Rethinking Distribution

8/2/2019 Rethinking Distribution

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By sharing resources and capabilities, companies can meet theircustomers' most extraordinary needs.

RETH INK ING DISTRIBUTION:

by James A. Narus and James C. Anderson

Flawless distr ibution can seem an impossiblegoal. No m atter how m uch inventory a wholesalercarries, when a custom er places a rush order, the es-sential item is often out of stock. No matter howbroad a range of services a dealer provides, what acustomer desperately needs is often some out-of-

the-ordinary service that the dealer has never sup-plied. And no m atter how mu ch effort a distrihutorexpends to beef up its capabilities, when a custom erhas an emergency, the distrihutor often lacks thecritical skills to respond.

To solve these problems, a handful of forward-looking companies are experimenting with theirdistribution channels to make them more flexible

Forward-looking companies aretrying to make their distributionchannels more flexible.

uations, they can take advantage of profit-makinopportunities that they could not exploit alone. Tact on this realization, these managers first identifinfrequent yet critical customer requirements ththey cannot fulf il l routinely on their own. The

they make progressive, cooperative arrangemenwith other channel members for the assistance thwill enable them to meet those requirements. Thnature of such assistance, the procedures for prviding it, and the appropriate remuneration are adefined in adv ance.

Business dynamics and emerging technologimake this new approach to distribution both essetial and feasible. Tough com petition is forcing man

agers to scrutinize every aspect otheir operat ion. Increas ingly, the

and responsive. Although the scope of the experi-m en ts and the specifics vary widely, each embracesa concept w e call adaptive channels.

The managers whose inno vations have given r ise

to this concept view their distribution channels aswebs of capabilities embedded in an extended en-terprise. They have realized th at by sharing their re-

an

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prevalence of strategic alliances apa r t n e r s h i p s ha s m a de m a na gemore willing to explore new ways

working together for mutual gain. And recent dvelopm ents in shared information systems and itegrated logistics system s (including the em ergenof highly competent suppliers such as Federal Epress) make such cooperative efforts more feasih

Finally, in many markets, global competitors aproviding the impetus for innovat ion. Exclud



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¡A D A P TIV E C H A N N E L S

no choice but to experiment with unconventionaldistribution arrangements.

The poten tial benefits of these new arrangementscome from the opportunity to leverage resourcesand share capabilities within the channel. As re-dundant pools of inventory and duplicate serviceoperations are pared back, costs fall, often by 15%to 20%. At the same time, the amount of husinesslost because of stockouts and the inability to re-spond to emergencies drops, sometimes by as muchas 50% to 75%. Even more important, participantscapitalize on new business opportunities, often tothe tu ne of 10% more in sales, because they can of-fer a broader selection of products and services thanthey could on their own. They can also heightencustomer satisfaction by augmenting their own ca-

pabihties with those of more proficient partners.To learn more about innovative distribution

practices, we conducted an extensive research

fames A. Narus is an assistant dean and a Babcock Re-search Professor at Wa ke Forest University's BabcockGraduate School of Management in Charlotte. NorthCarolina. Jam es C. Anderson is the W illiam L. FordDistinguished Professor of Marketing and WholesaleDistribution and a professor of behavioral science inmanagement at Northwestern University's J.L. KelloggGraduate School of Management in Evanston. Illinois.He is also the AT&)T ISBM Research Fellow at the Insti-tute for the Study of Business Markets, ¡ocated at Penn-sylvania State University in State College, Pennsylvania.

study in 1994 and 1995. We started by identifyingprogressive manufacturers and distributors throughdiscussions with colleagues, with managers froma variety of industrie s-including information tech-

nology and integrated logis tics-an d with the exec-utive presidents of two distributor trade associa-tions. Then we conducted a series of individualfield interviews in the United States and Europewith 62 managers from 17 U.S., European, andJapanese organizations that are considered to beleaders in distribution.

