In decades past, manufacturers needed a wholesale partner to sell to and physically distribute their goods to retail outlets. However, with the explosive growth of e-commerce and methods like drop-shipping or shipping via e-commerce platforms like Amazon, the role of the middleman has significantly shrunk. Losing the middleman means lower prices for consumers and higher profitability for manufacturers.
For an SMB, cutting out the middleman means taking control of your payment processing, consumer marketing and order fulfillment. We’ll examine the realities of cutting out the middleman and share why businesses are moving toward direct-to-consumer models.
What is a middleman in business?
A middleman is an intermediary in a supply chain or transaction. There are a few types of middlemen in sales:
- Wholesalers: Wholesalers buy products in bulk from manufacturers and receive lower prices for their bulk purchases. They sell the products to retail stores for higher prices, making a profit. Retailers go on to sell the products to consumers after adding their own markups.
- Distributors: Distributors often act as a middleman between a supplier or manufacturer and a wholesale business – providing yet another supply chain distribution layer. Distributors have direct contact with suppliers and essentially work in a sales capacity. They broker deals with wholesalers on behalf of manufacturers and take a commission for their work.
- E-commerce platforms: E-commerce platforms like Amazon and eBay provide a central online location where individual retailers connect with buyers, much like a physical shopping mall. The platforms also facilitate transactions by handling payments. In some cases, they also handle inventory storage, logistics and shipping.
Wholesalers and distributors make money through their relationships with the next level of the supply chain. Distributors make money via their wholesaler relationships, and wholesalers make money through their retailer relationships. At the end of the supply chain, retailers sell to consumers.
Various types of retailers interact with wholesalers and distributors differently – or not at all.
- Retailers that manufacture their own products: Some retailers manufacture their own products and sell them directly to consumers. For example, the personal care brand Lush makes its own products and sells them in e-commerce and brick-and-mortar retail stores. These businesses don’t utilize any middlemen.
- Retailers that purchase products from a manufacturer: Some retailers purchase products directly from a manufacturer. For example, cosmetics retailer Ulta buys products directly from various beauty industry manufacturers and sells them online and in retail outlets.
- Retailers that purchase products through a wholesaler: Many smaller retailers don’t sell at sufficient volumes to buy directly from manufacturers. They purchase their products through a wholesaler that acts as a middleman.
- Wholesale-retail blends: Other businesses are essentially a blend of a wholesaler and a retailer. For example, Sam’s Club and Costco buy products in bulk from manufacturers and sell them directly to consumers. Consumers enjoy significant discounts on products but must be willing to buy in larger quantities than you’d find at an average supermarket.
Retailers, wholesalers, sales reps, telemarketing and e-commerce are all examples of distribution channels. Choosing the right distribution channel is crucial for maximizing sales.
What are the pros and cons of using a middleman in business?
Although the influence of wholesalers has waned, a middleman is helpful in some situations.
Upsides of using a middleman
The pros of using a middleman in business include the following:
- A middleman lets manufacturers focus on core competencies. Having a wholesaler or distributor handle warehousing, distribution and sales helps manufacturers concentrate their effort, time and resources on product creation and efficient, high-quality manufacturing.
- A middleman provides valuable feedback on market trends and demand. Since middlemen deal with multiple retailers within an industry, they are well positioned to track industry trends, including higher or lower demand for specific products or categories, economic factors impacting retailers, new or strengthening competitors, and shifts in consumer behavior. This market intelligence can help you differentiate your product from the competition and pivot to current conditions.
- A middleman can aggregate products from diverse suppliers. In some industries, only a few significant manufacturers exist. In others, there may be tens or even hundreds of suppliers. In fractured industries like book sales – where there are hundreds of publishers – a wholesaler or distributor can help retailers obtain inventory from many suppliers via a single contact point.
- A middleman can add convenience for customers and exposure for sellers. Platforms like Amazon, Shopify, Etsy and eBay are also middlemen; they’re consumer destinations. They give smaller sellers access to a broader market than they could access alone. From the customer’s point of view, they offer the convenience of one-stop shopping, secure payments, shipping efficiencies and search capabilities.
Shopify also provides a payment service for businesses that need mobile credit card processing along with e-commerce functionality. Read our in-depth Shopify Payments review to learn more.
Downsides of using a middleman
The cons of working with a middleman include the following:
- Using a middleman means less profit for manufacturers. Since each middleman level takes a cut, using multiple intermediaries ensures the manufacturer receives the least amount of money for its products. By eliminating one or more layers, the manufacturer can charge more without ultimately raising consumer prices.
- The middleman has power in the relationship. Intermediaries can carry more power in the relationship than buyers or sellers. For example, consider the real estate market. The seller may pay a commission of up to 6 percent to their real estate agent.
- A middleman means less profit for retailers. Stores that buy directly from manufacturers can get lower prices than a wholesaler would offer. This lower price lets them increase their profit margin or lower consumer prices, increasing their sales revenue.
- A middleman means higher prices for customers. In most cases, increased costs from the supply chain are passed along and manifest as higher consumer prices. Sometimes, this contributes to overall inflation in the economy, causing a contraction that negatively impacts customer demand. Even without general inflation, higher prices usually dampen demand and may cause consumers to shop around for less expensive alternatives.
