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OPTIMIZING CHANNEL COMPENSATIONTEXAS A&M – NAW RESEARCH CONSORTIUM
BEST PRACTICES IN DEMONSTRATING VALUE AND CREATING FAIR COMPENSATION FOR CHANNEL PARTNERS
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Current Members of the Consortium
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OCC Consortium Member Profiles 14 members
3 manufacturing members (5 firms) 11 distributors (15 firms)
9 Lines of Trade Bearings, Seals, and Lubrication Systems Building Materials Chemical Electrical Electronics and Industrial Fluid Power HVAC Process Control and Automation Solutions PVF / Industrial
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Optimizing Channel Compensation (OCC)
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Channel Focus To who do we create value in the channel?
Who is important to us in the channel?
Equally important is, to who are we important?
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Channel Focus The volume or spend is the typical criterion to decide
important suppliers (e.g. top suppliers who account for 80% of business) The volume or spend tells how important a supplier to
distributor’s business but not the distributor’s importance to supplier
Need to go beyond volume in order to understand to who we are strategic
Mutual importance is the prerequisite to optimize channel compensation
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Mutual importance – Criteria From Distributor Perspective
Relative share of business What % of business from supplier X?
What % of supplier X’s business is from distributor?
Relative difference is key
Supplier’s channel strategy For a given supplier, % of direct business vs. distribution
Supplier’s distribution model Intensive
Selective
Limited or Exclusive
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Example
Supplier A Supplier B
Distributor business from
$7 MM $8 MM
% of distributor’s total business
17.5 % 20%
% of supplier’s (distribution) business with this distributor
20% 9%
Relative share of business (the absolute gap)
2.5% 11%
Mutual importance High &Balanced
Low &Unbalanced
Distributor’s total business = $ 40 MM
Lower the gap, higher the mutual importance
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ExampleSupplier A Supplier B
Distributor business $7 MM $8 MM
Relative share of business (the absolute gap)
2.5% 11%
Mutual importance High &Balanced
Low &Unbalanced
Channel strategy 75% direct25% distribution
50% direct50% distribution
Distribution model Exclusive Intensive
Who is the strategic supplier for this distributor?
To which supplier, is this distributor strategic?
Mutual importance is the prerequisite to optimize channel compensation
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Optimizing Channel Compensation
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Channel Pressure End-customers call the shots on how distributors should
be compensated in certain trades Large customers go around distributors to direct negotiation
with suppliers
Continuous pricing pressure
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Evolving Channel Value Proposition
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Business Process Framework
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Distributor Value Proposition
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Supplier’s Value Proposition to
Distributors
Example – SKF
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SKF Overview
Established 1907
Sales 2011 USD 9,960 million
Employees 46,039
SKF presence over 130 countries with production sites in 32
8%Changes in sales in local currency
15%Operating margin, level
27%Return on capital employed
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Distributors essential to SKF
• Local Presence
• Flexibility to fulfil customer demands
• Multiplication of SKF presence in market
• Distributor sales people
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Distributor sales people
• Maintain customer relations
• Improve SKF brand awareness
• Value sell SKF offering
• Close to the customer
• Understand the customers needs
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Communication
• Develops trust
• Increases market intelligence
• Optimises resource allocation
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Investment
• Local Inventories
• People selling our product
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Areas to support distributor growth
• Increased level of mutual engagement and joint activities toward final customers
• Equipping distributors' employees with arguments to defend the SKF value proposition
• Cost savings in supply chain and inventory level optimization
• Customer solution selling with the Certified programs and Solution Factory
