I have written several postings related to Various topics including the military, Voting, the economy, religion and etc in America. A list of links have been provided at bottom of this article for your convenience. This article will, however address additional issues in these topics.
What Is a Middleman?
The term middleman is an informal word for an intermediary in a transaction or process chain. A middleman, or intermediary, will facilitate interaction between parties, typically for a commission or fee. Some critics say that businesses and customers should try to “cut out the middleman” by dealing directly with each other, avoiding any increased costs or commissions.https://4897daf5044b5c1825beb37485a0dd6b.safeframe.googlesyndication.com/safeframe/1-0-38/html/container.html
Intermediaries also make money by selling the product for more than its purchase price. This difference is called the “markup” or cost the buyer ends up paying. Intermediaries can be small companies or large corporations with an international presence.https://4897daf5044b5c1825beb37485a0dd6b.safeframe.googlesyndication.com/safeframe/1-0-38/html/container.html
- A middleman is a broker, go-between, or intermediary to a process or transaction.
- An intermediary will earn a fee or commission in return for services rendered in matching buyers and sellers.
- Many industries and business sectors utilize middlemen, from trade and commerce to wholesalers to stockbrokers.
In the supply chain, an intermediary may represent a distributor who purchases goods from the manufacturer and sells them to a retailer, often at an increased price. Salespeople are often considered middle-people, such as real estate agents who match homebuyers with sellers.
Certain industries, either by policy, infrastructure, or mandate, include an intermediate layer of business. For example, automobile makers typically do not sell vehicles directly to consumers. Instead, their products are sold through auto dealers, which may include various accessories, options, and upgrades to upsell cars at a higher premium. Auto dealerships try to sell pricier versions of cars in order to turn a greater profit for themselves, as a large portion of the sales revenue goes back to the manufacturer.
The same is true for electronics, appliances, and other retail products. Sellers of electronics and appliances may attempt to steer customers to higher-end products in order to secure a greater profit margin than low-priced items. Such intermediaries may be constrained by the manufacturer in the ways they can sell a product, including how it is marketed or if the product can be packaged with other items to create special offers.https://4897daf5044b5c1825beb37485a0dd6b.safeframe.googlesyndication.com/safeframe/1-0-38/html/container.html
The rise of e-commerce has changed the dynamics of where an intermediary fits in some types of industries, and legislation continues to evolve in response.
In certain states, the sale of alcoholic beverages may be structured to require retailers, bars, and restaurants to purchase products through a liquor distributor. Under such policies, a winery cannot sell its products directly to retailers. This can limit the availability of their products as they are beholden to the intermediate distributors who control the channels they can pass their wine through.
Such constraints may also extend to the sale and shipment of their products from one state to another. For example, some states prohibit or allow the sale and shipment of products such as wine directly to the consumer through online purchases, thus eliminating the layers of middle-people. This has proven to be a contentious challenge to the distribution segment of the industry, which relied on wine and spirits makers being required to ship their wares through them.
Why role of middlemen is important in business? Middlemen are important in business because they make products available to customers and assume the responsibility of collecting payments from the consumers, thereby relieving producers of this responsibility. … As middlemen are in possession of the goods, they can quickly and efficiently distribute them to consumers.
What is a middleman in business? The term middleman is an informal word for an intermediary in a transaction or process chain. A middleman, or intermediary, will facilitate interaction between parties, typically for a commission or fee. … Intermediaries also make money by selling the product for more than its purchase price.
What is the importance of middlemen in business?
What, indeed, is the importance of middlemen in the world of business? Middlemen, by definition, are an added layer within a commercial process that may or may not facilitate a transaction at the most cost-effective level. Brokers are middlemen in that they act to try and bring consumers of stocks together with the companies seeking to sell shares. For this service, which can be conducted for the benefit of the buyer, the seller, or both, the broker or middleman receives a commission, usually a percentage of the value of the transaction.
Brokers or middlemen exist in many areas of commerce. Food brokers, for example, seek to find buyers for a wholesaler’s inventory of a certain category of food. Conversely, they help the buyer to identify the most cost-effective option within the wholesale community. Department or grocery stores are middlemen in that they buy food and other items from farmers and manufacturers, store and display these goods for the benefit of consumers, and manage the transaction, keeping a percentage of the value of the sale while compensating the manufacturer or supplier.
As this is the role of middlemen, one can understand why some wholesalers market their goods as being a better option for the consumer by promising to “eliminate the middleman.” What this means is that wholesalers or manufacturers are communicating directly to the public that the latter can buy products for less money because there is no middleman involved to whom a commission must be paid for facilitating the transaction. No commission or costs associated with middlemen means lower prices for the consumers, at least in theory.
While consumers can avoid the cost of middlemen, nevertheless, most choose that option. Middlemen, especially those who posit themselves as guardians of the consumer procurement process, can help consumers to identify the best product for the consumers’ personal needs. Honest brokers can steer consumers away from disreputable or unreliable suppliers or, conversely, can warn supplies away from potential consumers with records of delinquent payments to their suppliers. With reference, again, to the world of stocks, brokers walk a very fine line between ethical and unethical conduct on a daily basis. Stock brokers work off of a commission calculated on the basis of the value of stocks they transfer from the issuer to the buyer. The broker’s incentive, therefore, is to facilitate the exchange of stocks for cash as often and in as great a volume as possible. The more such transactions, the greater the commissions accruing to the broker. Consequently, it is not unusual for consumers to be sold questionable stocks by persuasive brokers more interested in their commissions than in the welfare of their clients.
Middlemen are an integral part of many commercial transactions. Whether they are needed on any given transaction has to be determined on a case-by-case basis. They can serve a useful purpose in bringing together parties with a common interest in concluding a transaction. They can also, though, subvert the process by secretly conspiring with one of the parties to the transaction to finalize a deal disadvantageous to the other party in the equation. Caveat emptor.
Middlemen are important in business because they make products available to customers and assume the responsibility of collecting payments from the consumers, thereby relieving producers of this responsibility. In addition, as they interact with consumers, middlemen are often in the best position to collect data about the changing needs, demands, and demographics of consumers. They can then funnel this vital information back to the producer to allow the producer to change the product to fit the changing marketplace. Middlemen can also let the producer know about the competition. Middlemen often take title to the goods they are selling, thereby relieving the producer of the risk of holding onto goods. As middlemen are in possession of the goods, they can quickly and efficiently distribute them to consumers. As middlemen often pay for goods in advance, they furnish the producer with capital necessary to carry on operations. Finally, middlemen often absorb increases in the prices that producers place on goods and keep prices stable with consumers because middlemen face competition from other middlemen and want an advantageous position with producers and consumers.
Who is a Middleman?
A middleman plays the role of an intermediary in a distribution or transaction chain who facilitates interaction between the involved parties. Middlemen specialize in performing crucial activities involved in the purchase and sale of goods in their flow from producers to the ultimate buyers. They typically do not produce anything but possess extensive knowledge of the market, thereby charging a commission or a fee for their services.
For example, a real estate agent with an established network of colleagues for contacting potential home buyers, in addition to a broad range of market information and advertising outlets. Wholesalers include the middlemen between manufacturers, producers, and retailers. The retailers themselves are the middlemen between wholesalers and the end customers.
- A middleman plays the role of an intermediary in a distribution or transaction chain who facilitates interaction between the involved parties.
- Middlemen can be classified into two categories, namely, merchants and agents. While merchants buy and re-sell their goods, agents specialize in negotiations of selling or buying transactions.
- They provide manufacturers with valuable market feedback and let them concentrate on production by providing the ancillary services of warehousing, distribution, advertising, insurance, finance, etc. They make goods and services easily available to consumers in the desired quantity.
Types of Middlemen
Middlemen can be classified into two categories, namely merchants and agents.
Merchants, such as wholesalers and retailers, buy and re-sell their goods. They take ownership of inventory and bear the expense of storing and distributing the product. They make money by selling the goods at a higher price than its cost to them. The difference is called the “markup.”
Merchant middlemen range from a shopkeeper to a large multinational corporation with international operations. Larger middlemen may focus on a core competency, such as delivery, advertising, warehousing, or a particular market segment.
Agents, such as brokers or real estate agents, specialize in negotiations involved in transactions. They do not take ownership of what they are selling. Instead, they make money by charging a commission or a fee for facilitating a transaction.
For example, brokers act as intermediaries between investors and the securities exchange. They provide trading services, investment advice, and solutions to their clients and charge a brokerage fee in return.
Functions of Middlemen
Middlemen perform the following functions in a marketplace:
- They provide valuable information and feedback to producers about consumer behavior, changing tastes and fashions, upcoming rival businesses, etc.
- They enable manufacturers to concentrate on the primary function of production by handling the ancillary functions of warehousing, distribution, advertising, insurance, etc. They promote the goods to the consumers on behalf of the producers.
- Middlemen like banks and other financial institutions render financial services to manufacturers.
- They make the goods and services available to consumers at the right place, at the right time, and in the right quantity.
- Buyers and sellers are often unwilling to assume the market risk for fear of a possible loss. It is the middlemen in the process chain who assume the risks of theft, perishability, and other potential hazards.
Importance of Middlemen
Intermediaries are important players in every market. Both consumers and producers stand to benefit from their services. In addition to constantly matching the supply and demand in the market, middlemen provide valuable feedback to the producers about their market offering. By specializing in functions such as banking, warehousing, transportation, underwriting, etc., they bring the economic benefits of specialization and division of labor to the market.
Buyers gain access to the right quantities of goods and services close to their homes through the intermediary channels. They benefit from other services of middlemen, such as advertising and delivery.
Disadvantages of Middlemen
Despite the many advantages that middlemen can offer, some people believe that middlemen do more harm than good and should be eliminated. As goods exchange hands from one middleman to the other, their prices inflate.
A higher price is charged at each junction to cover the cost of warehousing, insurance, transportation, advertising, etc. When a profit margin for each middleman is also factored in, consumers ultimately must bear the price of having intermediaries in the channel.
Seven Middle Men Who Made America
From Mark Zuckerberg to a particularly entrepreneurial meth dealer, celebrating the go-betweens who made America happen.
From its pirates to its merchant princes, its raiders to its robber barons, America was made by middle men. Sure, we celebrate the pioneers and inventors, the guys who shot buffalo or settled the frontier. But, as beautiful as the amber waves of grain may be, it takes a fleet of middle men to make them profitable. And, when it came to making America, it took a lot of guys buying grain and selling shovels, looking for a profit on both sides of the deal.
Let the Lloyd Dobblers of the world whine about not wanting to buy anything that’s sold or processed or process anything that’s bought or sold. It’s a cute speech, and Say Anything is a great movie, but let’s face it: at the end of the day, America runs on middle men.
Middle men are smack-dab in the middle of a fresh renaissance. Platforms and apps like Uber, AirBnB and TaskRabbit may spout off about the cutting-edge wonders of the sharing economy, but at the end of the day, they’re doing what middle men have always done: connecting buyers to sellers and making a profit off both sides. Sure, Uber enables every guy with a Jeep Liberty to become a taxi driver and AirBnB makes it possible for every renter with a spare room to become a hotelier. But while you might make a few bucks from stuffing guests in your study and calling it “Chez Bob,” AirBnB’s owners are riding your shoulders into the ranks of America’s millionaire middle men.
Still not convinced that middle men are what made America great? Well, here are a few examples to prove the point:
Sir John Hawkins
Before the first guy in a hat with a buckle on it stepped off the Mayflower, the New World needed middle men to help it turn a profit. After all, back in the 1500’s, it cost a fortune to ship goods across the Atlantic, and dragging an empty ship back home translated into time wasted and money lost. In 1555, John Hawkins, a ship’s captain and occasional pirate, began what became known as the “triangular trade,” a route from Africa to the Caribbean to England that turned a profit on each leg of the journey. Suddenly, commerce with the New World became a license to print money, a gravy galleon with biscuit sails.
For Hawkins, it was a win-win, and his naval work earned him a knighthood and a promotion to Admiral. For others, though, the triangle trade was a tragedy: one of the legs of Hawkins’ journey involved carrying slaves from Africa to the New World, which makes him not only the father of the New World’s economy, but also one of the fathers of the transatlantic slave trade. In 2006, his descendant, Andrew Hawkins, publicly apologized to 25,000 Gambians, draping himself in chains to highlight his ancestor’s role in bringing slavery to America.
Before New York could become America’s most prominent city, it needed to be settled — and that’s where John Jacob Astor came in. A German immigrant who came to New York in 1784, Astor made his first fortune on fur pelts, which he bought from rough-hewn frontier types and sold to high end furriers in cities around the world.
Astor could have used his money to build in New York, but he followed the middle man model, buying up huge chunks of Manhattan island and leasing them out to people who promised to build on them. Before long, he owned a sizeable, quickly-developing slab of the fastest-growing city in the world.
Astor ultimately became the fourth-richest man in US history, laying the groundwork for a family fortune that still survives, and a real estate market that breeds middle men…not unlike the rabbits and raccoons, minks and beavers on whose backs he arguably built New York.
If middle men have a natural habitat, it’s that sweet spot behind the counter of a store. After all, who could be more in the middle than the man who brings goods from around the world and sells them in his hometown?
From that perspective, Sam Walton lived the middle man dream in its purest form. Starting with a little Ben Franklin shop in Arkansas, he expanded, opening two stores. Then four. Then six. Then more. Within a few decades, his little chain grew into Walmart, the world’s largest — and one of its most profitable — retail companies.
Today, Walmart employs over 2 million people, generating an estimated $36 million in sales per hour. And, while its role as a middleman, bringing the produce of China to the small towns of America, may seem commonplace, the company’s profits are anything but. If Walmart was a country, it would have the 19th highest GDP. Of course, its sales associates would make the 32nd highest average wage. Then again, you don’t become a top middle man by giving top salaries to people who deserve it. That’s for another list of better people.
For all of Sam Walton’s innovations, he followed in the footsteps of a veritable army of merchant princes, many of whom are still enshrined in the shopping malls of middle America. But even JC Penney and RH Macy, Andrew Saks and Richard Sears are little more than the descendants of the first, and perhaps greatest, department store middle man of all.
When Alexander Turney Steward came to New York in the early 1800’s, he brought with him a load of Irish linens and lace, which he promptly sold. That sale financed other ones, and by 1848, he had built one of the world’s first department stores. Not long after that, he launched the first mail-order operation, which brought his goods to homesteads across the country. He was later copied by an army of imitators, from Sears to Amazon, but few have made the money that Stewart did. Adjusted for inflation, his fortune was worth an estimated $90 billion.
Supposedly, it’s impossible to put a price tag on friendship, but Mark Zuckerberg has come pretty close. Based on its current market cap, his company, Facebook, is priced at $180 billion, or almost twice the value of McDonald’s. But, while the golden arches traffics in the tangible wonders of Big Macs and Happy Meals, Facebook’s business model relies on something a little harder to quantify: friendship.
Forget FarmVille and Bubble Witch; Facebook’s main draw is friendship – or, rather, access to friendship. Through its amazing middle man machinations, you can catch up with your cub scout leader, cyberstalk your first girlfriend, and check in on your freshman college roommate — all without having to leave the comfort of your living room.
There is no lack of famous bootlegger middle men: hundreds of enterprising gangsters and rumrunners made their fortune defying Prohibition. Unlike the Capones and Lucianos, however, Joseph Kennedy did more than amass a great estate. He turned it into a political dynasty.
Today, Kennedy is known for a lot of things, including the political dynasty of his sons, his work with Hollywood studios, and his tendency to sleep around with famous starlets, including Gloria Swanson. What’s less known is his insider trading in the stock market, and his – largely alleged – work as a bootlegger.
According to mob boss Frank Costello, he and Kennedy were bootlegging partners during Prohibition – a claim that other famous mobsters, including Meyer Lansky and Joseph Bonnano, backed up. These allegations are impossible to prove, but there’s some good circumstantial evidence: before Prohibition, Kennedy’s father was a successful liquor importer, and he was himself widely known among his fellow Harvard grads as a great go-to guy when it came to getting hold of illegal booze.
Regardless, after repeal, Kennedy entered the legitimate business with his own company, Somerset Importers, which was the sole US representative of Gordon’s gin, Dewar’s Scotch and Johnny Walker.
Zhenli Ye Gon
In the beginning, methamphetamine was a somewhat amateurish drug. A low-cost, easy-to-manufacture pick-me-up, it could be made by anyone with a little chemical know-how and a good supply of cold medicine. As such, it spawned a flourishing cottage industry, pulling in mountain men and Midwest moms, motorcycle gangs and the occasional chemistry teacher.
