---
title: "The Flip Side of Distributor Profits: Internal Friction"
description: "A distributor reveals that despite high gross margins, profits can vanish due to internal inefficiencies. The article outlines how mismanagement of people, money, and goods leads to hidden costs, and emphasizes the importance of controlling internal friction to maintain profitability."
author: "调料人都在关注的"
publisher: "New Distribution"
email: "zhaobo258@gmail.com"
telephone: "+8615854817671"
published: "2021-12-13"
language: "en"
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---

# The Flip Side of Distributor Profits: Internal Friction

> A distributor reveals that despite high gross margins, profits can vanish due to internal inefficiencies. The article outlines how mismanagement of people, money, and goods leads to hidden costs, and emphasizes the importance of controlling internal friction to maintain profitability.

Source: 调料家 (ID: zgtlj2019)

"Our family's revenue exceeded 10 million in 1998, but at the year-end inventory, we found we earned less than when we did 4 million. Product margins were very high, 35% gross profit, but in the end, we didn't make money!"

Where did the money go? To figure this out, since I registered my company in 2004, I have only done one business: internal management consulting for distributors.

**Internal management for distributors boils down to three things: people, money, and goods. All work in a distributor company revolves around "people" and "money."**

We break down distributor internal management into 740 modules and found that each module has areas of loss, and these losses are profits that should belong to us.

**Internal Friction from People**

People, simply put, involves recruiting employees, from onboarding to work assignments, work standards, training, promotion, assessment, and supervision, until they leave. This entire process ultimately serves three purposes:

**First, support sales.** Distributors achieve sales goals by managing people and warehouses well.

**Second, maximize employee efficiency.** Employee wages increase every year, but if our work efficiency doesn't grow, the distributor will eventually lose money. So while raising wages, distributors must also consider how to improve efficiency.

**Third, control costs.** Business is about "increasing revenue and reducing costs." Increasing revenue is easy: manufacturers help you increase revenue with new products, promotions, and more outlets. But who manages cost reduction? For distributors, only the boss cares about cost reduction; others can't help and won't care.

Therefore, distributors need to consider two questions.

**First, how long can this distributor business last?** This isn't a new question. Data shows that in 2002, there were about 3.37 million distributors in China, and now there are only about 2 million. Many distributors can't continue.

**Second, how soon can the distributor boss hand over the business?** Some distributors, after reaching a certain scale, have more career options; others say the distributor industry is tough and choose to switch industries.

But most people have a mindset of "tired of the industry they're in," **always feeling that distributors are squeezed by upstream and downstream, and other industries are easier. But is that really true? Not necessarily.**

There's a peculiar phenomenon in China: no matter which industry you're in, no matter how high the gross margin, distributors end up earning the same amount. For example, grain and oil margins are about 20-30%, children's food 30-40%, alcohol 40-50%, infant products 50-60%, textiles 80%, cosmetics 90%, and health products even up to 95%... But distributors ultimately earn at most 3 points.

Why is switching industries difficult? Simply because the basics weren't done well before switching: people weren't managed, customers weren't managed, and costs weren't controlled. In fact, whether you go upstream to become a manufacturer or downstream to open retail outlets, when you do the math, you'll find that being a distributor is the simplest. **If you can't do the simplest business, you won't succeed whether you move up or down.**

What are distributors busy with every day? Performance and net profit!

Manufacturers chase distributors for performance, but what distributors ultimately want is not performance but net profit. Does bigger performance mean bigger net profit? Of course not. **More and more distributors see revenue growth without profit growth, but they ignore the costs between performance and net profit, which only the distributor cares about.**

As distributors scale up, manufacturers, new products, SKUs, and customer numbers all grow, and high-margin products increase, but costs also rise. Employee wages rise every year, employee turnover is a cost loss, and various "leaks" of internal friction grow.

Moreover, many cost losses are caused by internal employees themselves. Warehouse staff swapping goods, salespeople inflating invoices, diverting payments... In the end, the distributor bears the losses.

Is your distributor's finance truly professional?

* Can your finance balance the books daily? How much goods went out, how much money came back, and are there any debts?
* Can accounts receivable be quantified? Is the data updated daily, broken down by customer and salesperson, separating normal and abnormal receivables? Can finance clearly inventory the warehouse?
* Is inventory counting truly clear? Was a third party involved?
* Are the IOUs submitted by salespeople genuine? Does finance verify each one?
* When salespeople follow up on collections, can finance follow up promptly? How exactly are collections done?
* Can finance calculate the profit or loss for each product and each customer?
* Can finance calculate the capital occupation and turnover rate for each manufacturer's products?
* Can finance calculate the actual work efficiency of each employee? Can they calculate the cost accounts and how to handle old capital?
* How many of the 17 common legal tax avoidance methods does your finance know?
...