Pro-Active Selling
Education
Supply Chain Optimisation
Differentiation
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Pro Active Selling
• Development programs
• Structured follow up
• Collaboration
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Education
• Development programs
• Structured follow up
• Collaboration
• Documented value tools
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Supply Chain Optimisation
• Improving information flow
• Collaborative forecasting
• Maintain good service level
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Differentiation
• Joint development of distributor services
• Knowledge sharing
• Utilising distributor reach for service provision
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Industrial Distribution Strategy
Build sustainable and profitable customer relations in partnership with Distributors
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Channel Value Creation
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Optimizing Channel Compensation
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Alignment
SupplierSupplier Business Objectives SupplierSupplier Performance
Supplier performance
Distributor performance Product performance
Customer performance
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Supplier performance through stratification
Real-world Example
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Supplier Stratification Framework
•Low Profitability•High Spend Volume•Collaborative Relationship•Hard to Do Business With
CustomVendors
• High Profitability• High Spend Volume• Collaborative Relationship• Easy to Do Business With
StrategicVendors
• Low Profitability• Low Spend Volume• Limited Relationship• Hard to Do Business With
TransactionalVendors
• High Profitability• Low Spend Volume• Limited Relationship• Easy to Do Business With
EmergingVendors
Supplier ProfitabilityS
up
plie
r L
oya
lty
Ease of Doing Business
Gro
wth
Po
ten
tial
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Real World Example
Key Statistics
Data timeline 2011 (12 months)
# Total Vendors 117
Annual Spend $ $ 269 MM
# invoices 15,689
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Supplier Stratification Model
40% Purchase $ 100% SKU Penetration
30% Spend Growth %
15% New Items %
15% New Items $ Contribution
15% Net Gross Margin % 20% % C and D Items
35% Net Gross Margin $ 20% On-Time Deliveries %
15% New GMROII 20% Average Lead Time
35% Inventory Turns 20% Lead Time COV
20% Factors Rating
SUPPLIER STRATIFICATION FACTORS WITH WEIGHTS
60%
GROWTH POTENTIAL
50%
EASE OF DOING BUSINESS
50%
SUPPLIER PROFITABILITY
40%
LOYALTY
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Supplier Stratification – Real World Example
35
22M
42M
178M
30
1M
2M
8M33 1M
789K
6M
209M
2M
61M
117 $36,715,939 $49,849,602 $269,166,167
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
No of Vendors Average Inventory Gross Margin $ COGS $
Strategic Emerging Transactional Custom
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Distributor performance through
inventory & customer stratification
Real-world Example
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Customer Stratification Model
High ProfitabilityNo RelationshipLow Cost to ServeLow Volume
Opportunistic Customers
High Profitability Sustained Relationship Low Cost to Serve High Volume
Core Customers
Low Profitability No Relationship High Cost to Serve Low Volume
Marginal Customers
Low Profitability Sustained Relationship High Cost to Serve High Volume
Service Drain Customers
Customer Loyalty (Life)
Cu
sto
mer
Pro
fita
bili
ty
Customer Buying Power
Co
st To
Serve (C
TS
)
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Customer Stratification – Real World Example
145
48K
53M 9M
969
25K
12M3M
90
4K 3M
978K
72
17K 14M1M
1,276 92,967 $83,502,436 $14,507,073
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
No. of Customers Hits Sales $ Gross Margin $
Core Marginal Opportunistic Service Drain
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Inventory Stratification Model
Revenue & HitsRevenue & Hits
GM
RO
IIG
MR
OII
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Inventory Stratification – Real World Example
303
34K11M 2M
409K498
13K8M 1M
574K
718
9K4M 578K
565K
3K
9K2M 384K
661K
4,334 65,222 $24,089,198 $4,283,061 $2,208,653
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
# of SKUs Hits Revenue ($) Gross Margin ($) Average Inventory ($)
D
C
B
A
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Supplier-Inventory-Customer Alignment
ALIGNMENT
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Better Alignment
Supplier-Inventory-Customer AlignmentReal World Example
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Low Alignment
Supplier-Inventory-Customer AlignmentReal World Example
