Some of the World’s oldest viral and bacterial diseases were thought, a few decades hence, to be largely eradicated. Modern pharmacology had isolated diseases like tuberculosis and aggressive bacterial infections to small pockets in the Third World.  Today, however, these diseases are expanding as the underlying bacterial and viral strains have mutated to conquer existing medicines. The diseases we thought were conquered had adapted. In fact, we have the same old problems in a new way.

Akin to mutating diseases, optimistic management declared Channel Conflict to be on the wane a little more than a decade ago. We’re referring to the age-old strain between distributors and manufacturers.

Beginning with Narus’ and Anderson’s ground-breaking piece in the mid-1980s on making wholesalers “partners” in the supply chain, much of the work between manufacturers and distributors was geared toward driving joint marketing/information sharing effort to maximize the channel revenues.ⁱ

Yours truly spent much of the 1990s managing a North American distribution effort using the research and philosophy of a channel partnership. The results, after seven years of concentrated work including joint planning, point of sale information sharing, and targeted programs were stunning. Sales increased 60% and profits 75% in a more than 100 million dollar sales entity.ⁱⁱ

During this time, channel conflict was reduced significantly; both manufacturer and wholesaler knew what to expect and there was a consensus that joint planning, done well, drove profitable growth. This story was not unusual and there was a growing movement for manufacturers, distributors and buying groups to engage in joint-marketing and sales efforts.

But channels and their relationships are not steady states. They tend to move from stable markets/low-conflict states to markets in flux/increasing conflict environments. My assessment, in the last decade, is that channel relationships have moved well beyond the partnerships of the 1990s and early Millennia years to increasing levels of conflict.   Furthermore, the channel conflicts are new strains of the old problem and the fixes of the past will have little effect on their resolution. Only by correctly identifying the causality of the degrading relationships and proposing new solutions will manufacturers and their distribution drive profitable organic growth. Misdiagnoses of the underlying causes or attempts at resurrecting the “partnership” efforts of bygone days will, more than likely, fail in a costly manner.  

New conflicts from old trends we should have seen coming

Most of the channel conflicts that exist today were nascent trends 15 or so years ago. A little forward planning and study of the history of market movements could have alleviated the increase in channel conflict. Manufacturers and wholesalers, however, were chasing a roller-coaster economy during these years and there was little time and few funds to research where the market was going.  

Most going concerns were pragmatic albeit short-sighted. The economic environment was too choppy and too uncertain to work on long-term trends and channel relationships were assumed to be in good shape. Unfortunately, many — perhaps the preponderance — of these relationships resembled failing personal relationships where both parties are too busy keeping things going to study and invest in the efforts that perpetuate growth. At some point, the conflict from ignoring the needs of each party, and as it fits the changing environment, results in an escalation from squabbles, to skirmishes, to all-out shooting wars replete with lawyers. Welcome to channel relationships in 2014.

The escalation in conflict results from five basic events that have had a significant bearing on the degradation in relationships and we list them below:

1.  Globalization of Supply: As manufacturing moved offshore and domestic brands licensed or solicited foreign manufacturers to produce their mature technologies, the availability of low-cost/high quality goods exploded. Around 2005/06 distributors began, in a large way, to source these goods which were often 30% less than their domestic equivalents.ⁱⁱⁱ Today, most wholesalers have foreign brands or private label brands that are part of their sales and deem them integral to future growth.^iv

2.  Ongoing Consolidation: Consolidation in channels has been ongoing for the better part of two decades. Adam Fein’s ground breaking study in the late 1990s correctly predicted channel pressures from large firms acquiring their smaller kith and kin. 

This took capacity and cost out of the channel and gave end-users a better price. A bit of industry research will paint the picture. In 2001 the top 250 electrical wholesalers, ranked by sales, captured some 45% of the available market. By 2013, the top 200 electrical distributors had increased their share to 66% of the available market.^v

In our consulting work, as the large wholesale firms acquire, they become more sophisticated and hire more educated managers who can manage the growing complexity of the firm. They become more demanding and exacting in their expectations from their vendors who, too often, operate from an errant belief that small distributors are easier to manage.

Unfortunately, manufacturers who operate from this heuristic, back themselves into high-cost/less competitive supply chains. Why? Quite simply, consolidation from the industry drives out excess capacity and reduces cost — mainly redundant operations in the backdoor of the firm. Or, put another way, a bunch of small wholesalers have higher costs than a handful of large competitors. 

