Where is the Volume in Volume Rebates?
by Scott Benfield
The Great Recession has wrought many changes in the mature business-to-business channels of North America. As the protracted and anemic recovery is well into its second year, distributors are finding that a cherished and heretofore reliable source of income is drying up. The year-end volume rebate and its close cousin, the co-op dollar, are shrinking.
The reasons for this are not simply due to the Great Recession but also globalization of manufacturing and the immediate and accurate information on price and availability 24/7. Our forecast is for volume rebates and co-op dollars, from domestic vendors, to decline in many sectors. This article explores the issue and what, if anything, can be done about it.
History Doesn't Always Repeat Itself
For as long as our firm has served distributors or been involved in markets where manufacturers sell through wholesalers, the volume rebate and co-op dollar have been standard offerings. In some industries, volume rebates often equaled the pre-tax return on sales of the distributors they were meant for. Our work in distribution and as consultants finds that it is not uncommon to have monies in the 1% to 2% of purchases range and, depending on the vendor and competitive situation, the sums can go higher. For all intents and purposes, these funds have been a reliable source of income for North American distributors. But any assurance of stable income from future funds is far from certain.
Starting in the '90s, many manufacturers began increasing their performance stipulations on rebate and co-op funds and linking them to incremental sales, increased market share, or promotions for key products. Many of our associates were involved with domestic manufacturers during this period and managed budgets in excess of seven figures for North American distribution.[i] Rebates and co-op dollars began a slow transformation from a "given" in the 1970s and 1980s to "earned" status by the 1990s. Major manufacturers had better data on distributor performance including point-of-sale information that made financial rewards specific to market performance standards. Many, but not all, distributors welcomed performance-based rewards as they shared information with manufacturers and planned the expenditure of co-op dollars over a variety of marketing and sales activities. If the planning process worked, the distributors earned more money based on successful joint marketing. Joint marketing and rising manufacturer dollars, however, are no longer reliable and are facing significant changes due to globalization. Distributors, with the thinnest of margins, are finding that these monies are no longer secure and, because the funds are substantial, they will need to react quickly.
From Incremental Sales to Global Competitiveness
As rebate and co-op dollars became more performance-based, vendors linked payment to growing sales or margins. Many unique formulas were developed for evaluating how distributors earned the monies but almost all involved substantial weighting of sales growth or margin growth as predicated on product mix and new product sales.
The recession-driven drop in top-line sales across many distributor vertical markets has meant that year-end funds predicated on sales increases have taken substantial hits. For instance, in the PHCP market, from 2008 to 2009, sales-per-employee decreased approximately 10% from $406,000 to $363,000.[ii] Between January 2009 and September 2009, shipments for industrial distributors, on a year-over-year basis, declined 20%.[iii] While sales have recovered somewhat in 2010, the anemic recovery means that many distributors won't see pre-recession levels for three to five years. This, of course, means that year-end funds based on incremental sales will be substantially less than in prior periods.
The sales decrease and slow recovery exacerbates an already dangerously low earnings picture for many distribution verticals where earnings are, on average, expected to be some 30% below pre-recession levels.[iv] In most instances, distributor pretax earnings have fallen well below the average 2% to 2.5% of sales range where the sales value of the firm is, typically, no more than asset value. Additionally, many commodities were at record inflationary levels prior to the recession, which meant that sales increases were often the result of speculative investment and not real sales gains. As commodity speculation busted with the housing bubble, distributors are left in a depressed market and their skill sets, to secure real sales gains, have atrophied.
The recession-led drop in sales and busting of the commodity bubble, however, is only a partial contributing factor to the decline in vendor-based funds. Other, more structural events due to globalization, will cause a decline in vendor support from domestic manufacturers.
A BRIC to the side of the head
With the U.S. economy growing at a 2% or less annual rate, the common line of "we are out of the recession but it doesn't feel like it" largely applies. The recession, however, is primarily an event suffered by mature Western style economies of the U.S., Western Europe and Japan. These economies were victims of speculative investments and over-borrowing on the flawed assumption of ever-rising real estate values. Of the economies that have been severely hurt by the recession, Germany has the highest growth of 2.2% followed by the U.S. at 2% and trailed by other Western European countries and Japan.
The problem with these economies is that they are mature and well-established. Hence their attractiveness to multi-national and domestic vendors is less than developing economies of the BRIC nations (Brazil, Russia, India, China.) Long-term growth for these economies is expected to be 3x to 5x that of mature countries. A variety of reports find that leading U.S.-based industrial mult-inationals secure over 50% of their volume from international sales, especially in developing nations.
Our propriety research, however, finds that these sales are hotly contested by foreign competitors whose manufacturing and supply chain costs can be substantially less than the U.S.-based companies.[v] Our belief is that many vendors originating in North America and Western Europe will shunt year-end rebate and co-op monies away from domestic distributors in slow-growth countries, to those in high-growth economies. There is literally no way to prove this hypothesis, as vendors and distributors are reticent to openly talk about year-end funds, but the global economics for North American and Western European manufacturers, competing for share in growth economies, places tremendous pressure on funding high-growth markets over slow-growth ones. And a large pool of funds are the co-op and rebate dollars for the slow-growth markets.