But, as the meth epidemic heated up, restrictions on cold medications slowed down the supply of raw materials. That’s where Zhenli Ye Gon came in. The Chinese-born owner of Mexican pharmaceutical company Unimed, he imported several tons of meth ingredients into Mexico. At first, this was legal, but, according to law enforcement officials, he continued to do so, even after legal restrictions were placed on importation. Allegedly, many of these meth precursors ultimately found their way into the US.
It’s impossible to calculate how much money Ye Gon made from the sale of meth ingredients, but it’s clear that the numbers are staggering. In 2007, when the Mexican government raided his home, they found $207 million in cash; later, when Ye Gon was on the run from Mexico, he lost $125 million in various Las Vegas casinos, including the Venetian. Today, he’s in the US, awaiting possible extradition to Mexico.This content is created and maintained by a third party, and imported onto this page to help users provide their email addresses. You may be able to find more information about this and similar content at piano.io
The Sad, Lazy Myth of the ‘Middleman’
Dealerships take care of their customers for the entire lifetime of the automobile across the entire automotive ecosystem, not just the point of sale.
Many first year MBA students learn a marketing concept called the “Iron Law of Distribution.” The idea is that when you bring a product to market, you can change who owns the distribution channel for that product — but changing who distributes the product doesn’t change the cost structure associated with distributing the product.
That is, you can change whether a factory or an independent company owns the retail outlet — but that by itself doesn’t change or make retailing costs disappear.
This is a stumbling block for lots of factories that are looking for ways to reinvent themselves. It’s also a huge source of misunderstanding for business reporters who cover companies seeking to “sell direct.” If factories own their own stores, the narrative goes, then there will be no “middleman,” their costs and profits will go away, and the savings will get passed along to customers.
Except for the Iron Law. Changing retail ownership doesn’t actually create any savings in and of itself, because the factory store becomes the new “middleman.” The factory will need to make its own profits retailing. And worst of all, customers are usually hurt when factories vertically integrate sales with manufacturing, because it raises prices by reducing retail price competition.
The Myth of the Middleman
The fact is that when a factory decides to sell its products directly to customers, they incur costs of selling those products to customers — in the exact same way that an independent distributor would incur costs.
In the automobile business, that means factories “selling direct” would incur the costs of running a dealership. That is, they would incur the costs of buildings, land, equipment, inventory, insurance policies, utility bills, and all the human capital needed to run the operation.
And the auto dealership business is complex. Longtime auto industry analyst Glenn Mercer calls the dealership business, “the most complex retail business in America today.”
That’s because local dealerships don’t just sell new cars. They service them. They arrange financing for them. They handle registrations and titles. They take trade-ins. They advertise and collect sales data and customer lists. They often also sell used cars. This is another reality that gets completely lost in the “direct sales” debate: Dealerships take care of their customers for the entire lifetime of the automobile across the entire automotive ecosystem, not just the point of sale.
Manufacturers that experiment with selling directly always eventually run into that reality. They always find that auto retail is complex, that factories are not all that good at retailing, and that having local dealers buying those cars off the factory line, and selling and servicing them in their local communities makes a lot more sense as a business model.
“But what about the profits?” one might ask. “Can’t selling direct eliminate dealership profits?”
Not really. The fact is that dealerships make very little money selling new cars. Local dealerships are only profitable when they take into account the entire ecosystem of the vehicle — sales, service, used vehicle sales, reconditioning contracts, fleet maintenance, and on and on and on.
Local dealerships are capital intensive businesses — meaning it costs a lot in land, buildings and equipment to run them. American dealerships have invested more than $200 billion in land and buildings alone. Any factory wishing to sell directly would incur those same costs of capital — and its shareholders would certainly expect to get a return on those expenditures. Why sink money into a retailing operation when there’s no return on it?
For consumers, it’s even worse. When factories own retail outlets, there is no competition to keep prices down. Factories set prices, and hold excess profits for themselves. When independent retailers compete, that always creates price pressure. That’s why no supermarket can sell Campbells Soup for 10% or 20% more than another supermarket — they’ll eventually go out of business. Same thing with car dealerships. When car dealers compete, prices go down. One peer-reviewed academic study has shown that when dealerships compete in proximity to each other, the average price of a vehicle goes down by about $500.
And price competition impacts not only sales, but service and repairs as well. Customers at one factory-owned dealership chain have had to wait literally three weeks or longer for a service appointment. Can you imagine waiting three weeks to pay to get your vehicle fixed? Nowhere in America today would a customer have to wait that long to get service on a Chevrolet, Toyota or Jeep. If one local dealership can’t get you in for a service appointment this afternoon, the one down the street most certainly can. Consumers win when dealerships compete.
In the end, the “middleman” myth is a really lazy and simplistic way of thinking about business. If local dealerships are middlemen, then Walmart is a middleman. So is Amazon. And Walmart and Amazon aren’t expected to service or repair the products they sell, like dealerships do.
Local dealerships do more than sell cars. They help their customers over the lifecycle of the car – from sales, to financing, to registration, to service, to trade-ins. They compete for customers at every stage of the ownership cycle, providing choices and competitive pricing for customers.
That’s why locally owned dealerships are good for consumers, and the communities where they operate. It’s been that way for a hundred years — and the iron law of distribution explains perfectly why it’ll be good for customers for the next hundred years.
Cutting out the middleman means many different things. Most of the time, it means a brand is cutting out third party retail distribution. Warby Parker, probably the most famous example that it’s now a meme—”We’re the Warby Parker for x”—cut out third-party retail and sold directly to customers, online and now in-store. (Warby Parker is not the first to do this—dozens of brands sell only in their own stores and online, such as Zara, H&M, Gap and others—but it remains the most prominent to do so post-internet, especially since it started on the internet.)
The middleman fallacy
There is no single path to launching a business today. But the default towards direct to consumer or nothing has done plenty of harm. These startups, and the entire premise of cutting out the middleman, are predicated on a misunderstanding that is verging on a fallacy: that cutting out the middleman is inherently a good thing that makes it easier and cheaper to build a scaleable business. Many companies have been founded on this premise without considering the potential benefits or disadvantages of cutting out middleman—and the additional work doing so now requires. Additionally, the lack of specificity about which middlemen were being cut fueled the “Warby Parker for x” gold rush that was wildly misunderstood.
This meme-driven fallacy has had two major effects. First, it demonized the actual benefits of middlemen; and second, it undersold the challenges of starting a direct-to-consumer business and scaling it.
Two types of middlemen
There are two general types of middlemen for ecommerce companies who sell physical goods. The first and most common middleman is the third party retailer. This middleman has been the go-to one to eliminate, as evidenced by brands such as Warby Parker, Bonobos and Everlane, which sell their products exclusively through their own channels. Doing this, however, requires a vastly different skill set and cost structure than a traditional retail brand.
The other type of middleman is the back-end middleman, such as fabric mills, sewing factories, dye houses, logistics network and agents who tie all of these pieces together. These middlemen are entirely hidden from the consumer, but they add costs at every stage. The more middlemen involved, the more expensive the goods will be. Each of these middlemen deliver value, but some brands take care of these steps themselves, while others try to own the entire process and the infrastructure that powers it. These middlemen are most used when a brand outsources all of its operations, and are mostly ignored when a brand is vertically integrated.
Good middlemen and bad middlemen
Middlemen are not inherently bad. They are often very important because they bring tangible value to the table. I’ve written extensively about the exaggerated death of wholesale, the channel that has built hundreds of lasting brands. Retailers who buy products from brands at wholesale provide very real benefits. First, the retailer has an audience that a brand instantly gets access to. Second, the retailer (usually) takes responsibility for selling the product. This relieves the brand of this burden, and it can now focus on designing and producing excellent products, while the store manages the selling. This relationship continues to be very powerful, and we will continue to see many brands built this way, such as Vetements, because it works when everyone’s priorities are aligned.
A retailer, in this case, is a net good middleman. It is providing more value than it is costing, which keeps the relationship going. Yes, it’s causing the prices of products to double—a brand sells a retailer a shirt for around $45 and then the retailer sells it for $100—but everyone should be paid for the value that they provide. Real estate, marketing, customer service, and sales staff all come out of the retailer’s margin, which is why it marks up products accordingly. The value that middlemen capture is (often) not arbitrary. Yes, sometimes it is overpriced, but middlemen often deliver value—otherwise they wouldn’t exist.
Default to direct to consumer
The last few years have been riddled with a bias towards every brand starting by default as direct to consumer. The first half of this decade, starting with Warby Parker’s founding in 2010 and continuing until probably the end of 2015, cutting out the middleman was all anyone could talk about. VCs pumped money into the space and every month a new startup popped up that promised to “cut out the middleman” and “offer prices at half of the cost of its retail” competitors.
I find this bias illogical, since not every business should exist as a direct to consumer brand. Wholesale has often been left out of the entire conversation. This is unfortunate because wholesale has a lot of great benefits. It’s far from perfect, as I’ve written about extensively, but it is not inherently bad. It is just different.
The type of business one builds should be informed by one’s skill set and interests. If you want to start a design-driven fashion brand today, wholesale, or some combination of wholesale and direct, is probably your best bet. This allows you to focus on designing while someone else focuses on selling. If you want to be influential in the fashion world, a niche, wholesale brand remains very viable. Look no further than Vetements.
However, if you want to start a brand with simple products that really scale, direct to consumer might be the answer. Everlane, Bonobos and Dollar Shave Club all fit this framework. There is a tension, however, between being truly fashionable and design-driven while being a strong and scaleable brand. Why? Because of focus.
Middlemen and focus
The single biggest benefit of a middleman is what it lets a business focus on. To use a wholesale brand as an example, having a retailer take care of the merchandising, selling and servicing of the product enables the brand to focus on designing and producing the best product possible. The retailer charges the brand for taking care of the end selling by buying the product at the wholesale cost, which is half price. The retailer gets to double the wholesale cost and capture this margin because it is providing a valuable service and has a specific skill set that enables it to succeed.
If a brand wants to cut out a wholesaler and sell to the end customer, that’s totally fine. But now the brand has to pick up the retailer’s slack, which includes both a cost and a skill set gap. To capture the full margin, the brand now has to thrive at marketing, merchandising, customer acquisition, and customer service, all on top of designing and producing great products.
This is not impossible, but the brand has just doubled the number of tasks it needs to master, which objectively leads to a loss of focus. Regaining focus and mastery is far from easy, which is why we’ve seen many “we’re just cutting out the middleman” startups spin their tires: saying you’re cutting out the middleman is very different from having the skill set to actually do so.
Through this lens, it’s been very interesting to listen to Vishaal Melwani, the CEO and co-founder of Combatant Gentlemen, a direct to customer men’s suiting business, talk about his work to cut out the middleman on many levels. Melwani talks a lot about growing up in a family of tailors and factory owners, but one part stood out from a recent interview in the Wall Street Journal:
We go all the way down to raw materials. We buy raw cotton for shirts. We have grown our own cotton in the past, but we scaled past that point. Now we can buy full bales of cotton and produce shirts. Then we go directly to the mills … in China and Turkey, some denim in the U.S. We tell them that you are just sewing. They cut, make, trim. We supply all of the raw material. All they do is sew. Usually, you go to a factory and say, hey, this is the suit I want, figure it out and make the whole thing. We tell them you are just sewing, because we know you are going to put in extra cost for the buttons, and for the wool. We know where all of that comes in. And that is something I learned from the trading firm days. They would never let the raw material and the final production meet and procure each other, because that is where middleman costs come in.
We have a robust system of raw materials and final production, and we are constantly moving goods all of the time. There are 30 factories in total, from raw materials to final production, and they are all basically linked together through one infrastructure, which we call Tower.
Melwani is describing a very deliberate decision to start from the raw materials and cut out as many middlemen as possible along the way. He is entirely correct that there are many middlemen involved when making a single garment, which adds costs that are passed on to the consumer. Yet it’s clear that Melwani has a fundamental understanding of supply chain and sourcing, and built this understanding into his company.
That said, everything he described in Combatant Gentlemen’s supply chain takes an immense amount of work to coordinate and perfect, on top of building an excellent brand. There are less opportunities for focus here. The structure of the company, according to Melwani, reflects this. From the same article:
We look at it as tech first, fashion second. I think that as a digitally native brand, you have to be, these days. We have more engineers than we do people in fashion. It’s intentional. For today’s user interface, user experience, you really need to understand how the consumer thinks. And that is why we do it this way.
Combatant Gentlemen’s focus is on perfecting the supply chain and the brand experience, not necessarily on designing the best fashion out there. This is perfectly fine, but it’s important to understand that Melwani made a conscious choice to do this and arguably has the skill set to back it up. He’s able to cut out many middlemen in the supply chain because he knows how to thread the pieces together. But Combatant Gentlemen won’t be the most design-driven brand as a result.
Middlemen and vertical integration
Interestingly, few direct to consumer brands are vertically integrated. Zara isn’t, contrary to popular belief. Harry’s, the men’s grooming company (from a Warby Parker co-founder) is the first that comes to mind, since it bought a razor blade factory and only sells through its own channels. Even the idea of a Digitally Native Vertical Brand (DNVB), the term claimed by Bonobos founder Andy Dunn, is far from true vertical integration. In this case, only the brand itself is vertically integrated, but the company uses middlemen to facilitate everything below the actual branding and distribution.
Through this lens, Dollar Shave Club (DSC) is a fascinating case worth discussing. The company, which Unilever just bought for $1 billion, is one of the few successes in direct to consumer subscription businesses. (I’m going to leave the analysis of the subscription part of out of this piece and instead focus on where specifically DSC cut out the middleman.)
DSC was not vertically integrated. Quite the opposite, actually. DSC did not make its own blades. It bought them from a Korean manufacturer called Dorco, a middleman. DSC likely runs on Amazon Web Services, and uses a third-party fulfillment provider, yet another middleman.
DSC actually has very little to do with vertical integration. Instead, DSC’s move is about one thing: focus. Outsourcing parts of the core business that would not set it apart—supply chain, logistics and fulfillment—allowed DSC to focus on one key differentiator: the brand. DSC became an expert at marketing, customer acquisition and customer service, while everything else, including production of the core product was outsourced—to a middleman.
The return of middlemen
Vertical integration for direct-to-consumer brands might not be the answer. Instead, the way to become a Digitally Native Vertical Brand might be to use middlemen very wisely behind the scenes—the opposite of true vertical integration.
If I had to bet on one thing powering the next generation of Digitally Native Vertical Brands, it would be the continued growth of middlemen. There are so many services that brands can now tap into, from fulfillment services to credit card processing services to packaging services and so on. These middlemen are crucial for getting a brand off the ground and scaling it, all while enabling the company to focus on building the brand and making the best product.
Middlemen are crucial to a successful outcome, and we will continue to see more middlemen pop up to fill different holes in the stack. Brands should not shy away from them and try to replicate their services, as doing so will cause them to lose focus on their core differentiator.
Brands that smartly take advantage of many of these middlemen will prosper. The ability to focus on what actually makes the brand and the experience special is what sets the best brands apart from the pack. Not all middlemen are created equal and cutting out middlemen for the sake of it is futile.
What Is the Middleman in Marketing?
The main objective of marketing is to create valuable exchanges between consumers and producers. The market consists of those consumers who are willing and able to purchase products, hence creating exchanges that satisfy both parties. Middlemen, also referred to as intermediaries, play a vital part in ensuring that the distribution channel between the producer and the consumer is complete. The more intermediaries there are in the supply chain, the higher the distribution channel.
Types of Middlemen
Examples of middlemen include wholesalers, retailers, agents and brokers. Wholesalers and agents are closer to the producers. Wholesalers buy goods in bulk and sell them to the retailers in large quantities. Retailers and brokers acquire the goods from the wholesalers and sell them in small quantities to the consumers.
Consumers may also choose to bypass the intermediaries and buy goods directly from the producers. This is referred to as disintermediation.
Roles of Middlemen
The core function of intermediaries is to deliver goods to the consumers when and where they want them. To achieve this, they buy the products from the producers, store them as they search for viable markets, and then transport them to the consumers. In the process, they assume any risks facing the goods – for instance, theft, perishability and other potential hazards. In addition, middlemen promote the goods to the consumers on behalf of the producers.
Importance of Intermediaries
Intermediaries are very important players in the market. Both the consumers and producers gain immensely from the roles of middlemen, who ensure that there is a seamless flow of goods in the market by matching supply and demand. Intermediaries provide feedback to the producers about the market, thus influencing the decisions made by the manufacturers.
Buyers, on the other hand, gain from the services offered by intermediaries, such as promotion and delivery. Buyers can get the right quantity they want, as intermediaries are able to sell in small units.
Effect on Price
Regardless of the important role they play, there are some disadvantages to having intermediaries in the distribution channel. As the goods are exchanged from one intermediary to the other, their prices inflate. The rationale behind higher prices is to cover expenditures on the goods such as warehousing, insurance and transportation costs.
