Getting smart about distribution means looking at channel partners relative to their impact on profitability, not just revenues; their ability to drive and convert traffic to actual sales; and their prospects for future growth. Suppliers who arm themselves with this kind of information can make informed choices about which resources to devote to which channel partners, and so drive meaningful profit improvements within the year.

Companies that sell their products to other businesses often assume that their largest channel partners are also the most important and profitable. In fact, large channel partners frequently generate little or no profits. Moreover, they may have little potential for growth, while smaller customers with higher profitability and more potential remain neglected. While companies have invested huge amounts of money in Customer Relationship Management systems to analyze end-consumers, sophisticated channel analysis remains a rarity. Few companies have fully allocated profit-and-loss statements by channel partner that go beyond high-level, superficial, transfer cost analysis. This is hardly trivial, because understanding which partners are profitable for the supplier’s business, and which hold the greatest potential, can drive growth quickly – without major expenditures or investments. A smart distribution strategy can drive up profits by 10 percent in six to nine months. This article will take a closer look at how a firm can develop a smart distribution strategy. The truth hurts, but only for a little while Consider how this problem played out recently at a small-appliance manufacturer that engaged Mercer to develop a new distribution strategy. The manufacturer, which we will call Peerless, initially insisted that its largest channel partner was its most important and had to be its most profitable. Just behind that behemoth were two other dependable retailers that were large customers of Peerless but did not have the cachet of being Number 1. Peerless grouped all the rest of its retail partners into a virtually indistinguishable mass. Sales data confirmed these groupings.

But sales data do not provide a useful lens for assessing channel partners. A far more useful view emerged by disentangling the mix of SKUs sold, Peerless’s various promotional programs with different retail partners, its financing terms and accounts receivable, and then pushing to allocate overhead costs by function. As a result, Peerless could see the operating profit of each customer, and, to the surprise of executives, four of the 12 largest retail partners were losing money for Peerless, including the behemoth (see Exhibit 1).

By combining sales data with profitability data, Peerless could see that the largest account burned cash and dragged down the business; the dependable retailers were actually large and very profitable; and all the rest split neatly into two groups–those that made money for Peerless and those that lost money. The dependable channels offset the behemoth, while the profitable and unprofitable in the “all the rest” category also cancelled one another out. On the whole, the business was slightly better than breakeven (see Exhibit 2).

This type of detailed and factual de-averaging of channel partner profitability often challenges longstanding assumptions about the business (see sidebar, “Creating profit-and-loss statements by customer”). The addition of another analytic lens can help make the portrait even more nuanced. This lens examines which customers have the best outlook for growth. No firm can afford to devote resources to a stagnant channel partner, whether it’s a B2B manufacturer doing business with a logistics firm, a pharmaceutical company using a mix of distributors including Internet and mail order, or a consumer goods firm that relies on retailers. Consider the dramatic growth of warehouse clubs in the early 1990s, or Home Depot’s ascent in the late 1990s, and now the anticipated growth of Lowe’s. How does a company determine which players are likely to grow next?

To answer the question, it’s important to put channel partner size in the context of other factors. To continue with a retail example, other factors might include consumer traffic and on-floor conversion. Exhibit 3 illustrates why. For one particular Peerless product, Wal-Mart and Sears dominated the market because they have high consumer traffic and much of that traffic converts to an actual sale on their floors. Target has traffic almost equal to Sears in this category, but is not driving the same on-floor conversion. So Peerless must determine whether Target has any plans to improve conversion, or what Peerless itself could do to help improve conversion, and thus whether Target is a growth candidate for Peerless. Similarly, some other retailers have better conversion rates in this category on their floors than Wal-Mart and Sears, but less traffic. What do the growth plans of those retailers look like, and how will that affect their traffic?

A very useful picture emerges when the profitability and growth lenses are combined, as a supplier now can draw a matrix that arrays its channel partners in four quadrants (Exhibit 4):

• Red ink partners. Any channel partner with below-average profitability has a diluting effect on the company’s business. But the company that increases its business with such a partner (or a partner that returns no profitability at all), is putting up a major barrier to growth. Executives must turn the red ink to black or muster the fortitude to decrease business with these partners.
• Re-purpose partners. Channel partners with below-average profitability (or that are unprofitable) represent a less pressing problem if their business with the company is stagnant or shrinking. But they do impede growth by consuming staff time, promotional funding, and other resources that could be better used elsewhere. Diverting resources away from these channel partners will drive growth without incremental costs.
• Stalled partners. Profitable accounts with low or below-average growth are contributing to the business, but you need to jump-start their stalled business in order to create more growth and more value.
• Next-generation partners. These are profitable and growing—everything you could ask for in an account. The question now becomes, what might the next generation of growth with these rare and valued partners require from your company?

Let’s examine each channel challenge in turn.

Staunch the red ink

Doing the detailed work necessary to develop the profitability lens pays off when a company uncovers previously hidden reasons why the red-ink channel partners are losing money for the business.