Our research finds that, in the early years of the high-growth economies, American and Western European brands are often preferred, as foreign brands are deemed unreliable in quality and service. However, as the growth economy develops, foreign manufacturers build the user base, hire better employees and improve quality, whereupon they become formidable competitors. This observation is important as North American and European manufacturers moved to growth economies, almost en masse, in the 1990s and early part of the New Millennium. Today, with a decade's worth of experience, manufacturers from BRIC countries are qualified competitors and are aggressively attacking North American and European brands in their home countries and globally. In the fight for high-growth markets, we believe that North American and Western European-branded suppliers will move monies and resources from North American markets to the BRIC countries and other growth markets to combat the increasing aggressiveness of foreign brands and to maintain their dominance in growth economies.
Our hypothesis is not without its detractors, especially among North American-based domestic vendors. However, our conversations with numerous wholesalers in differing product-vertical markets finds that co-op and volume rebate funds are falling more quickly than the recessionary-based sales decline would suggest. Additionally, if funds are not in decline, the rules and regulations for earning them are becoming more complex and restrictive. Since distributors have a significant portion of their earnings in year-end rebates and co-op dollars, and these funds are dwindling at a time when earnings are at historic lows, the question arises, what should and can a distributor do? Our closing thoughts are in the next section.
Beat 'Em, Join 'Em, Play Both Ends against the Middle
While domestic vendor support funds may be falling, there is an ever increasing plethora of foreign vendors that offer excellent quality and service. Our 2007 research implored domestic distributors to source foreign brands, as their cost and quality were hard to beat in a global economy. A recent article on W.W. Grainger finds that the company is planning to increase sourcing of "private label" products to 23% of total or approximately $1.4 billion.[vi] Furthermore, these products yielded margins of some 20% better than mixed margins of all products. If one is a competitor of Grainger, the worry is, can and will the Chicago-based leviathan use its global reach to secure a cost advantage and take it to market? Our book, "Disruption in the Channel" predicted, three years ago, that the sourcing from foreign vendors for domestic distributors was not a financial option. Based on cost advantages of 30% over domestic brands, North American distributors would be forced to source these products once market saturation reached 30%.
Our research also finds that there are six distinct sources of foreign goods for North American wholesalers, with importers and master distributors exhibiting the best of price, service and quality. A recent visit to an importer of plumbing and industrial valves found the firm conducted extensive quality and performance tests on its foreign suppliers and had entered into product development. In essence, an importer had begun to move into research, development and testing that is typically reserved for the manufacturer.
If domestic wholesalers don't believe in sourcing foreign goods, they should rather quickly review the following:
- Price and quality of domestic brands versus foreign options
- Amount of rebate income and co-op income from domestic vendors
- Status of rebate income and co-op income including rules of usage and changes in regulations
- Detailed discussions with key vendors on their future policies on year-end monies
The differing programs and their rules and regulations often require significant investment of time and talent by the distributor to manage and maximize fund usage. Our estimate is that the time and talent used for these funds will increase due to the globalization of supply and competitive dynamics from growth economies.
Finally, our suggestion for distributors for their health and survival is to know the leading global sources of key products, the price and availability of all viable manufacturers, and select the best-in-class vendor regardless of country of manufacture. This advice may seem, to some, unpatriotic but our view is that global sourcing is not a matter of choice for distributors in North American markets where earnings are at historic lows. Indeed, global sourcing and establishment of low-cost and high-quality global supply chains is a necessity and will become more so in the second decade of the New Millennium.
Scott Benfield is a consultant for distributors and manufacturers in industrial channels. He is the author of five books on channel issues and his work can be seen at his site at www.benfieldconsulting.com. He can be reached at (630) 428-9311 or bnfldgp@aol.com.
[i] Benfield Consulting associates has worked for major Fortune-related companies that heavily marketed through distribution. Past employers include Caterpillar, Emerson Electric, Ingersoll-Rand and the Kohler Company.
[ii] Olsztynski, J. "Lowlights from ASA's OPR Report, Column for Supply House Times, September 1, 2010.
[iii] I-Stock Analyst, Outlook for Industrial Distributors, at: http://www.istockanalyst.com/article/viewarticle/articleid/4002046
[iv] Benfield Consulting 2010 forecasts based on PAR/OPR reports from select distributor vertical markets across North America.
[v] Benfield, S., Griffith, S., "Disruption in the Channel," 2008, Power Publishing, Introduction.
[vi] Konczak, L. "The Growth of Grainger's Global Sourcing," MDM Newsletter at: http://www.mdm.com/management-strategy/2010/10/07/the-growth-of-graingers-global-sourcing/PARAMS/post/26523
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