How important should price be when selecting your electronics distributor?
For procurement decision makers, selecting which distributor you use can impact your company’s bottom line…and your career. In her first article in a four-part series Asia-based procurement professional Ping Wang helps purchasing professionals evaluate distributors when considering price as a key decision factor.
A technology manufacturer’s sales channels and selling strategy are both carefully designed with one not being independent of the other. Your electronics distributor plays an important role in the electronics components segment of your enterprise supply chain and the distributor you choose can adversely impact these channels and resulting sales strategy if your decision process is not approached adequately.
Writing this article from an OEM’s perspective, we, as customers should understand the electronics distribution market and become familiar with helpful channels as well as how to evaluate and select a suitable distributor whose capabilities are in line with our corporate business objectives.
A thoughtfully selected distributor will create more opportunities for your company’s competitiveness in industry to help further enhance your overall corporate procurement strategy. (See, also: 7 China purchasing, supplier mistakes to avoid)
In the first of a series of four articles, I hope to inform you about distributor selection best practices and share helpful tips I’ve learned when considering a distributor based on price; geographic coverage (i.e., global or regional), the spectrum of products and services a distributor offers, followed by the fourth article in this series focused on a distributor’s capability to cooperate with your company’s strategic vision.
First, we can hardly talk about distributors without first understanding the original equipment manufacture (OEM).
Normally, if a big portion of your spending goes toward a specific product line, or brand, you would most likely explore the possibility to purchase directly from the OEM (e.g., Cisco, HuaWei and Lenovo, first, to enjoy optimal pricing and terms.
Otherwise, you are purchasing from distributors and therefore you are faced with distributor selection decisions based on the following conditions:
- You have significant purchases with a high amount spend for a specific OEM brand. Meanwhile, the OEM does not sell direct, or you decide not to purchase from the OEM directly due to pricing, terms…
- You have non-significant, infrequent, or sporadic purchases so instead of bothering to approach a new OEM, you would rather have one supplier / distributor handle all diversified brands for you.
- You have purchases with complex government regulation compliance requirements (e.g., custom clearance, tax claim processes) and you prefer the distributor provides these services to you.
In any of the situations above, price is always going to be an important factor in distributor selection. We next look at the nature of distributor pricing.
In reality, it is meaningless to study price alone because price is always dependent on service agreement terms and quality of services you enjoy, including but not limited to, product quality; billing and payments, delivery logistics, tax inclusion…
You have to always take the items above into consideration, together with price, in the overall evaluation of a distributor.
Looking at price at a high level, before you begin pricing comparison among distributors, let us first understand how distributors make a profit.
In most cases, distributors cooperate with OEMs on sales strategy. Besides charges of technical services distributor provides as related to the product such as design, installation, customization and integration etc. or other services like logistics etc., there are basically two ways distributors make a profit: markups and rebates.
Some readers may feel no interest in wanting to understand the details involved regarding how a distributor determines his markups or rebates and may to think about comparative pricing of various distributors simply on a parts- / components-, or services-level.
However, your supplier evaluation program will be more effective, and accurate, if you can understand the different pricing methods distributors use which should be taken into consideration in your distribution selection. This also helps you to achieve a more effective and generic (think: apples-to-apples) comparison on distributors’ prices.
We look at markup and rebate, in detail, first.
Markup is the difference between a distributor’s purchasing price (his cost) to produce a product or service and the price he charges to sell it to you. Every distributor applies a well-defined markup (or increase) amount to the products and services he sells to customers.
Before the distributor applies his markup he has to clearly identify and document whatever his internal cost of acquisition is from OEMs before applying his markup which determines the price he is willing to sell it to you.
Markup mechanisms are easy to understand and it is important to realize a distributor must turn a profit in order to remain in business.
However, we may still fail to benefit from markups, as a customer, in business atmospheres where openness and trustworthy communication does not exist between you and the distributor. (See, also: A better AVL in 5 steps that also improve your electronics supply chain)
Always try to encourage your distributor to be honest with you about disclosing their actual purchase price [for acquisition] whenever he sells to you while making a profit by means of a markup.
Markups can be negotiated with distributors and you should do this when possible because doing so will help you achieve a ‘best price’ scenario when looking at your line item, and overall spend, long-term.
Because of this, I encourage you to regularly analyze your transaction spend with your distributor accompanied by always striving toward open and honest communication.
Distributors earn rebates from their OEM partners whenever a distributor reaches a level of sales volume for that OEM. These rebates are normally shared with distributors after the OEM’s sales figures for a period of time are published (e.g., quarterly, annually).
When applying rebates, the distributor applies a different deformation of price:
- The selling price from the distributor to you (your cost) is still comprised of the cost plus markup. Any rebate OEMs do award a distributor are not passed to the customer.
- Contrary to the above, there is a situation where a distributor may provide a rebate to customers periodically, but only after the OEM awards his rebate to the distributor. The final (overall) price the customer receives is, where:
Distributor Acquisition Cost + Markup – Rebate = Customer Price
- The distributor’s selling price is defined by the OEM. For example, the OEM defines that its distributor should sell at a 15% discount off the OEM published list price while the distributor’s cost is a 17% discount off the OEM published list price. So, actually this is still a purchasing price plus markup model.
- In special cases, markup could = zero. The distributor sells to you (customer) at the same price equal to his acquisition cost from the OEM and therefore his only profit is a result of the OEM’s rebate.
- Although distributor benefit from OEM rebate afterwards, it makes an in advance overdraft based on rebate experiences and quote you low markup taking future rebate expectation into consideration.
Price comparison among distributors
Comparing price is a critical step in selecting distributors. You must determine what is the basis you will use to compare prices among distributors against? Below are two different methods with pros and cons. (See, also: AVL segmentation part of CPO strategy for competitive supply chain management)
Sample parts price comparison
In this method, procurement creates a list of selected samples representing historically frequently purchased parts that you then send to distributors for quotation. You then compare prices quoted. Part-by-part.
One benefit to this approach is you do not need to understand how each distributor generates their quote. You just examine the final price (cost) and select the distributor offering the best price. One shortcoming to this approach is that in your final contract agreement with the distributor, strictly speaking, only the sampled parts’ whose prices are examined and compared can be contracted.
Plus, no precedent can be established (and documented) and later applied to pricing in your contract agreement with the distributor for alternate parts outside of this sample group. Any purchases outside of this sample group could be troublesome.
Market and rebate composite comparison
Apply your understanding of markup and rebate, you ask both OEM and distributor to declare their pricing mechanism. You can then use markup and rebate as the object for bidding.
An important prerequisite of this technique is that the purchasing price for all distributors (from the OEM) should be the same. Then, and only in this situation, the distributor with the lowest markup and rebate combination is guaranteed to offer the best price.
Meanwhile, if the purchasing (acquisition) prices for distributors with respective OEMs is not the same the distributors’ purchasing prices (i.e. cost) should also be considered in the comparison. This overall approach will give you more confidence in distributor price management and future cooperation development trends.
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