Intermediaries are also out to make profits, hence they have to include some profit markup in the sales. Consumers then bear the price of having intermediaries in the channel.
A middleman is a person or organization that provides services and offers something of value to both buyer and seller. In other words, a bona fide middle person bridges the gap between suppliers and buyers by initiating quality contacts, providing sourcing services for buyers, assuring reliability of suppliers, and ensuring a continuous supply of products.
This matchmaking process can be hard work and deserves to be appropriately compensated. But once the suitors have been introduced and the relationship has been consummated, how can you, as a middleman, protect yourself from being cut out of the deal?
Unfortunately, there’s no way to ensure 100% fair treatment all the time. However, you can employ some techniques to discourage a supplier and/or buyer from taking advantage of you.
Hugh Henderson, President of HCI International in Lexington, Virginia, offers this advice:
Make yourself perceived as an indispensable employee by emphasizing the services you are providing to both parties. Remind them that the amount of money they pay you, as the middleman, is less than they can perform those services themselves. Demonstrate that you are the best person to structure the best deal for each party.
Contracting with the Buyer and Seller
One of the most effective ways to protect yourself is to obtain an exclusive contract with the manufacturer or the supplier. This contract should ensure that you receive a fee or commission on all business you generate within a defined set of parameters such as geographic area or industrial application.
Wise and experienced traders take this a step further. They also obtain an exclusive agreement from the buyer that stipulates a predetermined fee or commission payable to the trader for services rendered.
The more you control international commercial transitions, the better position you are in to protect yourself and assure payment for your services. Strive to act as a filter for every possible communication between the seller and buyer in order to keep in the loop from beginning to end on all transactions.
For example, you may want to act as the exporter of record in all transactions. Consider doing all pertinent paperwork and documentation in order to maintain control over your supplier.
The ultimate way to protect yourself is to purchase the product directly from the supplier at an OEM discount. You can then sell directly to the end user at a markup and manage all paperwork.
I have worked for many years with a three-man company that buys and sells compressors, valves, actuators and flow control industrial apparatus to a pipeline in Asia. The owner of this company explained the above technique and stated that his profits last year exceeded several million dollars; not bad for a three-man organization that neither manufactures nor inventories any product whatsoever but simply provides middleman services.
Remember, it is a natural phenomenon for buyers and sellers to connect directly. By offering value to both parties, controlling the transaction, obtaining exclusivity in written agreements, and passing title to the goods through your organization, you will be in a good position to benefit financially as a middleman in international commerce.
Top 10 arguments in favor of Middlemen in Distribution Channel
Although there have been certain criticisms leveled against the middlemen, the functions performed by them are very important. The following are the top 10 arguments in favor of middlemen.
1. There are many producers who may not have funds to perform the task of distribution. In such a case, it is only the middlemen who relieve such producers of their problems.
2. The consumers of a product are scattered throughout the country. It is, therefore, not possible for a producer to contact each buyer personally. The middlemen, thus, help the producers by distributing their products to the consumers living in different places.
3. The wholesalers, as middlemen, buy in bulk quantities from the manufacturers. Thus, a high inventory turnover is made possible because of the presence of middlemen.
6. The wholesalers, who are bulk buyers, maintain their own godowns. They store large quantities of goods in such godowns and sell to the requirements of the retailers.
7. Provision of credit is another important service of the middlemen. The wholesalers provide credit to the retailers and many retailers, these days, accept credit cards of their customers.
8. Certain goods are produced only during a particular season but are demanded throughout the year. On the other hand, there are certain goods, which are produced throughout the year but are in demand only during a particular season. In either case, it is only the middlemen who arrange to provide the goods when required.
9. The retail outlets are located in residential areas. As a result, it is possible for a consumer to buy what he wants at any time. He need not have to buy and keep stock of every item.
10. The role of Middlemen is indispensable for producer as they provide market information from time to time. With this market information, the manufacturers are able update their products to time to cope up with the demanding needs of the buyers.
To conclude, if middlemen are eliminated, then the manufacturers themselves may have to undertake all the functions hitherto performed by middlemen. But manufacturers neither have time nor resources to perform all such functions. It, therefore, goes without saying that middlemen cannot be eliminated.
Eliminate the Middleman?
Greg, it’s good to see you again,” Joe Lin said, extending his hand with a smile. “It’s been too long.” Greg Jamison, the chief global sourcing officer at USTech, an American consumer electronics firm, shook Joe’s hand and returned the smile. “It has,” he said. “But we’ll make up for lost time.” Greg paused, waiting for Joe to greet USTech’s new manager of Asian sourcing, Morris Chang. But Joe simply looked at Morris with a blank expression, hesitating just a moment before turning to say hello to the others who had arrived for the meeting upstairs.
This was even worse than Greg had anticipated. Until recently, Morris had worked at TaiSource, USTech’s primary product supplier, where Joe was the CEO. As a Taiwanese original design manufacturer, or ODM, TaiSource both designed and made products sold under USTech’s brand name, primarily for the U.S. market. Morris had managed TaiSource’s relationship with the U.S. company, which was one of the Tai company’s biggest customers.
When USTech created the position of Asian sourcing manager and Morris asked about the job, his experience and talents made him an obvious hire. Greg had worried that Joe might be upset by the departure of his longtime lieutenant. But he never imagined that Joe would consider Morris to be a traitor. If the two men couldn’t work things out, it would put a strain on USTech’s long-standing and mutually beneficial relationship with TaiSource.
As Joe chatted with Dan Rollins, USTech’s senior vice president for marketing, about preparations for the 2008 Olympic Games in Beijing, Greg wondered where the relationship between USTech and TaiSource was heading. The questions of loyalty and betrayal raised by Morris’s move to USTech were only part of this complicated situation, he realized. Indeed, the tense encounter between Joe and Morris, in the lobby of TaiSource’s Beijing manufacturing plant, spoke to issues at the very heart of USTech’s corporate strategy.
The China Question
Six months earlier, Greg and Dan had met with the rest of USTech’s senior leadership team at headquarters to discuss the company’s sourcing strategy. The CEO began by setting the context: USTech had positioned itself as a midlevel brand, offering more features than commodity producers and lower prices than higher-end rivals. Its goal was to capture the number three spot in the global market. But the company was losing market share, particularly to CaliTech and TexaTech, the number one and number two players, which were marketing more innovative products. And the commodity producers were pulling down prices and squeezing USTech’s margins. “My question,” the CEO said, “is whether rethinking our sourcing arrangements can help us regain share and solidify our position.”
The CFO jumped in first. “I don’t think we can wait any longer to source directly from China,” he said. “Where else do labor, electricity, taxes, and government fees account for just 5% of total manufacturing costs? Our numbers are showing that CaliTech and TexaTech cut their costs by 20% after they started doing their own sourcing in China.”
“Now, wait,” Greg said. “We should be cautious about jumping on the China bandwagon. What about the indirect costs that CaliTech and TexaTech are incurring? Have you tried to calculate those? Sure, labor is inexpensive in China, but what about dealing with government bureaucracies or resolving long-distance logistics breakdowns? We can’t begin to see all the hidden costs.”
“Sure, labor is inexpensive in China, but what about dealing with government bureaucracies or resolving long-distance logistics breakdowns? We can’t begin to see all the hidden costs.”
“But haven’t our years working with TaiSource given us sufficient experience to work directly with the Chinese?” asked the head of human resources.
“Not really,” Greg explained. “Yes, TaiSource has moved most of its manufacturing to China. But that hasn’t involved us. In fact, we’re getting the best of both worlds—TaiSource’s world-class research and design and its lower manufacturing costs. We’re getting the benefits of direct sourcing in China without the hassle of coordinating it.”
“We’re getting the best of both worlds—TaiSource’s world-class research and design and its lower manufacturing costs. We’re getting the benefits of direct sourcing in China without the hassle of coordinating it.”
“At what cost, though?” the CFO asked. “We should go through TaiSource only if the transaction costs of going to China ourselves would exceed the production cost savings.”
Greg sighed and flattened both palms against the table. “Okay, so why don’t you go ahead and find out—”
“Cost reduction is only a secondary benefit,” Dan interrupted. “The real gains have to come from market growth.”
“What do you suggest?” the CEO asked, swiveling his chair to face Dan.
“With our brand equity, we should be going after the China market more aggressively. CaliTech and TexaTech already have the high-end market there, and the low end is overrun by Chinese firms like Lenovo. There may be a niche for us here, a middle-market space that we could capture—a space that would be easier to occupy if we manufactured in China.”
“I like this approach,” Greg said. “But a midrange branded product requires us to maintain quality, and that means we need Taiwanese suppliers. Chinese companies just don’t deliver high quality yet. Even Lenovo sources components from Taiwan.”
The CEO turned to Greg. “What about a mix of Taiwanese suppliers—whether TaiSource or someone else—and Chinese suppliers? After all, the sole-source model has almost become an anomaly in our industry.”
The COO spoke up for the first time. “If we use more than one supplier, we have to make sure they can work together smoothly. Our operating costs will skyrocket if we have too many suppliers who aren’t integrated into our network.”
“Hold on,” the CEO interjected. “We need to stop trading off cost and quality. Our global sourcing practices can’t be considered apart from our overall strategy. For one thing, if we want to capture that number three position, we clearly need to figure out an effective China sales strategy.”
By the end of the meeting, the senior team had decided, tentatively, to enter the China market, sticking with the company’s positioning as a “premium brand at a lower price.” The team also decided to establish sourcing offices in Beijing and Shanghai, with the aim of identifying Chinese manufacturers that could play a role—to be determined—in USTech’s sourcing strategy.
A Cautious Welcome
Greg replayed the debate among USTech’s senior executives in his head as he and Dan flew across the Pacific en route to Asia. Since the meeting six months ago, Greg had hired Morris, who had opened the two sourcing offices and staffed them with a handful of Chinese employees. During this trip, Greg and Dan planned to check out the new offices, make some initial inquiries about Chinese suppliers, and get a feel for the Chinese market. They would also pay a visit to TaiSource’s Beijing factory and meet with Joe, who spent much of his time there. The first stop, though, would be Taiwan, where Morris planned to introduce them to some executives at ODMs he had identified as possible auxiliary suppliers to TaiSource—or even replacements.
Greg recalled with some embarrassment the obvious bias toward TaiSource that he had exhibited in the executive meeting. Still, it was a rational bias, he thought. Over the years, the two companies had developed a trusting, open relationship. Thanks to the free exchange of information, TaiSource had been able to create high-quality products at competitive prices for USTech. Indeed, Greg had always marveled at how hard the Taiwanese company’s engineering and design teams worked to deliver one custom product after another. Before he and his colleagues considered multiple sourcing, Greg realized, he would need to negotiate very carefully with TaiSource to establish rules for collaboration.
When Greg and Dan landed in Taipei, Morris met them at the airport and drove them to the complex comprising the Neihu Technology Park and Nankang Software Park. The parks—home to more than 2,000 companies, including famous Taiwanese firms such as Lite-On and BenQ, as well as R&D units of international firms such as IBM and Sony—were established in 2001 along the banks of the Keelung River, and their award-winning buildings created a spectacular skyline when viewed from the opposite bank.
Morris had arranged meetings with a number of companies, all of whom had track records of innovation and quality, unlike most of their Chinese counterparts. Greg showed the ODM executives some of the products that TaiSource had made for USTech and asked whether their companies could offer a lower price or higher quality. The response was cautious. Some of the companies had codeveloped virtual private networks with their U.S. customers, local suppliers, and Chinese partners. These alliances with their international customers would inhibit them from pursuing similar relationships with USTech.
After the meetings, Greg and Dan slid into Morris’s BMW 730 for the one-hour trip up the Sun Yat-sen Freeway to Taiwan’s other large high-tech park, the Hsinchu Science Park. There wasn’t much conversation as the three executives surveyed the urban industrial sprawl along the busy freeway, whose congestion was relieved only by the view of the rugged Central Mountain Range rising in the distance.
The Hsinchu Science Park, built in 1980, had the lush appearance of a botanical garden—a stark contrast to the gleaming Taipei complex. The nearly 400 companies at the park focused primarily on integrated circuit design and silicon chip fabrication. In fact, the Hsinchu park alone represented 16% of global semiconductor output. Companies with operations there included Asustek, a contract manufacturer of Apple iPods; Quanta, a supplier to Dell and Hewlett-Packard; and Taiwan Semiconductor Manufacturing, a partner of Qualcomm and Nvidia.
But here, too, the response to USTech’s overtures was guarded. As the men headed back to the airport, Greg wondered how varied the company’s sourcing options really were.
From Supplier to Rival?
When Greg, Dan, and Morris landed in Beijing, they were met by a driver who took them to USTech’s new sourcing office at Shangdi Information Industry Base, a technology park. The 45-minute drive on the Jingchang Expressway provided a striking contrast to the drive along the Sun Yat-sen Freeway in Taiwan. The traffic wasn’t particularly heavy, and numerous golf courses along the route gave the area a greenbelt feel.
During the drive, Morris described the benefits of the site. For one thing, it presented a variety of transportation options. Nanyuan Airport, offering domestic flights; Beijing International Airport; the Tianjin Xingang Port on the Haihe River; and Beijing’s freight railroad station were all within an hour’s drive. The park was also home to such famous Chinese information technology companies as Lenovo and Founder, and to international firms such as Novo Nordisk and Fanuc.
That evening, after the office visit, Greg, Dan, and Morris met at the Grand Hyatt Beijing for a drink. While Greg and Dan ordered Chinese “yellow wine” as a nod to the setting, Morris opted for a single malt. The busy lobby lounge was packed with Western and Chinese businessmen; both “hello” and “ni-hao” occasionally rose above the conversational din as a Chinese singer crooned Western lounge standards. Sitting at a table near floor-to-ceiling windows overlooking the grounds of the semicircular hotel, the men discussed the goals of the trip.
“The Taiwan visit wasn’t particularly satisfactory,” Greg said, sipping from his glass. “The companies were all okay, but none of them seemed qualified enough to replace TaiSource.”
“Yes, but this probably isn’t simply a question of sourcing capabilities,” Dan said, wrinkling his brow. “TaiSource, as a pure ODM player, is very attractive—but I’m not sure how long it’ll remain just that. A lot of ODMs, including some we visited today, have started marketing their own brands in China. If TaiSource decides to do that, it would become one of our biggest rivals. TaiSource sure does know the market here.”
Greg leaned forward in his seat. “I’ll bet a lot of Chinese suppliers have similar ambitions,” he said. “I think our strategic information is safer with TaiSource than it would be with a new Chinese supplier. We have a history with TaiSource. Think how long it would take to build up that kind of trust with a new supplier.”
Dan was shaking his head. “But TaiSource may be too sophisticated. Look at what they can do with R&D and manufacturing—it would not be hard for them to imitate our proprietary products and services if they wanted to launch their own brand.”
Greg and Dan turned to Morris, who had been sitting silently. Morris seemed to gather himself together, and then he looked Greg, then Dan, straight in the eye. “Joe has a plan to enter the China market in the next five years,” he said. “The strategy is to concentrate on the Asian and European markets first, then move to the United States. But think about it: USTech accounts for nearly half of TaiSource’s orders. Joe will not play hardball if we decide to do some of our own sourcing in China.”
Dan shifted in his seat. “This all makes me very uneasy. How can we keep sharing our expertise, resources, and technology with a supplier that will soon be our competitor in China?”
“How can we keep sharing our expertise, resources, and technology with a supplier that will soon be our competitor in China?”
“A sourcing alliance is a mutual thing, not a zero-sum game,” Greg said, his voice rising. “We count on TaiSource’s capability to produce custom-designed products. We can’t afford to damage this relationship. What do you think will happen if Joe starts to sense that we don’t trust his company anymore? We could see the quality of our products decrease and our costs increase before we have time to make other sourcing arrangements.
“Let’s wait and see what Joe says tomorrow,” Greg said abruptly. He drained his glass, rose from the table, and returned to his room.
The next day, the USTech executives made their stop at TaiSource’s Beijing factory. Following the awkward encounter in the lobby between Joe and Morris, the men headed to an upstairs conference room.
As they walked down a hallway, a number of TaiSource managers emerged from their cubicles and went off in various directions. Greg couldn’t help noticing how easy it was to tell the Taiwanese from the Chinese: The Taiwanese spoke to one another in English and to their Chinese colleagues in Mandarin. “One world, two languages,” Greg said to Dan. “The question is, where do we fit in?”
When Greg and the others reached the conference room, they were greeted by a new and unexpected face. “This is our new chief marketing officer, May Wang,” Joe explained. “She will be our major contact with USTech in the future.”
