Lead or Follow: Channel Pricing Strategies for the New
Channel pricing is one of the least understood and most complex aspects of a
supplier’s go-to-market strategy. To develop an effective strategy, suppliers
must establish discount levels for various customer segments and multiple
channels serving each segment. In addition, e-commerce and evolving logistics
capabilities are changing the roles that partners perform and, therefore, the
compensation that they should earn. Channel power, conflict and competition further
complicate the development of effective strategies. To be economically rational, a
strategy must consider go-to-market costs. Suppliers, however, have different costs
to serve each channel and partner.
Furthermore, distributors, retailers, and other channels have unique cost structures
and value-propositions of their own.
Given this complexity, it is no wonder that many suppliers simply copy their
competitors’ programs or remain paralyzed by indecision. With no underlying
rationale, suppliers drive down their own and their competitors’ profitability by
offering deeper discounts, rebates and allowances. At best, many suppliers resort to
a rash of special deals that are costly to manage and represent no overall strategy.
Progressive suppliers understand channel pricing. They take a leadership position to
protect their own profits and profits throughout their industry. A leadership position
can lower operating costs, improve customer satisfaction, and accelerate growth.
Suppliers without a well-considered strategy subject themselves to continued margin
erosion and the dissipation of their value to the channel and to the customer.
Channel pricing is fundamentally different than traditional pricing. Traditional pricing
sets the value of a product or service to customers in a competitive market. While
value pricing is important, it is not sufficient. The value of a product or service
depends on the customer’s entire experience including the interaction that
the customer experiences wit h the distribution channel. If the supplier does
not get its channel pricing right, it will never fully realize the value of its offering.
Channel pricing establishes the amount of compensation that independent
distribution partners earn on the sale of products or services. It pays for the
activities that third parties perform on the supplier’s behalf. It establishes whether
distributors, retailers, resellers or other channels will focus on a supplier’s brand or,
conversely, seek alternatives. It drives the channel’s behavior to take costs out of
the supply chain or to invest in activities that generate demand. Most manufacturers
think of channel pricing as little more than volume discounts or growth incentives.
While these programs may play a role, in today’s complex environment, suppliers
must utilize channel pricing to pay for functions performed, motivate behavior,
manage conflict and take costs out of the supply chain.
Factors Driving Suppliers to Rethink Their Channel Pricing
More than ever, markets are experiencing profound change. Is e-commerce the
Second Coming of the industrial revolution? Maybe yes, maybe no. One thing that we
can count on is a continued evolution of the relationships between suppliers and their
downstream partners. Suppliers must change the way they pay their partners as
these relationships evolve.
Advances in E-Commerce and Logistics Systems
E-commerce is revolutionizing the business world and will surely revolutionize
relationships between suppliers and distributors.
Regardless of the approach that each supplier selects in the new economy, the
common denominator is that relationships with downstream channel partners will
change. As these relationships evolve, suppliers must change their channel pricing
structures to reflect the functions that channels perform.
Channel Consolidation and Globalization
Distribution channels are consolidating to take advantage of economies of scale and
to leverage volume purchasing power. This consolidation enables them to extract
ever increasing concessions from their suppliers. Suppliers that are not armed with
an understanding of channel economics place themselves at a disadvantage in these
relationships. Channel pricing programs, including discounts, rebates, commissions,
allowances, and special deals, are very costly. Examples that illustrate these costs
? Rebates average 15% to 25% in certain industrial markets
? Distributor discounts of 90% off of list price in segments of the
building material industry
? Promotional funds average 12% of sales for consumer packaged goods
Most suppliers do not realize that after making the product, their highest cost of
doing business is the discount that they pay to their distributors. Suppliers must
consider the cost of these discounts in the context of their ability to sell direct. If the
supplier sold direct, it would sell at the street price rather than at the net price to the
channel. The distributor’s margin represents the cost that manufacturers incur by, in
effect, outsourcing distribution to distributors.
Globalization intensifies the challenge. Suppliers must offer pricing structures
that are coherent across geographical boundaries, trading blocs and
currencies. Suppliers that do not address these issues will suffer embarrassment
and reduced profits as customers and channel partners exploit irrational channel
The Need to Manage Conflict Among Channels with Different Value
Suppliers across industries go to market through a variety of channels. Each channel
has a unique value proposition and role within the supplier’s go-to-market strategy.
Each applies its margin or cost structure to most effectively serve the customer.
Suppliers must understand what they are dealing with when they experience channel
conflict. There are cases where a low-cost channel has simply found a more efficient
way to perform distribution functions than a higher cost channel. If this is the case, it
may be necessary for the supplier to simply allow channel Darwinism to occur.
