Distribution Cost: Definition, Importance, Types & Examples

For any company which is involved in distribution, distribution cost is a major bottleneck. There are many different distribution costs which must be taken care of. Furthermore, these expenses are not consistent and may change from time to time thereby changing the distribution cost as well.

What is the Distribution Cost?

The Distribution Cost is the cost of getting your product to its customers. This can include things like packaging costs, transportation expenses (freight cost), and advertising.

The total distribution cost can be a significant part of the overall costs incurred of making and selling your product. The distribution cost may also include any applicable taxes and duties.

Importance of Distribution Costs

Distribution costs are a major component of the cost of goods sold. They can include the cost of shipping costs, packing costs, transport cost, storage cost, and insurance.

Distribution costs are important because they’re necessary for any business that sells products or services to get their goods into the hands of consumers.

Example of Distributions Costs

A company in the 1st year of its foundation might be given an X salary to its employees. But by the 5th year of establishment, it probably has many more employees to whom they are giving salaries worth X or X + 10% or even X + 50% depending on their growth. Thus, the salaries have grown over the years which directly contribute to an increase in distribution cost and therefore distribution.

Before beginning, let us also understand the difference between distribution expenses and distribution cost.

Distribution expenses – The individual expenses made by the company for various reasons is known as Distribution expenses. These are individual or repeated transactions happening over time. An example may include – Rent, Salaries, Administrative expenses etc. All these are individual transactions or repeat transactions and these transactions can be called distribution expenses.

Distribution cost – The combination of all the expenses made by a company is known as Distribution cost. So continuing the above example – the total of rent, salaries, and administrative expenses will be considered a part of distribution cost. In terms of Formula

[The sum of all Distribution Expenses] = Distribution cost

So which are the various distribution costs which you have to consider to come up with distribution cost? Let us delve in.

1) Direct Selling Expenses

Any expense made towards selling the product to the target customer is a direct selling. Many manufacturers, wholesalers, and distributors carry out direct selling in the regions that they want to expand. They also would like to know the distribution cost of that region. Thus, they consider all direct selling expenses as the primary expense made by the firm.

Such Expenses will include – Salary of Field Salespeople (only for target customer sales), Travel of salespeople, Entertainment for sub-dealers, Training costs, Postage or office expenses needed for sales etc. All these different headers are categorized as direct selling expenses. They are one of the major contributors to distribution costs. The more you spend in sales, ultimately the more profit you will have.

2) Advertising & Sales promotion expenses

If a company wants to establish itself in a new region, it needs to have OOH advertising, it needs to run in-store branding, it needs to run ads in local newspapers or local channels. Thus, the company will be spending a lot towards advertising and promotions which are various forms of distribution expenses.

Example – Spends in Hoardings, Banners, Standees, ATL marketing, Advertising agencies, In-store branding and any administrative expense towards advertising and sales promotion will fall under that header only.

3) Product and Packaging expenses

I once dealt with a company which was having a very good reputation in the market. This company then started selling the products on Amazon. The product packaging was good but was not strong. As a result, the packaging suffered a huge wear and tear by the time it reached the customer and the customers returned the product.

This caused a huge loss to the company and they ultimately came up with a plan to have a different and sturdy form of packaging for Online sales. Such packaging is obviously a cost to the company and should be added as one of the distribution cost. Besides this, some other forms of product costs include raw materials, depreciation of the product in stock, salaries for employees involved in product development or related to product and packaging.

4) Trade discounts

Besides sales promotion exercises like advertising and marketing, a company launches several trade promotional exercises as well. This includes giving discounts to retailers, distributors, and suppliers on achieving certain targets.

Other type includes discounts on picking certain quantities of products (example picking a bulk of 1000 units will give 2% additional discount). Thus, Quantity discounts, sales allowances, and other such trade discounts are considered as distribution costs and ultimately distribution cost.

5) Credit, Outstanding and Overdue

A distributor who operates in a regional market needs the huge amount of money to conduct business. To arrange this money, the distributor takes a loan from the banks. This is known as an Overdue account. Hypothetically, If the distributor takes 1 lakh from the bank, within 30 days he should give back 1 lakh + 1% interest. Thus, a dealer suffers a loss when his money does not come back from the market in time.

