Can You Buy Your Channel's Loyalty?

By: Sam Shapiro and Mike Lucaccioni

Thanks to the Beatles, we all know that money cant buy you love, but can it buy your channels
loyalty? The short answer is yes . . . well, sometimes.

In the past few years, we have noticed a trend among manufacturers to add loyalty incentives to
their channel strategy. Typically, these incentives take the form of discounts or rebates ranging
from 2% to 10%. They replace traditional volume deals and encourage distributors, retailers,
value added resellers (VARs) or other channel partners to remain with, or become committed to,
a suppliers 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 often use
loyalty incentives to leverage their strong core brands to increase sales of their weaker
brands or product lines.
? New technologies As new technologies emerge, previously dominant suppliers
provide loyalty incentives to slow the acceptance of new market entrants.
? Import manufacturing Most product categories are under attack from low priced
import lines. Imported brands, while cheaper, may not offer a consistent source of supply
over domestic brands with a broad range of SKUs. Domestic suppliers often use loyalty
incentives to discourage cherry picking.
? Evolving channel roles It used to be that a distributor would go to bat for a
manufacturer, however, in order to compete in todays business environment, we
increasingly see distributors serving as fulfillment channels providing whatever brands
the customer requests. Therefore, manufacturers are using loyalty incentives to create a
reason for the reseller to remain focused.
? Inefficiency of volume incentives Historically, manufacturers used volume rebates,
order quantity discounts or end-of-quarter deals to motivate channel partners. Loyalty
incentives can provide the focus that suppliers desire without the negative behavior.
Should You Use a Loyalty Incentive?

First of all, if you can demand exclusivity with your reseller, you should. Some suppliers
have used the exclusivity approach for years and should continue to do so. Others need to back
off on this no sharing of-the-shelf policy because in todays marketplace, it is becoming
increasingly unrealistic to expect that resellers will support your brand exclusively. Instead, a
company in this position should use a loyalty incentive to create the economic conditions that will
motivate their channel partners to make the right decisions.

If your brand is a high-share player in the industry and its product category is strategic to
your channel, you should strongly consider a channel loyalty incentive. If your brand is a
weak or new player in a market, dont even consider a loyalty incentive you have nothing to
leverage. You are going to have to win the old-fashioned way.

When launching a new technology or a hot new product you should consider a loyalty incentive.
Even though at first a new offering can earn loyalty, establishing a loyalty incentive 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 when their patent protection ends. By employing a
loyalty incentive when your new brand is 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 dont earn
the incentive. Generally used by high share suppliers trying to thwart off new entrants.
? Full line The reseller must support a suppliers 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 resellers 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 manufacturers
brand as the lead line in each product category that the reseller participates in.
? Share of account The higher the suppliers share of the resellers 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 suppliers 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 cant measure it, you cant 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 program comes down to the question of whether you can
objectively measurable loyalty. 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:
? Third-party certification The reseller provides third-party verification of the suppliers
share of the resellers account. Often, the resellers 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 suppliers 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
resellers Web site, catalog, marketing materials, bid documents or other publicly
available information. The reseller may challenge the suppliers estimate through an
audit process.
? Point-of-sale information Some suppliers have access to their resellers 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 that suppliers and resellers often have conflicting
perspectives regarding a suppliers 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 suppliers offering is uncompetitive. The supplier of
course takes the opposite view. Loyalty incentives 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 resellers loyalty.

The approach that your company takes towards measuring loyalty will have a significant impact
on the relationship that your business has with its channel partners. Carefully consider the role of
your companys field sales organization. You do not want to put your sales team in an adversarial
position. Ideally, your channel marketing group will measure channel 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 create complementary sales or service opportunities
? Resellers dont trust you
? Your company cant deliver or invoice correctly

Conversely, if these factors are working a manufacturers favor they may be able to convert more
sales than pure economics would indicate.
There are five common factors to consider when determining the amount of your loyalty
incentive. These include:
? Your share of your resellers business
? The amount of 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 competitors brand.
? 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 distributors 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
competitors line. In total, the distributors new gross margin is $275K. Therefore, your loyalty
incentive needs to make up the $25K in gross margin that the distributor lost. The $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, and they will strongly support your program.

If you get the economics right, and other factors are in your favor, resellers on the cusp are likely
to switch. Finally, disloyal resellers will challenge your program, however, they will 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 properly
structured loyalty incentive can drive your channels behavior in the right direction.

You owe it to your loyal resellers, you owe it to your shareholders and to your companys future
managers, who will otherwise need to deal with todays inaction. Lets face it, while not everyone
agrees with Pat Benatar that Love is a Battlefield, in business loyalty certainly is.