Channel Pricing Associates

Can You Buy Your Channel's Loyalty?

In the past few years, we have noticed a trend among manufacturers to add loyalty incentives to their channel strategy. Typically, these take the form of discounts or rebates in the 2% to 10% range. These incentives replace traditional volume deals and encourage distributors, retailers, VARs or other channel partners to remain or become committed to a supplier’s line.

What is causing this upswing in the use of loyalty programs?

There are a number of factors causing manufacturers to increasingly use loyalty incentives to motivate their channel partners. These include:

Industry consolidation – As manufacturers acquire additional brands, they use loyalty incentives to leverage their position. Often, they use strong core brands to leverage their sales of weaker brands or product lines
New technologies – As new technologies emerge, previously dominant suppliers provide loyalty incentives to slow the acceptance of competitive market entrants.
Import manufacturing – most product categories are under attack from low priced import lines. While priced lower, imported brands may not offer as consistent a source of supply over a broad range of SKUs as the domestic brand. Domestic suppliers use loyalty incentives to discourage cherry-picking
Evolving channel roles – It used to be that a distributor would “go to bat” for a manufacturer. Increasingly, they are fulfillment channels that provide whatever brands the customer requests. Manufacturers use loyalty incentives to create a reason for the reseller to remain focused
The Inefficiency of volume incentives – Historically, manufacturers used volume rebates, order quantity discounts or end of quarter deals to motivate channel partners. The old school philosophy was that a “loaded distributor was a loyal distributor.” While volume deals drive short term sales, over the long haul, they do more harm than good. They create false demand, lead to order spikes, stock outages and lower margins for suppliers and their channel partners. Loyalty incentives can provide the focus that suppliers desire without the negative behavior

Should you use a loyalty incentive?

First of all, unless you are a monopolist, if you can demand exclusivity, you should. If you have the clout, you should dictate that if your reseller takes on a competing line they will lose your line. Some suppliers have used this approach for years and should continue to do so. Others need to back off of this no “sharing of-the-shelf policy” and use a loyalty incentive to create the economic conditions that will motivate the channel partner to make the right decisions. In today’s marketplace, it is becoming increasingly unrealistic to expect that resellers will support only your brand exclusively.

You should strongly consider a channel loyalty incentive if you are a high share player in your industry and your product category is strategic to your channel. If you are a weak or new player in a market, don’t even consider a loyalty incentive it – you have nothing to leverage. You are going to have to win the old fashioned way.

You should consider a loyalty incentive when you launch a new technology or have a hot new product. Even though your new offering can “earn” loyalty at first, setting the expectation up front will help later when additional entrants join the market. Often, companies rely solely on their patent protection to defend their position only to scramble when their sales, shares and profits plunge once protection ends. By employing a loyalty incentive when they are “the only game in town,” a company can add an extra barrier to keep competitors out.

Types of Loyalty Incentives

There are many ways to structure a channel loyalty incentive. Suppliers must closely evaluate their channels and competitive situation to determine the optimal approach. Some of the most commonly used options include:

Exclusivity – Easily measured – if the reseller carries competing brands they don’t earn the incentive. Generally used by high share suppliers trying to thwart new entrants.
Full line – The reseller must support a supplier’s complete product portfolio to earn the incentive. Used by manufacturers to encourage resellers to add a new brand or product line by providing an incentive on the overall portfolio.
Lead line –Requires that the reseller carry the supplier as the lead line in a category. Lead line may be the majority of the reseller’s business or the number one brand if the reseller carries multiple lines within a category. A lead line program can be combined with a full line incentive. This combination requires that the reseller carry the manufacturer’s brand as the lead line in each product category that the reseller participates.
Share of account – The higher the supplier’s share of the reseller’s business, the higher the loyalty payment. This can be difficult to measure as resellers typically will not share the amount of business that they do with competing suppliers.
Situation-specific – A supplier sees its reseller offering a competing brand on a bid or to a major account when the supplier’s brand would have been acceptable from a price and feature standpoint. After one or more occurrences of this type, the reseller loses the loyalty incentive. A “three-strikes-and-your-out” approach gives the reseller an opportunity to change the destructive behavior
Frequent-buyer programs –We typically think of airline frequent flier programs. These programs measure loyalty based on usage or “volume.” Many suppliers use volume programs with their channel partners that emulate a frequent buyer approach. The more you buy, the better the deal.

How do you measure loyalty?