These com panies' initiatives can be divided intothree broad categories. In the first, the distributionchannel is designed to ensure that the members areroutinely able to cope with unexpected or unusualdemands for products and services. In the second,

the new arrangements focus on meeting custom ers'growing demands for broader market offerings -products and services that the channel memberdoes not normally provide. In the third, the objec-tive is to improve the quality of service throughoutthe distribution channel by substituting the superi-or capabilities of one memher for the inferior capa-hilities of another.

Satisfying Customers'Extraordinary Needs

Every distribution channel occasionally faces un-expected or unusua l dem ands. A major customer's



ADAPTIVE CHANNELS

the local dealer doesn't have a vital part in stock.A machine tool distributor stretches its budget tocarry as much inventory as possible only to have acustomer place a hig order for machine tools itdncsn't have. Information svstcms professionals at

a large investment hank call their software sup- •plier for emergency problem-solving assistanceand get a busy signal.

Traditional distribution channels try to meetthose challenges by forcing the manufacturerand its distributors to stock excess inventory orhire surplus personnel. Recognizing the costli-ness of this approach, innovative managers are

experimenting with various kinds of auxiliarysupport systems. Sucb systems allow a manu-facturer and its distr ibutors to respond to ex-traordinary situ ation s by sharing inventories andsupport services in return for prespecified remu-neration. What makes the systems possible isinformation technology and integrated logisticssys tems that can monitor the avai lahi l i ty ofproducts and services, process orders, and deliverproducts and services rapidly from distant loca-tions to custom ers ' s ites.

Consider, for example, how Volvo GM HeavyTruck Corporation and its dealers solved a vex-ing business problem. Volvo GM sells commer-cial trucks and repair parts in the United Statesthrough a channel that includes regional ware-bouses and commercial truck dealers. Between1993 and 1995, the company's dealers had beenreporting more and more stockouts on criticalparts, even though invento ry levels were soaring.Because they couldn't provide consistent, timelyrepairs, the dealers were losing a considerahleam oun t of business - business that constituted

a major growth opportunity.Volvo GM managers knew that the problein

was related to the dealers' inability to predict dcmand for parts and service accurately. Throughcareful market research, they learned why thatwas the case. Customers use replacement partsin two qui te dif ferent s i tuat ions : scheduledmaintenance and emergency roadside repairs. Inthe first situatio n, Volvo GM's conv entiona l dis-tr ibution system was working well because cus-tomers ' requirements varied lit t le and the neces-

sary parts could be ordered and delivered ahead oftim e. In the second, the system was extrem ely inef-

fective because the demand for emergency repairs

much inventory the company put into the channel,it seemed that almost every time a truck brokedown, the critical parts were in the w rong place andnot readily accessible. Little wonder that whenowners learned how long they would have to waito get their trucks moving again, they located com-

pe t ing dea le r s tha t had subs t i tu te pa r t s andcould make the repairs.

Once Volvo GM understood the problem, icould address it. Working with FedEx LogisticsServices, the company set up a warehouse inMemphis, Tennessee, that would stock the fulline of truck parts . Now when a dealer needsparts for an emergency repair, the manager calla toll-free number and the parts are shipped ouhy FedEx, often on an afternoon flight so they arrive that same night. Parts can be picked up a

tbe airport hy the dealer 's personnel, delivered tothe dealer's offices, or even dropped off at throadside repair site. Volvo GM charges dealerfor the delivery service, but the dealers don'mind because they can pass tbe charges on toanxious customers who are willing to pay foprompt service.

Today Volvo GM is losing less business because of stockouts, and dealers' revenues fromemergency r epa i r s have r i sen s ign i f ican t lyMoreover, Volvo GM has eliminated three warehouses and reduced its total inventory hy abou1 5 % . Lower inventory and storage costs havmore than of fset increases in the company'freight charges. Managers report that they havbeen overwhelmed with compliments from hotdealers and customers.

