Optimizing Channel Compensation Texas A&M – NAW Research Consortium

OPTIMIZING CHANNEL COMPENSATIONTEXAS A&M – NAW RESEARCH CONSORTIUM

BEST PRACTICES IN DEMONSTRATING VALUE AND CREATING FAIR COMPENSATION FOR CHANNEL PARTNERS

Current Members of the Consortium

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

Optimizing Channel Compensation (OCC)

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?

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

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

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

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

Optimizing Channel Compensation

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

Evolving Channel Value Proposition

Business Process Framework

Distributor Value Proposition

Supplier’s Value Proposition to

Distributors

Example – SKF

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

Distributors essential to SKF

• Local Presence

• Flexibility to fulfil customer demands

• Multiplication of SKF presence in market

• Distributor sales people

Distributor sales people

• Maintain customer relations

• Improve SKF brand awareness

• Value sell SKF offering

• Close to the customer

• Understand the customers needs

Communication

• Develops trust

• Increases market intelligence

• Optimises resource allocation

Investment

• Local Inventories

• People selling our product

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

Pro Active Selling

• Development programs

• Structured follow up

• Collaboration

Education

• Development programs

• Structured follow up

• Collaboration

• Documented value tools

Supply Chain Optimisation

• Improving information flow

• Collaborative forecasting

• Maintain good service level

Differentiation

• Joint development of distributor services

• Knowledge sharing

• Utilising distributor reach for service provision

Industrial Distribution Strategy

Build sustainable and profitable customer relations in partnership with Distributors

Channel Value Creation

Optimizing Channel Compensation

Alignment

SupplierSupplier Business Objectives SupplierSupplier Performance

Supplier performance

Distributor performance Product performance

Customer performance

Supplier performance through stratification

Real-world Example

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

Real World Example

Key Statistics

Data timeline 2011 (12 months)

# Total Vendors 117

Annual Spend $ $ 269 MM

# invoices 15,689

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

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

Distributor performance through

inventory & customer stratification

Real-world Example

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

)

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

Inventory Stratification Model

Revenue & HitsRevenue & Hits

GM

RO

IIG

MR

OII

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

Supplier-Inventory-Customer Alignment

ALIGNMENT

Better Alignment

Supplier-Inventory-Customer AlignmentReal World Example

Low Alignment

Supplier-Inventory-Customer AlignmentReal World Example

Supplier and Distributor

Performance Alignment

Example – L&W Supply

L&W SUPPLY: Overview

•Founded 1971

•142 Locations

•Largest Specialty Dealer in North America

•Largest customer for our suppliers

45

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

THE L&W TRANSFORMATION

2009 201520142013201220112010

Branded Customer Experience

Branded Customer Experience

CorporationCorporationFederationFederation

47

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.

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

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

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

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

Optimizing Channel Compensation

Relationship – Key ingredients

Vision and StrategyCustomer

Internal Business

Processes

Financial

Learning & Growth

Balanced Scorecard

Source: Adapted from Kaplan and Norton’s Balanced Scorecard

Optimizing Channel Compensation

Compensation Drivers

Compensation Mechanisms

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

59

EXAMPLE

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

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

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

Channel compensation – Example Channel compensation from supplier

Changed distribution strategy from ‘intensive’ to ‘selective’ model

Better payment terms

EXAMPLE

Generating Growth Framework

Growth Strategy1

Growth Drivers2

Best Practices3

Growth Mechanism4

Metrics5

PRODUCT LIFE CYCLE

Alli

ance

&

Com

pens

atio

n

EXAMPLE

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

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

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%

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

Optimizing Channel Compensation

Questions and Discussion