Greg and Dan exchanged a quick glance. A new CMO? The idea of a marketing executive with a higher rank than Morris had had at TaiSource made Greg nervous. Maybe TaiSource planned to launch its own products sooner than Morris thought.
Greg started things off with a question about how TaiSource’s Chinese production was going. “This Beijing factory is not big enough to cope with strong demand,” Joe replied. “We plan to expand it and build a new factory in Shanghai to better supply our customers.” Greg decided that some straight talk was in order. “So, do you have any plans to launch your own brand in China in the near future?” he asked.
“Many global brands have had problems manufacturing in China,” Joe said, not skipping a beat, “and consequently the demand for contract manufacturing is booming. I don’t see any immediate need to worry you by launching our own brand. Besides, that’s not what we’re good at.”
Then May spoke up. “It is difficult for Joe to change his mind-set,” she said, a teasing smile on her face. “He’s an engineering guy who is proud of being the top-quality supplier. Brand marketing does not really interest him. But let’s talk about this in a more formal way.” May switched off the lights and brought a PowerPoint presentation up on a screen.
“We have three initiatives that will enhance the service we provide to USTech,” she said. “First, we are broadening our production base to other Chinese cities. This will improve our economies of scale in purchasing and manufacturing, creating cost savings we can pass along to you. Second, we plan to establish an R&D office in the U.S. that will help us work more closely with you on product innovation. Finally, we are acquiring capabilities that will allow us later this year to ship products directly to your U.S. warehouse, cutting your logistics costs.”
Dan interrupted. “Where will our orders be filled? From the U.S.? From Taiwan? From here in Beijing? Or from your new Shanghai factory? As you broaden your production base, will you be sourcing from other Chinese suppliers? We’re concerned about the safety of our proprietary information.”
“We will separate the design from the manufacturing work,” Joe replied. “Your orders will be designed in the U.S. or Taiwan and manufactured here in Beijing. We also plan to split the production of your orders from others so that your data can be protected.”
“Don’t forget,” May added, “that with our improved design ability and volume manufacturing capacity, we can help you improve your margins.”
The meeting continued, with May describing the ways TaiSource could better satisfy USTech’s requirements and Joe reassuring Greg and Dan about the security of USTech’s innovations. But Greg was aware of a conspicuously quiet participant: Morris. May and Joe both acted as if he weren’t in the room. Greg wondered whether hiring Morris to establish the local Chinese sourcing offices had been a good move. As the meeting broke up, Greg noticed two plaques on the wall of the conference room, each bearing a slogan. One read, “World-class quality”; the other, “Integrity and cooperation.”
Culture and Complexity
The next morning, Greg, Dan, and Morris flew to Shanghai to visit the other sourcing office and several potential suppliers. USTech’s office was on the outskirts of Shanghai and, like the Beijing office, was in an advantageous location—another sign of Morris’s savvy. The supplier meetings went well. Although the ability of these companies to meet quality specifications was uncertain, their prices were undeniably attractive.
That night, at the Grand Hyatt Shanghai, the highest hotel in the world, Greg looked out the window of his room at the sparkling city below. Across the Huangpu River, he could see the Bund, the famous street symbolizing foreign investment in China in years past. Clustered around his hotel were the skyscrapers of Pudong, symbolizing a new era of Western investment.
He turned from the window and noticed the Chinese calligraphy carved, as a decorative touch, into the wooden wall next to his bed. Someone had mentioned earlier in the day that the characters were in complex Chinese, used in ancient times and still used in Taiwan but no longer in China. The distinction was lost on Greg: The writing would look complex to him no matter the style.
And that summed up his feelings as he tried to decide whether to join Dan and Morris for dinner or take a break and eat in his room. Opting for solitude, he again pondered USTech’s sourcing situation. What had been a highly successful relationship with TaiSource was clearly fraying, if not unraveling. Morris’s move strained the partnership and exposed the potential shift from manufacturing collaboration to marketing competition. In fact, the two companies were likely at some point to compete in the same midrange market niche in China, with USTech trying to leverage its brand and TaiSource relying on its strong manufacturing platform.
The next day, as Greg and Dan took off from Pudong International Airport, Greg ordered a glass of California red wine and tried to relax. He had a feeling he would need to get used to these long-haul flights.
What should USTech’s sourcing strategy be?
Bruce K. Riggs (bruce.riggs@ gateway.com) is the senior vice president for operations and customer care at Gateway in Irvine, California. He previously worked at Quanta Computer, a Taiwanese original design manufacturer.
Greg Jamison needs to realize that the status quo—an exclusive supply relationship with TaiSource—is outdated and may no longer help USTech competitively. To improve the company’s situation, Greg must admit to a few mistakes and do some things differently. One is to realize that relying on a sole original design manufacturer, or ODM, for both development and production of technology products inhibits a broad understanding of supply chain risks and opportunities. For years, Greg saw the supply chain through TaiSource’s lens and couldn’t tell if the costs, quality, scheduling, flexibility, and engineering capabilities of TaiSource and its suppliers were current and competitive.
Certainly, a trusting relationship with suppliers is important. But I’ve learned from my experience both at a Taiwanese ODM, where I oversaw relationships with corporate customers, and at Gateway, where I manage the company’s relationships with ODMs, that trust alone is insufficient. Truly effective relationships need to be grounded in a current, quantitative, and shared understanding of the supply chain environment and best practices.
If Greg had looked beyond the TaiSource relationship, he wouldn’t have been surprised, or necessarily worried, by changes in it. The growing demand in China for information technology products—and TaiSource’s ability to respond to that demand with its own branded products—should have been a sign. Greg should anticipate change as both companies expand beyond an ODM relationship that was originally intended to support U.S. products for the U.S. market.
Greg also should begin educating himself about suppliers in both Taiwan and China—and his education must be more rigorous than a drive up the Sun Yat-sen Freeway, with stops to meet executives Morris Chang happens to know. A crucial first step would be to submit a formal RFI (request for information) and RFQ (request for quotation) to potential ODMs. He may be surprised to find that some Chinese suppliers can deliver the same level of quality as their Taiwanese counterparts.
As Greg gathers data on suppliers, he should consider alternatives to a pure ODM sourcing and fulfillment model. For example, USTech could assume management of the sourcing of key component technologies found in a family of products. Developing relationships with core technology suppliers, which typically span several product generations, would let USTech track changes in the cost, quality, and market demand of such technologies while expanding beyond a sole source relationship.
As Greg gathers data on suppliers, he should consider alternatives to a pure ODM sourcing and fulfillment model.
Finally, Greg must admit to himself that hiring Morris was a mistake. It’s clear that Morris won’t be able to manage the relationship with TaiSource effectively, whatever form it takes. While U.S. executives may move easily from company to company, a Taiwanese executive typically wouldn’t move to a competitor; if he did, he would likely “apply to resign,” a process that could take months. Morris’s accelerated resignation probably violates an unspoken covenant with Joe Lin.
But let’s face it: Joe’s feeling of betrayal isn’t just a reflection of cultural differences. Whatever the geographic context, Greg should have discussed Morris’s possible move to USTech with Joe in order to maintain good relations with his longtime supplier. Now he’ll have to hire someone else to manage the TaiSource relationship.
In addition, Morris seems ill suited for the other part of his job: finding alternative suppliers. At TaiSource he gained experience in production and scheduling, but it isn’t clear that he has the expertise to quantitatively assess suppliers in such areas as process control, manufacturing capacity and utilization, and quality management systems.
Had Greg looked at the situation objectively, considering immediate and future needs as well as cultural differences, he could have found a solution that would both meet USTech’s changing requirements and protect the company’s relationship with TaiSource.
Barry C. Lynn (firstname.lastname@example.org) is a senior fellow at the New America Foundation in Washington, DC. He is the author of End of the Line: The Rise and Coming Fall of the Global Corporation (Doubleday, 2005).
Greg should consider himself lucky. The cozy relationship between USTech and TaiSource was speeding toward a crisis even before he hired Morris. But thanks to what he learned from that questionable decision, Greg now has an opportunity to fix USTech’s sourcing strategy before disaster strikes.
USTech and TaiSource have become so interdependent that USTech must establish either a more formal alliance with the supplier or a more strictly defined arm’s-length relationship. Given the distrust on both sides, the only real option is the latter. Greg can now choose to diversify USTech’s ODM relationships; source directly in China and Taiwan, which would require quickly mastering certain management and assembly tasks; or combine these approaches, thereby enabling USTech to expand in China at a safe pace. Greg can afford no illusions: Whatever the choice, USTech’s costs will increase. The era of free-rider collaboration for a firm this size is over, and the sooner USTech recognizes that fact, the better.
Greg’s next step should be to gather the USTech team for an honest postmortem. In retrospect, the degree to which USTech trusted TaiSource will seem shockingly naive. All interdependent relationships are competitive. Absent a clear ownership structure, or the social constraints that exist within certain Asian societies, such competition will eventually destroy even mutually beneficial relationships.
In retrospect, the degree to which USTech trusted TaiSource will seem shockingly naive.
Although the relationship with TaiSource looked great on the bottom line, the result was to empower a new competitor. TaiSource has deep knowledge of USTech’s products and the ability to manufacture in both Taiwan and China, and it plans to open a U.S. R&D office—another name for a sales office.
A review of USTech’s sourcing system, if truly complete, will reveal that the company is still hugely vulnerable in at least one area: political conflict. In the event of political turmoil within China, or between China and another industrial nation, the flow of components on which USTech depends would be cut off. Direct entry into China by USTech would do nothing to lessen this risk. And no matter which ODMs Greg links up with in Taiwan, all rely on work done in China.
Sure, Thomas Friedman and other trade utopians insist that industrial interdependence prevents conflict among nations. But this is rank foolishness. The entirely unregulated industrial relationship between the United States and China is analogous to the fuzzy “collaborative” relationship between USTech and TaiSource. Eventually, there will come a struggle for a greater share of the profits, or for control of the system itself.
Unfortunately, Greg’s options here are few. Suppliers in the United States, Japan, Korea, Malaysia, and Singapore would all cost more. Given that the biggest immediate threat to USTech is posed by direct competitors, all of whom source extensively in China, the executive team has no alternative but to depend on China and hope for the best.
Which means that Greg’s next call should be to Washington. When any company discovers a political risk that no firm on its own can afford to address, it is time to sit down with the people who shape the market. After all, if no one company can mitigate the dangers, then the political risk has shifted from the level of the firm to the level of the societies that depend on those firms. At this point, Greg must cease to act as an executive and act instead as a citizen.
When Greg makes his call, he may be tempted to speak in anger. It will seem to him that the politicians have screwed up once again, this time by pretending that incredibly complex global markets could somehow be entirely self-regulating. Greg should use his own mistakes to help politicians understand what must be done. After all, just as USTech realized it could not rely safely on one supplier, so too must the United States.
Wang Dongsheng (email@example.com) is the chairman and CEO of BOE Technology Group, based in Beijing.
This may come as no surprise, given my position as the head of a Chinese manufacturer, but I would advise Greg to seriously investigate the Chinese sourcing option. In addition to the likely cost advantage, sourcing in China will give USTech a base from which to penetrate the fastest-growing market in the world—and a supply chain that should be able to react quickly to demand and technology shifts in the Chinese market.
Granted, exercising the Chinese sourcing option requires care. It’s not easy to find a qualified supplier in China. And when you do find one, it takes time to become familiar with both the Chinese business culture and your supplier’s procedures. To shorten that learning period, you must make a serious effort to build trust with the supplier.
Greg will need to draft a strategy and establish a process for choosing a Chinese manufacturer that can help USTech pursue its strategy in China. He’ll also need to hire a purchasing manager who knows both local manufacturers and the culture.
A crucial step for Greg will be educating himself about the local sourcing partners of CaliTech and TexaTech and determining how these relationships could influence USTech’s options. As Greg learned during his visit to Taiwan, international companies can lock up relationships with the best suppliers, although the current situation in China is more fluid. Despite these challenges, however, Greg will need to do at least some sourcing in China.
What may come as a surprise is that I would also advise Greg to work on his relationship with TaiSource. He’s definitely made mistakes. It wasn’t a good idea to hire Morris and then expect him to work amicably with Joe. And Greg should have begun investigating a multisourcing strategy years ago.
But it wouldn’t be wise for Greg to abandon TaiSource simply because of the current strains. While USTech identifies sourcing manufacturers in China that meet its requirements, Greg should consider ways he can rebuild his company’s relationship with TaiSource. At the minimum, he needs to buy time while he establishes links with Chinese suppliers. And Chinese suppliers, while their production quality can match anyone’s (just look at TaiSource’s decision to manufacture in Beijing), lack TaiSource’s design capabilities.
Greg does need to evaluate whether TaiSource can reduce its costs and pass the savings on to USTech. And he still has a strong bargaining position: Just as USTech needs TaiSource, at least in the short to medium term, so TaiSource needs USTech. But even in the long term, USTech should look for a win-win solution with its supplier. For example, Greg might continue using TaiSource for products sold in existing markets, particularly the United States, while shifting to Chinese manufacturers for new markets.
Greg might continue using TaiSource for products sold in existing markets while shifting to Chinese manufacturers for new markets.
I know personally the benefits of pursuing friendly, win-win business relationships. At BOE Technology Group, we make high-end flat panel display screens and other display components used in a variety of products, including televisions, notebook computers, video cameras, mobile phones, and medical instruments. We work closely with our customers—major global companies that, like USTech, sell finished and branded products to the end user—to build relationships that ensure our mutual success.
In the case of flat panel displays that use our proprietary wide-viewing-angle technology, we work with our partners to brand the component screens under our Viewiz brand, just as Intel does with its “Intel Inside” campaign. Although one could imagine this causing tension with suppliers, the increasing strength of the brand benefits us and them.
Paul Gaffney (firstname.lastname@example.org) is the executive vice president for supply chain at Staples, the office products company, based in Framingham, Massachusetts.
As Greg considers his sourcing options, two general principles should inform his thinking. The first—which is related to the issue of transaction costs, raised repeatedly by Greg as a reason to stick with TaiSource—goes something like this: As you seek lower initial product costs by removing parties from the supply chain, objectively assess the value they add and be sure you can replicate that value at equal or lower cost. It seems obvious, but there is a risk in the current environment for companies to say “Let’s source things directly in Asia” (or, in Greg’s case, “Let’s source things directly in China”) without having dispassionately considered this equation.
I recently oversaw Staples’ move to source, primarily from China, a new line of products bearing the Staples brand—everything from flash drives to printer paper. Our situation was somewhat different from USTech’s, in that we weren’t switching suppliers but shifting from selling only other companies’ branded products to selling some of our own. But we had to weigh the costs of taking on a new range of tasks—product design, packaging design, product life cycle management—that our branded suppliers had always done for us. This was the price we paid to obtain the lower initial costs of dealing directly with the factory. And we determined that in some cases it would be economically advantageous to have our new products made not in China but in the U.S. by manufacturers whose products we sell in our stores.
The second principle is that, as you consider your supply options, carefully and candidly assess the economic interests of potential suppliers. In our case, we weren’t making a choice between a Chinese manufacturer and an ODM like TaiSource. Instead, we had to gauge the different interests of a Chinese manufacturer and the sales and marketing organization of a U.S. branded goods company, our traditional source of products.
When you source directly in China, you’re typically building a relationship with a factory and the Chinese entrepreneur who owns it. That entrepreneur’s economic interests are basically to get a good return on his capital investment in the factory. Although he wants to grow his business by making more things, he’s not that concerned about what he makes. Contrast that with the sales and marketing team of a U.S. branded products company. For one thing, the company is interested not only in selling more things but also in selling things it wants to make. And its economic motives are harder to assess, in part because the owner—the shareholder—is several times removed.
Having determined a supplier’s economic interests, the next step is to consider whether they’re aligned with your own and, where they’re not, what the consequences would be. For example, the Chinese factory owner’s primary interest in the return on assets means that he doesn’t really care who his customer is; he would likely switch to someone willing to pay a marginally higher price. At the same time, because his interests are fairly transparent, it may be easier to work with him.
Having determined a supplier’s economic interests, the next step is to consider whether they’re aligned with your own and, where they’re not, what the consequences would be.
One final thought: Greg and his colleagues are almost obsessively focused on the likelihood that TaiSource will begin making and marketing its own branded products. Their concern is justified, but Greg should be trying to identify ways that this apparent conflict of interests might be transformed into a mutually beneficial situation. Some of our suppliers make their own branded products and those bearing the Staples brand side by side in the same factory. And we’ve seen some of our traditional suppliers introduce innovations on products even as we launched our own branded versions of the original product. In such instances, everybody benefited, including the customer.
The Advantages of Eliminating the Middleman
The term “middleman” describes an intermediary between a producer and an end customer. In a typical distribution channel, the middleman is the wholesaler or the retailer. Manufacturers would eliminate the middleman by selling products directly to retail stores or consumers. Wholesalers can do the same by skipping retailers and selling directly to consumers. This strategy has some advantages over a straightforward distribution process.
