A “channel” refers to a method of distribution that puts your product in the hands of customers. There are many different sales channels. Most businesses start out selling their products through a single channel. This channel could be a store, a website, or a distributor. But as time passes and the business expands, new channel opportunities present themselves. When selling through multiple channels, sales and marketing decisions become more complex. Without a proper understanding of the economics of each channel, you could hurt the profitability of your business unnecessarily.
What are channel economics?
Channel economics refers to the financial costs and benefits inherent to
a particular sales and distribution channel. It answers the question: All customers being equal, how much does it cost our company to sell via one channel versus another? By analyzing the economics of each channel, it becomes evident which channels yield the best profitability.
Example
Quivora Company sells a cellphone case which is waterproof, shockproof, and staticproof. The case retails for $40 and costs $10 to make. The company currently sells 1 million units per year via its e-commerce website, and 1 million units per year via its network of retail distributors across the country.
Via its website, the company makes a $30 gross margin on each case it sells for a total of $30 million. Via its retail distribution network the company also makes a $30 gross margin but must also offer a $10 discount to distributors, generating a margin of only $20 million.
On first glance, the website is without question the more profitable channel, offering an extra $10 in margin per case. Many companies only take channel economics analysis that far. But it’s important to go farther.
Deep dive into channel economics
Upon further research, Quivora’s director of marketing found some interesting data:
- 15 percent of the cases sold via the website go unpaid due to payment fraud
- 50 percent of the cases ordered over the website qualify for free shipping due to web coupons, which costs the company $8 per case that qualifies
- The cost of shipping inventory in bulk to distributors only adds $1 per unit
For the e-commerce channel, the economics now look like this:
- Revenues: $40 million
- Less COGS: $10 million
- Less discount to distributor: $0
- Less loss due to no payment: $6 million
- Less cost of shipping: $4 million
- Channel margin: $20 million
- Channel margin per unit: $20.00
For the retail distribution network, the economics now look like this:
- Revenues: $40 million
- Less COGS: $10 million
- Less discount to distributor: $10 million
- Less loss due to no payment: $0 million
- Less cost of shipping: $1 million
- Channel margin: $19 million
- Channel margin per unit: $19.00
As this simplified example indicates, the e-commerce channel is only marginally more profitable when all channel-related costs are taken into account. The management decisions that will be made as a result of this more thorough analysis will be far different.
Switching channels
After completing a channel analysis that shows that one channel is more profitable than another, many companies make the decision to start shifting all new sales generation efforts to that channel. It doesn’t always work. Many times it is more effective to shift existing customers to the new channel because it poses less of a risk. Established customers already know you and your company so fulfilling their buying needs in a new way isn’t asking for too large a leap of faith. But asking new customers with whom you don’t have much of a relationship to switch to a new channel may be asking for too much.
Finding the optimal mix of sales channels takes time and requires thorough research and continual testing. Start now!