Distributors and retailers often run unique, high-profile annual promotions or renegotiations in which they expect their supplier partners’ full participation. When viewed only in terms of sales, these promotions can look great. Even when using a lens of average customer profitability, it is easy for these promotions to bleed the value out of a channel partner relationship virtually unnoticed over the course of a few years. In many cases, it’s impossible to simply stop negotiating or participating in such high-profile activities, but it is quite useful to estimate what this channel partner business might look like without such promotions.

Many retailers, for instance, feature an annual promotion and encourage a special investment on the part of suppliers that will lower pricing. They may also ask the supplier to pay a special fee to cover administrative costs. Supplier organizations often take the fee from some general merchandising or promotional budget that’s not tied to the account in particular, but rather is spread over several brands or categories. Since these budgets are set as a percentage of sales across a number of businesses, one-time promotional costs are rarely scrutinized when the supplier is deciding whether or not to participate. Few executives want to risk losing volume by questioning a big promotion with a channel partner.

Fact-based analysis makes it easier to have such a conversation. One company we worked with recently (call it Acme) did $100 million in annual business with a retail channel partner that ran a well-publicized “After Christmas” sale. The retailer asked for $100,000 in incremental funds from each manufacturer to pay for advertising efforts, plus a $3 per unit investment to hit a hot price point on two products. Who would refuse a $100-million account for the sake of just $100,000 and $3 per unit?

Our analysis showed, however, that Acme was already losing $2 million overall in annual operating profit on this account. (The retailer generated a “profit” of $1 million in product sales for Acme, but this was wiped out by Acme’s losses of $3 million on its two “hot” products.) Sales executives may feel that investing in a loss leader is justified, but they at least will have more bargaining power if they know which products are profitable. In this case, Acme declined to invest in the first promotion and offered an equally attractive investment on another, higher-profitability set of products. As a result, the money-losing products were de-listed, creating $3 million in overall incremental profit for Acme, while the funds previously earmarked to promote those products were allocated to more profitable units. This $100-million account posted a profit increase of more than four percentage points with no new products, no new investment, and in a very short time.

Besides investing in the wrong SKUs or overinvesting in promotions, there are other reasons for below-average profitability. If freight, warehousing and other logistics costs have not been de-averaged across customers, they may need to be scrutinized.

Simple dashboards (see Exhibit 5), shared across your channel partner management team, can help identify and pull the levers that will drive improvements.

Another manufacturer Mercer worked with (call it Blanc) had extensive investments with a big-box retailer it deemed a “strategic partner,” meaning “give them whatever they want.” Profitability analysis revealed that the retailer was generating only half of the average profit margin for Blanc. In fact, the investments were driving more sales through this customer and thus pinching profitability.

Further investigation showed that the main problem was logistics. The big-box retailer was aggressive in promising to stock a selection that consumers could take home or have delivered immediately, so Blanc had overbuilt inventories and was running a special logistics program to ensure that every store had the item in stock. What was worse, a “no hassle” returns policy meant that consumers could take the product home to try it out and return it if they were not pleased. The retailer, with no capabilities in the reverse logistics required, found stores filling up with unpacked goods, which Blanc was taking back at a high cost.

After seeing this analysis, Blanc’s sales executives worried that investments with the retailer would be cut, or that they would be asked to negotiate higher charges for these services. Sales executives felt that either tactic would drive the retailer to another vendor.

The solution was to convene a logistics team focused on the unique requirements of the account. For example, the team recommended that the two companies share IT platforms in order to facilitate ordering and returns. This not only reduced costs sharply and improved profitability, but also caused the retailer to view the relationship in a more favourable light.

Re-purpose the laggards

For re-purpose customers, there is a natural impulse to help the account grow and become more profitable. But it makes more sense to take one step at a time, starting with profitability. If the account can be improved to average profitability, it deserves a share of your organization’s resources. If not, and absent some other substantial benefit, divert those resources to more promising opportunities.

To be sure, it takes discipline to turn away business, even when it’s unprofitable. Senior leaders must challenge managers to demonstrate a path to account profitability, and not just on paper, or else make the tough decision to walk away. The executive responsible for the account should be looking for unique and compelling changes to the business. If the profitability plan includes things such as new products that will be introduced to all accounts, then the account’s relative position will not improve. If the account has demanded high levels of promotion investment or more favourable pricing, simply saying that you will no longer provide these breaks is not compelling; the next moves must be mapped out as well.

Another challenge is avoiding hard feelings that the channel partner may never forget when you try to renew the relationship in the future. Consider two possible tacks. First, don’t exit overtly by simply stopping shipments, a move that may cause ill will; instead, make a series of moves (e.g., decrease sales of particularly low-profit products or promotions, or scale back co-op spending) that will encourage the account to end the relationship. Alternatively, do exit overtly by communicating that you are unable to serve the account appropriately. Indicate that you need to redress some systems and plans, but will make an appropriate reinvestment to serve the account better at some point in the future.