This is what professional finance looks like. If a distributor's finance can't clarify these issues, the distributor can't know where costs are going, and internal friction naturally can't be calculated.

**85% of distributor companies have an annual cost growth rate exceeding their performance growth rate.** That means we waste more money from our own hands each year than we earn.

**What do distributors rely on to make a living? Social resources accumulated locally and turnover rate.** For distributors, turnover rate is more important and more flexible than profit margin. Lower operating costs, local outlets, sales teams, optimized product structure... These are the distributor's bread and butter.

All internal friction is man-made. Therefore, distributors need to continuously improve and identify risk points.

**The pain point in managing people for distributors is: "Trustworthy people can't work, capable people can't be relied upon, useless people won't leave, and dangerous people dare not be fired."**

Bosses might think: I pay them, why don't employees work hard?

1. They feel underpaid.
2. They worry the boss doesn't keep promises.
3. You've offended them.
4. They've been brainwashed by people around them.

Are employees unable to do the job or unwilling? Behind "unable" is a lack of skills in the employee system, leading to low work efficiency. Most distributors train new employees by having old employees mentor them, but often this results in "each generation worse than the last."

Replacing people might solve it in one step, but overhauling a company isn't that simple. So what should distributors do?

You can start with the simplest housekeeping tasks, because office staff waste 20% of their work time annually on forgotten tasks and mistakes. Handling these well can save 20% of costs.

Additionally, provide necessary private space for field staff to enhance their sense of belonging. **Avoid doing thankless tasks for employees; start with employee emotions, so they have a positive attitude toward work.**

Make work hours transparent, post schedules on the wall, clarify job responsibilities and deadlines to improve efficiency. Reorganize supervision so employees supervise each other and progress together. Conduct thorough background checks for new hires, from contract details to criminal records; also have clear handover procedures for departing employees.

**Internal Friction from Customer Management**

**"The number of downstream customers determines a distributor's performance; the quality of downstream customers determines a distributor's profit."**

Returns, exchanges, and scrapped items all erode distributor profits. Why does this happen? Most distributors are out of control regarding their downstream customers.

What does "out of control" mean?

**First, you don't know much about their situation.**

**Second, information communication between you is poor, often misled by intermediaries.** Who are the intermediaries? Salespeople, who exaggerate things.

**Third, there's no stable customer relationship.** Distributors work hard to sell goods, but terminal customers pick and choose, taking only the best-selling items and rejecting the rest. It's like a rebellious child: even though the child is yours, they don't listen and go against you.

If distributors can answer the following questions, they're not out of control; if they can't answer half, it means customers aren't in your hands but have been taken over by salespeople.

1. How many total customers do you have?
2. Where are your customers located?
3. Have you categorized customer types? Which are restaurants, small supermarkets, large supermarkets, or cafeterias?
4. Have you classified customer cooperation quality? Which have good relationships, which have poor ones?
5. Have you classified customer sales quality (size)?
6. Have you classified customer sales characteristics? Some like selling new products, some like old ones, some only stock up when you have promotions.
7. Do you know customers' business orientations? For example, someone opening a small grain and oil store might want to turn it into a chain, some focus on sales volume, some on profit.
8. Do you know each customer's settlement characteristics? Each store settles differently: some pay the boss, some the boss's wife, some in the morning, some in the afternoon, some later, some earlier.
9. Can your promotional activities be communicated to customers promptly and comprehensively? For example, if you have a new product with a buy-100-get-5-free offer, can you ensure all customers know about it?
10. How many blank terminals haven't been covered? Even if you don't cover them, do you know there's a supermarket there?
11. Do you know how many terminal customers have stopped cooperating? If they haven't ordered in three months, the relationship is basically broken.
12. Do you know about historical issues with customers? After years of business, there must be some.
13. Do all terminal customers know you? Maybe they don't know your company name or the boss's name; they only know your salespeople and drivers.
14. Can your finance calculate how much you earn or lose from each customer each year?
15. How many common fraudulent methods of salespeople do you know?
16. Can you arrange for salespeople to rotate positions at any time?
...

Once customers are not in the distributor boss's hands but in the salespeople's, it may lead to salespeople selling private goods, working part-time for other trading companies, and padding expenses during business. In the end, the distributor bears the costs, but the salespeople sell other companies' goods.

This article is based on the keynote speech by **Pan Wenfu (General Manager of Shanghai Senpan Enterprise Management Consulting Co., Ltd.)** at the "2021 Tiaoliaojia Distributor Conference (Tianjin Station)" held on October 19, 2021.

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