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Thu 27 Oct 2005 04:00 AM

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Front or back?

Forget your back-end rebates and start concentrating on front-end transactional margins. This is the only way that the Middle East distributor and reseller community will truly evolve, and it is an area where vendors have a vital role to play.

Forget your back-end rebates and start concentrating on front-end transactional margins. This is the only way that the Middle East distributor and reseller community will truly evolve, and it is an area where vendors have a vital role to play.

Every level of the channel from vendor to distributor to reseller needs to work together to elevate the importance of front-end transactional margin and stamp out the current reliance on back-end rebates, which is stifling the overall market development.

The problem with back-end rebates has always been that distributors and resellers will discount product price in anticipation of the financial compensation that they will receive for hitting a certain volume target. Taken to its logical conclusion, this creates a situation where a channel player is actually prepared to sell below cost because of the rewards that they know they can qualify for at the end of the quarter.

This is not a healthy situation, because it only takes one player to sell below cost to damage the overall market pricing level. Vendors have a major role to play in terms of encouraging the channel to build front-end margins and stop relying on back-end rebates and incentives for the vast bulk of their profits. This can involve reducing the back-end margin component to such a level that distributors and resellers have no options other than to control their front-end pricing, stop selling at cost or slightly below cost, and adopt a more aligned collective channel pricing policy that gives everyone the chance to make a decent margin.

HP’s recent move to adjust its channel compensation structure and place more emphasis on second tier resellers has implications for its authorised distributors in the Middle East. They are being asked to show much greater awareness — and collective responsibility — when it comes to building and maintaining transactional front-end margin. It is a brave and necessary move in a region where some companies still place too much emphasis on trading and not enough emphasis on the mark-up that justifies the trade.

Last week, I spoke about the ‘blame game’ and explained how easy it was for each tier of the channel to pass the buck rather than everyone taking collective responsibility for the structural issues that exist in the market. As always, the feedback flooded in. Here’s what one marketing director at a major infrastructure vendor had to say about the current situation.

“Generally the channel is keen to sell volume products, which are established, but they have small margins and there are multiple distributors for these products. So the issues that determine where the resellers buy are stock, credit offered and price,” he said.

“As a result you see many distributors selling at cost and relying on 2% to 3% rebates they make for hitting vendor targets. If a distributor offers too much credit they will get their fingers burned, especially as they work on such thin margins — so a loss of US$100,000 revenue represents the profit at 5%, which would have been made on US$2m revenue,” he continued.

“Plus, cash flow in a distributor is critical, especially in a market like the Middle East, which is growing at 15% where you need to find more cash to fund your growth. Hardly surprising then that many distributors are frequently on credit hold with vendors as they have bad debts and low credit ratings with their banks,” he added.

The use of back-end rebate and incentive schemes destroys the channel’s ability to maintain front-end margins. In a region such as the Middle East, this is incredibly damaging to the long-term development of the channel because it creates a situation where distributors and resellers selling the largest volumes — and frequently adding the least value — have a financial advantage over their competitors. This eventually means that the sale is about nothing more than price, credit and availability.

While these are undoubtedly important factors in the channel, it is not a situation that any vendor should encourage if they are serious about building channel breadth, reaching in-country, understanding their resellers and driving a long-term growth and development strategy in the region.

This is still a problem for the majority of vendors in the Middle East. They will talk until they are blue in the face about the importance of channel support and development, and then implement a financial model that completely undermines these lofty ambitions. Unless the fundamentals of the financial model underpinning the Middle East channel are addressed soon, the market is going to face a credit crunch.

Every single channel player needs to change their emphasis from volume to value. Resellers need to reward the salesperson that brings in the high-margin deals. Distributors need to understand that volume re-exporters and traders may well account for a significant chunk of their revenues, but they only produce a tiny percentage of their overall profits.

Vendors can encourage this change in attitude by stopping their distributors placing so much emphasis on sales volumes and by reducing the back-end rebates partners receive for hitting quotas.

This sort of structural change is not easy. It requires a whole new mindset, and vendors — now used to seeing sales soaring skywards quarter after quarter — may be tempted to look the other way and let the status quo continue.

They need to understand that the channel’s ability to create front-end margin is indicative of the value-add services they also deliver to end-users. If there’s no front-end margin, you can bet your bottom dollar there’s no real value-add taking place.

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