Many product manufacturers, particularly those who make consumer goods, don’t deal directly with their end-user. They use a chain of distribution instead. This kind of company has to market to two audiences. It has not only to convince the end-user to buy, but it also has to persuade the distributor to stock the item in the first place.
The quantities taken by the distributor are called “sell in.” Typically, the distributor takes physical and legal possession of the product at the manufacturer’s factory loading dock. When this occurs, the manufacturer considers that the product is sold and credits himself with the associated revenue and profit.
If the manufacturer sells 100 units at $50 each, he may not credit the whole $5000 as revenue, since he has to consider the possibility that not all the units will be sold to end users at full price. He may set up a reserve for possible returns, based on his historical experience with this type of item and some amount of guesswork. If he assumes 5 units will be returned, he will only recognize $4750 as income. His other choice would be to show the entire $5000 in one accounting period but then have to record a loss on the returns in the next. Why do that? It would just make the revenue stream look more volatile, meaning that investors would place a lower value on it.
The topic of returns is a complicated one, and practices vary from industry to industry. I’m going to go into it here only in the briefest way.
On the one hand, there are legal and contractual agreements. On the other, the issue of maintaining good long-term working relationships sometimes means that the rules are bent a bit. And of course nothing can ruin a brand name faster than seeing a $1000 retail item being sold for $75 in a close-out store.
Often, to forestall returns of a slow-moving item, the manufacturer will provide a retailer with additional funds for promotion. The retailer may also be compensated for discounting he may have to do, either through payments or through discounts on future purchases from the manufacturer.
How do we find out about sell in? The information comes from the manufacturer, either through press releases, analyst conference calls or SEC disclosures. How much information a manufacturer is willing to disclose varies.
“Sell through” is the amount of merchandise that is actually bought by end-users. Ultimately, sell in should equal sell through + inventories in the distribution channel (less shrinkage).
How do people know this number? By and large, wholesalers and retailers have point of sale computer systems that record each item sold. Manufacturers can find this number out from each of their customers and thus have a good idea of how much inventory is left in the distribution channel and what reorders are likely.
What about us, though? A number of third parties collect POS information from retailers for distribution, often for a fee, to manufacturers (who can then compare sales of their products with those of rivals’), industry analysts and anyone else willing to pay. The biggest flaw with such data is that WMT figures it would give away more than it gets from this kind of information exchange and won’t release its POS data. WMT is about 10% of all retail in the US, which is bad enough, but in some categories it can be a third or more. In those cases, the third-party data must be taken with a grain of salt.
Why they matter
Looking at sell in vs sell through gives an advance look at how business is going, as well as a sense of how solid the revenue and profit numbers are that have already been booked. If sell through exceeds sell in, then inventories on the shelves are getting smaller and reorders may be on the way. If sell in exceeds sell through, stocks are piling up. In a really bad case, writedowns are possible.
This can be particularly important for a smaller company, where one big hit or one real clunker can have a material impact on the manufacturer’s fortunes. I was just reading the other day about a small UK publisher whose stock I’d owned once but had long-ago lost track of. It seems that it published and sold in 14 million copies of a Star Wars book, which sold through only 3+ million copies. The loss created by the 11 million or so returned copies, which maybe cost $140 million to print and were now just recycling, was reportedly enough to send the company scrambling for a merger partner to help it stay afloat.