The primary motive to eliminate your traditional buyer and sell further up the food chain is to save money. Manufacturers today sell directly to consumers thanks to Internet expansion. Rather than paying sales representatives to promote products to resellers, companies can promote products on their own websites, take orders and send goods directly to the final customer.
Eliminating the middleman usually creates a win-win for the seller and buyer from a money perspective. Each step in a traditional distribution process involves a trade buyer adding a markup to his costs. This ultimately makes the final customer’s price higher because he is paying for the original product costs, the costs of each buyer’s acquisition as well as the profit expected by the retailer. By getting rid of the middleman’s markups, you can offer the customer a lower price while getting higher gross profits for yourself.
Skipping steps in the distribution channel reduces the amount of logistics and transportation required in the movement of goods from manufacturer to consumer. This increases efficiency significantly. Manufacturers, for instance, can skip wholesalers and more quickly replenish retailers with stock. Additionally, companies can offer products and websites and quickly ship them to consumers following the purchase. Response time on customized orders also has become more efficient over time as companies have eliminated steps in the distribution process. This increases customer satisfaction and revenue.
An indirect benefit of eliminating the middleman, which some companies promote actively, is better environmental preservation. By minimizing the number of trucks and travel time moving products from one step to the next, you reduce the pollutants in the air. Additionally, local farmers have taken opportunities to market fresh produce to local buyers to improve freshness and minimize waste from delays in moving perishable foods.
The Future is Not About Being a Middle Man
One of the big changes happening in the world of work is the disappearing “Middle Man.” When a business starts, hiring is focused on two places – manufacturing and sales. In other words, the two most critical positions are the person who makes the widget, and the person who sells it. But as a company grows, middle level managers are hired to manage the salesforce and the widget makers. And the truth is, for a past generation, the role of “middle managers” was a reliable job for a variety of companies and organizations. But today, things are dramatically changing.
Due to a host of reasons including the last recession, corporate downsizing, outsourcing, and the growth of computer applications, the middle is being squeezed out. For example, after Kathleen and I founded Cooke Media Group, our first official employee was Brad Knull. At the time he was a producer and production manager for many of our projects. But when he and his wife Cindy’s daughters were born, they decided to move back to Ohio to be closer to their family, where Brad took a position with one the largest corporate media production houses in the country. Before long he rose to being the company’s head of production.
But Brad is very perceptive, so it wasn’t long before he realized that in the near future, middle men would start disappearing. And that’s when he bought his own video camera and starting shooting projects himself. Within a few years, he launched into a new career as a Director and Director of Photography, and that’s when his career exploded. Since that time, and just as he predicted, his former company has indeed reorganized, and eliminated those middle management positions.
But Brad is busier than ever.
We’ve been working together ever since, and Brad and I had this conversation a few years ago when we were filming in Cuba for the Museum of the Bible. We were discussing the fact that Cooke Media Group is celebrating our 28th anniversary in business, and one of the reasons is that from a staffing perspective, we’ve stayed lean and mean. We’re not interested in anyone who “manages the managers,” but in people who can either bring clients to the table, or create the actual projects.
Think about that with your own career. In the last two years, I’ve received an increasing number of emails from desperate people who have been laid off from jobs as middle level managers or similar positions in production companies, studios, and other industries as well. None were ready for the change, and all were caught off guard.
The lesson? You need to be critical to the process. Make sure you’re either bringing clients, customers, or funding to the table, or you’re directly involved in creating the product. My friend Seth Godin calls it being a “Lynchpin.” The world of business – and nonprofits as well – are changing, and the people who survive are the people the organization can’t live without.
Role of Pharmacy Benefit Managers in the Pharmaceutical Supply Chain
Pharmacy benefit managers play a central role in determining the cost of medications to consumers.
November 15, 2019 – As the healthcare industry works to tackle skyrocketing spending, a keen eye is turning toward the pharmaceutical industry. And with that, experts are examining the role pharmacy benefits managers play in the pharmaceutical supply chain and how they impact prescription drug costs.
A pharmacy benefits manager (PBM) is a middleman of sorts that handles most aspects of the drug purchasing process on behalf of private payers, federal and state programs, large employers, and other payer types, according to the Commonwealth Fund.
“By negotiating with drug manufacturers and pharmacies to control drug spending, PBMs have a significant behind-the-scenes impact in determining total drug costs for insurers, shaping patients’ access to medications, and determining how much pharmacies are paid,” Commonwealth Fund has noted. “PBMs have faced growing scrutiny about their role in rising prescription drug costs and spending.”
Specifically, PBMs maintain relationships with three key stakeholders in the pharmaceutical supply chain:
- PBM and drug manufacturer: The PBM negotiates a drug price and rebates from the manufacturer. In exchange for rebates, PBMs will put certain drugs on formularies, which ensures a drug manufacturer will get business.
- PBM and health payer: The PBM manages a payer’s drug formulary list (i.e., the medications for which plan beneficiaries may receive coverage.) In exchange, the payer gives the PBM money for administrative services, paying for the actual drug, and paying for drug dispensing. Drug rebates the PBM obtained from the manufacturer should factor into the lump sum the payer owes.
- PBM and the pharmacy: In some cases, a PBM will contract with a pharmacy to dispense drugs directly. They will also pay the pharmacy a drug dispensing fee.
Source: The Commonwealth Fund
PBMs are a vital part of the pharmaceutical supply chain that few consumers even know exist, let alone understand. However, their roles ultimately boil down to two principal functions: managing health payer drug formularies and negotiating drug prices and rebates with prescription drug manufacturers.
MAINTAIN DRUG FORMULARY LISTS
Central to the job of a PBM is managing and maintaining a healthcare payer’s formulary list.
A drug formulary is a list of prescription drugs that are preferred under a specific health plan. Also referred to as a drug list, formularies are essential to understanding healthcare benefits and what type of care a beneficiary can access.
If a patient is prescribed a drug that is not a part of her health plan’s formulary list, either she will pay the entire cost out-of-pocket or her provider will have to select another drug that is under the plan’s formulary.
Part of setting that drug formulary is determining patient access to a drug and a drug’s utilization, Commonwealth Fund says. Specifically, PBMs may create medication adherence programs and set up utilization management systems, such as prior authorization or step therapy.
If a drug requires prior authorization, a patient and her provider must obtain specific direction from a board of providers and other stakeholders from the payer for the patient to access the drug. Step therapy requires patients to use lower-cost treatments first, ruling out care options until they move further up the drug formulary.
A PBM’s key role in setting a payer’s formulary has opened the door to its next job function: negotiating drug costs and, in many cases, managing rebates from prescription drug manufacturers.
NEGOTIATING DRUG PRICES, MANAGING REBATES
The next leg of a PBM’s job is to negotiate a purchasing price from a prescription drug manufacturer. Drug manufacturers are in charge of setting a raw price, known as the list price, for its medications. The list price may be the baseline value manufacturers say their drugs hold, but it is rarely the price a PBM pays for the drug.
Drug manufacturers know that PBMs are responsible for creating drug formularies. And because the manufacturer wants its drugs – especially high-dollar drugs – on a preferred drug formulary, it will often give a rebate to a PBM, meaning that the PBM will need to negotiate a payment for a drug that is lower than the list price.
From there, the PBM receives reimbursements from its payer partners, while paying a drug dispensing and an administrative fee to pharmacies.
But this rebates and price negotiation process can be flawed, some stakeholders say.
For one, this process is left mostly opaque. It’s hard to know rebate values, the Commonwealth Fund reported in a separate March 2019 study. Information about drug rebate amounts is kept private in manufacturer and PBM contracts, so it is difficult for payers, consumers, and other stakeholders to know how much anyone may benefit from a rebate.
Furthermore, the process might incentivize PBMs to put higher-cost drugs on formulary lists, resulting in higher spending for the payer and potentially the patient.
“Because they often receive rebates that are calculated as a percentage of the manufacturer’s list price, PBMs receive a larger rebate for expensive drugs than they do for ones that may provide better value at lower cost,” the Commonwealth Fund explained. “As a result, people who have a high-deductible plan or have copays based on a drug’s list price may incur higher out-of-pocket costs.”
Critics have also raised questions about how PBMs pass savings along to stakeholders, including payers, patients, and pharmacies.
PBMs might engage in a practice known as price spreading, for example. As noted above, the PBM receives a drug dispensing and administrative fee from a healthcare payer. The PBM must also pay its own drug dispensing and an administrative fee to pharmacies.
But in some cases, those fees are not equal. When the PBM negotiates a more substantial fee from the payer than the PBM pays to the pharmacy, that constitutes price spreading, and it can be highly lucrative for PBMs.
As the healthcare industry continues to zero in on the rising cost of healthcare and prescription drugs, the role of the PBM and how it works with both payers and drug manufacturers will remain important. These middlemen play a key role in the setting of prescription drug prices, and as such, have a significant effect on healthcare spending, out-of-pocket patient costs, and, ultimately, drug affordability and access.
Pharmacy Benefit Managers and Their Role in Drug Spending
What are pharmacy benefit managers?
Pharmacy benefit managers, or PBMs, are companies that manage prescription drug benefits on behalf of health insurers, Medicare Part D drug plans, large employers, and other payers. By negotiating with drug manufacturers and pharmacies to control drug spending, PBMs have a significant behind-the-scenes impact in determining total drug costs for insurers, shaping patients’ access to medications, and determining how much pharmacies are paid.1 PBMs have faced growing scrutiny about their role in rising prescription drug costs and spending.
What role do PBMs play in how much we spend on prescription drugs?
PBMs operate in the middle of the distribution chain for prescription drugs. That’s because they:
- develop and maintain lists, or formularies, of covered medications on behalf of health insurers, which influence which drugs individuals use and determine out-of-pocket costs
- use their purchasing power to negotiate rebates and discounts from drug manufacturers
- contract directly with individual pharmacies to reimburse for drugs dispensed to beneficiaries.2
The federal Centers for Medicare and Medicaid Services found that PBMs’ ability to negotiate larger rebates from manufacturers has helped lower drug prices and slow the growth of drug spending over the last three years. But PBMs may also have an incentive to favor high-priced drugs over drugs that are more cost-effective. Because they often receive rebates that are calculated as a percentage of the manufacturer’s list price, PBMs receive a larger rebate for expensive drugs than they do for ones that may provide better value at lower cost. As a result, people who have a high-deductible plan or have copays based on a drug’s list price may incur higher out-of-pocket costs.3
What’s the controversy over the rebates PBMs receive from drug companies?
Drug manufacturers argue that the growing rebates they pay PBMs are forcing them to raise list prices for their products. According to a recent analysis, manufacturer rebates to PBMs increased from $39.7 billion in 2012 to $89.5 billion in 2016, partially offsetting list price increases.4 PBMs counter that they have been passing along a larger share of the rebates to insurers.
There is a lot of debate over whether PBMs should be able to keep the rebates they receive from drug manufacturers, which generally aren’t publicly disclosed. Some believe PBMs should be compelled to “pass through” all or a larger portion of these savings to health insurers and other payers. If PBMs were required to do this, insurers could use the savings to further reduce people’s premiums and cost-sharing payments. A recent study found that the share of rebates PBMs passed through to insurers and payers increased from 78 percent in 2012 to 91 percent in 2016.5 But many small insurers and employers say they do not receive this share of savings.6
A separate controversy involves a PBM practice known as “spread pricing,” whereby PBMs are reimbursed by health plans and employers a higher price for generic drugs than what the PBMs actually pay pharmacies for these drugs. The PBMs then keep the difference. Again, a lack of transparency allows this to happen: the payment schedules PBMs generate for pharmacies are kept confidential from health plans.https://e.infogram.com/6e951b4c-9136-4460-b1e3-c93ab486f258?parent_url=https%3A%2F%2Fwww.commonwealthfund.org%2Fpublications%2Fexplainer%2F2019%2Fapr%2Fpharmacy-benefit-managers-and-their-role-drug-spending&src=embed#async_embed
What reforms have been proposed to regulate PBMs?
Policymakers have considered three principal reforms to regulate PBMS:
- Require greater transparency around rebates. Federal and state policymakers likely need more data on the rebates PBMs receive to gain a more complete understanding of pharmaceutical spending and where reforms may be needed.
- Ban spread pricing. Policymakers could ban the practice to ensure that payers and employers are not overpaying PBMs for prescription drugs. A more limited proposal would mandate that PBMs update their cost schedules with pharmacies to reflect price increases for generic drugs.7
- Require PBMs to pass through rebates to payers or to patients. To preserve some of their incentive to negotiate price reductions with drugmakers, PBMs could be required to pass through 90 percent of their rebate savings to payers. Alternatively, PBMs could be required to pass through rebates to patients. The federal government has, in fact, proposed requiring PBMs contracted with Medicare Part D plans to pass through to patients at least one-third of the rebates and price concessions they receive.
Some experts think that PBMs also need to reorient their business model away from securing rebates and more toward improving value in pharmaceutical spending. For example, health plans and PBMs could do more to support physicians in prescribing the most cost-effective medications on their patient’s formularies. And PBMs could base formulary decisions and price negotiations on a drug’s health benefits as well as its effect on the total cost of patient care.
I have included a description and discussion of the Pharmacy Benefit Management services of PBM as an example of the middleman process in our pharmaceutical system in the US. I have recently read the Book “The Price We Pay, What Broke American Health Care-And How To Fix It”. This book was an eye opener about our health care system. What I found out is there is a great deal of mismanagement in the way the PBM system is managed. It is causing us a great deal of money in the purchasing of our pharmaceutical products in the US. I always thought it was that the pharmaceutical companies were greedy, well they are that, it is however, the PBMs that are causing the higher prices in the US. I wrote an article entitled “How Our Pharmaceutical System Works”. In this article I discuss how the System works in the US. I spent a great deal of time discussing the PBMs, so I won’t rehash it more in this article. In this article I have discussed middle management and the middle man system in the US. There is no denying that it has not streamlined many of our industries, but I feel that is not necessary in all industries. I feel that it has added greatly to the bureaucracy and the cost in our business model, that is our capitalistic system.
There is too much price gouging in this country, what is the answer? I frankly don’t know. The answer is not more governmental oversight. I do believe what we need is more transparency in our country. This is becoming problematic with big tech interfering in our freedom of speech as well as controlling the narrative. During the 2020 Presidential election, the Hunter Biden lap top from hell was kept from the press, the sexual harassment suit against Biden was covered up and the collusion with Russia and China was covered up by the press, so how can we expect transparency in our economic system. The swamp is simply too deep, as President Trump sadly found out.
Our country and capitalistic system is very efficient, most cases. That is why the middle man became more common. It helped reduce the infrastructure that companies needed to function. We have Independent Human Resource companies, separate accounting firms, legal firms, transport companies, shipping companies. All of these companies have been created to improve the efficiency of our small businesses. So in most cases it has worked. We just have to fine tune it.
“The Price We Pay; What Broke American Health Care – And How To Fix It”, By Marty Makary, MD; investopedia.com, Middleman,” By Adam Hayes; corporatefinanceinstitue.com, “Middleman;” esquire.com, “Seven Middle Men Who Made America: From Mark Zuckerberg to a particularly entrepreneurial meth dealer, celebrating the go-betweens who made America happen,” By Bruce Watson; blog.nada.org, “The Sad, Lazy Myth of the ‘Middleman’: Dealerships take care of their customers for the entire lifetime of the automobile across the entire automotive ecosystem, not just the point of sale,” By Jonathan Collegio; loosethreads.com, ” Cutting out the middleman;” smallbusiness.chron.com, ” What Is the Middleman in Marketing?” By Daphne Adams; shippingsolutions.com, “Middleman Blues: How to Make Sure You Don’t Get Cut Out of the Loop,” By Joseph A. Robinson; hbr.org, “Eliminate the Middleman?”, by Ming-Hui Huang; philcooke.com, “The Future is Not About Being a Middle Man,” By Phil Cooke; endnotes.com, “What is the importance of middlemen in business?,” By Walter Fischer; accountlearning.com, ” Top 10 arguments in favor of Middlemen in Distribution Channel;” yourbusiness.azcentral.com, “The Advantages of Eliminating the Middleman,” By Neil Kokemuller; impgroup.org, ” THE CHANGING ROLE OF MIDDLEMEN,” By Robert Olson; pharmanewsintel.com, “Role of Pharmacy Benefit Managers in the Pharmaceutical Supply Chain: Pharmacy benefit managers play a central role in determining the cost of medications to consumers,” By Sara Heath; commonwealthfund.org, “Pharmacy Benefit Managers and Their Role in Drug Spending;”
THE CHANGING ROLE OF MIDDLEMEN–STRATEGIC RESPONSES TO DISTRIBUTION DYNAMICS
”An advanced marketing economy is characterized by intermediary
sellers who intervene between the original source of supply and the
ultimate consumer. These middlemen include retailers and wholesalers and many specialized types of merchants, brokers and sales
These middlemen have played major roles in the evolution of trade and industry. Business
historians even claim that the entrance of the professional trader at the end of the Middle
Ages was an important driving force for the development of the society.
