Advantages and disadvantages of partnering with a distributor for your China business
The Chinese market offers incredible business opportunities but going at it alone can turn out to be a difficult enterprise.
However, utilizing an infrastructure and logistical know how that already exists in your target market may prove to be more of a time and cost-efficient strategy. This is where distributors come to play.
The distributor model allows businesses to leverage local expertise and knowledge, and is a popular method adopted by many foreign companies and brands. Finding the best fit partnerships is critical to your business success, as is effective communication to ensure clarity and transparency.
When it comes to China, leading a group of workers with different cultural nuances and the demands of such a venture can be overwhelming for a foreign company. Working with a local distributor to grow your business means instant market familiarity and exposure, among other advantages.
In China, many foreign companies are marketing their brands beyond the major cities to meet growing demand. More than 160 Chinese cities have populations of at least 1 million. Some companies, such as Adidas and Nike, already have strategies to penetrate smaller cities.
These developments and forecasts imply that businesses in China will need to greatly expand and strengthen their distribution and logistics capabilities, whether on their own or through third-party providers.
There are several significant benefits of working with a local distributor. Some of these are increasing revenue, expanding brand awareness, benefiting from a local presence, and leveraging existing contacts.
A local distributor can help you access a wider network of customers and channels in new markets, which can be extremely lucrative. They can also increase the market exposure of your brand thus making it more recognizable and accessible by larger number of customers, inadvertently resulting in better brand awareness.
Distributors in China are familiar with the characteristics and idiosyncrasies of the local market, and enjoy existing and established business relationships and networks, allowing them to quickly promote new products in their areas.
In general, distributors have processes and teams in place that know how best to sell to their customers, and deal with local customs and regulatory requirements. This helps businesses increase sales and make significant financial savings since they do not have to acquire additional premises and staff.
Another benefit of partnering with a distributor is that they are aware of the restrictions, regulatory licenses/quality standards and laws applicable to a product in the country.
Efficient and motivated distributors can make a significant contribution and impact to the potential success of your international expansion venture. Nevertheless, you should be aware of the drawbacks and disadvantages to working with distributors in international markets.
If you decide to partner with a distributor, you will have to accept a certain loss of control over a few variables. Being detached at a local level can result in a number of challenges, such as identifying whether your products are a good fit for the market, or whether your distributors are selling through the most effective channels.
The distance, both geographical and operational, from your target market can cause a series of problems, such as the lack of brand control. When your brand is not presented to the standard and quality that you would like, this may affect your brand reputation.
Other problematic area includes the executed channel strategy. Are your distributors selling through the most effective and optimum channels, and are they aggressively promoting and selling your products effectively?
Companies must analyze potential distribution partners, paying attention to material movement within China, because poor inventory positioning and stock-outs can harm brand reputation.
In general, distributors represent thousands of products and brands. They may invest more time and effort in the products that offer the highest profits or focus on product portfolios that do not prioritize the items that you are trying to sell. This can result in a lack of drive behind your brand, and poor market optimization to promote and sell your products in their local market.
Distributors partner with companies to generate profits. This can result in some distributors requiring margins as high as 30%. Some of them, due to their market share, revenue, and market dominance, can be quite aggressive with their margins, thus resulting in negative margin impact on your business.
Leveraging existing relationships may have its advantages, such as quick route to market and generating revenue efficiently. However, distributors working with existing relationships and networks may miss out on key market opportunities, to sell through more relevant channels or to a more profitable client base.
Although the security and proper handling of goods is in the best interest of distributors, the lack of control over the logistics and storage of your products can lead to problems and loss of stock that is out of your control.
In many cases, responsibility for distribution operations is initially placed on the distributor without identifying clear procedures and targets. Companies that use material flow mapping, particularly in rural China, and that have fairly sophisticated logistics, in-transit inventory, and distribution capabilities are likely to be more efficient at delivering goods on time and with minimal loss or damage. Mapping helps identify each part of the supply chain and which stakeholder is accountable for what.
Securing the right terms for your distribution agreement is crucial to your company’s ongoing success. An important question to ask is if you want to appoint a distributor on an exclusive or a non-exclusive basis.
The benefits of providing exclusivity can prove attractive to potential distributors and can be tied into achieving sales targets.
However, you may find it more beneficial to appoint a number of distributors in the same region on a non-exclusive basis, so they can work together and pool resources to market products in the same territory.
The distribution agreement should certainly include minimum sales targets. By setting out what you expect to commercially achieve throughout the agreement allows you to monitor the distributor’s performance and gives clarity to their obligations from the very beginning of the agreement.
It is crucial in China to protect your brand. Your distribution agreement should consider who is responsible in the event of a third-party bringing a claim against distributors for products infringing on third-party intellectual property rights.
The agreement should also explain clearly that distributors must obtain the supplier’s express permission before they distribute any marketing materials containing the supplier’s trademarks or make any claims or statements regarding the fitness or suitability of products for their customers.
Companies should not assume that Chinese distribution partners have advanced knowledge of downstream supply chain management, including the ability to forecast accurately or to assess service levels.
Operationally, this means that foreign-invested manufacturers and foreign companies that sell to China must invest more capital and time to transfer knowledge of material movement requirements, especially improvement strategies to reach key performance-indicator goals.
If rapid expansion in China is the goal, the company should focus on improving flexibility in distribution scheduling, placing inventory closer to the customer, and buffering lead times. Ready-to-use contingency plans, including scenario-based strategic decision making, should also be in place to respond to delays.
As a whole, Chinese distribution companies lack the capabilities of world-class logistics and supply chain companies in more developed economies. In particular, they tend to be weak in inventory management, lead-time planning, distribution network optimization, and demand forecasting.
Localized demand forecasting is also underdeveloped in China. Many distributors are, in fact, investment companies that purchase and resell products. Few Chinese distributors have sophisticated knowledge of demand forecast planning. They often exclude important variables such as seasonality, product cannibalization, and forecasting cycles.
When working with local distribution partners, foreign companies should determine how sophisticated the forecasting tools used by their downstream networks are. To reduce risk, foreign companies should also factor in additional time and costs when planning to supply the China market.
As with any strategic decision, international expansion and distributor partnerships require thorough due diligence to ensure investments are made with a deep understanding of all the potential opportunities and threats.
Before setting off down the distributor route, it is important to enter into a clearly written distribution agreement with your chosen distributor to steer clear of any pitfalls that can be associated with overseas trading.
With a robust distribution agreement in place, the next step is to perform some careful background research to appoint a distributor with a good reputation within the targeted geographical area and industry. Due diligence will help you find the most suitable, effective partners possible that meet your strategic objectives.
It is clear that the use of distributors can provide a relatively low risk, cost-effective solution to breaking into new, expanding overseas markets and can offer a great many tactical and logistical advantages compared with selling direct.
Negligence of the fundamentals can result in costly mistakes, resulting in loss of capital and time, however, the upsides are extremely attractive if executed properly.
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DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.