Another way to ensure that distr ibutors caroutinely satisfy unexpected demands is to havchannel members share the hurden of maintaining safety stocks and making emergency deliveries. Machine too l bu i lde r Okuma Amer icCorpo ration, a subsidiary of Japan's Ok um a Go

poration, provides an outstanding example ohow this can be done. The expense of stocking tuU line of machine tools {which often cost morthan $100,000 apiece} along with a com plete asortment of repair parts {which numher in th

thousands) is prohibitive. Historically, it has hampered the ability of distributors to provide respon

sive service. To overcom e the problem, O kum a crated its own auxiliary support system.

Okuma requires each of its 46 distr ibutors i



ber of machine tools and selected repair parts inits inventory. The company tries to ensure thatnearly all Okuma machine tools and parts arein stock at all times, either in its warehouse inGharlotte, North Garolina, or somewhere in thedistrihu tion ch anne l. A shared information-

technology system called Okumalink keeps dis-tributors informed ahout the location and avail-ability of machine tools and parts in Okumawarehouses in Charlotte and Japan.

When a customer orders a machine tool or apart that a distributor does not have, tbe distrib-utor checks Okum alink to determine if the itemis in stock. If it is available, the distributor canorder it electronically. If it isn't, the distributorcan contact the other distributors through Oku-malink's E-mail system to find the closest loca-

tion. Then tbe manager arranges for the item to

be delivered directly to the customer's piant site.Okuma further supports the availability of repairparts with a 24-hour shipment guarantee on allparts manufactured in Gharlotte: If the parts are notshipped with in 24 hours of receipt of the order, thecustomer gets them for free.

Okumalink will he upgraded to allow channelmembers to connect with one another directly.All the distributors will post their inventories onOkum alink and be able to scan those of their chan-nel partners. Equally important, they will he ableto arrange intrachannel exchanges of machinetools and parts electronically.

The benefits of Okuma's auxiliary support sys-tem are considerable. Investm ents and costs associ-ated with stocking and handling inventory havebeen reduced for all the members ofthe distribution network. Okuma

now has 48 potential pathways - its46 distributors and its two ware-bouses-forits products and servicesto reach each customer. The likeli-hood that a distributor will lose asale because an item is out of stockhas plummeted. Gustomcr satisfac-tion has increased because Okuma is consistentlydelivering the superior service it promises.

A third example of how an auxiliary support sys-tem can ensure superior service in extraordinarysituations is Microsoft's product-support approach.

Microsoft delivers most of its technical problem-solving assistance to customers by telephone. Al-

fashion by the service engineers at one of Mi-crosoft's three U.S. technical-support centers,the division's goal of answering 90% of servicecalls within 60 seconds is severely tested duringproduct launches.

To handle the overload during peak periods,Microsoft relics on a carefully selected networkof authorized support centers and Microsoft ser-vice providers. Microsoft programs its telephoneswitching system with call arrival forecasts,goals for minimum waiting time, and estimatesof support staff availa hili ty- its own and that ofits partners. When a Microsoft product-supportengineer cannot take a call during a prespecifiedinterval, the switching system automaticallytransfers the call to a designated service provider,

f where an engineer takes it and resolves the cus-

I tom er's problem. Microsoft com pensates the ser-I vice providers on a per-call basis with a guaran-f teed number of calls per day. Fees paid to service

providers reflect their investments in facilities,equipment, direct phone lines, and hiring and

training of support engineers. Microsoft managersreport that the system helped them handle techni-cal service calls smoothly following the introduc-tion of Windows 95 last year.

