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Deep Dive: Data rules upend channel partnerships
Can new data collaborations revitalize the value chain and accelerate the B2B revolution?
Welcome to my second newsletter on innovating B2B. I believe that every leader and every company must develop foresight about the future of business. Without foresight, there can be no innovation. In this edition, I review the mechanisms that lock the existing manufacturer/distributor partnerships in place. More importantly, I hope to kick-start a conversation about how new collaborations around data can revitalize the value chain and unlock entirely new B2B innovations. The ideas below are only a start. I invite you to add your comments and help push the conversation along.
Envisioning new partnerships
In the digital age, every business—and every business partnership—will run on data. This is undeniably true for the traditional value chain of manufacturers and distributors. At its best, the value chain operates as a collaboration of partners with dissimilar business models to achieve a shared goal—serving customers with integrated products and services. However, the formal arrangement that codifies the partnership is stuck in the past, reflecting long-held assumptions about business models and capabilities. Manufacturers and distributors are pursuing innovations without an understanding of how shared customer data, collected by manufacturers and distributors, can create mutual benefit and reinvigorate the partnership. Absent plans for collaborative data, the traditional value chain will become less relevant for serving customer needs.
In my conversations with business leaders, I found optimism that a new partnership can be discovered and implemented, perhaps best represented in this quotation from my book Innovate to Dominate: The 12th Edition in the Facing the Forces of Change® Series:
I think there is an openness with suppliers to talk about new approaches. Manufacturers recognize the value of distribution, and with all the disruption and digital transformation that is happening, they are willing to discuss how things might be done differently. We have been working on leveraging our data, automating our warehouses, and creating a multichannel or omnichannel structure. Artificial intelligence is now a part of this. On the one hand, artificial intelligence is about helping our inside sellers get up to speed very quickly on critical customer information. It’s about putting the right product information in their hands to enhance the sales process. On the other hand, artificial intelligence has a lot of potential to eliminate keystrokes so orders can move through your systems without human involvement. We’re starting to hear more about robotic process automation. We are making good progress, but if we work with suppliers on the value chain, we can do much more. Distribution is the sleeping giant in the middle. Distributors don’t spend a lot of time thinking about innovation, but if we set some time aside, and include our best suppliers, we can create new models. Lots of things are possible, it starts with taking time out and asking, “what if.”
President and CEO, Industrial Distributor
When products ruled
Before greenfielding a new partnership, it is essential to understand the constraints established by existing value chain mechanisms. The primary controls that guide value chain operations are distributor authorizations and channel compensation plans authored by manufacturers. Distributor authorizations define the primary roles assigned to manufacturers and distributors and assume that a manufacturer’s products are the primary source of value for customers. A distributor’s role is to stock inventory and service demand. Pricing structures provide a distributor discount that covers the cost of carrying local inventory and taking orders. Volume discounts motivate distributors to load up on stock in anticipation of customer orders. Additional discounts and rebates serve to enable tactical business operations and, sometimes, strategic alignment. Tactical execution is about facilitating payment terms, product returns, warranty administration, and so forth. Strategic alignment is achieved when discounts and rebates are deployed to motivate participation in marketing programs, coordinate sales activities, or encourage investment in capabilities that support a manufacturer’s brand or overall market positioning.
The one-two punch of distributor authorizations and channel compensation plans are a powerful combination because they impose a “buy and resell” margin-based business model for distributors. Distributor pricing establishes a gross margin that enables a cost structure for basic activities, consistent with a distributor’s overall value proposition for offering commodity services or specialized value. Incremental incentives (discounts and rebates, for instance) are small relative to a distributor’s top-line revenue but massive relative to net margins. For example, if a distributor earns a 4% net margin, a 1% discount on a manufacturer’s product represents an opportunity to increase net profits by 25%. Combined, distributor authorizations and channel compensation are a powerful force for policing existing value chain operations. Moreover, they work against new collaborations based on shared data.
