How to make profitable your distribution business?

How to make profitable your distribution business?

As a company that supply solutions to distributors, 3PL’s and wholesalers, we know all different models used in the distribution business, and we suffer when we see one of our customers struggling to barely get a 1% or 2% net profit. In this article I will analyze different distribution models and give you some options to make your distribution business profitable.

How does a distribution business work?

In general terms, a distributor is an entity that buys noncompeting products or product lines and sells them direct to end users or customers.

From the type of products distributed we can group distributors in 3 categories:

• Food products
• Non-food consumable products such as toilet paper, bath products, electronic accessories, etc.
• Non-food lasting products, like refrigerators, furniture, etc.

Pros of a distribution business

There are 3 good things that we can say about a distribution business that is generating profits and whose portfolio consists mainly of consumable products.

• They are pretty inelastic to changes in economic conditions: take as an example the COVID pandemic and closure of 2020. Many businesses were forced to close but distributors and supermarkets strived, because people could not go to the office, or restaurants, but they needed to eat and shower and change the baby’s diapers.
• Customer’s base is very stable: For a new distributor it might take a while gaining access to big retailers such as Walmart or Publix; but once they do it will be a long lasting relationship, as long as you deliver. So, because the contracts that you have with your customers are so long-standing that the probability of you ever losing a big customer is very small which means that your business will likely be around for decades.
• High intangible assets value: Once a distributor is profitable his assets will be growing in value with time. But more than the inventory and the warehouse, it is the customer base and the quality of the brands represented what have the highest value. As I said before, gaining access to the big retailers takes time and money. For a newcomer wanting to enter into the distribution business it makes sense trying to acquire an existing distributor with a stable customer base.

Cons of a distribution business

Let’s talk now about the potential and factual negative points that can drag a distribution business.

• Distribution can be an expendable business: If your distribution business limits to just move products from point A to point B, without any significant added value, then you face the risk to be replaced by another distributor that have added value. For example: supposed that you sell cookies of a non-leading manufacturer on a non-exclusive basis. What will do your customers if another distributor comes along offering the same type of cookies plus a more varied portfolio? They will most likely phase you out.
• Decreasing profit margin: A corollary of the just described issue is that you’ve got a lot of competition and what that competition does over time is forcing your profit margins down. It is not that that you have a bad business model; it is just that your customer knows what you are paying your vendor and what your margins are and that they know they can get your product from someone else cheaper. So they squeeze and squeeze until you’ve got no profit margins left.
• Expensive infrastructure: A distribution needs a lot of resources in order to efficiently manage the business:
  • Large warehouse
  • A warehouse management system
  • Trucks to deliver products
  • Technology to manage the inventory
• Pressing cash flow: any business need to have a positive cash flow in order to survive. What this means is that you need to sell whatever your product is and collect the money before you have to pay your supplier. In the distribution industry that is not straightforward. The figure below illustrates the money cycle of a typical distribution, assuming that:
  • The average delivery of new orders from suppliers is 30 days
  • It takes you 30 days to sell the products purchased
  • You have a 30 days credit line with your suppliers.

Under these assumptions you need to negotiate with your vendors a 90 days credit line for twice your average monthly sales, which is no easy.

Options to make your distribution business profitable

If you feel connected with the scenario depicted in the previous sections then it’s time for you to be thinking in strategies that allow you to increase your profit margin. I will suggest three possible course of action to consider, based on the potential cons of the business

• Make your warehouse space productive: The average distributor has spare space in the warehouse. Why not convert this idle space into a profit center? The global third-party logistics market size was valued at USD 956.80 billion in 2021 and is expected to expand at a compound annual growth rate (CAGR) of 8.6% from 2022 to 2030. The W&D (warehousing and delivery) and Value added sectors account for 20% of this growth. Why not take a portion of this growth to make your warehouse more productive? I have customers that manage to get 100% truck occupancy by becoming delivery channels of big e-commerce companies.

• Diminished dependency on suppliers: If your margins are decreasing due to price dumping of competitors you need to consider ways to counteract this trend. The most typical ways to do it is having your own brand. There are two ways to do that: negotiate a customized product relationship with your vendor or manufacturing your own products. The advantage of the former is that it does not involve investment on manufacturing structure, but the disadvantage is that you still depend on a vendor. You also face the risk of a failing product.

What stablished companies normally due is staring with and OEM agreement of successful products and at some point, when the cash inflow justifies it, step into manufacturing it.

• Explore complementary markets: Traditional distributors dwell in delivery to stores. But one of the learnings from COVID pandemic is the huge opportunity for email sales to end users, levering on the variety of existing technologies that integrate with WMS systems.

I hope this article on the WMS about the distribution industry has been helpful to you. I will continue posting information related to warehouse management, distribution practices and trends, and the economy in general. If you are interested in this article or want to learn more about Laceup Solutions, please subscribe to stay updated on future articles.

There is a lot of relevant information on our channel. Check out this video related to the distribution industry.