W ha t Customers W ant

Is Wha t They GetTen years ago, most large companies worked

with multiple suppliers. Today that is no longerthe case. Prompted in part by the quality move-ment, more and more managers are shrinking thenumber of their suppliers. The repercussions fordistributors arc becoming apparent. Sophisticatedcompanies are increasingly choosing to rely on asmall numher of preferred distributors for mainte-

Okum a's guarantee: If the partsare not shipped w ithin 24 hours,the eustomer gets them for free.

nance, repair, and operating supplies. In tbese rela-tionships, which are usually formalized throughintegrated-supply-management contracts, the cus-tomer effectively outsources a portion of its supply-management function to a distributor to reduce itstotal transaction costs. According to Frank Lynn &.

Associates, a distribution-industry consulting firm,



ADAPTIVE CHANNELS

reached $1.8 hillion in 1995 and is predicted toreach $5 billion by 1998.

Integrated-supply-management contracts pro-vide a tremendous opportunity for distributors toincrease b oth sales and profits; how ever, fulfillingsuch contracts typically requires a broader marketoffering as well. In add ition, c usto me rs arc likely toexpect the distributor to handle their infrequent or

suppliers can be delivered to customers separatelyor consolidated into one shipment.

When GISO receives an order , i t immediatelygoes on-line to see whether the items are availahlefrom Graingcr's traditional d istribution busin ess, ifGrainger cannot fill the order, GISO turns to its

netw ork of best- in-clas s suppliers - outs tand ingspecia l ty dis t r ibutors that car ry complementary

emergency requests for unusual products and sup-port services. Given that most distr ibutors havelimited financial resources, sell only narrow andspecialized product lines, and possess limited ser-vice capabilities, such ex pectations can be an insur-

mountable obstacle. In fact, distributors operatingin traditional distr ibution channels often forgosuch h usiness, telling prospects, "Sorry, we don 't dothat." Rather than let these opportunities vanish,forward-looking managers recognize that they cancapitalize on them by forming alliances with otherdistributors to share complementary product linesand services.

In tbese alliances, the members agree to pooltheir resources and capahilities in order to broadenone another's market offerings. By joining forces,tbey can exploit opportunities that they wouldn'tbe able to on their own, and they can mee t deman dsthat fall outside their traditional areas of specializa-tion. In return for its contrihution, each mem ber ofthe alliance shares in the resulting sales and profits.

Distributors can fulfillrequests for unusua l productsand support services by allyinwith other distributors.

Grainger Integrated Supply Operations, a com-pany division established in 1995 by W.W. Grainger,a large industrial distributor, shows how such analliance works. GISO's goal is to handle the acquisi-tion, materials-management, and warehouse activ-ities of major custom ers across as broad a range ofmaintenance, repair, and operating supplies andservices as possible. To do so, GISO draws on threegroups of suppliers: Grainger's traditional distrihu-tion husiness, independent hest-in-class suppliers,

products. Written contracts with each suppli-er specify the products it will supply throughGISO, and the suppliers set the prices of thoseproducts themselves. GISO pays the supplier immediately on delivery and then collects the rev

enues or holds the accounts receivable itself. Toparticipate in GISO, the suppliers pay an annuamanagem ent fee, a minor transac tion fee, and logistics costs.

Wben GISO gets an order that neither Graingenor tbe independent suppliers can meet, it turns toits own sourcing group. The group routinely scoursthe world to satisfy requests for unusual productsand services. For example, in the summer of 1995ARGO Alaska requested bear repellent for its oipipeline workers. GISO managers tracked down asmall business in a remote part of Alaska th at m an

ufactured the repellent. Then they determinedwhether spray or steam applicators would be mosuseful for oil pipeline workers and what size containers would be most economical. Once those de

cisions were made, GISO managerfigured out how to get the repellenfrom the supplier to the workers.

