March/April 2004

HEALING MANUFACTURER-DISTRIBUTOR RELATIONS

By Mark Dancer

The longstanding relationship between manufacturers and distributors is in critical condition. As channels have consolidated, manufacturers and distributors have become addicted to subsidies masquerading as incentive payments. Manufacturers seek to maximize clout through rebates and promotional allowances while distributors demand direct payments for access to customers, new product launches, shelf space and more. Both parties have reduced spending on customers and the customer, in turn has declared that brands and channels are commodities.

The proof is in today's headlines. The media has written numerous stories exposing rebate scandals and special deals between manufacturers to distributors. Most ominously, the Securities and Exchange Commission is reportedly considering legal actions against manufacturers such as Kraft Foods, Inc., Dean Foods Co. and Frito-Lay for their alleged role in enabling fraudulent accounting treatment of incentives at troubled wholesalers including Fleming and the U.S. Foodservice Inc.

Manufacturers must play a leading role in driving change

Unethical behavior on both sides must stop, but compliance with accounting regulations is not enough. Today's pricing practices must be overhauled to motivate distributors and manufacturers to work cooperatively for the customer's benefit. As with most cures, the first step towards and effective treatment starts with a thorough examination.

The traditional partnership between manufacturers and distributors is built on a few simple exchanges. Distributors provide access to customers and manufacturers supply products to sell. Manufacturers help distributors earn a margin for their services and distributors help manufacturers grow their market share. Each party provides value to the other and gets something back in return. Today, the exchange is changing, driven by many forces.

Deflationary price pressures and exploding employee costs have hammered many distributors. As a matter of survival, distributors look for profits beyond those earned in the markup they earn for value-added services. Rebates have become a primary profit driver and can create an extreme focus on supplier negotiations. A vicious cycle ensues, as customers demand lower prices, denying that distributors add value and driving distributors seek payment from the manufacturer to keep them whole. Large distributors make these requests a demand.

At the same time, manufacturers face extreme pressures from foreign products and competitors. Many are sending production overseas to lower costs while others look to take costs out of their channel. Manufacturers also face a proliferation of competitors with products of equal quality and performance. As a result, manufacturers are reaching around distributors to customers, attempting to build their brands and create deep, meaningful direct customer relationships.

When these forces reach a fever pitch, the partnership breaks down. Manufacturers and distributors compete with, rather than complement, one another. In my work, I hear words like tense, frustrating, destructive and uncertain to describe the relationship. I seldom hear constructive, well-considered plans for remedying the relationship. There are three steps to begin the healing process:

1. Rely on Truth, not Trust

When distributors feel challenged by their suppliers, they instinctively claim that a trust has been violated. Manufacturers get defensive and blame the distributors for not changing to meet competitive market conditions. To move forward, both parties must be forthright and acknowledge that a new exchange is required. For example, manufacturers can help distributors improve their employee productivity, lessening the effect of margin pressures. Or, distributors can bring customers and manufacturers together to work jointly on solving problems.

2. Reallocate Rebates

Volume incentives are notoriously unhealthy for both manufacturers and distributors. Distributors load up on inventory to prop up profits. Manufacturers push end of quarter results, but loose visibility to real customer demand. Rather than "throwing dollars" at distributors, hoping for loyalty and share, manufacturers should link pricing and incentives to outcomes beneficial to customers. Examples vary widely, but include raising the bar in customer training, specifying assistance, cost reductions and after-sale support.

3. Manage with Metrics

The days when manufacturers can manage their distributors solely on the basis of personal relationships are gone. Joint planning and professional business processes are required. Manufacturers can extend discipline learned through TQM, lean manufacturing, and Six Sigma initiatives to working with their distributors.

Bottom line, the manufacturer-distributor relationship will remain contentious for some time to come because both feel threatened - by each other, and the forces reshaping their markets. The future is uncertain, but change is not. As is usually the case, the end-customer is the one true safe haven. Manufacturers should do the right thing for the customer, reallocate roles and responsibilities with their distributors, and get on with finding new ways to compete and win in today's hyper-competitive markets.

Mark Dancer is a Partner and Vice President with Philadelphia-based Pembroke Consulting. He can be reached at www.PembrokeConsulting.com or mdancer@PembrokeConsulting.

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