Revive the stalled engines of growth

How do you jump-start growth for the group of customers who are stalled but otherwise attractive? One effective approach is to combine the detailed fact base of the growth and profit lenses with an understanding of the channel partner’s own customers. For consumer goods firms, for example, this would mean looking at consumer shopping habits among different retailers. Some market research organizations are an immediate source of rich consumer shopping data.

To begin, identify the reasons the channel partner’s customers purchase goods where they do. Compare the top three reasons for shopping at one store rather than another. Next, identify consumers who shop at more than one retailer, and determine the reasons for leaving one and buying at another.

For example, the data in Exhibit 6 shows that Wal-Mart attracts customers in large part because of its low prices, a fact that is widely known. In this particular product category, some consumers abandoned Sears despite its price-match guarantee, and went shopping for lower prices at Wal-Mart, where they purchased the item. Even more frustrating for Sears was the fact that the second most likely reason a consumer would leave its stores for Wal-Mart was product selection, despite the fact that Sears carried more SKUs in this particular category.

A deeper review presented opportunities for action. Store visits and discussions with shoppers revealed some broadly held perceptions about Sears being expensive and only promoting some brands. When informed of Sears’s price-match offer and breadth of offerings, consumers’ reacted with relief that their search was over.

Arming the sales force with this type of information is a powerful, low-cost tool to help trigger growth in a stalled account. It helps build account relationships as well as improve business results. Deploying resources to stalled customers can drive growth relatively quickly and profitably. For the accounts that are well above average profitability, reinvesting the right amount of the incremental profit into the same account can have a significant growth impact.

Invest in the next generation

Next-generation customers already represent high profitability and high growth for the business. It’s generally not fruitful to try to wring more of the same out of these customers–attempting to drive greater sales, greater margins and greater efficiencies–in the same ways.

Instead, sit down with them to think about the next generation of their business design and how resources might be reassigned to support that new design. Dedicating executive time to new growth agendas, and product development resources to a customized offering, can have high returns with these customers without diluting the strength of the existing business.

One effective route to higher growth with such accounts is a dedicated team that puts all of your organization’s capabilities within easy reach (see Exhibit 7).

Elevate the account managers in charge of these accounts to something more akin to general managers, and ensure they have the capabilities and resources of a GM. Review how decisions are being made in the organization and where the decisions for these accounts can be elevated. This applies whether the strategic plan revolves around product lines or brands. During budget review, ensure that there is a specific budget for each channel partner as well.

Such customized plans and budgets should not be just a sales roll-up or a marketing and promotion plan, but should address all of the questions that any business unit or function must address. Shifting a senior manager from a typical line of business in the organization to head up a next-generation channel partner account sends a powerful signal of commitment to the broader organization and to the channel partner.

Rallying the organization

For a seasoned executive developing a new distribution strategy, some of these moves may run counter to instinct and experience. Declining to cut a deal with Our Most Important Customer, or diverting resources from one account to another, is never easy. How to motivate the organization to sign on to this growth agenda?

One way is to emphasize the expanded role of the sales function. In many organizations, Sales is underestimated and presumed to be incapable of managing customers. Smart distribution uses the sales organization to actively monitor, measure and manage the performance of individual customers. Sales staff must understand the context for differential treatment of customers, as well as the effect on individual sales roles, so that individual salespeople don’t assume that they’re the ones being re-purposed.

There’s a broader mandate for the rest of the organization as well. Searching for new growth requires new performance measures–not necessarily a wholesale rewriting of human resource systems, but new criteria for success and clear communication of how the new insights and plans will be put into practice.

Besides the sales organization, the finance function must commit to providing analyses and reports in a different way and on a frequent basis (for example, monthly analyses by customer and by SKU). Finance managers may be reluctant to share this level of financial detail with the sales staff, out of confidentiality and other concerns. But genuine competitive information issues can be addressed by non-compete and confidential disclosure agreements. Logistics staff, meanwhile, will be called on to collaborate with channel partners to reduce costs without hurting service levels, to develop new solutions where required, or to help set the terms for how the partner and the supplier can work together most efficiently.

To motivate the organization, senior management can use certain decisions to send strong signals about their commitment to the strategy. A decision to walk away from unprofitable business or to change the level of resources with a channel partner sends the message that the company is serious about profitable growth.

Metrics can also help change behaviour. Even a simple table for each partner, comparing SG&A, logistical costs, promotional spending, financing costs and profitability, all as percentages of sales, can be eye-opening. Regular reviews around these figures and the plans and progress to improve them can help change an organization’s dynamics. With the organization on board, new growth can be achieved quickly.

The customer growth and profitability analyses that create new, meaningful images of the business typically can be completed within six weeks. Next, socializing the conclusions with the sales, finance, logistics and other staff, and then developing implementation plans, can consume another six weeks. This means the business should be ready to act on its new distribution strategy at the start of the next business quarter.

Of course, conversations with customers will lead to reconsiderations and revised plans. Still, within six months of developing the plans, companies can be on new growth trajectories with early wins under their belts. A 10% increase in profitability is well within reach, although the actual results will depend on the customer mix and the organization’s capacity for change.