What Is a Channel Margin?
Business owners often depend on other businesses within their industry. Distribution channels, for example, are interdependent relationships, typically between manufacturers, wholesalers and retailers. If your business is a member of a distribution channel, you must collaborate with the other channel members to ensure the final selling price is attractive to consumers without overly jeopardizing your profitability.
The classic example of a distribution channel starts with a factory, which sells its products to wholesalers, who then distribute the products to retailers, who sell the products to consumers. For example, a grocery store is able to offer a wide variety of products to consumers because it is the end point of numerous distribution channels. Various food manufacturers sell their products to wholesalers, who sell the products to grocery stores, who sell the products to consumers.
The price charged by each successive business in a distribution channel affects all the other members of the channel. That's because when any channel member increases its price, it marginally increases the price consumers must pay.
The price difference between what a manufacturer charges and what a consumer pays is called the channel margin. For example, suppose a breakfast cereal manufacturer sells its products to a wholesaler at a price of $1 per box. The wholesaler takes delivery of a large number of boxes and distributes them to various retailers across the country, charging $2 per box. Retailers then increase the price to $4 per box when selling to consumers. The total channel margin is thus $3.
Each marginal increase in price is a trade-off. On one hand, each channel member wants to make as much profit as possible, so there is always a powerful motivation to increase the price. On the other hand, high prices turn off consumers, so if any business in the chain increases its price too much, everyone loses. For example, if a grocery store increases its cereal prices too much, customers will go to other stores for cereal, hurting the future profit potential for all the channel members. In this sense, every channel member is dependent on all others and must think carefully about the ripple effects of any price increase.