Before raising retail prices, consider ways to reduce operational costs so you can keep your existing customer base and boost customer retention.
Why are businesses moving away from the middleman?
Manufacturers and retailers are eliminating or reducing layers of intermediaries for the following reasons:
- E-commerce: While e-commerce platforms are a type of intermediary, their rise has helped squeeze out more traditional middlemen like wholesalers and distributors. Retail juggernauts like Amazon enable direct-to-consumer sales in huge quantities.
- Drop-shipping: In the past, one of the main benefits of a wholesaler was that it would store the inventory. Today, retailers have a better handle on fluctuating demand. They can order just-in-time inventory directly from manufacturers or have manufacturers drop-ship products directly to customers. Drop-shipping has lowered the costs of starting an online business, making it easier for online retailers to operate.
- Social media: Manufacturers use social media to form direct relationships with customers. They can gather customer feedback to learn market insights, hear new product suggestions and glean competitive intelligence they previously would have gotten from a middleman. They can also use social media marketing to reach customers, replacing or supplementing retail sales.
- Sustainability: Shortening the supply chain helps businesses create a more sustainable business model. For example, consumer packaged goods like paper towels typically travel from a manufacturing plant to a regional distribution center to the retailer’s distribution center to a grocery store to the customer’s home. With a shortened supply chain, it might go from the manufacturing plant to Costco to the customer’s home, creating far lower carbon emissions.
- The buying local trend: Many consumers prefer buying from local producers and businesses instead of large corporations. Trends like buying fresh seasonal food from local farmers, shopping for homemade goods from Etsy producers and patronizing locally owned small businesses bring producers and buyers together with limited involvement from middlemen.
To take advantage of the trend toward buying local, develop your local marketing strategy with tactics like holding community events, gathering and posting testimonials, and building relationships with the local media.
What are the pros and cons of operating direct-to-consumer?
Like most business decisions, opting to ditch the traditional distribution system to go direct-to-consumer (DTC) has pros and cons.
The pros of operating in a DTC model include the following:
- DTC lets you focus on selling your products. When a manufacturer sells directly to customers from its e-commerce website, its products are showcased. Customers won’t see competitors’ products, keeping the focus firmly on your offerings.
- DTC gives you control of the sales pitch. When you’re in control of your marketing, you can spotlight the features and benefits you think will appeal to customers. You can use more compelling sales language in your sales pitch than an intermediary would or could.
- DTC gives you control over your customers. With direct sales, you have control over your customers’ contact information. You can build an email list, create personalized incentives, create a customer loyalty program and more. Additionally, you can upsell and cross-sell to existing customers, building stronger relationships.
- DTC improves your profit margin. Eliminating intermediaries means you’ll keep more money. However, remember that you’ll have additional costs for marketing, customer service and shipping.
The cons of operating in a DTC model include the following:
- DTC means higher costs for customer acquisition. Selling directly to consumers shifts the responsibility for marketing and sales to you. If you would otherwise sell through large retailers that spend a lot of money on marketing and have significant foot traffic (or online traffic), trying to replicate this could end up being very expensive.
- DTC means shipping, space, and logistical costs. With DTC, you’re responsible for shipping costs and logistics. You’ll also need space for sorting and packing your products and may need to hire employees to help.
- DTC may bring pushback from retail channels. If only part of your business is DTC and you continue selling through retailers, you may get pushback from your retailers because you’re directly competing with them. To get around this issue, consider marketing directly to customers but then sending them to local retailers. You can also try selling only to customers without a local retailer nearby or matching retailer prices.
If you sell through middlemen, try to form customer relationships by including warranty cards, loyalty program information or special offers inside your product package.
Case study: How Warby Parker eliminated the middleman
Designer eyeglass maker Warby Parker was able to eliminate wholesalers, brand designers and retail outlets. The company sends its frame designs to the same factories that manufacture other premium eyeglasses. However, it sells its eyeglasses directly to customers for a fraction of what they would cost in traditional retail outlets.
Many consumers equate high prices and brand names with high quality. They also want to try out products – particularly products they’ll wear. Warby Parker overcame these limitations by establishing a brand identity as a trendy alternative that provides quality products with a custom fit.
The company implemented the following tactics:
- Emulating in-store convenience: Warby Parker emulates the experience of shopping in a retail outlet by letting customers try on five pairs of glasses at home for five days. It also offers free two-way shipping.
- Targeting a trendy demographic: The company targets 18- to 34-year olds, a segment of the U.S. population already comfortable with ordering online. They’re brand-conscious and price sensitive.
- Prioritizing social responsibility: The company has established a socially responsible reputation. For example, its Chinese manufacturers are approved by labor watchdog Verite, and it partners with nonprofits to distribute glasses to the needy.
Today’s retail models are changing
Big stores like Walmart, Macy’s and Gap aren’t going away anytime soon. Still, retail model lines are blurring as businesses experiment with options that enhance customer engagement. For example, previously online-only stores like Warby Parker have opened retail locations.
The key difference is that, unlike traditional retailers, these stores don’t rely on wholesale distribution channels to stock their shelves. Whatever the distribution channel, reaching consumers directly avoids the inefficiencies built into wholesale. There was a time when these inefficiencies were a necessary part of doing business. For many companies, they no longer are.