Nine Tips to Avoid Disaster with Retailers and Distributors
Are you a brand ready to take the leap into wholesale? Our Director of Customer Success & Partnerships, Kunal Kohli, shares nine tips from his personal entrepreneurial experience to help you avoid disaster with retailers and distributors.
It’s amazing, you think to yourself, that the healthy snack brand you launched during COVID is taking off and selling out on your online store and now on Amazon. You are one of the millions of new businesses that launched during the pandemic, and you continue to see sales explode. Your marketing metrics continue to improve, customer acquisition costs (CAC) are down, lifetime value (LTV) is up, and now you have a serious business on your hands.
You’ve figured out the eCommerce side of things; now, the next step to prove out and add legitimacy to your business is to sell into retail grocery stores. You visit your local Sprouts and Whole Foods and talk to some employees there. They tell you the best way to get into their stores is to work through a distributor. Some of the store employees tell you to use a local distributor, and some recommend the bigger players like KeHE and UNFI.
Because of the success you have been experiencing online, you want to go big. You research and use your network to get introduced to the buyers of your category at these major distributors. You are lucky enough to secure a meeting and put together an amazing deck that shows how fast the company has grown and how much your customers love your brand. The buyers like what they hear and are willing to take a shot on you and your product.
They send you their standard contract and your excitement at the prospect of getting national distribution overpowers your reasoning. You sign and submit the contract and begin receiving sales orders within a few weeks. You invoice as the product is delivered and are now ecstatic about your future success. Easy, right? No, you’re terribly wrong. If you don’t understand the dynamic of how distributors and retailers operate, you are setting your business up for failure.
Owners and executives of brands you consume on a daily basis can tell you nightmarish stories. I myself have built a brand and can attest that multiple sleepless nights stemmed from stressing about distribution. Many brand owners will admit that it is a constant struggle to manage distributor and retailer relationships. From logistical mishaps that lead to a large deduction to distributors who over-order, the potential problems are myriad, but one recurring theme remains: no matter what the issue - you will get deducted for it.
In order to avoid a deduction disaster when working with retailers & distributors, here are the steps I wish I took before signing them up.
Know Your Margins
Net margins are calculated by taking the total costs to make and ship your product (Cost of Goods Sold or COGS), subtracting it from your wholesale price (price to distributor or direct retailer) and dividing it by the wholesale price. For example: if it costs you $5 to make your product, $1 to pick, pack, and ship it, and your wholesale cost is $10, then your Margin = (($10 - ($5+$1))/$10 = 40%
There are multiple definitions and accounting tricks to get to a NET margin. Don’t play games. Whatever it costs to make and deliver your product to customers is what your COGS are. In order to achieve success, you must have healthy net margins starting at 35% and a clear path to get to 40% or more. If you are struggling to stay competitive at 35% or higher, you need to quickly figure out what you can do to improve your costs or you will continue to lose money.
Know How to Price Your Product
Many brands falter by not understanding pricing strategy. Just because your closest competitor is at a certain price point doesn’t mean that you automatically have the ability to sell at that price. If you are just starting out, you may not have the efficiencies that come at scale. My suggestion is to always work backwards from an SRP (Suggested Retail Price) and make sure that you are achieving:
- The margin requirement of the retailer: Can range anywhere from 40-50%
- The margin requirement for the distributor: 25-35% depending on the level of service to the retailer
- Your margin requirement: Minimum of 35%, 40%+ is ideal
Secure Retailers First
Do not fall for gimmicks that some big distributors promote for newer brands. Many of these programs geared towards eager up-starts have hurt brands more than helped them. I have heard many horror stories about companies getting big orders and little support from distributor sales reps, and at the end of the day, unsold products equal more deductions.
If you want to secure placement with these big distributors, make sure you secure their “Anchor Accounts” first. Anchor accounts are major retailers that make up a bulk of the distributor’s business and/or utilize multiple distribution centers for warehousing and shipping.
Whether it be anchor retailers such as Sprouts, Albertsons/Safeway, and Whole Foods, or larger regional retailers like Stop & Shop or Publix, work with the buyers of these retailers first to secure placement, and let them work on your behalf to open the necessary distribution centers.
My first retailer was Whole Foods nationally; and because Whole Foods wanted my product on their shelves, their primary distributor had to set me up and order according to Whole Foods’ needs. By getting all the distribution centers (DCs) opened up, our team was practically given a hunting license to secure more retailers.