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Supplier and Distributor
Performance Alignment
Example – L&W Supply
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L&W SUPPLY: Overview
•Founded 1971
•142 Locations
•Largest Specialty Dealer in North America
•Largest customer for our suppliers
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L&W’s History with TAMU
Consortia Member• Sales & Marketing Optimization
• Optimizing Distributor Growth & Market Share
• Best Practices in Customer Service – Talent Incubator Lab
• Optimizing Channel Compensation
Capabilities assessment in 2009-10 Implemented Inventory Stratification in 2011 Received PAID “Award of Distinction” in 2012 Currently implementing Customer Stratification
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THE L&W TRANSFORMATION
2009 201520142013201220112010
Branded Customer Experience
Branded Customer Experience
CorporationCorporationFederationFederation
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Distributor / Manufacturer: Inventory Management & Replenishment Jan 2011 – Dec 2011
Inventory Stratification
• Supplier/L&W collaborated in the development of an Inventory Stratification process across shared key product categories
Process Improvements
• Aligned processes with Supplier’s customer service center and L&W’s purchasing agents to streamline replenishment and delivery processes
• Supplier /L&W instituted a 3PL tendering process to improve service to the branches
• Supplier/L&W evaluated order sizes and adjusted the shaping of purchase orders to increase pool opportunities, thus increased frequency of deliveries to the branches
Increased Visibility to Demand and Availability of Product
• Supplier/L&W coordinated process to enable increased visibility to slow moving inventory
• Supplier/L&W coordinated process improvement and training of existing processes unfamiliar to L&W enabling improved visibility to manufacturers product availability.
• L&W provides Supplier daily demand data for future demand projections in Supplier’s S&OP planning process.
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Shared Benefits
• Alignment of service level policies for A&B items improved product availability & service lead times resulting in increased sales
• Supplier reports lower costs via better asset utilization, more efficient order processing at CSC, fewer shipping errors and additional capacity utilization at plants during increased demand cycles
• Re-investment of more A&B to Supplier came from substantial reduction of C&D. C&D fell from 52% of inventory to 44% in 12 months. GMROII improves double digit %.
Challenges
• L&W change management for full adoption of new replenishment process and tools
• L&W data challenges on fully capturing GMROII (Supplier acceptance)
• Supplier’s Sales Management questioning L&W’s commitment to inventory
• Supplier’s Supply Chain/Mfg. building consensus internally with sales leaders
Distributor / Manufacturer: Inventory Management & Replenishment Jan 2011 – Dec 2011
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Distributor / Manufacturer: Alignment for GrowthOctober 2012 - Present
Field Sales Alignment
• Competitive Market Pricing
• Participation in Regional Sales Meetings
• Product Knowledge events at vendor plants Leveraging vendor expertise to collectively grow the market
• National training by vendors to educate L&W teams on best practice selling
• Customer webinars and training to educate the market on coming trends Value Stream Mapping and Continuous Improvement events
• Collaborative efforts to identify waste/inefficiency in the process Joint Marketing to create awareness and demand
• Developing processes for getting leads to the field
• Partnership with vendors on various national and local marketing efforts
• Identifying unique ways to engage customers together
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Project Management
• Dedicated project management resources for key initiatives
• Common scorecards for measuring success
• Regularly scheduled leadership calls / meetings Shared Benefits
• Commitment to joint sharing of the reduced costs through process improvements
• Formalized pricing management process to keep focus on selling and not negotiating
• Growth oriented program incentives Challenges
• L&W Internal
• Supplier Internal
Distributor / Manufacturer: Alignment for GrowthOctober 2012 - Present
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Alignment to Shareholder Value
Financial Drivers
Supplier Stratification
(Strategic)
Inventory & Value-add
stratification(A items)
Customer Stratification
(Core)
Optimal Channel
Value Proposition
Days Payables Outstanding
(DPO)
Days Of Inventory
(DOI)
Days Sales Outstanding
(DSO)
GMROIIResource Utilization
Cost to Serve
