Transfer Pricing

Channels of distribution

Companies use two principal channels of distribution when marketing abroad:

  1. Indirect selling,
  2. Direct selling.

Direct selling is employed when a manufacturer develops an overseas channel. This channel requires that the manufacturer deal directly with a foreign party without going through an intermediary in the home country. The manufacturer must set up the overseas channel to take care of the business activities between the countries.

Advantage of direct-selling channel

  • Active market exploitation since the manufacturer is more directly committed to its foreign markets.
  • There is greater control since the channel improves communication because approval does not have to be given to a middleman before a transaction is completed.

Problems of direct selling

  • It is a difficult channel to manage if the manufacturer is unfamiliar with the foreign market.
  • The channel is time consuming and expensive since without a large volume of business, the manufacturer may find it too costly to maintain the channel.

Indirect selling, also known as the local or domestic channel, is employed when a manufacturer in the United Kingdom, for example markets its product through another British firm that acts as the manufacturer’s sales intermediary (or middleman). As such, the sales intermediary is just another local or domestic channel for the manufacturer because there are no dealings abroad with a foreign firm. By exporting through an independent local middleman, the manufacturer has no need to set up an international department. The middleman, acting as the manufacturer’s external export organization, usually assumes responsibility for moving the product overseas.

Advantages of employing an indirect domestic channel

  • The channel is simple and inexpensive as the manufacturer incurs no start-up cost for the channel and is relieved of the responsibility of physically moving the goods overseas. Because the intermediary very likely represents several clients who can help share distribution costs, the costs for moving the goods are further reduced.

Limitations of indirect channel

  • In case the manufacturer has given up control, the situation may adversely affect the product’s success in the future. If the chosen intermediary is not aggressive the manufacturer may become vulnerable, especially in cases where competitors are careful about their distribution practices.
  • Indirect channel may not necessarily be permanent. Being in the business of handling products for profit, the intermediary can easily discontinue handling a manufacturer’s product if there is no profit or if a competitive product offers a better profit potential.

Types of Intermediaries in Direct Channel

Foreign distributor – A foreign distributor is a foreign firm that has exclusive rights to carry out distribution for a manufacturer in a foreign country or specific area.

  • Orders must be channeled through the distributor, even when the distributor chooses to appoint a subagent or sub distributor.
  • The distributor purchases merchandise from the manufacturer at a discount and then resells or distributes the merchandise to retailers and sometimes to final consumers.
  • The length of association between the manufacturer and its foreign distributor is established by a contract that is renewable provided the continued arrangement is satisfactory to both.
  • A distributor may sometimes take on the name of the brand distributed even though the distributor is an independent operator and not owned by the manufacturer. Brother International Corp. is an independent US distributor of Brother Industries, Ltd., a Japanese firm. Longines-Wittnauer Watch Co. distributes the Swiss-made Longines watch in the US market.

Benefits in using a foreign distributor

  • The distributor is a merchant who buys and maintains merchandise in its own name. This arrangement simplifies the credit and payment activities for the manufacturer.
  • To carry out the distribution function, the foreign distributor is often required to warehouse adequate products, parts, and accessories and to make facilities and personnel immediately available to service buyers and users.

Foreign retailer – These are used in cases where the product in question must be a consumer product rather than an industrial product.

  • The manufacturer contacts a foreign retailer through personal visit by the manufacturer’s representative to mailings of catalogs, brochures, and other literature to prospective retailers. The use of personal selling or a visit, although expensive due to travel costs and commissions for the manufacturer’s representative, provides for a more effective sales presentation as well as for better screening of retailers for the distribution purpose.
  • The use of direct mail, although less expensive, may not sufficiently catch the retailers’ attention. For such big-ticket items as automobiles or for high-volume products, it may be worthwhile for a manufacturer to sell to retailers without going through a foreign distributor.
  • In fact, most large retailers prefer to deal directly with a manufacturer. In Europe, for example, a number of retail food chains are becoming larger and more powerful, and they prefer to be in direct contact with foreign manufacturers in order to obtain price concessions.

State-controlled trading company – For some products, particularly utility and telecommunications equipment, a manufacturer must contact and sell to state-controlled companies.

  • Many countries, especially those in Eastern Europe, have state-controlled trading companies, which are companies that have a complete monopoly in the buying and selling of goods. Hungary has about a hundred state trading organizations for a variety of products, ranging from poultry to telecommunications equipment and for both imported and exported products.
  • Being government sanctioned and controlled for trading in certain goods, buyers for state-controlled trading companies are very definitely influenced by their governments’ trade policies and politics.
  • Most opportunities for manufacturers are limited to raw materials, agricultural machinery, manufacturing equipment, and technical instruments rather than consumer or household goods. Reasons for this limitation include shortage of foreign exchange, an emphasis on self-sufficiency, and the central planning systems of the communist and socialist countries.

End user – This is where a manufacturer is able to sell directly to foreign end users with no intermediary involved in the process.

  • This direct channel is a logical and natural choice for costly industrial products.
  • For most consumer products, the approach is only practical for some products and in some countries.
  • A significant problem with consumer purchases can result from duty and clearance problems. A consumer may place an order without understanding his or her country’s import regulations. When the merchandise arrives, the consumer may not be able to claim it. As a result, the product may be seized or returned on a freight-collect basis.
  • To solicit orders, a manufacturer may use publications to attract consumers. Many US magazines receive overseas distribution, and the advertisements inside are read by foreign consumers. US magazines, including Time, Newsweek, and Business Week, facilitate the ordering process since they publish international editions.

Types of Intermediaries in Indirect Channel

There are many kinds of local sales intermediaries, which be may be grouped under two broad categories:

  1. Domestic agents
  2. Domestic merchants

The basic difference between the two is ownership (title) rather than just the physical possession of the merchandise.

Domestic agents never take title to the goods, regardless of whether or not the agents take possession of the goods.

Domestic merchants own the merchandise, regardless of whether or not the merchants take possession.

  • An agent represents the manufacturer, whereas a merchant (e.g., a distributor) represents the manufacturer’s product.
  • The merchant has no power to contract on behalf of the manufacturer, but the agent can bind the manufacturer in authorized matters to contracts made on the manufacturer’s behalf.
  • Agents can be further classified according to the principal whom they represent. Some agent intermediaries represent the buyer; others represent the interest of the manufacturer.
  • Those who work for the manufacturer include export brokers, manufacturer’s export agents or sales representative, export management companies, and cooperative exporters.
  • Agents who look after the interests of the buyer include purchasing (buying) agents/offices and country-controlled buying agents
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