No Contract is Written in Stone
Everything is negotiable, or should at least, be discussed. For example, when I received my first distributor contract, it was 15 pages long. Of those 15 pages, 13 of them detailed all of the deductions we were going to be charged. You read that right; over 85% of the contract highlights all the fees that my distributor was going to deduct. I, along with many others, assumed it was the “cost of doing business” and that you can’t negotiate with their standard contract. Yes you can. Be open and transparent with your SRM (Supplier Relationship Manager). Stress the fact that you are just starting out and want this to be a partnership, not a dictatorship. Set goals and have in writing what happens when you achieve those goals. Get an experienced attorney within the CPG space to redline the contract. Most of the time the distributor will agree to some of the changes and have discussions when certain targets are achieved.
At the same time, there are certain things you cannot negotiate. Pallet configurations, delivery time windows, certain paperwork that needs to be attached to orders, etc. Make sure you know the requirements when it comes to logistics and that the third-party logistics (3PL) or delivery company you are using has experience working with these distributors.
You Don’t Have to Fill All Purchase Orders
A large purchase order from a distributor doesn’t mean that your product is expected to do incredibly well or that you are on a path to make a ton of money. The initial orders that distributors send are guesses generated from category data that may take into consideration how other brands in your category are performing. Stay vigilant. If you feel an order is too large, contact your SRM and buyer to understand where the demand is coming from and how it is being calculated. If you still think it is too big, ask for a reduction. Remember, if your product doesn’t sell or expires before demand hits, you will get deducted for the amount that is not sellable.
Spoils Allowance Is A Savior
Spoils allowance is a built-in deduction for expired, spoiled, or otherwise unsaleable inventory. Some distributors offer this standard in their contracts while others do not. Make sure you have a spoils allowance between 1-2% in your contract. This will automatically deduct 1-2% from your invoices, but it will protect you from being further penalized for expired or spoiled inventory. When there is no spoils allowance in place, whatever the distributor orders is actually on consignment. You may get paid for what you ship in the short-term, but if the product doesn’t sell or expires, the distributor will deduct you for the amount they purchased plus an administrative fee. This fee can range from 5-10% and is added on top of your cost to the distributor! More red ink on your Profit and loss (P&L).
Promotion Schedules With The Distributor Are Not Necessary
If you did it right, and secured an anchor account that is using a major distributor, you do not have to agree to a quarterly promotion schedule with the distributor. Instead, work directly with your retail partner to implement promotions. The retailer will actually prefer this approach as you can work together to get creative with the offer or go deeper on the discount. If you don’t have an anchor account, work closely with your SRM to understand what promotions work best for your specific category. Don’t fall into the trap of having to promote once a quarter. Understand the seasonality of your business and how to make it work in your favor to increase sales. Know your margins, know your price, and know what promotional plan is not going to hurt you, even if it performs well.
Forward Orders on Promotion
Another promotional model that can be problematic for new brands is called forward orders on promotion. When you set a promotion with a distributor that is normally MCB (manufacturer chargeback) or OI (off invoice), there is a time period that the distributor can buy the product on discount from you and have it available for purchase by the retailer on discount.
The “buy in” window for the distributor begins two weeks prior to the promotional buy-in for the retailer. However, some distributors will try to extend their window to stretch into (or sometimes past) the retailer window to procure more goods at a cheaper price.
For example, if the distributor normally keeps six weeks of inventory on hand for your product, they will order 8-12 weeks worth prior to the promotion window ending. They do this to make more money by buying on discount from you and selling at full price to the retailer. The key is to stay vigilant. Question your SRM and buyer as to why the orders have gone up. I have had buyers from major distributors reduce the order quantity after I provided data that showed the order quantities were too high.
Work With The Right People
One of the many mistakes that I made was not hiring an experienced CPG accountant. There are many solid accounting firms like Propeller, Stage 1 Financial, Accru Financial, Pilot, etc. that have experience working with CPG companies. They understand the deduction game and are the first to admit that many distributors keep deductions and payments manual and traditional on purpose.
The codes that are associated with these deductions require the skills of Robert Langdon from the DaVinci Code to decipher. They take time and resources to understand - two things that most entrepreneurs don’t have. The accounting firms can also help you determine if the deductions are correct or not, and regardless if they are correct, dispute them all! I had over $200,000 of deductions from distributors combined in the first six months of 2020.
I disputed and fought them all, even if I knew some were correct, and was able to recover over 20% of those deductions. I put over $40,000 back into the business because we proved that some of the deductions were duplicates, incorrectly charged to our account, or charged due to events that did not happen.
While this piece may seem particularly critical of the major distributors, rest assured there is still a time, place, and even a critical need for them. Every business relationship, like personal relationships, needs some TLC. The more you know about entering into a working relationship with distributors/retailers, the less shock and loss you will endure.
It is true that these distributors and retailers work on thin margins. It is also true that the impact of COVID has strained their operations and increased costs just like it has for brands. My recommendation is to be as open and transparent as possible about your business and goals. Advocate for your business and never assume that simply because you are just starting out, you have to accept unfavorable terms.
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