Executive Briefings

Rethinking High-Tech Distribution

Companies that make computing, telecom, and networking equipment have in recent years improved their ability to sell directly to customers or to resellers, either online or through their own sales forces. Accordingly, they have worked to become less dependent on their old distribution partners. The new approach works well for selling to big customers in developed economies. But as OEMs look for growth in new markets, they should take a closer look at the value offered by some distributors--particularly those known as two-tier distributors--so named because they buy from manufacturers and sell to resellers.

Two-tier distributors are well positioned to boost sales in emerging markets, where these distributors' revenues have grown by 33 percent annually for the past five years. What's more, in both the developed and the developing world, such distributors can help manufacturers sell to small and midsize enterprises--for they control 42 percent of all distribution to that market--which is growing by 7 to 10 percent annually, according to recent reports by the industry analysts Raymond James and IDC.

Two-tier distributors do well in these markets for several reasons. For one, deals are smaller, so the cost of a manufacturer's direct sales force is prohibitive in comparison with the cost of using a distributor. Such distributors sell multiple brands of hardware and software so they can gain scale and serve these markets more effectively. They also have well-established and integrated networks of value-added resellers (VARs) focusing on specific customer segments, geographies, and industries. Small and midsize enterprises prefer to buy from these small resellers, which understand their needs and are often located nearby. Further, local resellers are better at assessing credit risk in emerging markets and are more likely than large manufacturers to finance smaller deals. Finally, manufacturers sometimes have considerable difficulty forecasting sales in developing economies and building the necessary expertise to address them. A distributor with a network of resellers can mitigate credit risk for manufacturers by taking some of that risk on its own books and tap the local market knowledge of its resellers.

Some manufacturers are therefore finding that two-tier distributors and their reseller networks are the key to success in rapidly growing emerging markets and in the small and midsize segment. Manufacturers should therefore view these distributors as a strategic asset and invest in them to build strong and mutually beneficial partnerships.

Manufacturers can help to reduce the working capital distributors need by making products available with minimal lead times. They could also sell products to distributors at a lower upfront price rather than a higher one with a rebate (a common practice). The lower price reduces the value-added import tax that distributors must pay and eliminates the opportunity cost of capital that is associated with waiting for rebate payments. When credit is tight, manufacturers can extend more generous terms to help distributors carry a larger inventory and boost sales.
Over the long term, manufacturers can do even more. They can help raise demand by providing sales and marketing collateral for products and services and by providing access to demonstration centers. They can work with distributors to develop new bundles or solutions customized for certain markets (such as low-cost ones) or industries. If distributors and resellers fear channel conflict, a manufacturer might declare certain markets or segments off limits to its own sales force.

A manufacturer that proceeds along these lines should of course have something more than mere hopes for reciprocation; it might, for example, ask a distributor for exclusivity within a certain product niche. It could also work with its distributors to set goals for the reinvestment of their savings. One OEM, for instance, has asked distributors to reinvest some of their savings in activities that could raise sales of the OEM's products by up to 15 percent or more, to the benefit of both sides.

Some of these activities are contrary to the way many manufacturers now conduct business in these markets. But companies that recognize the value a distributor can bring to the table will invest in such partnerships rather than ignore them.

About the Authors: David Doctorow is an associate principal in McKinsey's Silicon Valley office, where Matt Lippert is a consultant and Vats Srivatsan is a principal. The authors would like to acknowledge the contributions of Bob Dvorak and Eileen Lau to this article.
McKinsey Quarterly

Companies that make computing, telecom, and networking equipment have in recent years improved their ability to sell directly to customers or to resellers, either online or through their own sales forces. Accordingly, they have worked to become less dependent on their old distribution partners. The new approach works well for selling to big customers in developed economies. But as OEMs look for growth in new markets, they should take a closer look at the value offered by some distributors--particularly those known as two-tier distributors--so named because they buy from manufacturers and sell to resellers.

Two-tier distributors are well positioned to boost sales in emerging markets, where these distributors' revenues have grown by 33 percent annually for the past five years. What's more, in both the developed and the developing world, such distributors can help manufacturers sell to small and midsize enterprises--for they control 42 percent of all distribution to that market--which is growing by 7 to 10 percent annually, according to recent reports by the industry analysts Raymond James and IDC.

Two-tier distributors do well in these markets for several reasons. For one, deals are smaller, so the cost of a manufacturer's direct sales force is prohibitive in comparison with the cost of using a distributor. Such distributors sell multiple brands of hardware and software so they can gain scale and serve these markets more effectively. They also have well-established and integrated networks of value-added resellers (VARs) focusing on specific customer segments, geographies, and industries. Small and midsize enterprises prefer to buy from these small resellers, which understand their needs and are often located nearby. Further, local resellers are better at assessing credit risk in emerging markets and are more likely than large manufacturers to finance smaller deals. Finally, manufacturers sometimes have considerable difficulty forecasting sales in developing economies and building the necessary expertise to address them. A distributor with a network of resellers can mitigate credit risk for manufacturers by taking some of that risk on its own books and tap the local market knowledge of its resellers.

Some manufacturers are therefore finding that two-tier distributors and their reseller networks are the key to success in rapidly growing emerging markets and in the small and midsize segment. Manufacturers should therefore view these distributors as a strategic asset and invest in them to build strong and mutually beneficial partnerships.

Manufacturers can help to reduce the working capital distributors need by making products available with minimal lead times. They could also sell products to distributors at a lower upfront price rather than a higher one with a rebate (a common practice). The lower price reduces the value-added import tax that distributors must pay and eliminates the opportunity cost of capital that is associated with waiting for rebate payments. When credit is tight, manufacturers can extend more generous terms to help distributors carry a larger inventory and boost sales.
Over the long term, manufacturers can do even more. They can help raise demand by providing sales and marketing collateral for products and services and by providing access to demonstration centers. They can work with distributors to develop new bundles or solutions customized for certain markets (such as low-cost ones) or industries. If distributors and resellers fear channel conflict, a manufacturer might declare certain markets or segments off limits to its own sales force.

A manufacturer that proceeds along these lines should of course have something more than mere hopes for reciprocation; it might, for example, ask a distributor for exclusivity within a certain product niche. It could also work with its distributors to set goals for the reinvestment of their savings. One OEM, for instance, has asked distributors to reinvest some of their savings in activities that could raise sales of the OEM's products by up to 15 percent or more, to the benefit of both sides.

Some of these activities are contrary to the way many manufacturers now conduct business in these markets. But companies that recognize the value a distributor can bring to the table will invest in such partnerships rather than ignore them.

About the Authors: David Doctorow is an associate principal in McKinsey's Silicon Valley office, where Matt Lippert is a consultant and Vats Srivatsan is a principal. The authors would like to acknowledge the contributions of Bob Dvorak and Eileen Lau to this article.
McKinsey Quarterly