Some large retailers purchase their goods directly from Asian manufacturers, who in turn buy the components and process them. That’s about as “direct” as it can get. It allows buyers to avoid the margins of all kinds of middlemen.

According to this view, very large retailers would buy everything directly in Asia, right? Actually, the trend among American big-box retailers seems to be just the opposite. They buy more and more from intermediaries who go through all the trouble of Asian production. Why is that?

It is interesting to remember what Wal-Mart’s founder wrote in his autobiography, about 20 years ago:

We don’t have any problem with the idea of paying a middleman a commission on a sale, if his services add value to the purchasing process by making it more efficient.

Our philosophy on this has always been simple: we are the agents for our customers. And to do the best job possible, we’ve got to become the most efficient deliverer of merchandise that we can. Sometimes that can best be accomplished by purchasing goods directly from the manufacturer. And other times, direct purchase simply doesn’t work. In those cases, we need to use middlemen to […] make the process more efficient.

Making the purchasing process more efficient

Can an intermediary allow for efficiencies, and this way create enough value to compensate for its margin?

Actually, yes, in a number of ways. But only in certain situations. It seems like most importers can do without an agent. But, in some cases, a competent and honest trading company can be quite useful.

I listed below three good examples. They all come from the book written by the top managers of Li & Fung. Their firm is the largest Hong Kong-based trading company selling primarily to large retail chains. They call themselves a contract manufacturer (but they own no factory) or a “network orchestrator”.

Example 1: managing a seasonal purchasing period

Millions of customers buy barbecue grills at the same time, once a year. It means factories in China have to produce everything in 3 months around the clock, and then nothing for 9 months.

They cannot build inventory in advance because they need financing and warehousing, and because retailers would have the upper hand to pressure prices. And, on the retail side, any shipment delay is a disaster (air freight or lost sales).

Here is a solution: the intermediary gets early orders from the retailer, offers credit terms that enable the factories to start production earlier, and arranges warehousing in China. Last-minute delays disappear and everything is shipped by sea. Both the manufacturer and the retailer win.

Example 2: accelerating development and manufacturing

Coca Cola needed 2 million custom-designed trees (with toy train and LED lights) for Christmas. The whole project was made and shipped out in only 10 weeks. How?

The contract manufacturer found sources for the component (i.e. the chips were flown from Taiwan). It launched production in 3 factories at the same time in the same area. The local contacts and organization of the trading company allowed it to ship the 700 containers in time.

Example 3: improving responsiveness to in-store demand

New collections of fashion apparel are designed at least for each season, and retailers have difficulties forecasting the demand for a given style. Most Western retailers decide very early (3 to 9 months before) on the quantities to purchase from Asia for the season. The downside is lost sales in case of commercial success, and unsold inventory in case of a flop.

The solution would be a much faster manufacturing cycle. It would allow retailers to place re-orders after a style has started selling. But how to achieve it? With “flexible commitments”. The trader reserves some sewing capacity in a few factories and some undyed yarn. Five weeks before delivery, the order is given with all the details (workmanship, colors, sizes…). Then, for re-orders, production is moved to countries closer to the market (e.g. in Central America to ship in the US), and the response time is even faster.