Whereas GISO relies on writtencontracts and cooperative agreements with memhers of its supplyalliance, other distrihutors acbiev

similar results through conso rtia. Tform a consortium, distrihutors ocomplementary lines contrihute equity and create a separate corpora

tion that markets the memhers' products and services, primarily to integrated-supply-managemencustomers. Through the consortium, mem her companies can serve customers individually, when thewant specialty products and technical service, ocollectively, when they want broader offeringGonsortium memhers can also draw on their parners' inventories when a traditional custome

wan ts something out of the ordinary. Participatindistributors share profits in the form of dividend



For examp le, consider Intcrcorc G roup, a consor-tium created by four U.S. mach ine-tool distr ihu-tors: Excel 2000 Machine Tools, Methods Machin-e ry Gompany, Machine Tool Corpora t ion , andWing & Jahaay. Individually, each distributor hadexper ienced dif f icul ty providing t imely, high-

qual i ty service , gaining large turnkey contractsfrom major customers, and reselling used equip-ment. Now when a consortium member spots anopportunity that it cannot handle alone or when itneeds to provide technical assistance and doesn'thave a service engineer available, its managers ask

Intercore for assistance. Intercore also gives thedistrihutors access to their partners' invcnto-

can be used to bolster those of others, they are ex-perimenting with wha t we call capabilities-sharingagreements.

Tbrou gh such agreem ents, the superior service ofone channel member is substituted for the inferiorservice of another. Each channel member offers agreater numher of high-quality services at far lowercosts than it could by acting alone. And each con-tributing distributor receives appropriate compen-sation when it shares its superior capability.

Otra, a $2.2 billion holding com pany hased in th eNetherlands that has approximately 70 electr icalwholesaler subsidiaries located across Europe, pro-vides a good example. Otra's wholesalers operate

ries of used equipment and enahles them to maketbeir own used equipment availahle to a broadergeographic market.

Based in independent off ices in Indianapolis ,Indiana, tbe consortium is largely an administra-tive operation. Each distributor has transferred oneor two service engineers to Intercore, and an execu-tive from one of the distributors serves as the headof operations. The consortium maintains relationswitb machine tool suppliers and end users, marketstechnical service contrac ts, dispatches service engi-

neers wherever needed, sends invoices to cus-tomers, and collects payments. Profits are distrih-uted to the owners through dividends.

Superior Service ThroughShared Capabilities

As the focus of competition has shifted fromproducts to services, managers have become in-creasingly concerned about the services their dis-trihutors provide. Ideally, every participant in the

distribution channel should provide the same high-quality services to every customer. In practice, ofcourse, such consistency is virtually im possihlc he-cause neither the manufacturer nor any of its dis-tributors is likely to excel at everything. Instead,com panies tend to do an outstan ding job with someservices and a mediocre job with othe rs.

To overcome those discrepancies, managers com-mo nly try to achieve the impossible goal of ma kingevery cha nnel mem her equally skilled in every ser-vice. Often this effort entails forcing distributors tohire addi t ional service personnel or sponsor ing

training programs for distributors. But innovativema nagers are trying a different a pproach . Recogniz-

for the most part independently within an agreed-upon market focus. To improve the service capa-bilities of all 70 wholesalers. Otra managers havedesignated some of them as centers of excellence.These centers possess superior knowledge or skills(such as the ahility to provide outstanding electri-cal-system design, point-of-sale materials, or ware-house layouts) that can he transferred to other Otracompanies. Otra managers encourage their whole-salers to seek assistance from the appropriate cen-ters rather than duplicate their efforts.

For example, Bcratungsgesellschaft für Licht-und E lektrotec hnik (BLE)-a center of excellence inSoest, Germany - serves primarily as a trainingcompany for the employees and electrical-contractorcustomers of all the Otra subsidiaries. BLE runstraining programs both at its own facility and atother Otra locations. In developing its programs,BLE consolidates and translates technical docu-mentation and training materials from up to 15suppliers of electrical products. A training sessionin lighting, for instance, might cover all the major

suppliers ' conventional products in an integratedway and address issues comm on to all of their lines,such as how to use software to calculate lightinglevels in the design of a customer's lighting layouts.

