OTHER ARTICLES IN THIS SERIES

This series takes concepts learned in an MBA program and adapts them for easy comprehension by scientists without a management background. This is currently the 14th part of the series and the seventh in an introduction to marketing.

When we introduced marketing several months ago, we discussed the four most important facets of marketing: product, promotion, pricing, and distribution. These famous "four P's" of marketing (the P in distribution is hidden) intertwine and form the basis for a successful strategy for selling your product. In the last few installments of this series, we tackled three of these four sections in depth. This week, we take a look at the fourth and silent P: Distribution.

Distribution strategy is figuring out the best way to get your product to your customer. To do this, the strategy involves several variables: The existing distribution channels for your type of product; the cost of setting up your own network for your product; the regulatory environment governing your type of product; and the cost of inventory and how this changes with the different distribution strategies. Of course, distribution strategy is intertwined with every other part of the marketing mix--your distribution strategy should be consistent with the price you choose, the product you have, and the promotion you do. And most important of all, your distribution strategy should be consistent with the most important rule of marketing: Knowing your client. If you know your client, you can usually figure out the best way of getting your product to them.

Let's say that you've started up a small biotech company. And, for the sake of argument, you've managed to get your first product, a cardiovascular drug, through both development and all the clinical testing required for approval. So, after years of research, you've finally got a product that is ready to be sold. If you've managed to do all this without a giant pharmaceutical company as a partner, one of your most interesting business decisions is to determine how you're going to distribute your product.

Existing Distribution Channels

The first thing you've got to do is determine how other drugs get to their customers: That is, figuring out what distribution channels already exist. Pharmaceutical products really only have one or two existing channels of distribution. The most traditional is that a pharmaceutical manufacturer distributes their product to a drug wholesaler, who then distributes the drug to a pharmacy, who then distributes the drug to the final customer. (In fact, there may be a whole bunch of drug wholesalers, including a national wholesaler who distributes to regional wholesalers, who distribute to local wholesalers, etc., but let's keep this simple.) This can be illustrated as follows: YOU --> WHOLESALER --> PHARMACIST --> CUSTOMER.

Chances are, there won't be huge "pull" demand for your product yet. This means that the wholesaler won't be all that interested in carrying your product. To get into this channel of distribution, you've got to make it worth their while. Which means you've got to do one of three things:

  • develop a "pull" demand for your product--if the wholesaler's customer (the pharmacist) demands the product, the wholesaler will try to provide it

  • make the product "worth the while" of the wholesaler financially by offering them larger margins and better terms than they'd get with other drugs

  • partner with a pharmaceutical company that already has a lot of clout with the wholesaler--if you're selling 50 different drugs to the wholesaler already, you can kind of force them to take the 51st

Other existing channels that you might want to consider are "direct-to-consumer" Internet- or mail-based drug stores, who may be happy dealing with you directly, and the doctors, who can, in certain cases, be the way drugs get to the customer. But direct-to-consumer drug stores don't have a huge market yet, and developing a distribution network to doctors may be as elaborate as the pharmacist network, so you're probably best off using the traditional channels of distribution.

Setting Up Your Own Channel of Distribution

Of course, one option that is always available to you is setting up your own distribution channel. In the case at hand, however, this is probably not feasible. Setting up a wholesale drug distribution business will be incredibly expensive. And you've got no expertise in running it, and still no distribution network (you've got to get these wholesale distributors "plugged in" to the pharmacists). So with the example we've given, it'd be pretty close to impossible to set up your own channel. However, with some other examples we've used in the past, it may be possible.

For example, let's say you're making a very expensive machine to be sold to hospitals. If you're setting up your own sales team (for promotion), you might also consider shipping these big machines directly from your factory to the hospitals--thereby becoming your own channel of distribution.

The Regulatory Environment for Your Product

Government regulations are a big factor in deciding on your distribution channel. In our case, regulations require the only channel of distribution to be the pharmacy: Only a government-registered pharmacist can distribute drugs to the patient (except in certain cases, when a doctor or dentist can do it). So you're stuck with this distribution network: It's got to be sold through the pharmacists. With most other products, the regulatory environment is not as rigid: often, all you need to worry about are the shipping requirements or other, more minor regulations that affect how you get your product to your customer.