Some partners however require high cost structures to take care of demanding
customer segments, support technical offerings or perform a bundle of value-added
activities. A common type of channel conflict occurs when high support channels
educate customers who ultimately buy from low-cost, low support channels. A
pricing structure that pays high support channels when their value-added services
are required is an effective tool to enable a supplier to achieve its marketing
objectives. A pricing structure that ignores the free rider effect or exacerbates
destructive conflict will cause the supplier to lose the support of its value-added
The Ability to Influence Behavior through Effective Channel Pricing
Channel partners, like most organizations or individuals, respond to financial
incentives. Channel pricing motivates partners just as sales force compensation
motivates the behavior of a supplier’s sales force. Executive compensation is tied to
performance—suppliers should also tie channel pricing to performance in
accordance with business objectives.
Channel pricing incentives do not have to be paid in large percentages to motivate
behavior. Of course the amount of the incentive depends upon the volume that the
percentage applies to. A one-percent incentive represents far more for a partner that
purchases $100,000,000 annually versus one that buys $10,000 per year. In either
case however, it is useful to remember that a typical distributor or retailer generates
2% to 3% net profit before tax. A one-percent incentive, if it went to the channel
partner’s bottom line, could increase net profit by 50%.
Factors to Consider in the Development of Effective Channel
Objectives and Values
To design effective channel pricing structures, start with your objectives.
The program must reflect the supplier’s overall sales and marketing
strategy. Is the objective to push new products or services? Reduce transaction
costs? Manage channel conflict? Effective design can drive successful business results
in these and other areas. Dysfunctional channel compensation programs can thwart
sales and marketing efforts or wreak havoc with operations.
Identify the activities and functions required to satisfy customer needs.
Segment customers based on their buying needs, purchase potential and
price sensitivity. This step establishes the activities that the supplier or its channels
must perform. It also establishes whether there are customer segments that require
unique channel pricing models.
Channel Capabilities and Objectives
Profile existing and alternative channels to determine whether they have
the capabilities to satisfy customer requirements. Consider all channel options
including direct, distributors, e-commerce, logistics, and other third-party providers.
For each channel option, determine whether functions such as sales, credit, logistics,
technical support, and order processing can be separated or whether the channel
must be hired to perform a bundle of activities.
Discounts are based on costs as a percentage of revenue. Consequently, it is
necessary to identify the supplier’s revenue potential through each channel
option. Start with the price that the end user pays (street price). This price level
sets the amount of revenue that the supplier could generate by selling direct.
The supplier’s revenue will depend upon channel conflict and power. An evaluation of
channel conflict indicates whether partners will abandon the product line as a result
of excessive competition. An evaluation of channel power considers whether the
supplier will lose sales if it does not sell through the end users’ preferred channels.
Determine the discounts and other forms of compensation that competitors
offer to channel partners. This is a data point for the discounts that the supplier
If the supplier has channel power, it will be able to offer lower discounts than
competitors. If the supplier has little or no channel power, it will have to offer
discounts that are equal to or higher than the competition.
Three cost analyses provide important information for suppliers to develop optimal
channel pricing strategies.
? Direct costs-identify costs, as a percentage of revenue at street price, which
the supplier would incur by selling to or providing functions directly to end
users. The supplier should be willing to offer a discount that is equal to or less
than the supplier’s own costs to serve the end user
? Indirect costs—profile the channels’ costs to perform functions required by the
supplier to satisfy end users. If the supplier utilizes distribution channels, the
compensation or discount to the channel should not exceed the channel’s
costs and a reasonable profit.
? Retained costs—assess the supplier’s retained costs under each channel
option. This assessment will help the supplier determine channel profitability
and investment. From a pricing standpoint, this analysis establishes the
baseline for pricing incentives such as volume, prompt payment, efficient
ordering, and other discounts that lower these retained costs.
Sometimes suppliers should develop structures that differentiate themselves from
their competition. In other cases, market leaders must drive entire industries to
change. Under traditional pricing approaches, suppliers let fear and competition
transfer profitability downstream. This profit transfer deteriorates the industry’s
ability to invest in new products and services and ultimately harms the customer. To
break out of this box, market leaders must introduce rational channel pricing
strategies that transfer profits back upstream.
These challenges require that suppliers develop new channel pricing structures that
provide flexibility to utilize channels strategically. New approaches pay for functions
that channels perform and do not pay for functions that channels do not perform.
They motivate partners to generate demand and lower supply chain costs. They pay
for performance and results and do not drive inefficiencies. They are rational across
channel partners, products and geographical boundaries. Optimal channel pricing
strategies are based on an in-depth understanding of costs, channel power and
conflict. This enables suppliers to respond strategically to partners that demand
deeper discounts and to determine when it is best to follow the competition and
when it is best to lead.