Value Chain Part 1: Distributors are Doomed

I love microeconomics. It is the poetic study of players in a market, their motives and their reasoning behind decisions. It is the foundation of business game theory.

A key principle of Microeconomics is efficiency. In a competitive market profitability erodes. Players inevitably compete on price, creating pressure for all links of the value chain to reduce cost - from the contract manufacturer, to the brand, to the distributor, to the retailer. The weakest links within the value chain will be removed as companies vertically integrate, reducing unnecessary costs and shortening the distance between the manufacturer and the consumer.

Within the outdoor sporting goods market this law of efficiency has driven three key movements of the last ten years: (1) the demise of the distributor (2) the rapid growth of private label and (3) the emphasis on direct-to-consumer business. For today, let’s talk about distributors.

In short, distributors are doomed.

Distributors once provided a critical value to the market. As brands focused their sales and customer service resources on their top retail customers, they offloaded management of smaller retailers to distributors, reducing their overall cost-to-serve. Distributors in turn provided smaller retailers with access to brands that they otherwise would not be able to carry, given their lower volumes and purchasing power.

In the past ten years, this model has been flipped on its ear. Why?

1. E-commerce Price Erosion and the Necessity of Pricing Policies

E-commerce players, cemented by Amazon, severely disrupted retail pricing models. Amazon took such low margin that it was selling products for prices equal to or sometimes below the wholesale cost independent retailers were paying from distributors. These retailers then demanded profit protection and threatened to drop brands that could not provide price integrity.

Brands were faced with a decision. The only way to maintain the high volume of Amazon and not lose business altogether from retail was to introduce distribution and pricing policies such as MAP (Minimum Advertised Price) or UPP (Unilateral Price Policy). The linchpin to any such policy is enforcement. Having a distributor in between the brand and the retailer creates a barrier to such enforcement. How does a brand cut off supply to a violating retailer if they cannot control who receives product?

2. The Decreasing Cost-to-Serve

Rather than run their own fulfillment operations, brands discovered that they could outsource the picking, packing, and shipping of orders to logistics companies. By outsourcing fulfillment, brands could reduce both their overhead and their transaction costs.

Serving independent retailers directly does not require more customer service manpower. A brand’s options in terms of digital solutions are endless. Many brands now have B2B functionality build into their own ecommerce sites. There are also outside B2B solution providers such as Handshake and Shopify that empower independent retailers to order directly from the brand.

The Exceptions

As with any hot take, there are exceptions to the assertion that distributors are doomed.

Some product categories face complexities that make them less susceptible to ecommerce disruption. Firearms sales require an FFL background check, which must happen in-person at a retailer, pawn shop, or gunsmith. Compound bows and higher-end bicycles require a customer fitting and tuning before the consumer is ready to use the product. The necessity of service and expertise reduces the power of Amazon and other ecommerce players.

Distributors can also provide plug-and-play solutions for SKU-intensive product categories. Maurice Sporting Goods specializes in curating regionally relevant tackle assortments for sporting goods retailers, alleviating the logistical burden and need for expertise on the part of the retail buyer.

These market-specific intricacies are not a guarantee for success. Within the cycling market, QBP has moved toward vertical integration, launching their own house brands such as Salsa Cycles. Longtime firearms industry stalwart Ellett Brothers declared bankruptcy in 2019, even after years of record firearms sales. Maurice Sporting Goods was purchased by its once rival, Big Rock Sports Group, in 2017.

So, do you disagree? Am I out of my element? I’d love to hear your comments.