Price wars between distribution channels

If you work in the commercial area of a company that manufactures mass-market or industrial products, the following situation may sound familiar: for some time now, you’ve been receiving more and more calls from some of your distributors (wholesalers or retailers) complaining about the severe erosion of their product line margins. They claim that several of your major distributors have started a price war in the category, systematically reducing retail prices on your lines. Worse yet, the affected channels say that unless you do something to end this all-out war, they would rather stop selling your lines and instead market competing products that offer better margins. In a panic, you’ve taken actions such as assigning exclusive territories, allocating accounts, and holding “evangelizing” meetings with your largest distributors, among others. But unfortunately, these countermeasures have not achieved the expected results, and conflicts between your channels are getting worse. You fear that your entire distribution network could collapse and that your geographic coverage will shrink to a minimum.

Channel conflicts: minimum retail prices
The situation described above is what is known as channel conflict or, more specifically, minimum retail price conflict. But is this really a problem for your company? Should you really be concerned that your channels are experiencing “perfect competition”? The answer to these questions depends on how differentiated your products are and on the communication and distribution strategy adopted by the manufacturer. Highly differentiated products—where the selling effort is done mainly by the channels and where distributors with different service levels coexist—create the perfect breeding ground for channel conflicts.

In mass-market environments, electronics manufacturers often experience this situation. Sony sells its home-theater systems through low-service distributors (wholesalers, hypermarkets, and informal retailers) as well as high-service distributors (specialty store formats like Sony Center). If channel compensation were based solely on volume discounts, distributors providing a purely logistical function would have a clear price advantage over high value-added channels. In this case, a customer could visit a Sony Center to enjoy a comfortable demo of the surround-sound systems and later head to an informal retailer or a hypermarket to buy the equipment they already selected. If this behavior were repeated systematically (thanks to the price difference), Sony Center would soon close, seriously affecting sales not only for Sony as the manufacturer, but also for other channels, since customers would no longer find in-store demonstrations of this brand to support their purchase decisions.

In industrial markets, the same situation occurs with manufacturers of highly differentiated products, where customers value technical support and after-sales service. If large, low-service distributors win all the business, small, high-service distributors will soon stop selling the company’s lines due to low margins. In the long run, no one will be left to provide the technical support and after-sales service that some customers value, leading to a decline in the manufacturer’s sales.

When channel competition is welcome
Fortunately for many companies, the conditions that make channel conflicts harmful do not always arise. Manufacturers of mass-consumption products whose communication reaches the customer directly (pull strategies) may even benefit from channel competition. In these cases, the role of distributors is mainly logistical. When a distributor faces heavy competition in a particular region, it may not be profitable to compete there due to low retail prices. The distributor will then have incentives to look for new, less-served regions where it can enjoy better margins. As a result, the manufacturer—often without realizing it—expands its geographic coverage and numerical distribution. The same applies to undifferentiated industrial products, where the selling and service efforts carried out by the channels are low or nonexistent.

Functional discounts
So what can be done in cases where channel conflict truly represents a serious threat to the company’s sales? Simplistic compensation schemes based on volume discounts, as well as practices such as exclusive territories and account assignments, have proven ineffective for resolving channel conflicts. The best distributor compensation practice known to date is called functional discounts. These simply consist of paying channels according to the functions they perform that add value to the product. Sony, in addition to offering volume discounts to segment wholesalers from retailers, offers additional discounts for display conditions, in-store advisory, and after-sales service, in order to segment distributors by service level. This way, Sony Center can offer competitive prices despite having higher costs and receiving smaller volume discounts. And if an informal retailer or hypermarket wants access to these discounts, they can obtain them as long as they comply with Sony’s required display and service standards. Similarly, an industrial manufacturer grants additional discounts to channels with the technical support infrastructure and after-sales service capabilities.

In summary...
A certain level of competition between channels is healthy for the manufacturer, as it can improve both the quantity and quality of distribution. Only when it truly harms the company’s sales does it become a problem that deserves attention. In such cases, the important goal is not to prevent distributors from competing with each other, but to ensure that the channels adding the most value to the product and generating the most demand activation can remain competitive. And for this, it is essential to design a proper channel-pricing strategy that is transparent and proactive—one that encourages distributors to adopt behaviors beneficial to the manufacturer without requiring policing controls that make strategy management inefficient and costly.