The Problem. Due to changes in the floorcoverings industry, Crafton Industries is exploring the possibility of developing their own direct distribution channel. Crafton is faced with the following problem:
- Should Crafton Industries modify its distribution channel in light of intensifying price competition and increasingly costly demands from its current wholesalers?
Recommendation. Although the profit potential for switching to direct distribution is intriguing, the qualitative factors for this case suggest a different outcome. Based on the combined quantitative and qualitative factors, Crafton Industries should maintain their current distribution channel.
Economic Uncertainty. Dollar sales in the carpet and rug industry have declined sharply since the onset of a recession in 2007. As Exhibit 1 indicates, dollar sales have declined from $13.2 Million in 2007 to $9.3 Million in 2009. This is a 29 percent reduction in total sales dollars. Despite this industry-wide decline, Crafton Industries managed to enjoy a modest 3.6 percent growth. Nevertheless, this economic uncertainty makes the opportunity to switch from wholesale to direct distribution extremely risky. Although the profit potential detailed in Table 1 is intriguing, the risks associated with the economic conditions suggest this decision should be delayed.
Lack of Wholesale Expertise. Although the costs detailed in Table 1 indicate that direct distribution is a more profitable solution, those costs do not factor in the cost, both literal and figurative, of managing the wholesale operation. If Crafton had an opportunity to phase the rollout of their wholesale operation, they would have a chance to develop this expertise. Since they are faced with all-or-nothing decision, Crafton must instead gain this expertise immediately. There is more to managing 4,000 accounts and operating 7 warehouses that simply the personnel it takes to drive the forklifts and man the phones. The coordination of this effort may be beyond the skills of Crafton currently has in-house.
Wholesaler Relationships. The decision to move from wholesale to direct distribution is one that cannot be easily undone. The wholesalers have already made it clear that if Crafton moves forward with the distribution change they will no longer carry their products. If the distribution change does not work out for Crafton, it may not be possible to rescue the relationships with the seven current wholesalers. Additionally, an aborted attempt at direct distribution may foster ill will with other wholesalers making it very expensive, if not impossible, to revert back.
Funding Direct Distribution. As Table 2 details, Crafton has over $16 Million in working capital that can be used to fund the conversion from wholesale to direct distribution. Although this is enough capital to cover the cost of direct distribution, it only leaves $3 Million should something catastrophic occur. Based on Crafton’s aforementioned lack of wholesaling experience, the possibility that costs have been overlooked or efficiencies overestimated is a very real possibility. When coupled with the volatility of the economy and the impact it has had on carpet and rug sales, the risk that Crafton will end up dipping deeply into their working capital is very high.
Profit Potential. Although the decision factors in this case seem heavily weighted toward maintaining the status quo, the costs of operating a direct distribution system are lower than the existing wholesale arrangement. As Table 1 indicates, there are more cost items to worry about, but the overall costs are over $4 Million lower. This more than doubles their current profit of $3 Million indicated in Exhibit 3. This $4 Million of additional profit is highly contingent on the scenario playing out as expected. In fact, this can only be considered a best-case scenario. If there is a change in the economy, or difficulty securing and servicing the existing 4,000 retail accounts, the additional $4 Million of new profit will quickly evaporate.
I would have included the tables mentioned above, but converting them was a big PITA.