Implementing a functional discount structure

Manufacturers need to tread carefully when transitioning from a single distributor discount structure to a “Discount for Value” one

by Tom Halpin

If you are an independent distributor or a manufacturer selling through distribution, you probably read a lot about functional discount structures recently.

Functional discount structures greatly contrast today’s most common form of manufacturer discount, the “single discount” structure.

In the single discount structure, manufacturers typically don’t recognize distributors for their functional differences and distributors are extended a discount off of manufacturer list price. So there could be a high-performing distributor that offers far more value than another distributor, and their discounts would be the same.

Functional discount structures attempt to reward distributors according to the value they provide, as determined by the manufacturer. For example, the manufacturer builds a matrix that supports their business and then grades the distributor accordingly. You might ask, “What does that look like?” 

See the example below.

What you see above is a partial example of a functional discount structure where the manufacturer assigned 40 percent of the total value available to ownership and possession and customer service.

There would be additional elements that would total 100 percent, which would then become the multiplier of the manufacturer’s maximum discount on a given product.

The rationale behind the movement toward a functional discount structure is understandable as manufacturers search for ways to reward those distributors that offer more value than others.

However, having been involved in the unsuccessful implementation of a functional discount program, there are some lessons I’d like to share with those considering a similar move.

First, distributors don’t like to be told how to run their businesses. And functional discount structures foster that kind of relationship, as they require distributors to be graded by their suppliers.

This is not a big deal if you are 3M, have lots of new product in the pipeline and end-user demand is bursting at the seams.

However if you are a $20 million manufacturer and have products on the downward slope of the product life cycle curve (see graph above), you may want to consider an intermediate program that bridges your current single-discount structure to the functional discount structure you envision for the future.

As an example, an intermediate program could have three components making up the total discount, such as:
1) stocking position, 
2) point of sale information, and 
3) average days to pay requirements.

In this situation, the manufacturer weighs each component according to priority. I like this because it starts to change the rules (from single discount structure to functional), but in a manner more reasonable to your distribution partners.

Which types of distributors are better positioned to adapt to a functional discount model? Without question larger distributors look better on paper when compared to traditional distributors in a functional discount structure. Their logistics networks and overall sophistication allow them to offer more inventory and marketing support to manufacturers.

However, larger distributors tend to fall short when it comes to engaging with manufacturers to create demand at the end user level. Advantage traditional distributor.

Specifically, the traditional distributor has the edge when the manufacturer has new, more technical products that need missionary selling during the introduction phase of the product life cycle. Larger distributors have trouble giving up that much mind share and would prefer to be mass merchandisers of product than invest in a longer, technical sale. 

Speculation about the inefficiencies of inventory management within the industrial distribution channel abounds. Exploiting those inefficiencies, distributors such as Grainger and MSC are investing in regional warehouse models that allow them to ship product next day to a large portion of the U.S., while carrying less inventory than ever before.

This new model, much of which has already come to fruition, will hurt some traditional distributors. However, for those traditional distributors that have a strong value proposition, functional discount structure or not, they will compete, survive and prosper for years to come.

My final advice to manufacturers considering a functional discount structure? Take stock of your value proposition, your relationships with key distribution partners and your overall objective in implementing a functional discount structure.

Count on the fact that if you take a rigid stance without creating buy-in from your key distribution partners on the front-end, there will be backlash and implementation will be difficult.

However, if you have a distributor council, solicit their input on the framework of the functional discount structure and implementation of the program. Distributors involved in the decision-making process will be more likely to buy in over the long term. In parallel, a functional discount structure inherently culls low-performing distribution partners, making it an ideal mechanism for rationalizing your distributor base.

I suspect we will see many manufacturers roll out functional discount programs in the coming months and years. This is a good thing. Manufacturers that do not have a succinct channel strategy, have tenuous relationships with their distribution base and have mature products need to go slow, consider an intermediate approach and poll key distribution partners up front. Failing to do so will be damaging to your distribution network.

Tom Halpin is President of Titan Marketing, a consulting firm focused on various sales and marketing disciplines. His 15-plus years of sales and marketing experience in both manufacturing and distribution provide a unique edge to potential clients. For more information, visit www.titanmarketing.net or contact Tom directly at tom@titanmarketing.net.

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