Selling is a Route with multiple shortcuts.
Optimum Distributions Channels (ODCs) represent the best supply avenues a company can establish. ODCs are extremely critical in the operational process of an organization because the decisions to set up specific avenues will determine the aptitude to generate consistent profits. This concept is very simple but its efficient implementation is less certain in most organizations. Some managers believe that their best strategy is to open as many supply chains as possible and try to sell their products/services to everyone. However, they tend not to analyze if each distribution channel can produce the expected minimum level of profitability.
The best strategy available is Return on Investment (ROI) Approach.
A Company produces four types of electronics (CD Players, DVD Players, Radios, and TVs). Furthermore, the Company uses only four distribution channels to sells its products. The production, revenues, and channels are shown in the chart below.
RETURN ON INVESTMENT (ROI):
To calculate the ROI, divide each revenue stream by its cost of production. See chart below.
$1.21 means that for every $1 spent in the production of CD players, the Company received $1.21 in return. As you can tell, TVs bear the highest ROI, which is $1.34.
Obviously, from this straightforward illustration, it seems that the Company should invest its entire budget in the production of TVs and sell only in Channel 4. However, this strategy may not be as easy to implement because of the following reasons:
- The demand may not exist to accommodate more supply for this product line in this channel
- The channel may be contractually saturated. This means that vendors are contractually obligated to receive supplies from other companies
- Every other company will see the benefit and start producing TVs only and selling in this channel, which will drive prices down and erase further profit-making ability
First, let’s calculate the direct profit margins for each product line.
Let’s assume the following:
|Products||Prod. Cost||Revenue||Profit||Profit %||Channel||ROI|
Let’s also assume that each channel is saturated and the Company cannot increase its supply in other channels.
With this assumption, it shouldn’t make sense to change the product lines and distribution channels regardless of the profit margin. Even the product with the lowest ROI (Radios: $1.14) is still profitable ($25,000). This is the belief system of many supply chain managers. As long as a product line is profitable, it makes sense to keep it alive.
However, if you analyze critically the table above, you can perhaps determine that Radios in Channel 3 could be eliminated.
Even though Radios are profitable, the following cost/benefit analysis must be performed:
- Does a 5.05% in the profit group justify the investment? Simply put, is it worth the trouble?
- Could the $180,000 for the production of radios be used for something else such as research for example, which has proven to increase a company’s competitive ability?
- Will the operational process improve if One product line is eliminated?
- Will the staff become more productive because they will have to specialize only in 3 products instead of 4
Holding everything else constant, the best strategy is to eliminate the production of radios and supply channel 3. A straightforward cost/benefit analysis would agree.
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