Four myths about distribution channel compensation

​A consumer goods company decided to sell at the same price to all its customers. They considered it fair and equitable to each of them, as well as a way to avoid conflicts between their channels. Six months later, they had to reverse this decision, as the problems with their customers became unmanageable. Are volume discounts really harmful? Should all products have the same discount on the list price? Should distributors be granted geographic exclusivity? These, and other myths about distribution channel compensation are discussed below:

Giving everyone the same discount
How can you justify to the largest customer that they deserve the same discount as the smallest customer? Simply put, you can’t. Buyers—whether distributors, retailers, or institutional clients—expect to receive discounts in proportion to the volume they purchase. Even if one tries, unilaterally, to violate this basic principle, the market will constantly remind you. If we refuse to give a high-volume customer a proportionally larger discount, another competitor will. The principle is simple: higher volume means greater bargaining power. The discount structure must reflect this principle.

On the other hand, does it make sense to give the same discount to a distributor as to a wholesaler? Consider this: a distributor performs a function that a wholesaler does not, which must be compensated: numerical distribution. While a distributor has a sales force that visits points of sale, the wholesaler generally just has a warehouse where store owners come to buy. Similarly, there are many other functions that must be identified and compensated across all types of channels: display, technical support, minimum inventory, customer financing, etc.

Offering the same discount across all products in the portfolio
The profitability perceived by a marketer—whether wholesaler or retailer—when selling a product is determined by the combination of margin and turnover. The margin indicates how much money the distributor earns per unit sold, while turnover reflects how much the product sells over a given period. This concept is known as GMROI—Gross Margin Return on Inventory.

If one product turns over much faster than another, and the discount—and thus the margin—is the same, the distributor will prefer to sell the faster-moving product. This means that if we want the distributor to sell both products, we need to give a higher margin—greater discount—on the slower-moving product so that the GMROI is similar to the other product.

Assigning exclusive territories
When a manufacturer assigns exclusive geographic areas to each distributor, it eliminates natural competition between channels. This lack of competition generates two perverse behaviors in distributors. First, it reduces their economic incentive to reach the more remote areas of their territory, causing them to sell "comfortably" to the largest and closest customers. Second, the lack of competition allows them to raise prices excessively, affecting the manufacturer’s sales.

This situation is resolved by creating healthy competition among distributors within the same geographic area. This way, they are forced to seek more profitable customers in more distant areas, and it becomes difficult to indiscriminately raise their selling prices.

Controlling retail prices
There are two reasons a manufacturer might want to control retail prices. First, because they feel distributors are selling above the suggested price, affecting sales volume. Second, because the manufacturer believes some of their customers are selling below the suggested price, harming relationships with other distributors. In both cases, there are no legal mechanisms for a manufacturer to force a distributor to sell products at a certain price. Additionally, it makes no sense to exhaust efforts trying to convince them to change retail prices if they have economic incentives to sell at a different price.

The way to prevent a distributor from selling below expected prices is by using the functional discounts explained in the first myth: only give a higher discount to a distributor performing more functions and incurring higher costs. Finally, the way to prevent a distributor from selling at excessive prices is to create competition among channels, as explained in the previous myth.

In summary…
Offering differentiated discounts to distribution channels is not harmful, but necessary. The important thing is that the reasons for these discounts are directly related to the functions and conditions that the clients fulfill. Any discount should be less than the cost incurred by a distributor to meet the condition.