Direct Vs. Indirect Distribution

by Jessica Mendiola, Audit Manager at Sensiba San Filippo

We are living in an age of convenience — a time where just about anything can be ordered online and delivered straight to your doorstep. As more consumers choose the convenience of online outlets over instore retailers, manufacturers are flocking toward selling their products on an easy-to-use online platform. Aside from ditching the storefront, there are some important things to consider when moving your distribution to the internet.

While distribution channels have not largely changed over time, the demand of consumers to have fast and convenient delivery has become the norm. Amazon.com and other online shopping outlets have become the choice for shoppers and therefore the necessity for companies to adapt to. Even the fresh food industry has been shook by Amazon Fresh and meal distribution companies like Blue Apron. How does this affect your distribution strategy?

There are two types of distribution channels: direct and indirect. As the names would imply, direct distribution is a direct sale between the manufacturer and the consumer, and indirect distribution is when a manufacturer utilizes a wholesaler or retailer to sell their products. There are pros and cons associated with either method, and deciding the right choice for a business heavily depends on the trends and preferences of the consumers.

Direct Distribution.

This relationship-driven model gives companies complete control of the overall consumer process. They control the consumer experience, the brand image as well as have the added benefit of direct interaction and relationship building with the consumer. This control also eliminates intermediaries, thus reducing outside fees like commissions, broker fees, and reduces allowances such as advertising and promotional expenses.

On the downside, with great control comes great responsibility — and risk. In a direct distribution setting, the company bears 100 percent of the financial risks. Selling directly to consumers requires impeccable documentation and tax records due to the increased likelihood of an audit. The startup cost for direct distribution will also be much higher depending on the necessity to purchase delivery trucks, equipment, warehouses, etc. This cost generally pays off down the road, but requires significant capital upfront.

When it comes to selling products online, it’s important that the customer’s shopping cart show instant, accurate sales tax calculations — which need to be monitored for current rates and taxation rules. Final prices must also consider individual state taxes and exemptions. For this reason, many direct distributors purchase technology to automate their operational and financial processes to reduce error and labor costs.

Indirect Distribution.

With indirect distribution, companies gain a significant competitive advantage. They gain access to an increased consumer base without the challenge of getting the customer through the door. This grants them more time to focus on their product, their customer base and increasing the range of their target consumer. The startup cost will be lower, and the relationship generally makes the process much simpler for the distributer. Additionally, since sales tax is only required to be paid once, selling to third-party distributers will likely lead to an exemption of sales tax under the resale exemption.

While having access to a third-party’s logistics and system planning has its benefits, utilizing a retailer or wholesaler has its price. Outside costs like commissions, broker fees and allowances can greatly affect the bottom line. There is also a constraint on the company’s freedom to set prices. Companies need to factor in these costs and ultimately weigh them with the benefits.

Choosing between indirect and direct distribution ultimately relies on the wants and needs of the target consumer. As a whole, people currently favor online shopping over retail shopping. However, specialty items or luxury brands generally require a more interactive experience with hands-on assistance. On the other hand, online shopping allows for increased transparency, which is a huge factor for consumers looking to compare reviews or search for the lowest price. A study by Pew Research Center indicates that 40 percent of U.S. adults always check online ratings before purchasing a new product. Even if the product is ultimately purchased through direct distribution, the chances of the consumer reading online reviews before purchase is not something to ignore.

 

Jessica Mendiola is an Audit Manager at Sensiba San Filippo. She specializes in audit and advisory services for manufacturing and distribution, technology and clean tech companies. Jessica can be reached at 935.271.8700 or at jmendiola@ssfllp.com.

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