Data is the destroyer
Armed with a view of the past, we can now imagine the future. The future is about data. Manufacturers and distributors are digitally transforming their businesses. If a manufacturer’s products can generate data as used by customers, they are making plans to capture that data to better track product performance, manage repairs, prompt replacements or upgrades, and transform pricing models. But independent of product planning, manufacturers are overhauling their go-to-market assumptions. Digital marketing creates the opportunity for manufacturers to have a more direct and engaged relationship with customers, diminishing the perceived necessity for distributors to manage the front lines of customer relationships.
Moreover, e-commerce enables manufacturers to build platforms that enable customer shopping, cost analysis, ordering, and scheduling delivery to meet operational requirements. Combined, there is a huge temptation to skip around distributors, disintermediate them, and take back marketing, sales, and fulfillment roles traditionally transferred to distributors. If necessity is the mother of invention, the absence of necessity is the father of disintermediation. Every business wants to control its destiny. If manufacturers decide that they need distributors less than before, they will build a digital capability, enabled by data, to achieve that outcome.
Distributors are also digitally transforming and making very similar calculations. If manufacturers no longer need distributors to stock inventory to service demand, distributors must evolve their business models to focus on their front end. The customer experiences they offer are supported by digitally enabled marketing, sales, technical support, delivery customization, and more. Instead of selecting a portfolio of products and brands stored in a warehouse and optimized to achieve margins to cover the cost of a fulfillment-focused business model, distributors are instead imagining a portfolio of customer experiences. These customer experiences assume that distributors can create value for customers based on their knowledge and the capabilities of their people and processes, enabled by data, artificial intelligence, and automation. More and more, it is every distributor’s dream to break free of the longstanding “buy and resell” business model where their margins are constrained, directly and indirectly, by manufacturers.
Ideas for innovating B2B
I found inspiration and a potential path forward in an article published by McKinsey Analytics titled Collaborating for the common good: Navigating public-private data partnerships. Just as private corporations and public entities are dissimilar organizations that might collaborate around data for social good, manufacturers and distributors have different business models that might collaborate for customer benefit. New collaborations are not without risks, and the article identified four categories: commercial, regulatory, security, and privacy/ethical risks.
Perhaps more importantly, since we are at the very beginning of imagining a new value chain partnership, the article identifies five dimensions of value that may be achieved through data collaboration:
Discovery of new insights
Faster, more accurate decision making
Increased prediction accuracy
Optimized process efficiency and coordination
Every B2B leader should understand how McKinsey’s value dimensions and risk categories translate from public/private collaborations to leveraging data in the context of manufacturer/distributor partnerships. I intend to use this framework in my ongoing research for my NAW Fellowship, and I would encourage my newsletter audience to do the same. If we are to revitalize the value chain so that it runs on data, we must work together to answer at least four critical questions:
What are the immediate and longer-term benefits that can be created for customers?
What data can manufacturers and distributors contribute to creating those benefits?
How can the data be combined, analyzed, and acted on while protecting proprietary interests?
What are the new value chain control mechanisms that will replace the old ones?
It seems to me that as distributors and manufacturers reinvent their partnership around data collaborations, the concept of the value chain may not even apply. A chain implies a linear progression of value, starting with products, and with services added to a final customer solution. Suppose the manufacturers and distributors are innovating on the front end of their businesses, creating new customer experiences. In that case, a more relevant visualization of the partnership may be that each partner stands side-by-side serving customers. In this context, the future of B2B may be less about a value chain and more about a value team, alliance, bridge, or complement. Words are important. Words can spark a new mindset. And if the value chain is to reach its full, revitalized potential, a revolutionary mindset may be mandatory.
Join the journey
Thank you for reading my second newsletter on innovating B2B. Like the first, my goal is to introduce new ideas and look for a path forward. Read the McKinsey article here. Share your thoughts in the comments section below. Don’t be a stranger. If you like, reach out directly at email@example.com.