The first question that people invariably ask when considering a loyalty incentive is “how are you going to measure it?” It is a good question. If you can’t measure it, you can’t reward it. Loyalty is particularly difficult to measure in that most resellers prefer not to divulge their sales of competing suppliers. In addition, there is a general sense that loyalty is “something to be earned” and that you cannot buy it.

Often, the success of a loyalty program comes down to the question of whether loyalty is objectively measurable. There are different ways to measure loyalty and the correct approach will depend on the relationship that the supplier has with its channel partners. Measurement options include:

3rd Party Certification – The reseller provides 3rd party verification of the supplier’s share of the reseller’s account. Often, the reseller’s independent auditor is asked to certify the share-of-account percentage. We have found resellers surprisingly willing to participate in this type of program.
Audit – the reseller divulges its sales of the supplier’s line and that of other brands. The supplier reserves the right to audit the data. Resellers that are unwilling to divulge the information do not earn the incentive.
Public information – The supplier determines its degree of loyalty based on the reseller’s web site, catalog, marketing materials, bid documents or other publicly available information. The reseller may challenge the supplier’s estimate through an audit process.
Point-of-sale information – Some suppliers have access to their reseller’s sales information because they have supplied the channel with point-of-sale terminals or have access to the point-of sale-information. This is a fool-proof method however few suppliers have access to this type of data.

Another challenge in measuring loyalty is the often conflicting perspectives that suppliers and resellers have regarding a supplier’s product line. Suppliers offer high and low end products, products priced competitively or at a premium, strong and weak categories. Often, resellers argue that a portion of a supplier’s offering is uncompetitive. The supplier of course takes the opposite view. The loyalty incentive can backfire if the supplier does not realistically assess its competitive power position. From a measurement perspective, it is critical to clearly define categories that are “core” and those where the supplier must “earn” the reseller’s loyalty.

The approach that you take towards measuring loyalty will have a significant impact on the relationship that your business has with your channel partners. Carefully consider the role of your field sales organization. You do not want to put your sales team in an adversarial position. Ideally, your channel marketing group will measure your channel’s loyalty.

How much should you pay?

Resellers have considerations other than pure economics when choosing their vendor strategy. Manufacturers need to realistically evaluate their brand strength and channel relationships. Even with a loyalty incentive, resellers will not convert business when:

Their business strategy dictates being a “one-stop shop” for all major brands
Customers expect any “real distributor” to carry a particular competitive brand
Competing brands creating complementary sales or service opportunities
Resellers don’t trust you
Your company can’t deliver or invoice correctly

Conversely, a supplier may be able to convert more sales than pure economics would indicate these factors are working in its favor.

There are five common factors to consider when determining the amount of your loyalty incentive. These include:

Your share of your reseller’s business
The amount of the competitive business that you expect to be able to convert
The gross margin the reseller can earn on your line
The gross margin the reseller earns on the competing line
Your sales through the channel

The following example calculates the amount that a supplier should pay to convert distributors that are “cherry picking” its line.

Your distributor sells $1.2M of a product category. This consists of $1M of your brand and $200K of the competitor’s

Each line generates a 25% gross margin for the distributor. This results in $250K in distributor gross margin on your brand and $50K on the competing line for a total of $300K.

The distributor’s cost-of-goods sold are $750K on your brand and $150K on the competitive line.

If the distributor switches completely to your line, they will be able to convert 50% of the formerly competitive volume. They will lose the other 50%

By converting, the distributor gives up $25K in gross margin that they formerly earned on the competitor’s line. In total, the distributor’s new gross margin is $275K. Your loyalty incentive needs to make up the $25K in gross margin that the distributor lost. $25K is approximately 3% of your new sales to the distributor. In other words, the distributor breaks even with a 3% loyalty incentive.

How will your channel partners react?

A loyalty program rewards channel members that choose to work closely with their suppliers. Resellers who are “more loyal” will view the program as proof of your commitment to them. They will strongly support your program. Resellers on the cusp are likely to switch if you get the economics right and other factors are in your favor. Disloyal resellers will challenge your program. They will, however, at least understand the rules of the game and why they are at a disadvantage versus their competitors.

In summary, when you have the power, use it. Under the right circumstances, a correctly structured loyalty incentive can drive your channel’s behavior in the right direction. You owe it to your loyal resellers, you owe it to your shareholders and your company’s future managers who will otherwise need to deal with today’s inaction.