Timeless lessons of managing distributor networks
by Scott Benfield
"There is nothing new, just timing and application of what is known." ~Anonymous
The history of modern distribution goes back about 100 years. Somewhere in the early years of American industrialization, companies established distributor networks to get products to market.
As these channels matured, they established basic governing principles still familiar to companies that market through distributors. Like most areas of knowledge, it doesn't hurt to get in touch with the basics and realize that common knowledge is not always common.
It's not simply how much they buy
Purchase volume is a frequently used metric of distributor performance. Distributors that buy more generally get the best price and special consideration for new territories and other benefits. Distributors cover multiple market segments, however, and distribute to numerous geographies. Hence, it's not how much they buy, but how much they sell and to whom they sell.
Manufacturers are famous for stuffing the pipeline with dating terms when times are slow. Too often, they forget they artificially filled the pipeline and make wrong-headed decisions with wrong numbers about a distributor's performance. A year later, when everyone's purchases but theirs increased, distributors that didn't want or need extra inventory and turned down extended terms get criticized by manufacturers. Of course, the better-managed distributors forecast better and balance inventory with market demand. They realize that extended terms too often don't cover the other costs of handling, shrinkage, insurance and obsolescence.
In one instance, a company filled the pipeline with 15 percent extra inventory. A year later, management reviewed which distributors deserved open territories and those distributors that turned down the previous year's "fill" were behind in purchases. Management forgot they gerrymandered demand and rewarded the territories to distributors that took the extra inventory. Ironically, the distributors that turned down the terms were better forecasters and financial managers and stronger companies. But, they lost the territory consideration due to poor channel measurement by their manufacturers.
When measuring distributor performance in sales, we recommend using piece volumes and average percentage increases. We also recommend using a three-year average benchmark. For example, if Distributor A sold 10,000 pieces in year one, 11,000 in year two and 10,500 in year three, it averaged 10,500 in annual piece sales. The "growth" in year three is minus 5 percent. If the average piece sale growth for other distributors in similar markets is minus 5 percent, distributor A had an average year. Three-year averages often smooth out many of the pipeline effects and piece volume is not subject to inflation factors.
Manufacturers that want to measure detailed distributor performance can use a modeling technique called relative share modeling. They calculate market share for a given branch using demand approximations specific to the local market. Average branch sales are normalized using a common denominator such as sales-per-1,000 establishments or sales-per-million population. Manufacturers can attain a reasonably good approximation of performance by comparing average sales of distributors in similar markets. Relative share models take some work but the data is readily available from U.S. government sources including County Business Patterns. Distributors must report sales by branch, segment or product category to make the data accurate and useful.
If you're not talking the same segments, you're not communicating
In order to engage in joint market development, distributors and their manufacturers need common customer definitions. If the market is residential remodeling contractors, both parties should understand the size, service, product and pricing needs of the segment. Far too often, manufacturers give co-op dollars to distributors that spend the money on poorly defined segments. Manufacturers should spend some co-op money on defining segments and their needs.
Going to market without a common segment definition is akin to a quarterback describing a pass pattern as a "dogleg to the left and the pass will be a hook." Unless the receivers are golfers, they simply wouldn't get the message. A manufacturer can't communicate go-to-market strategies intelligently unless the manufacturer and its distributors have a common segment definition.
Understanding distributor segments and their needs takes time. It is crucial for manufacturers to work with distributors to define segments by asking these key questions:
- How large is the segment in dollars?
- Is the segment growing and is it profitable?
- What are the product needs of the segment?
- What are the service needs of the segment?
- What is the average account size in the segment and how do we find out who they are?
- And, is the distributor interested in the segment?
One of the more disconcerting aspects of channel relationships is that manufacturers foist products on distributors for segments the distributor doesn't serve. It happens when channel partners have a poor understanding of their common served segments. So, don't expect positive results from joint planning without a common customer classification.
The difference between customers and partners
A common segment definition helps the manufacturer and distributor focus on the distributor's customers. Too often, manufacturers treat distributors as the sole customer. They may have excellent communication between their shipping and the distributor's purchasing and warehousing functions. But, they have little to no knowledge about the market needs downstream. And, they can't tell a good distributor partner from a bad one since there is no market-based definition of performance.
