Pricing Must Account for Distributor Margins

A pricing strategy that does not provide sufficient margins for the distribution channel to be profitable is a strategy for failure.

Many technology companies, particularly technology leaders, mistakenly believe that distributors are taking money that the inventors rightly deserve. This lack of appreciation for the distributor's contribution leads to margin pressure that can cripple the channel and the manufacturer.

The Distributor's Reality:

• High Costs: Distributors have very high costs of doing business (inventory, warehousing, order processing, service) and typically earn very low net profit margins (e.g., 5% pretax).
• Value-Added Services: The margins paid to distributors are not pure profit; they are spent on providing services that customers value, such as local inventory, credit, and administrative savings.
• Weak Channels Need Margins Most: The weakest distributors are the most desperate for margin, and they are often the only ones who will tolerate a supplier's low-margin policies. This creates a weak and ineffective channel.

The Strategic Use of Margins:

Competitors, especially market followers, can use generous distributor margins as a powerful competitive weapon. A high margin gives the distributor a strong incentive to push that product line, effectively buying the distributor's loyalty and sales effort.

A company that fails to provide for its distributors will find itself with a weakened channel that is highly susceptible to being co-opted by a competitor with a more enlightened margin policy.