The distribution trap.

• Author: Thomas, Andrew R.
• Position: Dysfunctional American business model - DOLLARS & SENSE

THE SPAT BETWEEN MacMillan and Amazon.com about the prices charged for e-books exposes how profoundly dysfunctional the American business model has become. Over the past 30 years, with little fanfare, businesses of all sizes have been drawn into a misconceived form of marketing and selling. It works like this: companies invest blood, sweat, tears, and money into an innovative product or service (like books published by MacMillan); sell it through the largest mass market distributor possible (Amazon.com); maximize the volume of sales with that distributor, deal with inevitable cost-cutting demands; find themselves forced to export capital, jobs, quality control, and pollution to developing markets; watch the innovation become a commodity; lose money; begin to develop new innovations; then start the process all over again.

A large portion of what has driven us into the Great Recession is rooted in this dysfunctional system: sell more and more through a mega-distributor (with much of the profits split by distributors and overseas manufacturers). Earnings obtained by the latter are reinvested into the U.S. and then lent to consumers so that Americans can continue to spend beyond their means, thereby propping up the global economy.

Discussions are abundant about out-of-control lending and consumer spending, the impact of outsourcing, and the lack of sustainability, but little attention is paid to the harmful impact that distribution strategies employed by mega-distributors have played, not only on manufacturers, but the overall economy. As we talk to business leaders around the world, it is clear that many of them realize a fundamental change has occurred. Power has shifted from those who create innovative products and services to those who distribute them.

Mistakenly, many companies see deals with mega-distributors as the way to boost sales and market share. In reality, the megas live by high volume and low prices. They use their powerful leverage to demand price cuts and other concessions from suppliers. Thin profit margins are the result, with innovative products and services being treated like commodities by the megas and the buying public.

An article in the Journal of Business Research by Sandra Mottner and Steve Smith provides evidence that smaller businesses that sell to WalMart have significantly lower gross margins than similar firms that do not. During the recession, Wal-Mart and the other large-scale distributors have experienced...