Distributors are customers when it comes to taking costs out of the supply chain between the manufacturer's shipping dock and the distributor's receiving dock. Distributors are partners when the manufacturer's sales and marketing efforts work with the distributor's sales and marketing to penetrate common segments. The distributor-as-customer requires collaboration on the back door of the wholesale firm. The common goal is to get cost out using technology and better information sharing. The distributor-as-partner requires joint planning on common customers, supported by timely and accurate market research. The goal is to sell more profitably.
More distributors doesn't mean more sales
Weak manufacturing companies or vertical markets with weak distributors can have too many distributors. In general, following the product life cycle, distribution moves from exclusive to selective to intensive. Today, life cycles move rather quickly, and there are few exclusives in mature wholesaling markets. Too often, manufacturer salespeople, paid on total margin dollars or top-line sales, set up a plethora of distributors. Over time, the cost to serve many distributors becomes enormous.
Too much distribution also means that better performing distributors can't earn enough on the product or afford to differentiate the brand. They are constantly in fear of a poor-performing distributor undercutting the price. The poor distributor does this because it offers a stripped-down service platform and doesn't fully service the brand. Better performing distributors advertise, promote, train and handle warranties, while poor performers simply sell the product and don't care about building the market. If this goes on too long, better performers will switch lines to find a marketable advantage.
For manufacturers with too many distributors, we recommend the following corrective paths.
- Differentiate pricing between high-performing and low-performing distributors by volume, market penetration, activities performed and costs to serve. This approach rewards better distributors that invest in promoting the brand and trimming the supply chain and makes the freeloaders increasingly non-competitive. Of course, when taking this tack, a manufacturer must make sure it is in line with pricing legislation (consult the corporate attorney and a qualified channel professional) and that its lower price is supported by a lower cost to serve.
- Set minimum standards on order size. Too often, smaller distributors order small transactions with a low profit per transaction. By setting a larger transaction size and differentiating the price, small distributors either order enough to make the transaction profitable or buy from a master distributor.
- Develop a distributor agreement with area of primary responsibility (APR) performance standards and a checklist of objective requirements. About once a year, account managers should review the requirements and evaluate each distributor. Manufacturers should give under-performing distributors a chance to get better, and if they still can't cut the mustard, don't renew the agreement. Again, manufacturers must have measurable, objective standards for performance, treat similar distributors alike, and must review the standards on a regular basis.
It's about service also, not just product
Research projects on the value of the manufacturer's brand show that end-user customers value the distributor's services as much as they value a brand's features and benefits. Savvy manufacturers measure distributor service performance by segment. They understand service needs for each segment and explore how they can help improve distributor service. They also know which distributors are gaining in the market with service excellence. Of course, there are many services that manufacturers are not responsible for and, if a distributor's service platform goes south, it may be time for a change of middlemen.
There is great opportunity for manufacturers and distributors to partner together to develop services that customers will pay for. These services can include time-specific delivery, kitting, special packaging, education on product application, and any number of unique services. Today, there is little collaboration on service development. What little work being done is quite profitable for both parties. Don't be satisfied solely with selling product. The partnership should include joint service offerings to segments that want them.
A channel is a buying system
A marketing channel is a living system that includes those that take title to the product and those that support the sale, including specifiers, designers, influencers and knowledge brokers. When reviewing a channel strategy with a distributor partner, manufacturers can't forget to outline the entire channel. They should list each participant, what they do, how they make money and where their influence can be helpful. Channel diagrams with a simple No. 2 pencil can be illuminating and quite useful. There is no substitute for understanding the buying system and how to use it to get the product to market.
There are also opportunities for service development. One manufacturer found that specifiers and designers needed product schematics on a CD to help with developing blueprints. The company developed a CD specific to a popular design software, sold it for a tidy profit and got more products specified.
Understanding the channel system is a forgotten perspective. Our advice to manufacturers is to take several weeks, visit varying members of the buying system and familiarize themselves with their function and purpose.
Remembering and practicing these principles can help avoid channel conflict. Good distribution networks are built over time. Overnight success building a strong channel seldom happens. Strong channel partners can keep other manufacturer competitors out in the cold.
Scott Benfield is a consultant for industrial manufacturers and their distributors. He can be reached at (630) 428-9311 or firstname.lastname@example.org.