How the number of distributors for a company impact its sales growth

Over the course of the past 8 years of managing client money, I have seen three instances of portfolio companies rationalising their distributor network. In all three cases there was an acceleration of sales growth post a reduction in the number of distributors. Perhaps there is such a thing as too many distributors. 

 

In economics, the concept of a Laffer curve suggests that there is an optimal tax rate beyond which increasing the rate will not result in an increase in government revenue. Until that point, increasing the tax rate will result in increasing government revenue. Beyond that, the incentive to underreport income and evade taxes becomes greater than the incentive to comply. 

 

 

 

              A Laffer curve like relationship exists between the number of distributors a company has, especially in a B2B business, and the sales growth of that company.  

     For the company in question, focusing on ‘farming’ the existing distribution network comes with a mindset to being selective of who you choose to represent your brand, to train the end sales team at the distributors better. A smaller network allows for higher engagement and toolkit sharing such as shared marketing materials, better coordination on supply chain and working capital management.     Doing so by introducing tiered incentive structures make the fringe distributors’ economics unviable but give a significant advantage to the larger ones. This in turn makes the remainder distributors in the network more aligned with the company’s success.   Among my portfolio companies, I noted this phenomenon in the largest diagnostics company by volume, the largest cables and wires player by volume and the most consistent domestic agrochemical. The sales growth for a couple of years following the rationalisation was over ten percentage points higher than a couple of years prior.  

  

     

The pattern is almost always the same. Sluggish growth results in rethinking of the sales channel. Once a change is implemented, initially it causes a fallout of the fringe distributors, perhaps even confusion in the ones that remain in the network. This results in growth slowing down even more immediately after implementing such a move. However the acceleration post the move is digested by the sales network is severe. 

 

This is however a one time tool in the company’s arsenal to revive growth. Rationalise your distributors time and again, and they lose faith in the company. Also reduction in the number of distributors without doing activities that assure focus on the existing network (such as additional training, sales support, marketing materials, etc.) will not have the desired outcome. A company that is however proactively rethinking and streamlining their channel partner network would have an action bias. 

 

Any company that chooses to downsize their distributor network, warrants an investigation from an investor. India is a growth market for investors. Having markers to identify growth inflection points in companies can help one get in on a growth ride of a business and therefore its stock price at an opportune time. The best thing about this marker is, it affords one time to investigate, a crucial advantage in today’s fast discounting markets.

  (Harini Dedhia is Head of Research at Tamohra Investment Managers. Views are her own.)