Distributorships and Dealerships

Distributorships and dealerships are in essence a license to distribute a product. Both dealers and distributors work with a manufacturer to get its goods to the buyer. Both dealers and distributors have a continuing relationship with the licensor of the product, but do not need to incorporate the entire business plan of the licensor into their own business. A dealer differs from a distributor in that a dealer will normally sell only to a retailer or a consumer, while a distributor can sell to a number of dealers or to the general public.

Dealerships and distributorships are known as product franchises. The term "franchise" refers to a variety of business opportunities in which the owner of a product, process, service, system, or name gives permission to a second party to use it in exchange for payment. As of early 2000, there were roughly 1200 businesses in 18 industries offering franchise opportunities in the United States, according to Arthur Pressman in the Legal Intelligencer. The resulting 550,000 franchises generated over $800 billion in annual sales. Franchises are a popular method of starting a new business, and for good reason. Mitchell Stern, author of Buying Your Own Business, notes that the failure rate for new businesses is nearly 40 percent in the first year, compared to less than 5 percent of new franchise failures in that same year.

Legal Aspects of Business Opportunity Ventures

While the majority of dealer/distributorship opportunities are legitimate business ventures, there are some unscrupulous individuals and businesses that prey on prospective franchisees with the promise of fast money. In addition, franchises are not always successful. Courtney Price, co-author of Tips and Traps for Entrepreneurs, notes that nearly 35 percent of franchises go out of business within four years. Prior to engaging in a dealership or a distributorship, it is crucial that a small businessperson determine whether the business is a legitimate business opportunity venture.

The Federal Trade Commission has established a number of elements that must be present in the franchise relationship. The basis for the relationship is the fact that the dealer/distributor must distribute or sell goods/services supplied by the manufacturing company. In order to do this, the manufacturing company must assist the dealer/distributor in finding a retail outlet or accounts for the products/services. Prior to or within six months of beginning the business venture, there must be a cash transaction of at least $500 between the dealer/distributor and the company. All details of the contract and conditions of the relationship between the dealer/distributor and the company must be in writing and in the hands of the prospective dealer/distributor at least ten days before s/he purchases the business or signs a contract. This is also known as the Uniform Franchise Offering Circular (UFOC).

A UFOC should contain a detailed description of the dealership/distributorship offering, including the purchase agreement as well as three years of audited financial statements. It may also include information on the business backgrounds of the franchise operators and disclose any litigation, bankruptcies, or securities law violations the operators or managers engaged in over the previous ten years. The UFOC should be reviewed in concert with your legal counsel, as well as your accountant.

In addition to the FTC, some states have business opportunity laws governing franchises, including distributorships and dealerships. Their main focus is to get a disclosure, similar to the Uniform Franchise Offering Circular, into the hands of the prospective franchiser. They also may cover the rights and remedies of business opportunity investors. If the seller of a business opportunity is not required to provide a presale disclosure by the Franchise Rule of the FTC (as noted above), then these states will most likely require them. States with business opportunity laws include: California, Connecticut, Florida, Georgia, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Nebraska, New Hampshire, North Carolina, Ohio, Oklahoma, South Carolina, South Dakota, Texas, Utah, Virginia, and Washington.

According to Andrew Caffey in Entrepreneur magazine, the rate of compliance with federal and state laws tends to be higher with franchise operations than other types of business opportunities, so it pays to be sure of what you are purchasing and to shop around.

Distributorships

A distributor is an independent selling agent who has a contract to sell the products of a manufacturer, but is not entitled to use the manufacturer's trade name as part of its trade name. The contract may also limit the distributor to selling only that company's goods, rather than marketing different products and services from different firms. The manufacturer sells the distributor the products at wholesale prices.

A distributor is also sometimes referred to as a wholesaler. Wholesalers resell the products to dealers. A contract distributor purchases a product from a manufacturer, consolidates it with other products, improves it, and resells the product. A contract distributor differs from a wholesaler in that a wholesaler merely purchases a product, along with other products from different manufacturers, and resells the product with little if any changes. A contract distributor may have a smaller geographic sales area to cover than a wholesaler may have.

Generally speaking, the manufacturer of the product does not impose a method of operation on the distributorship. However, the company may provide training to the distributor in order to improve product information and sales techniques. The distributor can also provide the manufacturer with a number of services, in addition to the distribution of the product. These may include product inventory, modification of the product, adding value to the product, fabrication, warranty and servicing of the product, market feedback, consolidation of products and services, and marketing of the product.

Dealerships

A dealership is sometimes called a retail distributor. It is similar to a distributorship, except that a dealer usually sells only to the public. Unlike other types of franchisees, including distributors, a dealer is not usually restricted to carrying one product line. Most commonly, this type of arrangement is found in the automotive industry.

Just as in other franchise businesses, a prospective dealer will receive a product or service with a proven market, the ability to use trademarked names associated with the products or services, an accounting and inventory system, a marketing plan, and the ability to purchase and advertise in volume. In addition, a dealer may receive the following from the manufacturer: a prospectus covering their rights and responsibilities in the relationship, training and support, site selection criteria/assistance, and quality control information. For quality control across its dealerships, a manufacturer may also require regular onsite inspections of the facility and regular customer and vendor feedback.

Securing a Dealership/Distributorship

In order to determine which business opportunity or franchise to invest in, it is important to do careful research. While the advantage of investing in a business opportunity or franchise is that it can be a "turnkey operation," it is crucial to plan and investigate the investment even more thoroughly than with a traditional entrepreneurial effort.