As a result, Overdue accounts, Market outstanding and credit are given in the market to contribute to the distribution costs. The more credit given in the market, the higher is the value of interest applied. There are also expenses towards collecting the outstanding from the market and to close all bad debt. Thus, all these distribution costs related to credits, outstanding and overdue contribute to distribution cost and must be taken into account.

6) Market research

When reputed companies like Samsung, LG or Sony want to establish themselves in a new market, they buy market research reports from the likes of IMRB or Nielson. These reports may cost hundreds or thousands of dollars. Not only in a new market, even in an old market, a company might want to conduct a satisfaction survey or a survey of new ideas regarding distribution.

The company might find in this survey that the time taken for delivery is quite high. Or it may find that other companies are giving higher credit, therefore resulting in loss of sale for a parent company. In all this, the market research costs are generally kept up to a percentage of the total profits or revenue of the company. So market research cost for a branded company might be 1% of revenue.

7) Warehousing and handling within warehouse

Warehousing is a major cost of distribution. When a company expands to newer markets, it needs to have new warehouses in each new territory. Domino’s or McDonald’s practically have warehouses for every 3-4 towns so that they can supply to local retail outlets very fast. Because of Domino’s and McDonald’s handle frozen goods (burgers or fries), their expenses are even higher because they need cold rooms and cold chains to deliver the products.

NOTE – Warehousing cost is different from transportation and delivery cost which is calculated separately.

Thus, the various warehousing costs include rent of the warehouse, salaries of warehouse managers and material handlers, electricity expenses, administrative expenses for warehouse management, supplies and utilities, specialized equipment etc.

8) Shipping and Delivery

With the rise of E-commerce, delivery is a huge focus area for all manufacturers. The stock must be in the market – whether it is on an E-commerce portal or in a retail outlet or with the distributor. Everyone knows that if there is no stock on display, the sale will not happen and this creates friction between the different distribution channels.

Thus, Shipping and delivery are important to the firm and hence companies ensure they are operating above capacity. Companies can choose to use their own transportation and company-owned trucks or they can use outsourced transportation to reduce such transport fare and shipping cost.. Retail chains generally use their own transportation within warehouses due to regular movements of goods. Consumer durables and FMCG use outsourced transportation because the movement of goods is erratic.

Overall, the transportation costs or transport fees include – freight charges, manpower for loading and unloading, utilities, insurance of product, repairs and maintenance, salaries of truck and vehicle driver, management of records etc.

9) Commercials & Accountancy

It is a government requirement to present all your sales and purchases as well as balance and profit sheets to the government to determine profit earned by your firm. Furthermore, these statements are also important for the firm itself to note the growth year on year as well as to determine the performance and future potential. Thus, commercials and accounts are documented precisely in any firm.

The distribution costs towards commercials and accountancy include – Processing of orders and maintaining accounts receivables, sales invoices, payment proof’s, clerical jobs, invoicing and accountancy software, printing and stationery expenses, utility expenses. All these expenses together form the distribution cost of commercials and accountancy.

10) Customer Service

In the industrial segment, there exist industrial distributors who take care of both – Sales and service of the product. In such cases, it is the distributor who must take care of the service of the product as well. As a result, customer service expenses become distribution expenses and contribute to distribution costs.

The running of a customer service centre, the salaries of customer service executives, the utilities and tools required, specialized equipment, rent, electricity, administrative and clerical expenses are all various distribution expenses filed under customer service.

11) Sales returns

If a dealer or a retailer rejects a material, then the material comes back to the manufacturer provided it is in the returns policy of the company. This returned material may have come back due to cosmetic conditions (it was damaged or dented) or it may have come back due to performance issues. In any condition, the returned product is a cost to the company.

The company can either repair the cosmetic damage, reutilize the product again or sell it off at a discounted rate. In case of performance issues too, the product can be repaired or recycled or sold off. The distribution expenses of sales returns include freight of bringing damaged products back, repairing of the product, loss due to discounted sale, loss due to recycling of the product, bad inventory in stock, clerical or other administrative expenses towards handling sales return.

Thus, the above were the 11 types of distribution cost which occur in a distribution based firm. The total of all these distribution expenses is known as distribution cost.

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