approach), you release significant working capital and complexity to focus on your core activity which is creating market leading offerings. However, a new threat emerges, how do you make sure the channel partners sell your product? What is stopping the Distributors and Resellers from switching demand for your products to other OEM offerings?

Typically, OEMs attack this problem using a pincer movement. Firstly, they invest considerable sums of money into building differentiated products for the marketplace. Secondly, they work hard to generate demand through market making activities such as advertising, etc. Thirdly, they influence the end user pricing and experience through direct touch account teams. Fourthly, they support both Distributors and Resellers with expertise, funding and account management. Finally, once they have established a significant position in the market, they will start to control distribution with authorised reseller or distributor programs, quotas, development funds and other commitments to impose loyalty.

Another interesting discussion is margins. In many markets, the OEM/Vendor retains the most margin, and the distributors and resellers exist on thin margins. However, this is not always the case. Depending on the nuances of a given market, and particularly when OEMs do not have exclusivity over a product or produce commodities with little differentiation, the reseller or distributor can become very powerful.

The key to the channel and understanding margins is about understanding “who-needs-who-more?” Similar to the principles of negotiation, if you are going to control margins, the other parties in the cycle must have limited options but to deal with you. When you look at most supply chains, someone invariably has the power. In groceries, it is the reseller. In electronics, it is the market leading OEMs, etc.

What is exasperating is witnessing instances of misunderstanding of the Model. The classic is the OEM who does little market making activity and expects the reseller and distributor to build their market for them. Typically, these OEMs will go to market with the false promise of a higher margin opportunity. Why would anyone switch sell an end-user from a requested non-exclusive product to another non-exclusive product when you are operating on razor thin margins? Why interrupt the sale? The Reseller completes the order, maximises margins and moves on to the next deal. That is what resellers do. Furthermore, why would a Reseller or Distributor build a market on behalf of an OEM to lose exclusivity the moment the offering goes mainstream? The correct approach is to generate End-User demand, and the Resellers and Distributors will come to you to provide services.

Another example is the end-user buyer who pressures the wrong party for cost savings and discounts. The key takeaway for Buyers is to discover who in the supply chain makes the most margin and pursue them for discounts. Why? Because if one party has 60% margin and another has 5% to 10% margin - where do you think you are going to get the best discount? That is right! The big discounts come from the people with the most margin at their disposal!

No matter what industry or market, the principles of success in a channel model are as follows:

Vendor or Original Equipment Manufacturer

• "Product-Market Fit."
• Demand Generation & Market Making
• End-User Support

Distributor or Wholesaler

• Best Price Tactics
• Stock and Availability
• Highly efficient operations

Reseller

• Highly reliable and convenient buying and after sales experience
• Breadth and depth of product portfolio
• Competitive Pricing

Is this always true? What about value? There are plenty of companies that sell based on Value in Channel Models!

Value is a fascinating subject! Channel models always involve commodities, and that means that somewhere in the chain a party is faced with a competitor who sells an indistinguishable offering. In these circumstances, people compete on price and availability, and a race to the bottom is inevitable. If you want to make big margins, your value has to be inseparable from the offering and genuinely unique. Value of this nature is rare, and people will often describe it as a "differentiator." Unfortunately, in the game of business bingo, the term "differentiator" is abused, and few characteristics described this way indeed qualify.

In a supply chain, the person that has the power is the person who creates a real differentiator with "product-market-fit."

There will always be anomalies. It is common to find small niche businesses that make large margins where theoretically they should not. Once investigated, you discover people are exploiting market inefficiencies that just can't scale. While enjoyable and profitable for owners, these businesses are focused on relationships and not Value.

Differentiators are often scarce in Channel Models because the model occurs as part of a trend towards efficiency in established markets. Start-ups most commonly create differentiators in acts of revolt against incumbency. There are fewer start-ups in developed markets and therefore little innovation. Most businesses in the supply chain find a "good enough" state that means they are competitive but not unique. They then become obsessed with conserving their position as opposed to doing anything revolutionary. The result is a broad spectrum of "me-too" businesses, largely indistinguishable from each other to an outsider except for name and logo.

Once established, channels are very resilient, despite constant speculation that the structure will erode or dismantle, there are so many personal interests at all levels holding it together. A structure like this that looks ripe for disruption is very robust. Also, the foundation of the structure's existence is efficiency itself, and therefore hard to disrupt.

Ultimately, what destroys these structures comes from End-User behaviour. Quite simply, End-Users start buying different offerings from a parallel supply chain. The result is the incumbent channel starved of revenue and slowly cannibalises itself into something smaller and consolidated. In some cases, you see the total extinction of much of the structure. Good examples to look at are the move to digital download and on-demand services on the retailing and distribution of music, video and television.

It is interesting to review these types of disruption because they invariably come from new market entrants. What happens, is the new entrant creates a parallel supply chain that diverts End-Users into the new channel. It explains the reasons why incumbents fail to react. Incumbents simply can't see the new competitor. The competitor exists in a different universe outside of the incumbent's normal sphere of business and experience. It is like being a fish in a barrel, watching the water level decrease in your tank and trying to find who is taking all the water. Your problem is not in the tank you are in - it is coming from something outside of your tank altogether. As a result, occupants react far too late and essentially have to become a new entrant into what was their market in the first place. An excellent example of someone acting fast to this issue is Microsoft in the cloud business.

The takeaway for those that inhabit channels is to determine the difference between fads and trends quickly, invest wisely, but make bold plays. There are many dead bodies in the graveyard with "its a fad" as an epitaph.

Let me know your thoughts on the subject?

Richard Wilkins is a Consultant, Advisor and Experienced Leader in high growth technology businesses who have scaled globally. Experience ranges from Fortune 500 companies to SMEs. My view: "...everything starts with great Leadership." I focus on Sales Leadership, Commercial Strategy and Sales Operations. Outcomes are High Growth, Scalability and Productivity.  

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