Deep Dive: Creating a value chain for the digital age

Innovation demands foresight and collective action; can manufacturers and distributors work differently to build a next-generation supply chain?

A value chain for the digital age is a data-driven system with participants operating as connected businesses. The coming value system will run on processes steered by algorithms in pursuit of values and goals set by humans. Such a future is revolutionary and will not be achieved without tearing down some of today’s accepted dogma and raising up a way of doing business with new cultures, capabilities, processes, and leadership.

In this Deep Dive edition, I explore two truths that stand in the way of innovating the value chain. I hope to expose and explore the accepted practices that stand in the way of progress. I invite you to share your ideas and experiences, your hope for the future, and the things we must all do to get there.

Acknowledging unspoken truths

Two truths stand in the way of innovating the B2B value chain for the digital age. The first truth is that manufacturers and distributors cannot innovate without foresight, also known as an actionable story for the evolution of customer offerings, business models, and partnerships. The second is that the value chain will not transform without collective action. These truths are suspected but not acknowledged; whispered but not spoken. 

A robust and truthful conversation is required to move forward—one that explores both truths from every angle and identifies the intractable barriers that lock today’s system in place—and that replaces them with new partnerships and mechanisms for shaping roles, guiding behaviors, and allocating profits.

Foresight is fighting for the future

Distributors and manufacturers cannot innovate without foresight. Companies can implement best practices without foresight, but doing so isn’t innovating; it’s copying. Innovation is doing something new. Innovation requires ideas. Innovation is hard because business leaders can’t (or won’t) break free from running their business to think about what it might become in the future. Disruptors innovate from the outside, seeking to defeat or displace incumbents. Incumbents react defensively, surviving without thriving; adjusting, not innovating. Foresight is fighting back, and fighting forward.

The B2B value chain, the manufacturer-to-distributor-to-customer end of the supply chain, is a collaborative partnership. The collaboration is both voluntary and compelled. Manufacturers can go it alone, selling direct to customers and disintermediating distributors. But customers value distributors’ services, creating pressure for manufacturers to use them. Relations can be tense, but the partnership works because manufacturers and distributors are mutually dependent, needing each other even as they fight over who owns the customer and how the earned margin is allocated.

Distributors and suppliers share an understanding of how partnerships work today, but they lack foresight for how they might work in the future. Doubtless, as intermediaries and manufacturers, both parties view the future differently, seeking the best positive outcomes for their differing business models. Debate is essential, but so is a commitment to seeking mutual benefits. Foresight, shared and considered, is mandatory.

Foresight is not a skill that can be learned, but an attribute that must be developed. I will dig into developing foresight in an edition coming soon, applying insights from a book by Rich Diviney. But for now, I assert that foresight is a critical requirement for building a digitally enabled value chain. But it’s not sufficient. Something more is needed.

Collective action is recommitting to collaboration

If the value chain is to step up to its fullest potential in the digital age, partners must learn how to share and automate around data long held as proprietary. And they must automate so that algorithms do in seconds what warehouse workers, truck drivers, salespeople, marketers, buyers, accountants, and financial analysts currently do over hours, days, quarters, and years. And they must connect, so that smart and hyper-fast activities happen in a way that coordinates manufacturer and distributor activities, working together to create new and unexpected customer value. 

The second truth is that the value chain cannot transform if the partnership, and the mechanisms that guide and enforce it, do not themselves transform. The partnership in every industry and line of trade must evolve in a way that is aligned with unique customer needs and market dynamics, but is also based on a shared, understandable, and implementable framework. Otherwise, the value chain will deconstruct and decentralize, confusing and de-satisfying customers. That path will lead to the lowest common denominators, meaning competing on price with commodity products and services.

Committing to collective action for transforming the value chain begins with finding a shared purpose—one that is best served by a vibrant value system comprised of all distributors and manufacturers working together in new and unforeseen ways. That purpose will not be just about finding competitive advantage and earning profits for companies and their owners.

Distributors and manufacturers do business in free markets as partners that often collaborate and sometimes compete—and financial success is of the utmost importance. But they also operate in a worldwide system of commerce impacted by increasingly assertive authoritarian regimes and changing geopolitical dynamics. By stepping up through intentional collective action, manufacturers and distributors can modernize the value chain for the digital age and, at the same time, help protect our free and open way of doing business.  (Read here for more on freedom and protecting our modern, collaborative way of doing business.)

Understanding the current system for what it is

During the post world war era, a system settled in place that still exists today: Distributors sell products manufactured by suppliers, and suppliers set prices and provide incentives that directly impact a distributor's ability to operate at a profit. Working together, manufacturers and distributors function as a system, and channel compensation is the mechanism that makes it work. Channel compensation—meaning discounts, rebates, and market development funds—sets the distributor’s buy price, shapes margin potential, and directly impacts distributor profits. Channel compensation is a powerful mechanism because, accepting reality, distributors optimize profits by negotiating roles, policies, and strategies with suppliers and then work to earn incentives (and profits) around activities that achieve mutual benefit. 

Most of the time, channel compensation is aligned with the basic activities of taking a product to market—stocking inventory, taking orders, marketing products, and selling them. But some manufacturers have learned that channel compensation is a powerful tool for achieving strategic collaboration around critical initiatives. The approach is called functional compensation and involves aligning a portion of overall channel compensation with specific objectives and outcomes. Many variations are possible, but as an example, a manufacturer may offer a discount (or rebate or market development fund) granted if a distributor helps the supplier enter a new market, launch a new product, upgrade customer experiences, act on shared customer information, optimize supply chain efficiency, or more.

Before going further, it's worthwhile to touch on the peculiarities of a distribution-centric value chain. Distributors do not operate as third-party logistics (3PL) providers. Distributors perform services for manufacturers, but not under contract with explicitly defined responsibilities, performance expectations, and payment. If they did, distributors would lock in profits because their cost-to-serve and acceptable profit margin would determine the compensation manufacturers pay. Instead, distributors are independent actors who take title for the products they buy and resell to customers. Manufacturers get what they need, but also something more.

Distributors are entrepreneurs. By working side-by-side with customers, they are familiar with every customer’s day-to-day operations and longer-term plans. Distributors assemble a line card of products from multiple manufacturers to fit customer needs. Distributors adjust their services to drive results and create value in the customer’s business, often independent of a product’s features and benefits. Distributors shift with shifting markets, and in today’s rapidly changing digital world, distributors are inventing customer experience business models that help customers innovate and drive explicit outcomes in the customer’s business.

Manufacturers and distributors both exist to solve customer problems, but with different approaches executed through different, though complementary, business models. Today, channel compensation methods lock the status quo in place. An updated functional compensation approach, directed by foresight for the future, may help encourage and direct collective action, even as distributors and manufacturers develop their own digital business strategies and capabilities.

Your thoughts?

My analysis of the two unspoken truths and the need for foresight and collective action is inspired by my work with industry institutions, companies, and creative individuals. Every day, I witness the desire to move forward, fired by a commitment to do the right thing, but held back by seemingly invisible roadblocks. Precedent holds us back. Progress requires visioning a destination, a marketplace of ideas, and collaboration across businesses. Progress requires a new system for operating the value chain, for creating customer value, and for monetizing actions and investments.

I am optimistic about the future, but impatient at the slow evolution of leadership, business models, and partnerships.

In this edition, I frame what I see as the most fundamental barriers to ushering in a bold and bright future for the value chain and our way of doing business. In a future edition, I will offer a specific plan, or perhaps several. I need to hear from you. Please let me know if you agree or disagree, or have other ideas and experiences. Share your comments below, or reach me at mark.dancer@n4bi.com.