Gross Margin RONA Net Margin
Spend Percentage
Market ShareMarket
Penetration
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Optimizing Channel Compensation
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Relationship – Key ingredients
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Vision and StrategyCustomer
Internal Business
Processes
Financial
Learning & Growth
Balanced Scorecard
Source: Adapted from Kaplan and Norton’s Balanced Scorecard
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Optimizing Channel Compensation
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Compensation Drivers
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Compensation Mechanisms
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Effect of compensation on ROI (Example – New Product Development)
with distribution as channel partners
Return on Investment (ROI)
(Revenue – COGS –
Distributor compensation –
Operating expenses)
--------------------------------------------
(Net Assets)
Customer Service & Market Reach
without distributors in the process
Return on Investment (ROI)
(Revenue – COGS –
Direct expenses –
Operating expenses)
-------------------------------------------- (Net Assets)
Customer Service & Market Reach
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EXAMPLE
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Channel compensation – Example Distributor’s value proposition
Improve customer retention for a given supplier
Distributor’s action plan Define retention metrics
Measured the base line & set the targets
Through focused sales effort, improved retention
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Core Customer Retention Metrics
50%
39%
11%
OPPORTUNISTIC CORE
63 323MARGINAL SERVICE DRAIN
3256 756
53%
35%
12%
55%
33%
12%
Year 1
Year 2 Year 3 Year 4Retention
Internal Defection
External Defection
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Customer conversion through focused sales effort
OPPORTUNISTIC CORE
63 323MARGINAL SERVICE DRAIN
3256 7566%
7%
1%
Year 1
Year 2
Core
Opportunistic to Core
Marginal to Core
Service Drain to Core
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Channel compensation – Example Channel compensation from supplier
Changed distribution strategy from ‘intensive’ to ‘selective’ model
Better payment terms
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EXAMPLE
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Generating Growth Framework
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Growth Strategy1
Growth Drivers2
Best Practices3
Growth Mechanism4
Metrics5
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PRODUCT LIFE CYCLE
Alli
ance
&
Com
pens
atio
n
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EXAMPLE
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Quantifying Value (Supplier Performance) – Real World Example Distributor Profile
Industry – Automotive components to dealers
Revenue – $ 400 MM +
# Locations – 17
# SKUs – 2,500 +
# Suppliers – 16
Best Practice Quantify value addition in channel
Determine % of additional safety stock due to supplier lead time variation beyond agreed variation
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Linking to shareholder value
Basic Input Parameters
P&L andBal. Sheet
Lead Time LT Var.
% of re-investment
Expected Turns
Additional Revenue
RONAGMROIITurns
EBITDA
Average Inventory
Safety Stock
Re-invest ?
YES
NO
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ResultsVendor Number
International / Domestic
Agreed Safety Stock $
Actual Safety Stock $
Additional Safety Stock $
50160 Domestic 3,006,102 4,741,632 1,735,530 50055 International 2,326,274 3,340,528 1,014,254 50665 Domestic 1,207,422 2,182,698 975,276 56755 International 470,496 780,698 310,202 61235 International 489,696 759,351 269,656 50805 Domestic 267,983 472,485 204,502
136630 International 196,276 327,361 131,085 50125 International 472,071 585,232 113,162 61445 Domestic 177,098 214,369 37,271 57340 Domestic 72,992 99,067 26,076 63420 International 35,282 55,702 20,419 50105 Domestic 12,276 30,330 18,054 50255 Domestic 22,775 34,130 11,355
197650 International 5,635 13,064 7,429 59740 International 7,558 10,820 3,262 63675 Domestic 1,716 1,854 138
Grand Total $ 8,771,650 $ 13,649,321 $ 4,877,671
36%
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Channel Compensation Benefits Channel Compensation
COGS adjustment to compensate additional carrying cost
Quantified performance information for annual negotiation – leading to improved delivery performance hence customer service
working capital
Additional safety stock reduced to 13% in the following quarter
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Optimizing Channel Compensation
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Questions and Discussion