Through these training programs, BLE augmentstbe capabilities not only of Otra's wholesalers butalso of its electrical-products suppliers. BLE's pro-grams are often more thorough and unbiased thantbose of tbe sup pliers. Th ey also elim inate the needfor each supplier to create and run separate but sim-ilar programs for each Otra wholesaler. As a result,the suppliers can save money and devote moreattention to developing better technical materialsand running training programs for their higher-



ADAPTIVE CHANNELS

Independent ly owned channe l member s canachieve similar gains through capabilities-sharingcontracts witb more proficient partners. The tech-nical problem-solving arrangement between MoriSeiki, a Japanese machine-tool builder, and Landre& Glinderman, a distributor based in the Nether-

lands, illustrates how. Because of Mori Sciki's lim-ited presence in Europe, the prohibitive costs ofmaintaining a large staff of service engineers, andoccasional difficulties in dispatching service engi-neers from its Düsseldorf offices, the companyfound that it could not consistently guarantee endusers prompt, on -site technical problem -solving as-sistance. In addition, although Mori Seiki's engi-neers were quite knowledgeable about their equip-ment 's hasic technology, they sometimes lackedthe expertise to solve problems for customers who

had unusual applications.To help Mori Sciki overcome those challenges,

Landre & Glinderman's management proposed andhas implemented an arrangement with Mori Seikicalled "rent a service engineer." Now when MoriSeiki receives a request for service, it determineswhether it has the requisite knowledge of the cus-tomer's application, whether a competent serviceengineer is available, and whether that engineercan reach the cu stom er's plant site prom ptly. If theanswer to every question is yes, Mori Seiki dis-patches one of its own engineers. If the answer to

any qu estion is no, Mori Seiki asks Landre & Glin-derman to send one of i ts engineers to the cus-tomer 's plant site. Acting as a representative ofMori Seiki, the service engineer corrects the proh-lem. Mori Seiki then pays Landre & Glinderman

sharing capabilities, channelmembers can offer better

service at a lower cost than theycould by acting alone.

a prespecified per diem fee for the engineer's time

plus travel expenses.This arrangement benefits hoth Mori Seiki and

Landre & Glinderman. Mori Seiki can confidentlyoffer prompt, high-quality on-site technical proh-lem-solving assistance without incurring the highcosts of hiring more engineers and regularly dis-patching them across Europe and also without re-quiring that its European distrihutors' engineers be

Landre &. Glinderman, in turn, uses its service egineers' time more productively and gains a highereturn on re la ted expendi tures . In addi t ion, thcompany has added a profitable service to its repertoire. In fact, this venture has been so successfuthat Landre & Glinderm an has entered into a sim

lar arrangement in Europe with Dresser Industriea U.S. manufacturer that huilds gas engines fopower cogeneration system s.

From Idea to Implementation

Although the idea of a more flexihle and responsive distribution system is appealing, experiencemanagers recognize that significant hurdles stanbetween the idea and its implementation. To hegiwith, channel members are Ukely to be skeptic

about the rewards of participation. That is particularly the case when the benefits of the n ew arrangment are conceptually different and more complethan those to which the dis t r ihutors are accutomed (for instance, when increased leverage cash flow replaces a straightforward gross margon inven tory sales).

Channel members are also likely to feel threaened by new cooperat ive ar rangements hecauthey stand to lose long-estahlisbied functions, rsponsibilities, and relationships. To take one simpexamp le, despite all the talk abo ut virtual organiz

tions, most distributors still feel more confideahout their abili ty to provide f irst-rate customservice when they have a warehouse full of invetory than when they have to share supplies wianother distr ibutor SOO miles away.