Similar thoughts are expressed by Hicks (1969) who concludes that when these professional
firms, specialized in trading, entered the scene, they became the engines in the evolution of
our world. Channel researchers also emphasize the central role of middlemen in the past in
the conclusion that “wholesalers as institutional type have for thousands of years been
involved in what we refer to as global marketing”.
Various types of middlemen have continued to be significant actors, as witnessed in the quote
above. At the end of the 1900s, however, their central positions in distribution systems were
severely challenged. Technical development in manufacturing, logistics and systems for
information exchange made new types of distribution arrangements possible. In particular,
information technology development (IT) improved conditions for direct producer-consumer
contacts. IT also reduced the need for inventories because of faster and more accurate
communication and enhanced control of material flows. Since warehousing was one of the
main functions of middlemen these changes threatened their position in a time that was
characterized as “the revolution that is taking place in distribution”. Far-reaching consequences were expected and it was argued that the on-going changes “will modify many of the assumptions on which distribution channel structure is based”. As described above, the consequences were expected to be most dramatic for middlemen and the authors concluded that “many intermediaries will die out”. Some years later a comprehensive literature review on the role of intermediaries in distribution indicated that these perceptions were still valid, since a main finding was that “there is no room in this revolution for middlemen”.
However, Pitt et al. claimed also that “new channels and new intermediaries will
take their places”. The most significant effect in this respect was supposed to be achieved
through ‘electronic’ intermediaries. There is no doubt that ‘traditional’ middlemen in some contexts, and some situations, have been outperformed by such firms. However, in many cases it is the ‘traditional’ middlemen that have taken the lead in the restructuring of distribution. They have done so by changing their roles in ways that makes it possible to claim that they appear as ‘new intermediaries’. What is even more important is that these firms work in ways that definitely makes it relevant to talk about ‘new channels’. For example, one study concluded that in some new types of distribution arrangements, where middlemen have redefined their roles, “it is often difficult to distinguish whether they are wholesalers or retailers in the traditional sense”.
This paper deals with issues related to the need for re-interpretation of the roles of middlemen
in light of the on-going transformations of distribution. ‘Role’ is not a clear-cut concept in the
distribution literature – it has been used in various meanings. In this paper the role of a firm is
defined firstly by the operations in which it is involved (sometimes identified as ‘functions’)
and the skills required for the undertaking of these operation. Secondly, a role is defined in
relation to what business partners these operations and skills are directed. This is because
potential roles become manifest through the value-generating opportunities they provide.
We begin in the section below with an overview of previous research on the dynamic features
of middlemen as the point of departure for our framework. The literature review indicates
that the analysis of potential roles for middlemen in today’s business landscape requires a
holistic perspective. On this basis we adopt the industrial network model in the framing of
middlemen and their potential roles. In the framework we explore central conditions in
distribution networks in the three layers of activities, resources and actors and discuss what
they may imply for the role of a middleman. After that follows the empirical information
illustrating the efforts of a mobile phone distributor to take various roles and positions in
relation to its business partners. The findings from this case study are analyzed with the
concepts and models identified in the framework, followed then by conclusions and
THE DYNAMICS OF MIDDLEMEN – A BRIEF HISTORICAL REVIEW
The professional trader, mentioned above, dominated the distribution arena for long time.
The main reason was that manufacturing in general was characterized by small-scale family
operations. In the United States only a “small amount of manufacturing was carried on
outside home”. Therefore, in the colonial time, before the industrial
revolution, the ‘Grand Distributors’ ruled the game. These organizations were ‘all-purpose’
businesses and sold all types of goods and performed all the basic commercial functions by
acting as “exporter, wholesaler, importer, retailer, ship-owner, banker and insurer”. This broad engagement was required in order to secure the supply of goods from
geographically distant sources of goods. Since specialized actors were not available, this
middleman had to integrate all these activities within its organization. These firms served as
coordinators of the small producing units, through their business transaction with consumers
and end-user in the ports and river towns where they located. They also supplied the
producers with raw materials, tools and furnishings. The societal importance of these trade
firms are illustrated by the fact that they “acted as the community’s financier…provided
short-term loans to finance staple crops and manufactured goods… and made long-term loans
to planters, farmers and artisans to enable them to clear land or to improve their facilities”
(Chandler, 1977:17-18). At this point in time Chandler concluded that the ‘mass-marketer’
played the most important role in distribution. This middleman selected goods from small scaled manufacturers and supplied consumers that had little choice, but buying what was
Around 1800 these conditions changed considerably. One reason was the industrial
revolution that over time resulted in substantial expansion of the size of companies in the
manufacturing sector, consequently enhancing their power. Furthermore, various types of
enterprises specializing in some of the distribution functions appeared, such as banks and
insurance companies. Some merchants began to specialize in one or a few lines of goods, for
example, cotton, wheat and dry goods. Moreover, they tended to “concentrate on a single
function: retailing, wholesaling, importing or exporting”. In the middle of the 1800s manufacturers began to establish their own sales organizations.
They did so because mass production required mass distribution and existing middlemen
were unable to sell and distribute goods in the volumes they were produced. Other
manufacturers engaged in sales and distribution because their technically advanced products
required specialized services like demonstration, installation and after-sales services, which
current middlemen had neither the interest in providing, nor the competence to supply.
Therefore, over time “the mass producer rather than the mass marketer took over the role of
coordinating the flow of goods”. The power balance thus had shifted in favor of manufacturers.
These organizational changes were made possible through technological changes. The
integration of mass production with mass distribution under the control of manufacturers was
achieved through ‘a revolution in transportation and communication’.
Efficient systems for physical delivery could be established because of advances in
transportation in terms of railways and steamships, while new opportunities for information
exchange were provided through telephone, telegraph and improved postal services. These
developments contributed to enhanced specialization of middlemen that now could reach out
to larger markets even when they narrowed their assortments. Thus, at the end of the 1800s,
such as steel, mining, textiles and ship-building”, while others specialized “by product
categories, for example, welding supplies, cutting tools and industrial chemicals”. These firms lay the ground for what was later identified as industrial distributors.
The direct sales organizations of manufacturers covered only large accounts in geographically concentrated markets, while they relied on industrial distributors for small-scale and geographically dispersed end-users. It is a huge difference in the position and status of these firms in comparison with the Grand Distributor. This middleman had been a trader that was “seeking out sources of supply of dependable goods at reasonable prices” . In the new arrangements powerful manufacturers with trade-marked goods, more or less, dictated business conditions and the roles of middlemen “have become less of a trading nature and more of a distributing nature”. In particular the position of wholesalers was weakened, because they were threatened from both sides by firms that wanted to bypass them. The functions of wholesalers were taken over “more and more by manufacturers, retailers, and to some extent by consumers – either directly or by agencies they own or control”.
After World War II, middlemen have regained the initiative. Firstly, they have been in a better position than manufacturers to handle increasing costs for personal selling and physical distribution, particularly in relation to small and medium-sized customers. A middlemen representing several manufacturers can allocate costs for sales-visits and logistics on several accounts in comparison with a manufacturer with only one assortment in the product
portfolio. Therefore, industrial distributors have improved their position as a sales channel for
manufacturers. Secondly, the standardized approach required in large-scale manufacturing has been replaced by enhanced attention to customization. In the demands for individualization
middlemen are closer to the end-user and therefore, in certain situations, they have greater
opportunities in these efforts. Thirdly, retailers have improved their position considerably in
today’s distribution arrangements. Increasingly they design the products in their assortments
and then contracts out manufacturing. Moreover, they develop their own brands and
strengthen their power through the establishment of chain organizations.
Fourthly, and most important, middlemen have been able to exploit the conditions appearing
from the second revolution in communication and transportation. The technical developments
during the recent twenty years in relation to logistics and information technology, in
combination with flexible manufacturing systems, provide opportunities for entirely new
distribution configurations, relying more on efficient flows of goods, than on inventories and
warehousing. The same developments have strengthened a separation of the physical flow
from the information flow that was initiated some fifty years ago and identified as the
‘separation of the two halves of distribution’. This separation began when logistics emerged as a strategic corporate function, from previously being integrated with marketing in the broader area of distribution. The long-term effect of the separation is that “marketing and logistics which were initially closely linked drifted apart”. In combination with the development of information
technology this separation provided opportunities for further specialization of middlemen. Firms focusing on either the physical flow or the information flow are in a better position to
exploit new opportunities than companies involved in a huge number of middlemen
functions. New types of actors identified as third-party logistics providers have evolved
through specialization on the flow of materials. Others have focused on information exchange and been defined as information brokers and electronic intermediaries.
The short exposé above illustrates the significance of dynamic modifications of the roles for firms we call middlemen. The broad pattern described illuminates a development towards enhanced specialization over time. This development has affected the role of a middleman in several aspects. The role of the Grand Distributor in terms of institutional levels covered and functions performed, differs greatly from some of the middlemen of today, specializing either on physical flows or information exchange. However, taking the steps toward modifications of roles is a complex issue. It is complex because such actions require reformation of internal attitudes and cultures. Moreover, changes in what to do, and in relation to whom, will impact on other organizations as well, and these firms may either support or oppose such rearrangements. These conditions show the relevance of empirical studies of what potential roles can be identified for a middleman in today’s business landscape. This objective will require a framework for analysis that is presented below.
In the Introduction we presented two significant aspects of the role of a middleman. The first
regards the operations and the skills required, while the second concerns what type of
business partner to emphasize. The dominant paradigm when it comes to distribution and
middlemen is the marketing channel perspective. This view is completely producer
orientated. A well-known text book explains distribution as something starting in the factory,
describing “the route taken by a product as it moves from producer to the user”, and looked
upon “through the eyes of marketing management in production firms” (Rosenbloom,
1995:5). This view was highly relevant in the era of mass production, because large-scale
manufacturing required that products were channeled out of the factory in the most efficient
way. However, over time this perspective has become increasingly unrealistic, since today’s
distribution arrangements to a large extent build on customized solutions and build-to-order
These changes have made the channel view less appropriate since current distribution
arrangements have been characterized as “webs of capabilities embedded in an extended
enterprise” and as “networks of value-adding partnerships like confederations of specialists”. These features are nicely illustrated in an example of the ways in which a specialty grocery products manufacturer organized its distribution onto supermarket shelves: “It was using an array of third-party players, including food brokers, grocery wholesalers, and health food distributors… When the company drew a structured diagram it looked like a bowl of spaghetti” . Such ‘bowls of spaghetti’ are preferably analyzed with the industrial network model distinguishing three central layers in the business network: activities, resources and actors. The activity layer concerns issues related to what is done in the network. The resource layer involves the resources used for the undertaking of activities. Finally, actors are those controlling resources and undertaking activities. Since activity specialization and resource sharing were identified as central features in today’s distribution arrangements, the ARA model is well suited for analysis of potential roles for middlemen. Below we discuss some central features of today’s distribution arrangements in the three network layers and explore what consequences these conditions may have for middleman roles.
THE ACTIVITY LAYER
The most central concept in the network’s activity layer is interdependence since “the
execution of any activity is dependent on other activities”. Mass production, mass distribution, and huge inventories of standardized offerings for long time ruled activity structuring. Over time these features have been replaced by just-in-time deliveries, build-to-order, and customization, in a shift from ‘speculation’ to ‘postponement’. These arrangements make activities increasingly interdependent because buffering inventories are replaced by more or less seamless flows requiring enhanced synchronization. They also modify the conditions for the ‘traditional’ middleman since warehousing and inventory handling used to be cornerstones in their activity undertaking. Moreover, increasing functional specialization calls for coordination of activities of specialized firms.
In a historical study of wholesaling, covering three industries in the UK and Ireland, it was concluded that the main driving force for change was ‘a search for efficiency’ through improvements in the activity structure of the network. Their research showed that efforts to economize on activities can produce significant reductions in the cost structure, such as the effect of information technology in the 1990s. Technological development impacts considerably on the activity layer by providing opportunities to undertake activities in more efficient ways. A study of wholesaling in the pharmaceutical industry showed that cost-reduction processes impacted substantially on the productivity of activities in warehousing, transportation and order processing. A strategic opportunity for a middleman is obviously to focus on some activities, divest and outsource others, and through this specialization reposition itself in the activity layer, either on the basis of particular capabilities in information handling or logistics and transportation.
The separation of the flow of information from the flow of goods calls for coordination. Such integrative efforts thus provide strategic opportunities for middlemen. This option is illustrated by large-scale logistics service providers connecting the physical distribution
activities of a huge cadre of small firms, through sophisticated IT-solutions.
THE RESOURCE LAYER
The shift from speculation to postponement affects the value of resources. In current
networks, advanced equipment for logistics and materials handling in combination with
information technology solutions constitute the most important resources. As discussed above
one significant characteristic in today’s networks is that companies increasingly rely on the
resources of others. Enhanced outsourcing and focus on core competence reduces the single
firm’s ownership control of the resources that are critical to its operations. These conditions
impact also on the importance of individual resource elements, because “the value of a
resource is dependent on its connection to other resources”.
Middlemen can contribute to value generation in the resource layer in various ways. Significant illustrations here concern extensions of offerings to include more than physical distribution of finished products. Many middlemen are involved in problem-solving of various types for their business partners. These ‘added-value services’ play a greater role for wholesalers today and include, for example, the design of “retail sales programs, marketing strategies, computerized inventory management systems”. Middlemen also engage in design and development of products, the manufacturing of which is outsourced to sub-contractors. Furthermore, both wholesalers and retailers have developed strong brands which contribute to improving their competitive position. Other wholesalers take responsibility for the creation of product assortments, for example, by becoming engaged in consolidation and category management.
THE ACTOR LAYER
The actor layer has always been significant in distribution analysis, since the main perception
of middlemen used to be that they reduce the number of transactions by connecting producers
and users. Historically, relationships among distribution actors tended to be characterized by
transactional processes, based on arm’s-length arrangements. These conditions have been reconsidered when activity interdependences and resource combinations cut across company borders. From an industrial network point of view the role of a middleman is not only to connect other firms in order to reduce transactions. Even more important is the position of the middleman in the activity and resource layers. These positions determine the activities in which to be involved and the resources to control through ownership – and to what extent to rely on others in these two respects.
Value generating efforts in the activity and resource layers impose challenges for the actor layer. Middlemen involved in these actions must be able to work in a cost efficient way, at the same time as advanced capabilities and competences are required. In general, these role modifications call for large-scale operations, attainable through mergers and acquisitions. Wholesaling is therefore increasingly characterized by consolidation of previously fragmented businesses. Such findings are reported for wholesaling in general in Europe, the US and Japan, as well as for specific industries. The main benefits of consolidation are that increasing wholesaler scale provides the financial power ”to make operative decisions about product assortments and geographical territories independently from manufacturers”. Also retailing features consolidation and these parallel developments have resulted in closer connection between the two levels and made it possible for a wholesaler to establish exclusive relations with large retail chains.
So far we have dealt mainly with the operations and skills required for the potential roles of middlemen. As expressed in the introduction the second aspect of a role is to identify towards what business partners these operations and skills are to be directed, which is obviously an issue for the actor layer. We argued above that the mainstream distribution literature has considered middlemen as a means for the efficient outward distribution from the factory of the producer. We question this narrow perspective and claim that it needs to be extended in the analysis of the conditions in the current distribution landscape. Here we rely on Gadde and Snehota (2001) who make a distinction between three main dimensions in the role of a middleman: trader, distributor and provider. The middleman Astrader is typically represented by the ‘grand distributor’ discussed in the historical exposé. The middleman as distributor is the conventional view of middlemen in the marketing channel perspective. Over time the third role has become increasingly important: the middleman as provider. In this case the main attention is directed to the customer side and the middleman’s main function is to serve as purchasing agent for these firms. This significant role of a middleman was pointed out long ago in the claim that “the middleman is not a hired link in a chain forged by the manufacturer”. However, the dominant paradigm of ‘middleman as distributor’ has tended to overshadow this role.
In today’s business reality, there is a clear shift in the orientation of middlemen, from “facilitating the sale of what is produced, to one of identifying customer needs and then sourcing solutions” (Dawson, 2007:315). Similar observations of an enhanced provider role are reported from Japanese distribution where wholesalers seem to have adopted new business models making them “a more integral part of their customers’ operations”. Another opportunity would be to follow the example of middlemen that saw their main purpose to be “to help both suppliers and customers” and thus avoid to be perceived “as extensions of either suppliers or customers”. Similar recommendations come from Mudambi and Aggarwal in the claim that the central issue for an industrial distributor “is the ability to consistently provide added value, both to manufacturers and to customers”.