Costs

If you've got a lot of different options for how to get your product to your customer, one of the factors you have to consider is what each option will cost you. The most obvious cost is shipping: How many different places must the product be shipped to, and what will that do to the cost of the product (both to us and to the end customer)? In our case, like many, the cost of shipping is very minor. The two most important costs are the margins each step of the distribution channel will require, and what your inventory cost will be as the manufacturer.

In our biotech company with a drug ready for sale, these two costs will be a large factor in choosing which drug wholesalers to go with. First, lets assume each drug wholesaler can get your product to the same customers--a large assumption, but one we'll use for the example. (If this isn't the case, you may want to go with the more "expensive" wholesaler if it will mean more sales for you--but that's a fairly elaborate calculation that you've got to do based on the specifics of the case.) The next step is to look at how many levels there are to each drug wholesaler, and how much inventory each level needs.

For example, the choice may be between a drug wholesaler where the channel of distribution is YOU --> WHOLESALER 1 --> CUSTOMER and a drug wholesaler where the channel is YOU --> WHOLESALER 2 --> REGIONAL WHOLESALER --> LOCAL WHOLESALER --> CUSTOMER. Wholesaler 1 may charge more than wholesaler 2 for their services--they may want a 40% margin (meaning whatever they buy from you for $1.00 they sell to the customer for $1.40), where wholesaler 2 may only require a 10% margin. In fact, the whole chain of wholesalers in the second case may result in a cheaper distribution margin than in the first--whatever the first wholesaler buys from you may make it all the way to the customer for only $1.30 or so, each level only requiring a 7% margin. Despite this, you may want to go with wholesaler 1.

Here's why: In the case of wholesaler 1, the channel is very simple. You send 100,000 pills to the wholesaler. They sell them to 1000 pharmacists. The wholesaler gets paid within 30 days. You get paid within 60. And you've only got to make 100,000 pills to get to 1000 pharmacies. At any point in time, there's only 100,000 pills in the "channel," that haven't been sold to the final customer yet.

In the case of wholesaler 2, the channel is more complex. You send 100,000 pills to wholesaler 2. They send them to 10 regional wholesalers. These each send 1000 pills to the local wholesaler, who then sells them to the pharmacists. The end result is largely the same: 1000 pharmacies each get 100 pills. However, there are some considerable differences. In this case, the local wholesaler gets paid by the pharmacist in 30 days, regional takes another 30, wholesaler 2 takes another 30, then you get your money (another 30 days or so). So it takes 120 days or so before you're paid for a pill that gets sold to the pharmacist. This doesn't really matter if you're in a "continuous" sales cycle--it kind of becomes like that month before your first paycheck at your new job. Paychecks keep coming every 2 weeks, but you're really being paid for work you did a month and a half ago. Which doesn't make any difference, except that first month, where you don't get any paychecks, is pretty hard on your pocketbook.

The second big cost is the cost of the inventory itself. Remember that, in wholesaler 1's case, there are only 100,000 pills in the channel at any given time. That is, a "fully stocked" wholesaler will keep about 100,000 pills in inventory in order to be able to fill the requests of the 1000 pharmacies it receives orders from.

In wholesaler 2's case, you need more pills to fill the channel. Wholesaler 2 needs 100,000 pills in inventory so that they can fill the regional wholesaler's request at any time. The 10 regional wholesalers each keep 10,000 pills in stock. And the 100 local wholesalers each keep 1000 pills in stock. So the end result is that, for a properly stocked "channel," you need to manufacture 300,000 pills to fill the requests of those same 1000 pharmacies. If your cost of manufacture is high, it may be worth the extra money to go with wholesaler 1, because these pills cost you money.

Being Consistent

Of course, the most important part of the distribution strategy you choose is keeping it consistent with the other strategies (pricing, promotion, and product) you've chosen, and keeping it consistent with your final customer. Neither of these really apply to the case we've got here, because the distribution strategy you need to choose is pretty inflexible, but you get the idea.

Next month, we'll have our last segment in our intro to marketing. We'll explore the concept of brand equity and we'll use everything we've learned so far to figure out how to capture a part of the consumer's mind space.