To allay such fears and doubts, inova tors have to build trust and gathe commitment of potential chanel members . For many organiztions, pledges and guarantees aregood way to begin. By committi

essential resources to the new sytem and gua ran t ee in g i t s pe r fomance (most of ten with provisiofor serviee recovery if the systefails) , companies like Okuma ha

been ahle to overcome distributors' initial reservtions. Then, as experience huilds, the network relationships within the distr ibution channel cbe broadened and deepened: soon all of Okumdistr ibutors will post their inventory on Okumlink, enabling channel members to exchange mchine tools and parts electronically. (For anoth

example of how pledges and guarantees can helpcreating an adaptive distribution channel, see t



Getting Distributors on Board

Netherlands-based Dunlop-Enerka produces con-veyor belts for mining and matiufacturing companies

around the world. In Europe, about 80% of its ordersrequire customization: cutting and splicing lengths ofbelt to fit custo m ers' needs. This has presented a prob-lem both for Dunlop-Enerka, which sells directly tooriginal equipment manufacturers, and for its distrib-utors, which handle maintenance, repair, and operat-ing-supply sales. Traditionally, the company tried tosolve the problem by stocking huge quantities of beltsof various sizes in locations throughout the continent.But the result was burdensome inventory costs.

In 1990, Dunlop-Enerka's managers decided to de-velop an auxiliary support system for its European

operations. To secure the participation of its distribu-tors , the company began by pledging i ts own re-sources. It created a shared multilingual informationsystem called Dunloc omm , bought and installed com-puter monitors at all the participating distributors 'sites, and provided free systems training for the dis-tributors ' personnel. Dun locom m m onitors the inven-tory in stock at the company's warehouses and at thedistributors' sites on a daily basis. When a distributorneeds an out-of-stock belt, it can use the system to

locate the ne arest source and arrange, by phon e or fax,for its delivery the next day.

To al lay dis tr ibutors ' fears that they would beunahle to get the equipment they needed, Dunlop-Enerka guaranteed the availability of all the stockslisted on Dunlocomm. If a distributor needed a beltthat was supposed to he in stock but wasn't, Dunlop-Enerka wo uld custom ize the order from its own inven-tory and guarantee delivery with in 24 hours.

Reassured by these pledges and guarantees, d istrib-utors throughout Europe agreed to list their inven-tories on D unlocom m. Initially, distributors ' invento-ries dropped precipitously- causing Dunlop-Enerka'sstock to soar. But over time, the company's inventory

level has dropped by 20%. The result: thanks to lowercosts and faster inventory turns, Dunlop-Enerka 'sprofit m argin s have risen hy an average of 5% per prod-uct line, generating income that the company has cho-sen to invest in new-product development. Productinnovations funded hy these investments have in-creased Dunlop-Enerka's total sales hy 30% over thepast five years. Distributors' profits have also risen astheir inventories have declined and their abihty toprovide fast and reliable service has im proved.

Equitable compensation is another essential in-gredient in designing new distribution systems. Al-though this statement may seem obvious, deliver-ing fair and eonsistent rewards is more difficultthan most managers think. In part, the problemarises because manufacturers and distributors oftendo not have a clear understanding of the specific in-vestm ents and resources that each partner w ill con-tribute and the specific gains that each partner willreceive. Before negotiating the terms of a newarrangement, therefore, each potential participant

should evaluate both its own position and that ofits channel partner.

Parallel sets of T-accounts (like those in an ac-counting ledger} can be a useful tool in the evalua-tion process. Each channel partner constructs twosets of T-accounts, one for itself and one for its part-ner. In one column, th e managers list all the invest-ments the company will have to make; in the other,all the gains it expects. These accounts can providea basis for idetitifying discrepaticies and negotiatingperceived inequities.

Although this approach may seem elementary -even simplistic-companies that have used it findit a powerful tool. For example, before Microsoft

providers, its managers idetitified and quantifiedthe investments those partners would have tomake and the operating costs they would incur. Atthe same time, the managers learned that theprospective service providers were worried thatthey would not receive enough calls per month tojustify their expenditures on equipment and servicepersonnel. Based on a more thorough understand-ing of their potential partners' concerns, Micro-soft's m anagers proposed a compensation agreementthat would entail a set fee per call and a mini-

mum number of calls per day. This arrangementenables service providers to cover operating costs,to earn a fair return on their investments in sys-tems and training, and to plan their operationsbased on a guaranteed minimum compensation.