In the Introduction the role of a middleman was defined in two respects:
- the operations in which it is involved and the skills required for these operations
- in relation to what business partners these operations and skills should be directed
On the basis of the discussion in the analytical framework, the empirical study of middlemen
roles should focus on operations and skills with regard to the activity and resource layers. In
the activity layer significant issues revolve around specialisation (what activities to be
involved in) and coordination (the linking of interdependent activities). In the resource layer a
central question relates to what resources are crucial for the undertaking of the activities.
Furthermore important issues concern what resources that need to be controlled through
ownership and how these internal resources are combined with resources accessed from
business partners. For the actor layer significant issues concern the nature of the middleman’s
relationship with other actors and its position in the network. These aspects are central for the
value-generating capacity of the middleman.
We have claimed above that the issues dealt with in this paper call for a holistic approach in
the framing of the research problem. This conclusion has its methodological consequences
and favors a case-study approach. A case study “investigates a contemporary phenomenon
in its real-life context”. This approach is recommended for studies of complex systems and events that are unique and where broad conceptual frameworks are used. Eisenhardt provides another argument for this methodology in the claim that “the case study is a research strategy which focuses on understanding the dynamics within single settings”. Qualitative case studies are frequently used by industrial network researchers (Dubois and Araujo, 2004), because they make possible analysis of problems in settings with unclear boundaries.
- Within the case study framing we rely on the principles of systematic combining. Systematic combining is a non-linear, path dependent process based on a continuous interplay between theory and reality and vice versa. Systematic combining is expressed as “a process where theoretical framework, empirical fieldwork and case analysis evolve simultaneously and it is particularly useful for development of new theories”. In this process data and theory are successively adapted to fit with
each other through the processes of going back and forth between theoretical framework,
empirical observations and analysis. This means that what is found in the empirical world
might call for refinement of the framework, which then requires additional theory. In the
same way the modified framework may call for additional information about the empirical
The case study centers on a distributor of mobile phones and its efforts to define new roles
for its business. Besides the data collection in the focal company interviews have been made
with the business partners of the distributor, representing significant actors in the distribution
network illustrated in Figure 1.
Producers of mobile telephones (often identified as brand-owners) apply a multitude of
distribution strategies for reaching out to end-customers. They can use several types of
independent middlemen in the form of distributors (wholesalers) and retailers. Some
producers prefer a direct relationship with end-customers, either via the internet or through
retailers that they control through ownership and therefore are focused on selling telephones
of this specific brand. Other retailers are owned by operators, with the main mission of
supplying subsidized telephones together with subscriptions valid for this specific operator’s
network. A third category of retailers are independent from operators and producers,
functioning as multi-brand stores where mobile solutions are part of a larger assortment in,
for example, home electronics. Operators work closely with producers, distributors and
retailers to integrate subscriptions and SIM cards to mobile solutions together with other
hardware, e.g. mobile telephones and accessories.
In general, operators or retailers are responsible for the main contact with end-customers,
through retail stores, telephone, or web sites. Distributors and wholesalers buy phones,
accessories and other things from producers and sell to retailers or (to less extent) directly to
end-customers through web-shops. Furthermore, producers of accessories are important since
accessories enable the end-customer to individualize the mobile solution. The margins on
Distributors, Producers of mobile phones, Operators of mobile networks. Producers of accessories, Independent multi-brand retailers, Retailers owned by operators, Retailers owned
by suppliers of mobile phones and End-customers. Logistics firm accessories are also a lot higher than on mobile telephones and they are therefore an important product category for the actors in the distribution network. Last, but not least, logistics firms play a crucial role by handling the physical flow in the distribution networks.
The main data collection method applied in the study is personal interviews. The types of
firms and their representatives that have been subject to interviews are listed in Table 1. The
data collection has been conducted in Sweden with the exception of one interview with a
- EMPIRICAL STUDY: MOBILE INC. – A NETWORKING MIDDLEMAN
The case study focuses on Mobile Inc., a middleman involved in selling ‘Wireless
equipment’ with a focus on mobile phone solutions. For a functioning mobile solution three
essential parts are required. The first is the physical hand-set, or mobile telephone itself.
Second, a subscription is needed that entitles a user of a mobile phone to access one of the
existing communication networks (provided by one of the operators) in order to communicate
with other users. Third, a SIM-card is required to connect the mobile telephone and its
functions to a specific user and that user’s subscription. Besides this, a great number of
accessories are available for mobile telephones, such as screen protection, covers, head sets,
loudspeakers, and even ‘jewelry’. These parts, in various combinations, together form a
mobile solution for an end-customer. (see figure 2)
Mobile Inc. is a global actor in the distribution network making such mobile solutions available to end-customers, and is normally recognized as a wholesaler or a distributor. They act as a spider in the network and work closely together with actor network actors. In the following sections we describe the various roles that we identified in the operations of Mobile Inc. in relation to its business partners.
MOBILE INC. IN THETRADITIONAL ROLE AS ASSORTMENT PROVIDER
Mobile Inc. was established some 30 years ago as a so called ‘box-mover’, purchasing large
quantities of mobile phones from producers. These products are stored in Mobile Inc.’s
warehouse and then shipped to retailers in requested quantities. Physical distribution to
retailers is outsourced to logistics service providers. Through the large purchasing volumes of
Mobile Inc. the cost per unit can be kept lower for retailers than if they would by directly
from producers. A main issue in this set-up is to create representative assortments for
retailers. The retailer (or the operator) is responsible for the contact with the end-customer.
This type of arrangement was the origin of Mobile Inc. and it still accounts for a large
proportion of their business. We refer to this role as assortment provider. In this set-up the
main task for Mobile Inc. is to bring together large volumes of mobile phones to make the
firm an interesting business partner for producers, and in this way become an important
bridge to retailers. Producers, in turn, are able to reduce the number of direct customer
contacts. By breaking up large shipments into smaller assortments (breaking bulk), Mobile
Inc. provides value to retailers. A further important aspect is that Mobile Inc. takes title to
goods in this arrangement, and thereby also handles the risk of ownership. Capabilities in
estimating demand and being sensitive to end-customer trends is therefore crucial in this setup and this skill has been developed successively over the years.
When mobile telecommunication expanded, operators grew larger and thereby became the
favored counterparts of many producers of mobile telephones. As the operators became
larger it became more interesting to sell products directly to them rather than through
middlemen like Mobile Inc. Operators were interesting to producers since they ‘owned’ the
Mobile solution, Accessories, Mobile telephone Subscription SIM end-customers and thereby were assumed to have the possibility to influence their behavior. Through campaigns and various other mechanisms like subsidies, operators could guarantee that the products actually found their way to the hands of end-customers. Furthermore, by selling to operators producers could increase the exposure of their products to the end customers. Altogether this implied a new setting to relate to for actors such as Mobile Inc. Another change was that in the early days the telephones were very expensive and the only end-customers able to afford them were companies and some wealthy private consumers. During this initial phase profit margins were substantial, which resulted in a fortune-seeking market, with a lot of ‘easy’ money to be made by simply moving ‘boxes’ around. This consequently led to the appearance of many small actors. However, as market penetration rose, margins decreased. The number of companies decreased and the remaining ones gained in size in order to attain large-scale operations to counter decreasing margins. For Mobile Inc these changes led to the conclusion that the traditional way of doing business, i.e. the box moving arrangement, was no longer sufficient. Instead they needed to focus on becoming better in other aspects than focusing only on large purchases and provision of assortments. As an effect of these changes Mobile Inc. tried to approach operators in order to find new ways in which they could be part of their businesses. We illustrate this with the relationship
with the operator Connect Me.
MOBILE INC. AS A LOGISTICS SERVICE PROVIDER
Connect Me is a large global operator, relying mainly on their own stores, even though they
use also external retail chains to a limited extent. Because they are a large global company
group they were able buy directly from producers. Each local country organization of
Connect Me forecasts the coming sales volume. These are aggregated by the global market
organization that makes a final global forecast for the entire company group and places
central orders with producers. By working in this way each country organization can benefit
from economies of scale, they could not have reached themselves. However, Connect Me
neither has the logistical capabilities required, nor the interest to handle this volume on their
own. Instead they have outsourced this task and chosen Mobile Inc. as their partner in
Sweden. Mobile Inc. is here used as a logistics service provider, in charge of the physical
handling of the whole volume. All products are shipped from producers to Mobile Inc.’s
warehouse, where they are stored in a dedicated area, and then shipped to the stores of
Connect Me for sales to end-customers. Mobile Inc. never takes title to these products.
Furthermore, if the end-customers of Connect Me demand products that are not ordered on a
global basis from producers, Connect Me in Sweden can source these items locally from
Mobile Inc. Organization of return logistics is also a responsibility for Mobile Inc. For these
operations Connect Me requires that all products that are returned and sent to Mobile Inc. are
checked and evaluated in order to make a judgment whether the product can be sold as ‘new’,
be used as it is, or if it needs to be disposed. The interaction between the two firms is intense.
The Key Account Manager at Mobile Inc. is in daily contact with the logistics manager at
Connect Me to discuss operational issues. For example, Mobile Inc. receives information from
Connect Me about incoming shipments in advance, so that they can plan the handling of the
deliveries from producers. Beyond this daily contact there are also monthly meetings where
other issues are brought up for discussion. These issues can, for example, concern invoices
for the logistics services, specification of services, cost issues, service levels and quality
aspects, upcoming forecasts, campaigns and events. There are also quarterly business reviews
where several representatives from both companies meet. During these meetings the
discussions focus on future plans and projects.
MOBILE INC. AS A PURCHASING COORDINATOR
- TeleX is one of Mobile Inc.’s retail customers. They are basically a franchise based retail chain running about 50 stores in Sweden. The stores are owned either privately or by the central TeleX organization. Some years ago, this company experienced some difficulties through its widespread and loosely coupled organization and therefore approached Mobile Inc. in their search for new ways of conducting business. Before these discussions TeleX used to order 20% of their purchasing volume from Mobile Inc., whereas the remainder was sourced more sporadically from a multitude of other distributors. TeleX wanted a new business arrangement with Mobile Inc., because they expected potential benefits from aggregating purchases to a single supplier, while Mobile Inc. saw a possibility in securing the whole business volume of TeleX.
In the new arrangement all orders from the stores of TeleX were coordinated and then
sourced buy Mobile Inc. In this relationship, therefore, Mobile Inc. can be seen as a
purchasing coordinator. This new arrangement required lots of communication, information
exchange and persuasion to get all on board. People at retail stores were not convinced that
this was a great idea for them, since they lost part of their autonomy. A key supporting factor
in this reorganizing was that Mobile Inc. developed a new web service. Through this web
service the stores of TeleX became much more tightly connected to Mobile Inc. Each TeleX
store now could get its own unique web-site and individual web-shop. Mobile Inc.
customized each store’s web shop by utilizing a standardized solution and then make some
alterations with regard to name and layout to reflect the specific store. The website in turn
was linked directly to Mobile Inc.’s warehouse, implying that end-customers logging onto the
web shop to place orders had a direct visibility into Mobile Inc.’s warehouse and the stock
available. Orders were sent to TeleX to be confirmed, while all other operations were handled
directly by Mobile Inc. A main issue for Mobile Inc. with this new arrangement was the
opportunity to test and try out the new web service. Through this service, end-customers
interact directly with Mobile Inc. and their warehouse. The main physical flow is directed via
a transportation firm to the stores of retailers. However, in a few cases products are delivered
directly to significant end-customers. Ownership is always transferred through TeleX. A
planned step for the future is to locate consignation storages at retailers, i.e. to keep parts of
the inventories of Mobile Inc. in the retailer stores. In this case it is Mobile Inc.’s
responsibility to make sure that the ‘right’ products are available in stock. Already today,
Mobile Inc. is responsible for forecasts so this is not a totally new situation. However, for
Mobile Inc. such a change would mean about 50 new ‘warehouses’ to manage. The
functionality of such system would require retailers to ‘open up’ totally to Mobile Inc. with
regard to transparency.
MOBILE INC. AS AN END-CUSTOMER INTERFACE
The web service developed in the relationship with TeleX was later adapted and offered to
other customers of Mobile Inc. When establishing the relationship with a new customer, the
web services solution was key for the actual closing of the deal with this firm. The new
customer, here named Web Mob, is an internet-based retailer, selling mobile telephones and
accessories to end-customers. Web Mob is a pure internet retailer with no physical stores and
no warehouse of their own. Hence, they needed a stock-keeping partner. By collaborating
closely with Mobile Inc., Web Mob is able to provide the entire range of products of Mobile
Inc. In this case Mobile Inc. acts as an end-customer interface. The existing web-shop solution
was thus a main reason for choosing Mobile Inc. as partner. Through the arrangement with
Mobile Inc., Web Mob can display all products to their end-customers that Mobile Inc. holds,
while still not assuming any of the risk of ownership or tying up any capital. Web Mob are not
committed to buy the products they reserve, but in return they cannot demand that specific
products are kept in stock. When Web Mob closes a deal with an end-customer through
Mobile Inc.’s website, Web Mob actually buys the product from Mobile Inc. that in turn
delivers it to the end-consumer. The products are always transported by a logistics provider
directly to end-customers. However, a drawback related to this set-up is that Web Mob is
limited to the products in the assortment of Mobile Inc.
From being the only a distributor to Web Mob for some years, this situation recently changed.
Currently, Web Mob works with three distributors, who all deliver directly to end-customers.
However, Mobile Inc. is still the first-hand choice and the majority of Web Mob’s sales are
sourced from Mobile Inc. Owing to the mutual investments in the relationship with Mobile
Inc., Web Mob can do things together with this firm that they cannot do in relation to the other
distributors. For example, when a customer wants to change an order, Web Mob is allowed to
do last minute modifications in relation to Mobile Inc, which is not possible with the other
distributors. The relationship with Web Mob represents Mobile Inc.’s most advanced IT solution. For example, reservations of products can be made and there is a frequent transfer
of information between the companies concerning historical orders, stock levels, and tracking
and tracing of orders. Furthermore, there are lots of regular meetings between the companies.
Aspects discussed in these meetings regard, for example, future plans and volume
forecasting, as well as upcoming campaigns. This information makes it possible for Mobile
Inc. to secure that the right products are in stock, and to dimension staff accordingly. Return
logistics is another crucial factor for Web Mob. Since Mobile Inc. already had an established
structure for handling such processes it was natural to partner with them also regarding this
task. If an end-customer experiences problems with a product they are instructed to return it.
Then Mobile Inc. sends it to a repair center that checks the product and determines whether
the fault is a user error or if it should be repaired or completely scrapped.
MOBILE INC. AS A MARKETING ORGANIZER
Some years ago, a Taiwanese producer – Tai Man – wanted to expand sales in the
Scandinavian countries. Since they felt that their market knowledge concerning these
countries was very limited. Therefore Tai Man approached Mobile Inc. and together they
decided to partner in order to achieve this expansion. In this relation Mobile Inc. became in
charge of market communication, including advertising, as well as sales to retailers. In this
relationship Mobile Inc. acted as the marketing organizer of Tai Man. Mobile Inc. was also
responsible for storage and physical handling of products.
However, the main objective of Tai Man was to successively strengthen the position in
Scandinavia. Over time, they established their own sales offices in these markets which
modified the role of Mobile Inc. Today there is less emphasize on the extended responsibility
featuring the marketing organization role. Therefore, the relation between the two has
evolved from a very close relationship towards something similar to Mobile Inc.’s
relationships with other producers, i.e. primarily the logistics service provider role.
MOBILE INC. AS A PRODUCT DEVELOPER
- During the late 1990s prepaid refill cards for mobile telephones were launched. With these
cards, end-customers could preload their subscription with a set amount of money that then
could be used for calls. In order to reach end-customers effectively with these pre-paid refill
cards Mobile Inc. had to identify new business partners. The previous arrangement, based on
phone retailers, was not appropriate for this new product with quite different demand
characteristics. End-customers needed to buy these cards regularly and sometimes outside
of the normal opening hours of regular stores. Therefore, convenience stores were found to
attractive counterparts. However, there was an increasing problem when it came to the
handling of these prepaid cards. In essence, these small cards were equivalent to money.