3.  E-Commerce and the Internet: As the ability to transact sales via e-commerce becomes an increasing reality, vendor-to-wholesaler relationships morph and conflict often ensues. First, non-traditional entities such as Amazon Supply enter the market and pick off a certain amount of sales that go through the traditional channel.  

These entities offer a stripped-down service/low cost model that often conflicts with the full-service model of traditional distribution. Channel conflict emerges as traditional distributors find that transactional entities are aggressively courted by their existing vendors.

The nature of e-commerce is that it is a 24/7 sales tool available to anyone who knows what they want with a valid credit card. Boundaries of time and geography aren’t as constraining as they were in the branch centric model of yesteryear. Conflict often arises as distributors take orders from geographies outside their approved area of responsibility as the customer can be anywhere and order anytime.  

Attempts to work the existing geographic constraints are messy and costly and many distributors find that manufacturer attempts to fairly police competing territories fails. The gray market often becomes the market in its totality.

4.  Technology, Price Pressure, Degrading Margins and Measuring Profit: Distribution is a thin-margin business with the predominance of durable goods distributors earning 2.5% of sales before tax. The capital returns, as this level of performance, are barely enough give a shareholder return equal to the public markets sans the added benefits of diversification and liquidity.  

Most wholesalers readily admit that pricing pressure has increased as the internet and e-catalogs have increased. Our recent survey of wholesaler customers finds that pricing availability is the second most cited reason that e-commerce is used behind product identification.^vi

As price pressure escalates, wholesalers cut back on traditional channel supports including sales and sales promotion. This is often seen by manufacturers as lessening loyalty when, in reality, it is a rational reaction to decreasing margins. Too, wholesalers pressure suppliers as margins degrade with the result being a jumble of attempts to align channel compensation, in its various forms, with market realities. 

Finally, the field of activity costing, long a curiosity in wholesale markets, is beginning to take hold. The box-in/box-out model of distribution has long been ill-served by traditional period-based accounting where labor and overhead cost are below the gross margin line.  

In 2003-2007, activity costing’s inventor, Robert Kaplan of the Harvard Business School, recanted the original models as they did not include capacity. Today, we recognize four entities that have developed reliable models for distributors where it is readily accepted that 40% of accounts are profitable to the operating profit line. The new financial knowledge measures instead of counts with the resulting effect that distributors are much more choosy about which accounts get their support. Too often, account stratification and prioritization efforts conflict with manufactures who want more “feet on the street.”

5.  Misalignment of Channel Supports and Channel Compensation: Globalization of supply and instant information of price and availability make clearer the opaqueness of competition. Wholesalers simply cannot hide price on “A and B” item commodities like they used to.

The time required for the end customer to size up a competitive offering and tender an order is reduced. To combat the real-time effects of more perfect information and more product sources, manufacturers and wholesalers have stretched existing channel supports and compensation from planned events that support strategy to something less than tactical events to “just get the order.”  

Growing methods of channel compensation include SPAs (special pricing agreements) where wholesalers get special pricing, specific to the order, to match the competition.   As e-commerce increases the customer’s loyalty to price, the use of SPAs balloons and becomes the dominant means of pricing. Too, volume rebate agreements, based on long-term horizons and planned events, become increasingly less coherent as the customer bounces orders between suppliers.   

Our view is that the entire field of Channel Compensation and Supports needs review between manufacturers and their distributors. The supports from yesteryear no longer make sense in a fast-moving and less loyal world stemming from technology and global competition.

These five areas of channel conflict stem from changes that, largely, began in the 1990s and just as partnership efforts were reaching their peak. In our next blog installment, we’ll address what wholesalers and their manufacturers need to do to limit channel conflict, and engage in a new era of partnership that can drive organic growth and shareholder value.

ⁱ Narus, J, Anderson, J, “Turn your distributors into partners,”  Harvard Business Review, March-April 1986

ⁱⁱ Aftermarket Division of Emerson Electric, 1990-1997. 

ⁱⁱⁱ Benfield,S., Griffith, S., “Disruption in the Channel,”  Power Publishing, 2007.

^iv Benfield, S., “Growth Research for Merchant Wholesalers,”  Industrial Supply Magazine, 2014.

^v Benfield, S., Presentation to ISBM on the Distribution Supply Chain, February 2014, from Electrical Wholesaling’s annual review of top electrical distributors.

^vi Benfield, S., “E-Commerce Research for Wholesalers,” Benfield Consulting sponsored research due Summer of 2014.