United States: Discount Structure Dynamics

Last Updated: July 31 2007
Article by John Henderson

Distributor discount pricing structures continue to be one of the most misunderstood and underutilized elements in distributor marketing programs. Yet, their direct affect on your company's and your distributor's profitability makes discount structures the most important element in your business relationship.

The truth is that most of your existing discount structures were not designed to support today's marketing strategies and need to be re-evaluated. Many of you probably inherited your current discount structures and cannot find internal documentation that identifies the logic behind their original design. Some of you may find it difficult to identify the individual responsible for discount structure design/strategy.

Many companies change the structure using a "team" approach, but few have an individual that owns the responsibility. And, if you're like most companies, you are avoiding making changes to your discount structures, fearing that the end result will be perceived as either "a price increase" (which will reduce unit sales) or a "a price decrease" (which will reduce profitability).

It is quite common—and generally successful—to change the way your sales force is compensated in order to promote a positive change in its behavior. So, why not change the way in which your distributors are compensated? Why not pay for the value you receive?

Does Your Distributor Discount Pricing Structure Create the Desired Channel Behavior?

A well-designed distributor discount pricing structure helps you achieve your marketing objectives:

  • Increase market share
  • Establish presence in a distribution channel
  • Emphasize particular product lines
  • Discipline and control your marketing expenditures
  • Reduce costs
  • Differentiate between distributors
  • Communicate your values and strategies
  • Acknowledge and reward channel excellence
  • Acknowledge and reward loyalty

Activity- and Value-Based Discount Structures

Well-structured discount programs are designed to compensate the distributor for performing marketing functions (and the costs associated with performing these functions) that the manufacturer would otherwise be responsible for:

  • Carrying inventory
  • Sales and technical support
  • Order handling
  • Extending credit

The concept of activity-based discounts is an extension of this cost transfer thinking. We believe that activity-based discounting will be the future basis for all channel compensation. The roles and responsibility of distributors and the basis for their compensation change as manufacturers work to take costs out of their channel systems and improve customer service.

Another reason we believe that functional, activity- or value-based discounting will be the basis for future discount structures is because we see new channel models emerging in various industries.1

Some of these channels perform functions/activities that represent only a portion of the activities performed by traditional channels. Manufacturers and service providers must assign a value to specific functions and activities to deal with these new channel models (and to avoid overpaying traditional channels).

Many firms are attracted to activity-based discounting because it is fair and generally supportive of their overall marketing strategies. In essence, an activity-based discount structure "pays" the channel for "what it does," or looking at it from the channel's perspective (just as your sales force does), "you get what you pay for."

We have found that typically your best distributors applaud changes that result in differentiated prices to your distributors. That is because your best distributors want to be recognized for the investments they make to support your line—and they do not want the distributors that do not make the investment to get the same deal.

Legally, you are allowed to differentiate your price to competing distributors if the discounts/rebates you make available for the performance of activities or functions are generally available to all your distributors.

Many of the channel tiering programs that are becoming more common are intended to segment dealers and distributors based on what they do for the manufacturer/service provider and differentiate discounts and other benefits accordingly.

Basic Types of Discounts: Cost-Based and Value-Based

Cost-based discounts relate to transactions between the manufacturer and the distributor. The manufacturer compensates for costs incurred by the distributor:

  • Transferred costs that impact the distributor's overall cost structure (e.g., inventory, sales, technical support skills)
  • Transferred costs that occur on a case-by-case basis (e.g., co-op advertising, getting your brand specified)

The manufacturer can also compensate for costs that have been reduced as a direct result of the distributor's efficient activities. Examples include:

  • Discounts for orders entered via EDI
  • Cash discounts for prompt payment
  • Rebates for low level of returns

Conversely, vendors must charge distributors for costs incurred from inefficient channel activities (e.g., expedited orders).

Value-based discounting is used to differentiate and upgrade the performance of the channels. Your distributors would typically be classified into groups representing differing performance levels. Discounts are provided to distributors based on their performance levels.

Performance criteria might include:

  • Number and quality of resources committed
  • Sales growth
  • Point-of-sale reporting
  • Specific repair, tooling, kitting capability

Value-based discounts are often determined based on their combined value to the manufacturer and the distributor (e.g., increased sales are a benefit to both).

A "value" that many manufacturers and service providers would like to incorporate into their discount/reward structures is loyalty. Let's face it, if you can be sure that your dealer/distributor is representing your brand when in front of an opportunity, your costs associated with supporting that opportunity are significantly reduced.

Many value-based programs are incorporating a loyalty component. Examples include:

  • Exclusively represent a manufacturer's brand
  • results in extra discounts
  • required to achieve top tier ("Gold") status
  • Lead-line status
  • in exchange for being your lead-line, extra discounts or other benefits
  • Share of a distributor's sales in your category
  • rewards that are weighted based on your share

These programs require manufacturers/service providers to be able to measure a channel's loyalty—and most that have incorporated a loyalty component into their discount programs have a process for measuring loyalty (we do not advise that you use your sales force as the main enforcer of a loyalty program).

Many companies' discount structures are based on order volume or sales forecasts and are not effectively transferring marketing costs (see accompanying article). Due to poor design, these structures compensate distributors for performing certain functions even though the manufacturer continues to incur the costs associated with these functions. Consider your own situation—is your distributor discount pricing structure creating the channel behavior you desire? Are you getting what you're paying for?

Are you interested in learning more about the new trend in discount structures? If so, you may want to attend the Discount Structure Dynamics workshop offered by Frank Lynn & Associates, Inc.

1 These include integrated suppliers in industrial markets, a direct to builder model in residential construction, various forms of third-party logistics suppliers (3PLs), direct models enabled by the Internet and aggregators and procurement outsourcers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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