Is Your Discount Structure Pushing Your Product into Commodity Status?

Tactical mistakes with your channel discount structure can lead to strategic mistakes in the market.

A leading industrial manufacturer approached us with concern about the "commoditization" of their market and the channel's unwillingness to support a premium for its product. After some analysis, we were able to determine that the manufacturer's discount structure encouraged far more commoditization than that of the market or channel alone.


Background on Volume and Growth Rebates
Historically, manufacturers relied almost exclusively on two basic forms of channel compensation to drive its channel strategy
Volume discounts - the more you buy the better the price
Growth rebates - the more you grow the bigger the rebate

These programs greatly favor the biggest channel partners and encourage the growth of the largest distributors at the expense of the small and medium distributors. While this may have made sense 30 or 40 years ago when there were not many billion dollar "mega" distributors, the channel environment has dramatically changed since then. Billion dollar "mega" distributors exist in almost every major industry, driven by the growth of national contracts associated with strategic sourcing. Today, everyone is familiar with names like Wal-Mart, Target, Best Buy, Circuit City, The Home Depot, Lowe's, and Costco on the retail side.

However, similar but less familiar names exist in other markets. For example, the industrial market has Motion Industries, WESCO, Grainger, Ferguson, Graybar, Hagemeyer, C.E.D, Anixter, Fastenal, Airgas, MSC and McMaster-Carr. The technology market has created the "mega" wholesaler distributors, Ingram and Tech Data, which continue to see growth from "mega" second-tier distributors like CDW. Unfortunately for manufacturers that lack strong brands and policies that support a differentiated brand, the "mega" distributor will almost always encourage the commoditization of brands as a method to increasing its market power. One of the most notable examples was Rubbermaid's losing struggle with Wal-Mart, which ultimately resulted in the purchase of Rubbermaid by a competitor.

Manufacturer Case Study Example
The success of the manufacturer's product has historically been built on a high-quality, technical product that was sold and supported by a technically superior channel. The technical sales and support expertise of the channel supported the premium product positioning and pricing by ensuring that the end users received the additional technical expertise they needed. Channel power began to consolidate into the hands of few, very large distributors. The manufacturer felt compelled to give these large distributors the "best" price through volume discounts and growth rebates, even though the manufacturer acknowledged that these distributors were far less loyal and often did not provide the end user with the same level of technical support and/or value add offered by its traditional distributors.

The net result was that the large "mega" distributors used a combination of the following to lower the product street price and gain market share from the traditional distributor.
Lower cost structure - created by economies of scale and by simply not offering all the technical support and value-add activities
Lower buy price- created by the manufacturer offering large volume and growth rebates

As this situation continued, it generated a large amount of dissatisfaction from the traditional value-added distributors. Ultimately, the traditional value-added distributors did one of two things
Lowered their price, but stopped performing the additional value-added activities necessary to differentiate this product to the consumers, which allowed them to reduce their costs
Stopped selling the manufacturer's product


Discount Structures Encourage Street Price Erosion

The final result for our client was that
A significant point of strategic differentiation (channel technical support and value-add) was almost lost completely
The street price of their product was substantially reduced putting tremendous pressure on them to lower the distributor buy price
Channel power was shifted away from the manufacturer and strongly in favor of the large "mega" distributors


Summary
Most manufacturers fail to realize the significance of their channel pricing programs on channel behavior and, ultimately, product differentiation. Volume and growth rebates are frequently applied inappropriately, and this can result in negative consequences for the manufacturer's strategy. In the case above, the actions of the manufacturer contributed most significantly to the commoditization of the product.