“We are currently giving our distributors a straight discount of 12% on our invoiced sales to them as distribution fee. All our competitors give the same except for this new player who is giving 12% distribution fee plus 1% if the distributor submits their required reports on time. The idea sounds interesting for me. Are other suppliers from other industries following a similar practice?”   - Bret from Quezon City
As a general practice, third party distributors are given a certain percentage called distribution fee by their suppliers based on gross sales or invoiced sales. This is a good financial tactic since the cost becomes variable (i.e. it varies with volume) and not fixed. There are suppliers or principals who do not provide a variable fee but guarantee the net income after tax as a percentage of net sales. This seems more interesting on the part of distributors as income is guaranteed. However, one of the conditions in this arrangement is for the distributor to invest and provide for all the capital expenditures and working capital dictated by the principal. This partnership requires transparency in financial reports and added mechanical and supervisory costs for the supplier. The beauty of this scheme is that it encourages the distributor to accelerate top line growth rather than be consumed by ‘managing’ operating costs. As a distribution strategist, I prefer that more principals or brand owners boldly follow this scheme for their third party distributors when they have reached a comfortable volume and market share.
There are few suppliers who have started to further break down their distribution fees (in %) into something similar to this:
-       Basic distribution fee (if you give 12% this should be around 7%)    
-       Sales returns (recoverable on the distributor part)
-       Attainment of sales target (usually by semester or year either based on sales to distributor or sales to customers)
-       Submission of reports (sales reports and competitive information)
-       Sales promotions (paid and initiated by distributor with approval from principal)
The percentage rates above will depend on the volume size, sales turnover rate, and the feelings of the sales manager. Yes, I bet you, they are largely based on feelings though most managers would like to think they are rational.  When I was a sales manager myself, I used to develop different permutations to come up with what is acceptable to my boss and the distributor partner. When I was a sales manager in L’Oreal, I split the distribution fees into Commercial and Physical (an attempt to separate the selling activity part from the non-selling services like logistics). I found this better (as opposed to giving a straight discount) as this gave me the flexibility to evaluate in which area the distributor is really adding value to our company. For example, I could retain a distributor to provide me with commercial or selling function only while I outsource the order-processing and logistics functions to another distributor who is an expert in non-selling aspects of distribution. Ideal scenario presents someone who is an expert in the two functions. This is rare.
You need to identify all the basic activities or functions performed by a third party distributor and assign a cost to each function. Consult your accountant or finance manager when doing this activity-based costing approach. The following are activities performed by a distributor and cost represented by each function:
-       Physical possession (storage and delivery costs)
-       Ownership (inventory carrying costs)
-       Promotion (personal selling, sales promotion, public relations costs)
-       Negotiation (time and legal costs)
-       Financing (credit terms and conditions of sale) 
-       Risking (price guarantees, warranties, after-sales service costs)
-       Ordering (order-processing costs)
-       Payment (collections, bad debt costs)
Use this as guide in computing for the right distribution fees rather than giving a straight 12% discount. Tell me then, what you discover.
Emilio “Bong” Macasaet III is Partner and Chief Distribution Strategist of Mansmith and Fielders, Inc. (www.mansmith.net), the leading marketing and sales training company in the Philippines.  For inquiries, please email info@mansmith.net, call (+63-2) 584-5858 /412-0034 or text (63) 918-81-168-88. Please also send your marketing, sales, strategy and innovation questions to mentors@mansmith.net.