Begin with an assessment of your own skills and goals for the business. Keep these in mind while reviewing franchise possibilities. Start with a thorough reading of the UFOC or the business disclosure statement. If the franchising business does not have one, ask why and be concerned about the dependability of the business. Get copies of the company's financial records, as well as details in writing about what exactly is being offered for the purchase price, including training and support. Find out what other distributors exist and, if possible, talk to them about the success of their franchise, the quality of the product/service, and the support of the franchiser. Test the potential of the product/service with family and friends. Ask yourself, "Would I purchase this product/service?"

Another factor in securing a dealer/distributor business is the large initial investment. There are normally two types of fees associated with franchises and business opportunities: the original start-up fee or purchase price, and ongoing fees or product costs. The purchase price may depend on whether the small businessperson is investing in a "turnkey" operation, such as a car dealership, or a less complete franchise. Prospective franchisees should not be afraid to negotiate the purchase price and terms of the business opportunity.

A franchise territory can be exclusive or non-exclusive. There are pros and cons to each type of territory, but be sure you are aware of the status of your prospective business and determine whether you can work in this environment.

It should be noted that both distribution and dealership agreements tend to have a shorter term than a traditional franchise agreement. Distribution and dealership agreements frequently are renewed on an annual basis, by mutual agreement. A traditional franchise agreement normally covers a minimum of five years.

Benefits of Dealerships and Distributorships

There are differences in operating a distributorship and a dealership. A distributorship normally costs more than a dealership and requires leadership capability and a better knowledge of basic business skills. It will most likely have a larger territory than a dealership and may even extend to more than one location. A dealership tends to be local and requires less start-up capital. A dealer can focus his/her efforts on the management and success of one location. As a dealer, you work closely with a distributor so it pays to nurture that relationship as well. In the end analysis, the distributorship can be more lucrative, but with more effort and investment put into it.

The benefits of being a dealership or a distributor are many. A franchise is normally able to secure a lower price on goods, giving them greater buying power, than an independent seller would be able to get. Frequently, a dealership or distributor handles a specific territory, with exclusive rights to sell the brand in that area. Competition for sales of the dealer/distributor's brands, therefore, is non-existent with sales territories. Dealerships especially are known for their advertising programs. By joining together in a cooperative manner to purchase air time and produce television and radio advertisements, they are able to secure a presence that an independent business could not beat. Most franchisers also provide their dealers or distributors with point-of-sale materials. Sometimes they may offer the benefits of a credit card program and a national warranty as well.

Challenges for Dealerships and Distributorships

One recent challenge for dealers and distributors are changes in the relationship with the original manufacturer or franchiser. For example, General Motors in the early 1990s wanted to establish 10 percent of their dealerships as factory-owned, according to Robert Ulrich in Modern Tire Dealer. GM was looking to maintain its brand name at its dealerships, many of which had begun selling more than one car line under their roofs. Existing independent dealerships were concerned that factory-owned dealerships would receive preferential treatment in the areas of advertising, service agreements, promotions, and even inventory. Dealerships viewed their ability to sell more than one brand as an opportunity for cross-selling into the GM brand when the buyer may have been initially interested in another brand.

The advent of the Internet has also changed the way that dealerships and distributorships operate. Dealerships and distributorships emerged as businesses when manufacturing companies were new and focusing on production, as opposed to distribution. As production costs diminish with increased pressure for profits, many manufacturing companies are looking for a bigger piece of the pie. Business-to-business selling has increased dramatically. Manufacturers have begun selling their products directly to the public, and the Internet is a relatively inexpensive method of doing so. While this may take away some sales from the distributor, a manufacturer's web site can also benefit its distributors. Many manufacturers use the site as a storehouse for information on the company and its products, providing prospective sellers with needed information that its distributors cannot deliver to unknown markets or sellers.

While they may engage in direct online sales, it is in the best interest of the manufacturer to also direct visitors to the distributors themselves, providing another channel of opportunity for the distributor. In order to improve their chances at getting that sale, a distributor should establish its own web presence. While online purchasing capabilities are most likely beyond the resources of a distributor, a site gives the manufacturer something to direct the customer to and provides another marketing opportunity to the distributor.

Dealerships and distributorships can be great business opportunities for the prospective entrepreneur. The benefits of established brands, no manufacturing costs, and marketing and training support from a larger company come at a price, but may mean the difference between success and failure.

Further Reading:

Brack, Ken. "A Direct Hit on Distribution." Industrial Distribution. March 1999.

Caffey, Andrew A. "Different Worlds: How to Choose Between a Franchise and a Business Opportunity." Entrepreneur. June 19, 2000.

Caffey, Andrew A. "Eight Steps to Choosing the Perfect Business Opportunity." Business Start-Ups. September 1998.

Entrepreneur Magazine Starting a Home-Based Business. John Wiley, 1999.

Estratiades, Anastasius. "Ten Key Questions to Consider Before Your Client Goes Global." Journal of Accountancy. February 1997.

Gibbs, Andy. "How to Sell Your Product." Entrepreneur. September 4, 2000.

Peterson, Dean D. "In the Beginning." Doors and Hardware. August 2000.

Pressman, Arthur L., and Craig R. Tractenberg. "An Introduction to Franchise Law." The Legal Intelligencer. May 31, 2000.

Price, Courtney, and Kathleen Allen. Tips and Traps for Entrepreneurs. McGraw Hill, 1998.

Ulrich, Robert J. "Alignments Can Help Dealerships." Modern Tire Dealer. June 1992.