As the Microsoft example suggests, companiesthat have successfully implemented new channelarrangements usually go beyond the trade dis-counts th at historically have been the sole means ofcompensating distributors for sharing resources.Based on average resale costs and profit margins, a

trade discount is supposed to allow a distributor torecover its costs and achieve a reasonable profit.But innovators are turning more and more to new



ADAPTIVE CHANNELS

arrangements and functional allowances, which re-flect the distributor's actual costs and provide de-pendable revenues.

Under a fee-for-service arrangement, a channelmember is paid a predetermined amount for per-

forming a particular task. Microsoft and Mori Seiki,for example, pay their partners set fees for provid-ing technical assistance to customers in extraordi-nary situations. LeBlond Makino, a Japanese-ownedmachine-tool builder, has taken this approach onestep further by specifying the numher of servicedays or hours it expects its distributor partners toprovide. In essence, distr ihutors are kept on re-tainer hecause they are paid whether or not theyactually provide service.

Other companies are us ing funct ional a l low-ances to compensate channel members for sharing

their capabilit ies. The agreement between ShellChemical Company and GLS Corporation, a majordistributor of composite materials and thermoplas-tics, provides a good example. Shell 's synthetic-rubber compound, Kraton, is a versatile materialwith man y app lications. In order to devote the com-pany's own resources to developing sales in mar-kets with substantial applications (such as adhe-sives and lubricants). Shell turned to GLS for helpin introducing Kraton to the smaller, rnore frag-mented market for plastic molded goods.

In the mid-1980s, GLS became K raton's ex clusiveU.S. supplier for that market. To meet the chal-lenge, GLS created its own applications-supportlaboratory staffed with two chemists and a ma-terials engineer. It also hired sales engineers andtrained them to provide product-specification andapplications assistance, as well as technical salespresentations. In return, GLS received hoth a func-tional allowance for market development, whichwas paid as a reduction in the acquisition price ofthe Kraton, and bonuses for sales growth.

GLS not only found applications and customers

for the compound; it also developed its own pro-prietary line of thermoplastics made with Kraton,

called Dynaflex. Shell's management was so pleasewith GLS's results that i t s ingled out the company and two other distr ibutors as "branded nework co mpo unders" (companies that have the r ighto manufacture other therrnoplastics from Kratoand to use the Kraton name). Now when Shellmanagers ident i fy an emerging appl icat ion foKraton that they cannot handle because of constraints in resources or capahilities, they immedately turn it over to the ne two rk. The results? Saleof Kraton, Dynaflex, and their derivatives havgrown to account for almost 20% of GLS's saleand GLS has become one of the largest purchaseof Shell's synthetic-rubh er p roduc ts.

Companies that have been most successful in redesigning their distribution channels are strong

committed to experimentation. Volvo GM, for eample, has no intention of stopping with the gainit has already achieved. Plans to enhance its auxiiary support system through a shared on-line invetory database are well under way. Soon, wh en deaers need parts for emergency repairs, they will bable to scan the inventories of all the other VolvGM truck dealers to find the nearest location, futher reducing inventories and increasing dealerresponsiveness.

As companies gain experience, the benefits of eperimentation and innovation will only increasThanks to the f lexibili ty that technological anservice advances now allow, we expect other nearrangements to emerge as more managers reconize opportunities to streamline tbeir existing oerations, broaden their selection of products aservices, and improve their after-sales service. Twinners will be those who hest link their manufaturing, service, and distribution functions to mecustomers ' needs.

The authors gratefully acknowledge the financial support of

Institute for the Study o f Business M arkets and tbe con

butions made by the managers who participated in the firesearch.

Repr in t 96409 To order reprints, see the last page oí this i



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Rethinking Distribution

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