Saturday, September 7, 2013

From a cost perspective should you buy through an OEM versus a Distributor?

On LinkedIN someone asked the question about whether it would be cheaper to buy through an OEM versus a distributor and there were so many bad responses and misconceptions that I decided that I would write a post about it.

Every company will have a number of markets or what are called “sales channels” that they sell through. A company may have OEM sales. OEM stands for Original Equipment Manufacturer meaning the company that is purchasing the product will imbed that product within their product and as such will not be competing against either the company or its authorized distributors for sales. The company may also sell to VARS. A VAR or value added reseller is one that adds specific value to the product and sells that. Since they are adding value to the product they too are not directly competing against the company or its authorized distributors. The company may
direct customer account sales where they usually sell to large users of their product(s). They may also sell through Authorized Distributors. An authorized distributor is a company that has entered into an agreement with the manufacturer or producer to sell products. Normal authorized distributor agreements will have agreed geographical territories that they can sell within, they will have the obligations of the distributor and company defined such as responsibilities for marketing and conduct and they will have a a defined method of compensation.There are two primary models companies have for sales to distribution. One is a simple discount off list where the volume of the distributor's purchases will increase their discount off the company’s list price as their volume increases. The other is a form price protection where the discount they receive is tied to selling close to the targeted price. Distributors can provide a wide range of services from just being an order location to providing stocking and value added services.

Each of these "channels" will have different sales terms and different pricing or discount structures. Most companies will also have a tiering approach within a channel where terms and pricing or discounts you get will be based upon the volume of business and your importance as a customer. The highest tier in any channel will get both the best price and the best terms. Lower tiers will get higher prices or less discounts and less favorable terms. Normally the best pricing and best terms would be given to the highest tier OEM accounts. That is because they provide volume sales for the company, they don’t compete with the company or their authorized distributors for sales, and there is less sales and administrative expenses in dealing with that one OEM versus dealing with multiple companies that would provide the same volume of sales. If you fall below a certain level of business a company may not sell to you for whatever channel would be applicable to your business. You can also find companies that sell exclusively through distribution. In both those situations you would need to buy the product through one of their authorized distributors.

As to what what sales channel is best strictly from a cost perspective, if you have significant volume and can buy it directly as an OEM, that is usually the best way to go as OEM’s will normally get higher discounts than a distributor. Further out of their discount the distributor has to pay for there operating costs out of the discount they earn, so they have less of a margin to work with in selling to you. If you don't have significant volume you may be able to buy it for less from one of their high volume distributors but then the issue of distribution territories can impact that. I’ve had situations where I needed to have another subsidiary buy and resell me a product simply because they could buy it from a distributor in another location at a lower cost. Another thing that can impact your sourcing decision is if there is a problem with the product and it needs maintenance or repair, who will perform that? If the distributor performs service or maintenance they may be unwilling to do it on a product that they didn’t sell.

In addition to price there is another consideration you need to take into account. When you buy from a distributor, you do not have privity of contract with the original manufacturer. The manufacturer will provide a warranty to the Distributor that they assign to you. Most of the time that warranty cannot be further assigned. If there is any problem with the purchase other than what would be covered by their product warranty, since you bought from a distributor, your sole recourse is against the distributor. This means the smaller the distributor you deal with, the less the assets, the larger the potential risk. There are only two parties that could go directly against the original manufacturer; the distributor who purchased the product from them, and any third party is injured by the product who can claim product liability negligence.

The last thing to take into consideration in sourcing is your warranty on the product. You need to read the fine print in the warranty and especially read any warranty exclusion. Many times third party repair or use of third party materials will void a warranty. If you buy it in one country or location and your local distributor won’t service or repair it because you didn’t buy it from them, if you use another company to fix it that isn’t authorized by the company to perform such work, you may have voided your warranty.

OEM can also be used in describing the source for the parts. An OEM part is one that is sold by an Original Equipment Manufacturer. That part may also be available from the manufacturer the OEM purchased the product from. Parts that provide the same form, fit and function may also be available from other suppliers or from what is called "after market" suppliers. For example you purchase an IPad from apple and the earphones that came with it break. You could buy replacement earphones from Apple (the OEM) or from a variety of other sources.