Study: Channel Program Abuse Costs Vendors $1.4 Billion In Profit

Abuse in vendor channel incentive programs may be costing manufacturers up to $1.4 billion in lost profits each year, according to a white paper called, "When Channel Incentives Backfire," by Deloitte & Touche and sponsored by the Alliance for Gray Market and Counterfeit Abatement (AGMA).

The abuse of channel incentives, which chiefly involves VARs receiving special pricing for a specific customer but not selling all the products to that specific customer, also helps to fuel a still-thriving gray market, according to Deloitte.

"We see this as an industry-wide problem. A lot of companies want to move product through distribution partners and resellers and they're offering up various promotions and discounts, special pricing deals," said Brent Nickerson, a partner at Deloitte & Touche. "What we found is those programs are not monitored, not managed, and companies don't have controls in place to track veracious programs to their partner community which can lead to abuse."

Survey respondents, nearly half of whom came from large vendors with more than $25 billion in annual sales and indirect channel models, estimated that incentive abuse may affect up to 25 percent of all channel sales, according to the study.

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In addition, half the respondents strongly agreed that incentive abuse is responsible for gray market activity.

The first area of vulnerability, according to the study, lies with the broad base of channel partners. Two-thirds of the vendor respondents count on more than 5,000 channel partners to bring their products to market, which increases the probability of abuse, according to Deloitte.

Further, more than half of all channel sales receive incentives, according to two-thirds of the companies surveyed. Special pricing, once used to help vendors and VARs secure big deals rather than lose them to a competitor, is no longer special.

"Channel incentives designed to boost sales and boost loyalty and motivate sales, are open to abuse. What's staggering is to look at our own member companies who don't realize the extent of the problem," said Scott Olson, spokesperson for AGMA regarding the study and vice president of global price and sales compensation management at APC by Schneider Electric.

Jana Arbanas, a senior manager at Deloitte & Touche, said more of an onus should be placed on vendors to create channel programs and controls strong enough to ensure that the right product gets to the right end user at the right price.

"Without proper controls, opportunities for channel partners to take advantage will continue. It's creating this unlevel playing field that causes channel partners to look for ways to circumvent because they need to compete at a lower price," Arbanas said.

The study could not ascertain whether much of the incentive abuse is being committed by a small number of partners or whether a large percentage of solution providers occasionally abuse the system, Arbanas said.

Channel abuse becomes a cyclical problem with both VARs and vendors blaming the other while the situation worsens, added Olson.

"If you've got poorly designed programs they will ultimately get abused. It creates channel animosity almost between partners, and manufacturer resentment," he said. "If I'm a VAR, I may be pleased if I'm able to take advantage of loop holes but it hurts you in the end because you compete against the same issues you were taking advantage of so to speak."

Next: Abuse Voids Warranties

Russell Peacock, president of Xerox North America, said at the recent Xerox Fusion conference that it's incumbent on vendors and solution providers to work together to remediate channel program abuse.

"We do have a brand protection group that focuses more on supplies and consumables than hardware. But no question there's been significant abuse. The processes have not been strong enough to control that environment," Peacock said. "It's important we focus on the worldwide market, a lot of abuses are cross-border trading. People acquire product in a geography where it shows up below distributor [pricing]. We work very hard on initiatives around the world to stop stop leaking revenue."

Tom McDonald, president of NSI, a Naugatuck, Conn., solution provider, said it's in customers' best interests to buy only authorized products, even print supplies, because a vendor may not honor the warranty for products purchased through illegitimate means.

"We're running into that in the market. We had one customer that had some [United Kingdom] part numbers. We had to explain to them you don't want this attention. Eventually they realized the price [they paid] was too low," McDonald said. "I think most manufacturers are pretty good at tracking stuff down. If we got a special bid pricing for 100 units for education and sold 10 to corporate, that would come back to haunt us. The customer is going to report a warranty claim."

In the study, Deloitte does not recommend harsh penalties for abusers, instead recommending more education about the programs themselves and stronger terms and conditions for VARs, said Nickerson.

"One key feedback point we heard was enhancing the level of communication between manufacturers and partners. Communicate the benefits of incentive programs: what is permitted and what is not permitted," Nickerson said. "We're not so much looking to penalize partners but rewarding those partners that abide by the rules, send in their reports on time and accurate. Those partners should be rewarded for that behavior. We see that as a pretty effective tool." Terminating or de-authorizing a partner for continued abuse can be a costly proposition, he added.

"Termination is always an option but what we find is more effective is encouraging more positive behavior and complying with the agreement. We also have seen as an effective strategy sending out alerts when a bad partner abuses the system to send a message to the market and make them an example," he said.

Deloitte offers some long-term and short-term recommendations to improve channel incentive programs.

First, vendors must gain control of their programs, a problem exacerbated by the fact that vendor executives said in the study that they struggle to get the necessary resources internally to better manage and monitor channel programs, Nickerson said.

"These are companies that are global players in multiple markets with multiple incentive programs," he said. "Many vendors are so decentralized and managed at a geography level, they don't know the population of programs out there."

Second, vendors need to create more consistent policies and procedures, according to the report. "Stay close to the business and the sales reps working with distributors and resellers to monitor activity," Nickerson said.

Third, vendors need to better educate their channel partners on channel incentive programs, he added. "That creates communication and more touch points throughout the sales cycle," he said.

Next: Two-Way Communication Helps

Lastly, vendors should set up a self-monitoring program for channel partners where they can audit themselves to ensure their compliance in incentive programs, Nickerson said. "This self reporting could be checked periodically by vendors," he added.

In the short term, manufacturers should revisit their program terms and conditions to close any loopholes, said Arbanas.

"You want to make an environment where channel partners are incentiviezed to do the right thing, with a strong contract and [terms] to clearly state what a channel partner's obligations are," she said.

Deloitte also recommends an increased focus on serial number tracking to give vendors better visibility into where the product ends up.

"With special pricing deals, if you could trace back through the system for partners involved and what went awry for why serial numbers ended up in the gray market," Arbanas said.

Communication should also be a two-way street, Arbanas said, with solution providers being more proactive talking to vendors.

"In conversations with some companies we interviewed, when channel partners are doing the right thing but are struggling with an unlevel playing field, that communication becomes important," Arbanas said. "Vendors rely on channel partners to provide information as to what's happening in the market. Some vendors had great experiences when partners come to them to address some of those conditions."

Despite the fact that the proliferation of incentive programs has turned special pricing basically into discounted every day pricing, the programs are not likely to go away, Olson said.

"We're all committed to investing in channel incentives, to make those marketing dollars be most effective, a pay for performance. If we tighten some programs, it will be a win-win," Olson said. "It's not just a choice between control or profits. Some benefits are a better functioning environment, a more even playing field, but it also makes better programs. We find some programs to be more effective and make reinvestments in those."