Thus, each transport of cards was similar to a money transport and the storing of cards
required rigorous security protocols. In addition, Mobile Inc. felt that the physical distribution
of a code that was basically a digital product, was highly unnatural and expensive. In the light
of this finding they collaborated with another actor, Sys Mob, to develop a new electronic
distribution system. This solution made it possible to remove the physical card and distribute
the code digitally, and then print it at the time of purchase at the retail outlet. Hence there was
no longer a need to either store the pre-paid cards physically or to transport them. In this case
Mobile Inc. took on the role as a product developer to solve as specific problem.
THE COMBINED ROLES OF MOBILE INC.
Above we have high-lighted six quite different roles that have been identified in the
operations of Mobile Inc. In reality, however, Mobile Inc. fulfils several roles in relation to
each of the business partners. To illustrate these conditions we turn to the relationship with
the operator CallU. This operator used to work with external retail chains. However, recently
a decision was taken to establish its own nationwide retail chain. Their plan is to maintain the
relationships with external retailers, but to increase their total sales through supplementing
with own stores and internet sales. Until recently, Mobile Inc. was only one of several
distributors supplying CallU. However, CallU reconsidered this multiple-sourcing strategy
and decided to select one distribution partner as a single supplier. The reason for this was the
opportunity to take advantage of the economies of scale and specialized competence that one
distributor can provide. After evaluation of several distributors, Mobile Inc. was chosen. In
this relationship Mobile Inc. works partly as an assortment provider by taking title to
products and then selling them to CallU. One of the benefits for CallU is Mobile Inc.’s
considerable product knowledge. Furthermore, for CallU it is an advantage that other
operators also use Mobile Inc. because the volumes handled, and consequently the scale of
operations, is increased. Mobile Inc.’s business relationships with other retailers are also
regarded an advantage. For example, if CallU has bought products that they cannot sell, then
Mobile Inc. can take it back and deliver it to a retailer.
Even though the assortment provider role is the most dominant in this setting, both firms try
to develop the relationship. For example, the single sourcing set-up has enabled CallU to use
Mobile Inc. as a partner for its internet sales. CallU’s web shop is directly linked to the ERP
system of Mobile Inc. and their inventory and warehouse. Orders placed in the web shop are
handled by Mobile Inc.’s ERP system and products are packed and shipped from Mobile
Inc.’s warehouse. Furthermore, the two firms have a frequent dialogue when it comes to new
product launches in order to decide which products to focus on. The next step will be to
initiate a ‘product council’, responsible for planning in a three to six months horizon.
Through this arrangement, CallU intends to increase the accuracy of forecasts. The purchase
coordinator at Mobile Inc. is also in charge of providing CallU with statistical reports
concerning stock information. CallU requires a rather comprehensive weekly report of
warehouse activities regarding ‘their’ products. These reports include information about what
is available in stock, what is sold, eventual backlogs or orders that have yet to be fulfilled. In
addition to the reports the purchase coordinator at Mobile Inc. is also in charge of the
buying of SIM-cards and all sales material related to CallU’s products, for example welcome
letters to new customers.
Finally, some of the business arrangements between Mobile Inc. and CallU differ from this
general description. In these cases Mobile Inc. does not take title to the mobile phones. First,
one of the producers requires CallU to buy directly from them, rather than utilizing Mobile
Inc. Second, CallU sometimes lease out huge numbers of phones to customers. These phones
are often sourced directly from producers. In both these cases Mobile Inc. is responsible
for the logistics operations without taking title to products. Hence, in these situations they act
more like a logistics service provider than as assortment provider.
CENTRAL FINDINGS IN THE MOBILE INC. CASE
The main conclusion of the empirical study is that numerous opportunities are open for
identification of roles for middlemen in the current distribution landscape. From being a
typical ‘traditional’ middleman, Mobile Inc. evolved into a multidimensional actor featuring
quite diverse conditions in relation to its business partners. The six distinct roles of Mobile
Inc. are based on operations with quite different characteristics: logistics, marketing,
purchasing and product development. Each of them requires its particular capabilities and
skills. In addition, the traditional role as assortment provider calls for supplementary skills, as
does the crucial issue to handle these various business operations within one and the same
organization. The study also shows that a middleman can generate value for various types of
business partners, in this case: end-customers, retailers, operators and producers.
It is also obvious that a middleman cannot fulfil all these obligations entirely through its
internal operations and skills – it is dependent on activities and resources of other firms.
Logistics service providers are involved in all physical distribution operations which is one of
the cornerstones of Mobile Inc.’s business model. Moreover, SysMob was an important
partner in the development of the digital refill cards. For all six roles the interaction with the
specific business partner was crucial for the value-generating capacity of Mobile Inc.
Another important observation is that the role-set of a middleman tends to evolve through
interaction between various roles and functions. In the efforts to develop a specific function
for a particular role, ideas may appear that contributes to improvements of other functions,
which paves the way for another role. The web-shop solution is one of the significant
examples from this case. This means that middlemen starting to reinterpret the traditional role
will be provided with several possibilities in various directions to identify new business
The above analysis clearly shows the multiplicity of potential roles that can be fulfilled by a
middleman in today’s distribution reality. Previous classifications of the functions and roles
of distribution in general, and middlemen in particular, first appearing in Shaw (1912), have
primarily been rooted in the activities undertaken. Clark (1922) condensed the number of
functions to three: exchange (buying and selling), physical distribution (storing and
transportation) and facilitating functions (financing and risk-taking). These tasks are then
distributed among firms through a division of labor among institutional levels, identified in
terms of producers, middlemen and consumers. The conditions for this division of labor
change over time, implying that activities are moved from one institutional level to another,
because the prerequisites for efficient undertaking of activities change (‘functional spin-off,
according to Mallen, 1973). Alderson (1954) identified four factors that determine the
economic rationale for middlemen in the division of labor: (i) they reduce the number of
business ties between producers and consumers; (ii) they contribute to scale advantages by
19aggregating demand from several users; (iii) they provide benefits through specialization by
focusing on particular activities; and (iv) they are involved in redistribution of risks.
Coming back to Clark’s classification, the facilitating functions have since long been taken
over by specialists in banking and insurance. During recent decades specialists in terms of
logistics service providers have become increasingly important concerning physical
distribution. Furthermore, the conditions for the exchange function have been modified
considerably through the development of information technology and we have already
mentioned the specialized actors showing up in this area. It is clear therefore that
specialization in the activity layer is one significant role for middlemen today.
Enhanced specialization opens up for another role emanating from the activity layer. With
ever increasing specialization of activities there is a need for coordination of the activities
undertaken by specialized actors. This takes us back to Alderson’s first rational for a
middleman: to reduce the number of business ties. In current settings it means that an end user (or a producer) rather than dealing separately with a bank, an insurance company, a
logistics service provider and an information broker, would prefer to use only one business
partners for these operations. One example is provided by Dawson who concludes
that “some wholesalers have transformed their organizations to become coordinators of the
total supply (demand) chain”. Another sign of the same development is the increasing
reliance on extended offerings combining products with various service elements.
Consequently, this role can be classified as coordination in the activity layer.
From an industrial network perspective, the resource layer also represents significant
opportunities for formulation of strategic roles. In fact, some of these can be derived from
Alderson’s four rationales. The scale advantages that can be realized from aggregation are to
a large extent driven by efficient resource exploitation. Furthermore, the benefits of
specialization evolve from enhanced skills and capabilities. In the analysis of the resource
layer we first turn to the claim by Bucklin (1960) that production needs to be considered as a
function in the marketing and distribution system. So far this aspect has been largely
neglected, but in contemporary distribution landscapes it is important to recall the ideas of
Bucklin. In the analysis he identified production as a function coupled only to the
manufacturer. At that time intermediate institutional levels were mainly involved in the
handling of finished products. In Alderson’s terms middlemen primarily contributed with
time and place utility, while form utility mainly concerned changes in packaging format and
issues related to breaking bulk. Increasingly, however, enhanced attention to postponement
implies that final assembly and other finishing operations are undertaken by various types of
middlemen. This involvement in the transformation of the form features makes the resource layer increasingly significant from a middleman point of view. Furthermore, the importance of the resource layer is stressed by Rosenbröijer (1998) in the argument that the variety of middleman characteristics is explained by their diverse capabilities, in turn determined by the inherent heterogeneity of their resource mixes.
- Resource combining is thus a third role that can be defined from an industrial network context. This combining may take the point of departure in technological resources, such as infrastructures, vehicles and handling equipment, but also concern organizational resources in terms of, for example, logistical competence and skills . We claimed above that equipment for materials handling have become more important than inventories and warehouses. However, in many situations physical inventories are still significant in efforts to secure availability. Large-scale resources in this respect may be valuable for small and middle-sized companies illustrated in a study by Cantú et al. (2010). In this case a new middleman was able to improve performance for wholesalers, dealers and industrial users through the establishment of a central warehouse. What is particularly interesting with this example is that this new middleman represents an extra level in the distribution system, clearly contradicting current management literature, where one of the main recommendations is about cutting out middlemen by reducing the number of institutional levels.
When the middleman in the example above had become established in the network, through
its efficiency in physical distribution and inventory handling, the firm extended its offering to
include various types of other services and also logistics consultancy. Therefore, this example
illustrates another potential role in current distribution arrangements that we identify as
problem solving. This role is obvious also in the evolution of logistics service providers.
These firms got a foothold in distribution networks when producers, middleman and also
consumers outsourced physical distribution. Once this foothold was established these firms
extended the scope of their operations into advanced problem-solving through “a shift from
traditional ‘piecemeal outsourcing’ of isolated activities towards outsourcing of distinct sets
of subsystems and even outsourcing of bundles of such subsystems to a single TPL provider”.
An illustration of a problem solving middleman is presented in Figure 3, portraying the offering of the PC-distributor Atea. Through careful customer analysis this firm has identified in which dimensions they can provide services that support the operations of PC-users. Atea then designed their offering in terms of valuable services stretching from buying advice and specifications, over installation and use, and finally recycling of used PCs.
- The problem-solving role of a PC-distributor The actor layer is highly significant in role formulation and value-adding operations. Any role implies a specific positioning for a middleman in relation to other firms. Mainstream
literature defines the middleman’s position through its connection to other actors and the
opportunities to reduce the number of connections and transactions between producer and
user. From an industrial network perspective, however, this view needs to be supplemented
with analysis of the middleman’s positioning in the activity and resource layers. Regarding
the activity layer it was concluded that a middleman may take a narrow position through
specialization on either logistics or information exchange. Another value-adding approach
would be to apply a broad perspective and function as a coordinator of activities. In the same
way the particular form of resource combining in which a middleman is involved will
determine a specific positioning in the resource layer and the same is valid for the problem solving approach applied. The critical issues in these respects concern what activities the
middleman should be involved in and what resources need to be controlled through
ownership. Furthermore, it is decisive to develop appropriate interfaces between these
internal activities and resources and those of other firms. The actual positioning in these
respects determines the conditions for joint value-generation.
The specific value in relation to a business partner is generated through interaction..
Depending on the middleman’s positioning in the actor and resource layers, various types of
interaction patterns evolve. So far we have primarily discussed relationships with the receiver
of the value provided through the specific role. Another crucial issue in the actor layer
concerns relationships to business partners involved in the design and creation of the offering
of the middleman. Increasingly, the required resource combining and activity coordination
cut across the boundaries of firms. Therefore, enhanced relationship involvement is necessary
in today’s distribution networks.
- Interaction is thus a common denominator of any middleman role in the current distribution landscape. Interaction with both the producer side and the user side makes it possible to handle “the never-ending battle to reduce costs while maintaining and improving quality and service”. The benefits related to interaction were analyzed in a study of
outsourcing to third-party logistics providers. First, enhanced interaction improves the opportunity to identify a relevant scope of the provider’s role, which can regard anything from single activities to total solutions. Second, close interaction over time improves conditions for learning, concerning the two partners’ operations and resources.
CONCLUSIONS AND IMPLICATIONS
Our study of the changing role of middlemen provides contributions in three dimensions.
First, the analysis of the historical development of distribution in general, and middlemen in
particular, improves the understanding of the prerequisites and consequences related to the
current challenges for middlemen. Second, the industrial network model showed to be a
useful framework for identifying potential roles for middlemen. Third, as a managerial
contribution from the study, a five-step procedure for analysis and implementation of role
modifications for middlemen is suggested.
Concerning the first contribution we return to the quote in the Introduction that there is no
room for middlemen in the on-going revolution. The analysis of the historical development
shows that middlemen have always been confronted by challenging conditions, making their
future questioned and uncertain. In these situations one outcome was that some middlemen
‘died out’, in line with the prediction in the Introduction. For example, a study of consumer
retailing concluded that “the retail graveyard is full of formerly famous names that have been
unable to adjust to environmental changes, or have been done in by self-inflected strategic
However, the main finding in the historical analysis is that middlemen and intermediaries
have been able to respond to these challenges. For example, in the late 1940s it was claimed
that “the survival and continued vigor of the wholesaler is remarkable considering the
persistent attempts to supplant him”. Half a century later another researcher argued that wholesaling continues to be a highly significant function, despite the fact that “business analysts have been anticipating the wholesalers’ demise for several decades”. The middlemen that survived did so because they had been able to accommodate to new conditions. They realized that their previous business missions had to be modified because the conditions for their value-generating operations had changed. In these modifications, the role of the middleman had to be reinterpreted. What had been an appropriate role in the past was not valid for the future. The particular business context where middlemen and their business partners reside is in continuous flux and the business models and roles of firms must be adjusted accordingly.
The second contribution of the paper is the finding that the industrial network model is an
appropriate tool in the analysis of potential roles. The basic point of departure for this
reorientation is that any middleman must in some way generate value for their business
partners. As shown in this study there are numerous value-generating opportunities available
for a middleman. In fact, our findings indicate that there is more room for middlemen in
today’s distribution networks than in those of yesterday. The underlying argument for this
statement is the huge variety in the operational involvement of current middlemen, as well as
the diversity in the capabilities they represent. The network analysis identified two roles in
the activity layer: specialization and coordination. Similarly the resource layers gave rise to
two roles: problem solving and resource combining. For the successful implementation of
these roles the position of the middleman in the actor layer is crucial, as well as the
systematic interaction with the business partners.
As shown in the study there is considerable variety in the roles played by an individual
middleman. This variety is caused by the diversity in the demands of various business
partners, the features of the value-generating capability and the conditions in the business
context. Similar results concerning the variety of roles were found in a study of a Norwegian
logistics service provider. Finally, as shown in our case, a middleman can
fulfil several roles in relation to one and the same business partner.
The third contribution of the study is a five-step procedure for analysis and implementation of
role modifications. The first step in this procedure is to apply a framework for analysis. We
have suggested the industrial network model as a relevant framing of the situation for
middlemen. This model is particularly useful since it provides three dimensions for the
analysis of potential roles: the activity layer concerns the operations that are crucial for value generating; the resource layer regards the capabilities and skills to exploit, while the analysis
in the actor layer relates to (i) the firms for which value is to be generated and (ii) the
business partners that are necessary for this value-generating.
The second step is to analyze more precisely what value-generating approach to apply. The
two main principles in this respect are to contribute to rationalization and cost-efficiency, or
to innovation and development. The rationalization option takes its point of departure in the
activity layer and various mechanisms for efficiency improvements. The development path
relates to the resource layer and deals with potential benefits of resource combining and
recombining. Irrespective of which of the two options is selected, a middleman will be
dependent on other firms for the fulfilment of its role. The crucial thing here is to exploit the
opportunities residing in the network of actors.
This takes us to the third step in the transformation. One major issue here is to decide what
activities to undertake in-house, and to what extent to rely on the operations of other firms. A
second main task is to identify the resources that must to be controlled through ownership
and the resources that can be accessed through business partners. In today’s network
arrangements both activity coordination and resource combining span corporate borders,
which call for inter-organizational skills and capabilities to handle interaction processes.
The fourth step concerns the development of appropriate interaction patterns with the
business partners. In this respect the ‘problem-solving’ role requires broad and long-term
interaction with customers in order to identify the specific opportunities in relation to
individual counterparts. On the other hand a ‘specialist’ might be engaged in large-scale
solutions that are more or less standardized, implying that high-involvement with business
partners is not needed. Differentiation of interaction patterns is thus required for successful
The fifth step, finally, is to combine the previous four steps into a coherent set-up, by
formulating the company’s ‘business model’, which is explained as the “view of the firm’s
logic for creating and commercializing value”. What is considered to be the central components of a business model is expressed in various ways. However, there seems to be some consensus regarding the three aspects identified in Mason and Spring (2011). The first concerns what technology to apply in terms of product and process technologies, and the features of current production and distribution infrastructures. The second issue deals with the market offering of the company, with regard to the combining of products and services and the extent of customization. The third important component is the network architecture, involving the constellation of firms that together generates value to the buyer. A middleman following this five-step analysis for role modifications is provided with
ample opportunities to successfully transform its operations in response to current dynamics
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