Why “Getting rid of the middlemen” startups often fail

“We are here to get rid of the middlemen!” is the proud proclamation of many startup founders.

Middlemen, or dealers, are seen as evil not only by many startups, but also by many government sponsored initiatives to make help SMEs and farmers alike.

In their eyes, middlemen do not put in any hard work, but capture a higher profit than those who actually labour hard to produce the products.

Therefore, by ridding them, the prices for end customers will decrease while the earnings of producers will increase – a perfectly happy scenario.

Not as simple

Time and time again, we see these companies fail. Those who survive often become middlemen themselves, operating exactly the same model they had tried to dislodge.

We see financial comparison websites, some of which having raised tens of millions of dollars, become lead generation call centres; we see B2B distribution platforms become distributors themselves, buying goods from brands and selling to retailers (and offering credit).

But what exactly are you replacing?

Efficiency and costs are, oftentimes, not the only factors. Middlemen often play other roles that are essential in the trade.

The role of ‘middlemen’

Take the example of B2B ecommerce. There are many startups trying to cut through the multiple levels of distribution and reach directly to end retailers.

Why not? With three to four levels of distribution, the prices hike up, and information feedback takes too long: factories can’t adjust their production timely according to market demand, and distributors often face inventory problems.

The ecommerce model these startups are building is called M2R – Manufacturer to Retail. It is not hard to figure out that the platform needs to make both M and R happy, or make one of them very happy, to be sustainable.

Let’s see how the middlemen’s role in this:

To M

For Manufacturers, marginal cost of more production is often low, however inventory cost and risk can be significant if there is an over-production. What is the role of master distributors here? They take away the inventory risk from manufacturers. In return, they are often granted with credit, and profit margin.

Master distributors then sell to sub-distributors, sometimes extending the credit, but mostly dispersing the inventory risk.

So on and so forth, by the time the goods reach the retailers, the inventory risk is spread over so many parties that it becomes insignificant for any of them.

There are only two ways this could collapse: dramatic shift of consumer demand; and tightening of credit in the market – both are macro factors impacting pretty much everyone in the economy.

This is one of the key components of Miniso’s business model. But of course, by taking all roles (from master distributor to retailer), Miniso is also taking some significant operational risk.

To R

For retailers, they want to be able to get (and sell) the goods they want (in the quantity and terms they desire), and ideally have credit extended to them.

Also, it is very important to highlight that retailers often undertake the highest inventory risk (relative to their size). As a result, independent retailers are often quite careful in purchasing – the resulting lost sales for certain SKUs is not as painful as having excessive inventory rotting in the shop.

The long term relationship they often have with distributors give them some level of comfort: they can negotiate terms, and sometimes do consignment (although this is becoming rather rare); sub-distributors oftentimes give retailers credit terms (although this is becoming rare as well); they can source for different goods with different sub-distributors, with flexible/negotiable terms and, in the case of China, sourcing and paying on platform – WeChat.

These relationships, with the trust and flexibility, take years to build.

How to disintermediate then

We are not saying that middlemen can’t be dislodged. In the contrary, we believe that the current middlemen models in many sector have lots of inefficiencies to be addressed.

However, quite often, B2B startups blindly copy the strategy and tactics of B2C startups: namely subsidies, massive marketing and fulfillment.

These are some of the major mistakes causing the downfall of Indian B2B ecommerce site Just Buy Live.

To build a successful business to address these issues, one needs to clearly understand the ecosystem with all the players, the exact role(s) middlemen are currently playing and their inefficiencies, as well as the key pain points of buyers and sellers in the ecosystem.

That’s why many of the successful B2B Startups are run not by novice disruptors, but industry veterans who know the ecosystem and pain points too well.

We are also learning in this field, especially through the HalalNode project we are building. There are too many failures in B2B halal ecommerce space for the reasons mentioned above; and we are proud to be working with some of the industry’s best and most experienced.

If you want to find out more about HalalNode, for collaboration or for investment, please write to us at [email protected].