First Learning about Supplier Relationships
I started my first eCommerce business with two cofounders as a college sophomore at Quinnipiac University in 2010. I was studying economics, business, and mathematics. I had a fixation for the Internet.
As Amazon started to make eCommerce a global phenomena, I began learning about the ins and outs of supplier relationships. When we first started, we were buying textbooks back from students at prices higher than the bookstore could offer. We would list the books online and ship them to our Amazon customers.
In this column, I’ll define the supplier relationships that exist in the retail chain and offer a realistic view of the retail industry from the eyes of a consumer.
Supplier Relationships 101
Every retailer around the world have their own way of communicating and working with their supplier network. The supplier network are the manufacturers and distributors that the retailer purchases products from so that they can sell directly to us, the consumer.
The manufacturer is the business that makes and sells its own products. Think of Kitchenaid or Bose. Some manufacturers will only sell to wholesalers while others will sell to both wholesales and consumers. A wholesaler is a distributor or retailer…a business that purchases the manufacturer’s goods at wholesale costs.
The distributor is a business that buys products directly from manufacturers and then resells them to retailers at slightly higher prices. Distributors have their own warehouses where they store the goods that they purchase before selling them to the retailer, but they do not sell directly to consumers.
The retailer is the business that sells the end good directly to the customer. Think of Target, Amazon, and Best Buy. Traditionally, retailers only sold in brick and mortar stores, but with the emergence of the Internet, they sell both online and in stores. A brick and mortar store is simply a physical store where you shop and purchase the goods in person.
Let’s look at a few examples…
Example 1: The Retailer
Amazon is an online retailer. They sell products to the end customer and make a profit on the difference between the wholesale price and the retail cost. The wholesale price is the cost that they purchase the product at from the manufacturer or distributor. The wholesale price is also referred to as the Cost of Goods Sold (COGS). The retail price is what we are charged as the consumer. The difference between the two is the retailer’s gross profit.
Amazon purchases products from the manufacturers and distributors then stores them in their network of fulfillment centers. Fulfillment centers are warehouses where products are stored until they are sold on Amazon’s website. Once an order is placed, the information is communicated to the fulfillment center and the product is shipped directly to the customer.
After the customer has received the order, Amazon continues to handle the shopping process by providing all customer service. They will process returns, make exchanges, and handle any negative feedback.
Being a retailer is not an easy business. Dealing with customers can be difficult and you are always relying upon the selection and pricing that you have in your store.
Example 2: The Manufacturer
Majestic Home Goods is a manufacturer that designs and builds their own home and furniture products. Once their products have been produced, they sell them at wholesale costs to distributors and retailers so that they can eventually be sold to us, the end consumer.
Majestic Home Goods makes a profit on the difference between the wholesale price and their cost to produce one unit of the good. On average, manufacturers will try to sell their products for at least a 50% markup from what it cost them to make it.
Manufacturers will offer larger discounts to distributors and retailers that are willing to purchase their products in bulk. For arguments sake, let’s say that Majestic Home Goods offers their products at 50% markup when purchases are under $10,000 and a 40% markup for purchases over $10,000. This forces the retailer and distributor to make a decision based off of the demand they project for the product.
Manufacturers may also have minimum purchase quantities. A minimum purchase quantity is a minimum dollar amount worth of goods that the distributor or retailer must purchase in order to carry their products. Majestic Home Goods may have a minimum purchase quantity of $5,000. This means that distributors and retailers must purchase at least $5,000 worth of goods to carry their products in their inventory. Minimum purchase quantities are common for large brands that have a strong foothold in the consumer market. A great example is Fisher Price.
After selling the products to the distributor or retailer, the manufacturer is finished with the supplier chain. They continue to design and produce goods then sell them off to the wholesalers. There are definitely exceptions and we’ll get into it in a couple of sections.
Example 3: The Distributor
The distributor is the middle man between the manufacturer and the retailer. The distributor also purchases products directly from the manufacturer, but they do not sell directly to the end consumer.
Rather, the distributor buys the products in bulk at heavy discounts, stores them in their warehouses, and then sells them directly to the retailer.
The distributor makes money on the difference between the wholesale cost that they pay the manufacturer and the cost that they sell the product to the retailer.
You may be wondering…”why do distributors exist?” Valid question.
Distributors exist for both the benefit of manufacturers and retailers. If a manufacturer does not have the proper facilities to store and manage their inventory, they will work with a distributor that can handle the storage in their warehouse. The distributor also has stronger relationships with retailers so it offers the manufacturer a salesperson to push their product out to the public.
For retailers, distributors can offer a more organized one-stop-shop for products for their store. Distributors will carry hundreds of brands so it makes it simple for retailers to make large orders for their stores depending on the retail season. Granted they may not be getting the best pricing, it eliminates the headaches of working directly with over 100 manufacturers, all with different operations systems and processes.
Example 4: The Hybrid…Manufacturer and Retailer
As I was referring to earlier, some manufacturers also operate as retailers selling their products to both retailers and the end consumer. Nike is a prime example.
Nike designs and manufacturers its own goods storing them in their own warehouses. Nike will sell their goods to big box retailers like Dicks Sporting Goods, Sports Authority, and other sporting goods stores. However, they also own their own retail stores and online store where they sell directly to the consumer.
By handling both the manufacturing and retailing, Nike is able to take tighter control of their profit margins. Because of their strong brand, they can negotiate better deals with the big box retailers. When selling directly to the consumer on their own website, they are able to keep the full margin between what they produce the product for and what they are selling it for. Talk about the ideal gross profit!
Being a hybrid manufacturer and retailer is becoming evermore popular given the ease of creating a store and marketing plan on the Internet. Selling online requires little to no overhead and provides you with the opportunity of reaching customers all across the country.
Before the Internet was around, retailers were dependent upon their physical locations. As a manufacturer, it was much more difficult to handle both the production of your goods and a physical store. The overhead costs were too heavy and the logistics could be a nightmare.
The Reality of Retail to Us
The retail industry is built off of markups and supplier relationships. When you purchase a product from any retail store, it is going through tiers of mark ups before it reaches you as the end consumer. The industry has been the same way for hundreds of years and shoppers have come to simply accept the prices that we are paying for products. But doesn’t it make you scratch your head when you see the breakdown of how much it actually cost to make that product?
Let’s look at the reality of the retail industry with a simple example of an electronics product.
Sony is a manufacturer of electronic consumer goods. They make headphones. After manufacturing 100,000 units of Sony headphones at $3.00 each, they sell them to distributors at $6.00 each. That distributor then sells those same headphones to the retailer at $8.00. The retailer then lists and sells those same headphones to us (the consumer) at $15.99.
At the end of the retail chain, you are paying $15.99 for a pair of headphones that cost only $3.00 to make.
And that, my friends, is the reality of retail.
If this column interested you, check out 5 Key Changes in eCommerce in the past 5 Years. I dive into the past 5 years of online retail and how it has drastically changed based off of the consumer’s perception. I also give you a front row seat to each busy season through my eyes as an eCommerce entrepreneur.