Channel Fraud Still A Big Issue For Vendors

While some distributors and solution providers bemoan the fact that vendors want more information on end users, unauthorized sales in the channel by some of those same companies are a big reason why vendors say they want the information in the first place.

Vendors believe too much of their product is ending up in the wrong hands, and in at least one instance a vendor took the drastic measure of ending the relationship to stop what it considered fraudulent activity in the channel. Seagate last November deauthorized its top U.S. distributor, eSys, after it grew suspicious that eSys wasn't accurately reporting sales. The vendor wanted to bring in a third-party auditor, but eSys said no.

Seagate says eSys refused to provide sales records to the vendor and would not cooperate with an audit. For its part, eSys said it declined Seagate's requests for an "intrusive" audit because of its commitment to the confidentiality of data relating to its customers and other vendors.

"The audit would not be justifiable to our worldwide business partners under normal business practices," according to a statement from eSys.

Neither Seagate nor eSys could be reached for comment for this article.

The incident highlights a growing issue for the channel: How do you strike a balance between protecting customer information and vendors' rights to protect their revenue and profits? It's an uneasy subject for all parties, but one that needs to be addressed, said Jonathan Elster, executive vice president at distributor SED International.

Unauthorized sales are an increasing problem, despite advances in sales reporting systems, he said.

"This is a story that needs to be told. We deal with it on a daily basis," Elster said.

Problems arise when product is sold to a different customer than for which it is intended, executives said. In such cases, vendors often won't support the product, leaving customers screaming to solution providers, even if the solution provider was not at fault.

In the past few months, Post Computer Systems had at least two customers buy whitebooks that were meant for foreign markets and thus were unsupported by manufacturers, said Art Torres, owner of the Wilbraham, Mass.-based PC solution and service provider.

"We said you can return it where you bought it, or you can pay us to come in and do any work on the units. They chose to pay us," he said.

The end users bought the whitebooks from other sources because Post Computer could not match the price, Torres said. In both cases, it was the end user that learned the lesson. "We look like the hero more than anything else," Torres said.

Arlin Sorensen, president of Heartland Technologies, a Harlan, Iowa, solution provider, said stories like that outweigh concerns about vendors calling a customer. It's best to run your business as if vendors can get any information, he said.

"I'd love for them not to have a direct marketing touch, but that's just not real. The customer relationship is the key driver to dong business with us anyway. We're never the lowest price. The burden is on us to maintain strong ties to the customer," Sorensen said.

"We run into channel conflict at times. We always get the channel sides of the [vendor] organizations involved. They intervene and get the direct side to take the customers out of their database," he said. "The concept of doing business with generic customers is not going to happen. They can get it anytime they wanted anyway."

Another solution provider who learned the hard way said it pays to pass on deals that seem too good.

"I used to work for a company that jumped around from distributor to distributor. I was working with a high-end customer putting [Seagate] hard drives into medical devices. [Another executive at the solution provider] finally convinced me to use eSys. The pricing was great and they swore up and down they were U.S. drives. Then the thing blows up in my face," said the solution provider, who asked not to be named.

The VAR sold its customer drives marked for Asia and Seagate told the end user, without the VAR's knowledge, that it would not support the drives. The irate end user called the solution provider and its role as trusted adviser to his customer was damaged.

The solution provider called Seagate and told the vendor where it had sourced the drives. All parties worked a deal to make amends with the end user and a reputation was repaired. "We have a better relationship now [with Seagate]," the VAR said.

Still, it's a situation the solution provider now proactively tries to avoid.

Next: Cleaning up the channels

Some distribution executives believe the Seagate-eSys example is likely not an isolated one, but they could not provide specific examples of fraud in the channel.

"This is a microcosm of what is happening [in the market].[Some [companies] are literally lying, cheating and stealing," said one distribution executive, who asked not to be named.

The executive believes some wholesale "distributors" are really brokers skirting the truth in their sales reports to make more money.

As an example, the executive said a wholesaler will tell a manufacturer that it needs a special price for one customer on a 10,000-unit deal. In reality, there is no large-volume deal. The distributor sells the units in small orders and keeps the extra money made through the volume purchase price.

In another scenario, a distributor may buy 10,000 units and tell the manufacturer that it sold 1,000 units and needs price protection on the other 9,000 units. In truth, the distributor may have sold 7,000 units and thus receives price protection on units already sold. It either pockets the financial gain or uses it to lower prices on its next shipment of product and further commoditize the vendor's products.

In either case, the model disrupts the natural flow of the channel, the executive said.

"As vendors get more sophisticated in their [sales] reporting, they realize these guys don't add value, they they're only getting to the lowest price by cheating," the executive said. "It will be a little bit of a wake-up call to the industry to [find] some of these alternative distributors that cheat so blatantly."

More and more vendors are taking steps to clean up channels by requiring more customer data, Elster said. He cited Pioneer Electronics, maker of displays and recordable-media drives, as one example.

"They've changed their special pricing approval process and asked us for more information to stop product from coming from overseas. We get copied on e-mails coming from the U.S., coming from Europe. They've done a better job tracking serial numbers, which is a new thing to find exactly where the product is coming from and who sold it to begin with," Elster said.

The most-volatile product category is hard drives, said distribution executives, but there are growing concerns with optical drives such as DVD- and CD-R/RW drives, too. Several executives and solution providers said finished goods also are at risk.

"A lot of vendors have changed their pricing models so that all regions have the same pricing. That will help the problem but for so many years, there were so many different rules," Elster said.

North America is a year or two ahead of other regions in terms of trying to clean up channel issues, but it will remain a challenge as long as there is even one weak link in the supply chain, said Kevin Murai, president and COO of Ingram Micro, Santa Ana, Calif.

"We're recognized around the world as distributors with the culture and the polices in place to drive ethical business with all our partners," Murai said.

One large distributor claimed to have walked way from hundreds of millions of dollars in business over the past few years because it was unprofitable to the point that customers were buying products for less than it could buy the products, said an executive who asked not to be named.

"It's not in anybody's best interests, in particular our customers, to have a channel that has those kinds of practices. There needs to be better transparency on pricing to allow distributors and solution providers to compete on value, not just on price," the executive said.