Arnold (2000) 7 rules of international distribution

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Arnold (2000) 7 rules of international distribution

  1. 1. Companies entering markets in developing countries learn quickly that they need to work with local distributors-but those partnerships nearly always blow up in the end. Much ofthe blame lies with the multinationals themselves. They need to understand how their new partners are different from the ones at home. Seven Rules o/lnternational Distribution by David Arnold AN / ESTABLISHED CORPORATION LOOKING FOR new international markets makes a foray into an / emerging market, carefully limiting its exposure by appointing an independent local distributor. At first, sales take off, revenues grow pleasingly, and tbe entry is praised as a smart move. But after a wbile, stagnation sets in and sales plateau. Alarmed, tbe multinational's managers try to discover wbat happened. They soon settle on wbat tbey perceive to be tbe main obstacle to sustained growtb: the local distributor that got the company off to a flying start bas run out of ideas and is now underperforming. This pattern is repeated again and again as multinationals expand into new markets in developing countries. Over time, a corporation's executives decide tbat the distribution organization isn't run as they would like. They rush in and make major changes, in some cases buying the local distributor or, more often, reacquiring tbe HARVARD BUSINESS REVIEW November-December 2000
  2. 2. Seven Rules of International Distribution distribution rights and starting their own subsidiary. In either case, it's messy. A transition from indirect to direct sales is usually costly and disruptive. It can also create new problems that come to the surface only in the long term: executives may discover a few years later that they've gone too far in correcting a number of situations like this, saddling the multinational with a dense and inefficient network of national distributors. The frustrations are summed up by the CEO of a major U.S. specialty cbemical company: "In the end, we always do a better job witb our own subsidiaries: sales of local intermediaries, corporations need to partner with local distributors to benefit from tbeir unique expertise and knowledge of their own markets. Tbe multinationals know that on their own, they cannot master local business practices, meet regulatory requirements, hire and manage local personnel, or gain introductions to potential customers. At the same time, the multinationals want to minimize risk. Tbey do tbis by hiring local distributors and investing very little in tbe undertaking. Tbus, the companies cede control of strategic marketing decisions to the Neither the multinational nor the distributor invests sufficiently in strategic marketing or in aggressive business development in these less-developed markets. improve, and we have greater control over the business. But we still need local distributors for entry, and we are still searcbing for strategies to get us tbrougb tbe transitions without battles over control and performance." I examined tbis pattern of imbalance and correction in a two-year field study of eigbt corporations in tbe consumer, industrial, and service sectors. Tbese companies had entered almost 250 new country-markets, and I looked at tbeir international distribution strategies in tbese markets. The research showed that avoiding the pattern of under performance and correction meant accepting that, in most cases, tbe problem wasn't as simple as the distributor's being poorly run. I learned tbat a corporation could avoid this scenario by overseeing marketing strategy from the start. Below, I'll look at what goes wrong with most distribution arrangements in developing countries and then present seven guidelines to head off potential problems. In the long run, multinationals come to see that it makes sense to continue working with independent local distributors wbo handle sales and a distribution system, even after the international companies have taken control of marketing strategy and major global accounts. local partners, mucb more control than they would cede in home markets. Nevertheless, as tbe CEO of tbe chemical company points out, up to now many multinationals have eventually wanted to control tbeir own operations tbrougb directly owned subsidiaries; they're seeking the economies of scale and control obtainable across a global network of marketing operations. For many multinationals, it's a foregone conclusion that local distributors bave merely been vehicles for market entry, temporary part- IS THERE A FUTURE FOR For distributors in emerging markets seeking to sell multinationals'products, my research findings are alarming. In the eyes of many corporations, the independent distributor is an endangered species. Virtually all executives of multinationals I interviewed bemoaned the lack of strategic marketing by distributor organizations, and many predicted that the gradual globalization of competition would lead to the disappearance of many such distributors. What Goes Wrong and Why Most multinationals stumble onto a stepwise strategy for penetrating markets in emerging countries tbrough a series of unplanned actions to reinvigorate sales. As the pattern recurs witb entries into subsequent markets, tbis approach, dubbed the "beachhead strategy," becomes official policy in many organizations. On the surface, tbe strategy makes a certain amount of sense. Multinationals start from scratch in sales and distribution when tbey enter new markets. Since markets are nationally regulated and dominated by networks The track record of distributors in new markets seems to support this bleak view: in thegreatmajority of cases, multinationals bought or fired their distributors at some point during the partnerships or created their own direct-sales subsidiaries. In only 5% of the 250 cases I studied, multinationals switched to new distributors. A few distributors have managed to continue as representatives of multinationals over the long run (in some cases, for more than ten years). Most, it's true, were located in countries not considered strategic by the multinationals-a characteristic over which the distributors had no control. But the surviving David Arnold is an assistant professor at Harvard Business School it Boston. 132 distributors shared two other characteristics. HARVARD BUSINESS REVIEW November-December 20O0
  3. 3. Seven Rules of International Distribution ners incapable of sustaining growtb in tbe long term. plateau to a lack of drive by distribution organizations, (For a discussion of distributors' long-term prospects, see which in emerging markets tend to be privately owned. tbe sidebar "Is There a Future for Local Distributors?") To paraphrase many managers, "The typical distributor However, most managers don't admit tbis. Instead, is looking not for market domination but for a stable, tbey find fault witb tbe ways local distributors run their midsize business that will make it wealthy but is not too businesses. If you ask managers of multinationals wbat big for it to control personally." typically goes wrong, you'll hear one of tbree tbings Predictably, tbe local partners often bave tbeir own and sometimes you'll bear all of them. ideas about why the relationships don't succeed over tbe "The distributor didn't know how to grow the market" long haul: "Tbey didn't give us enough support for growIn many cases, distributors achieve initial sales growtb ing tbe business." "They expected the impossible." "Their by "picking tbe low-hajiging fhiit"-making easy sales of company politics were too complicated." And so on. tbe multinationals' proven, core products to tbe distribThe mutual finger-pointing overlooks a point that utors' existing customers. When tbe business cballenge seems obvious as tbe same tbemes repeatedly emerge: shifts to introducing additional products or penetrating neither party-the multinational nor the distributormarket segments in whicb tbe distributors aren't estabinvests sufficiently in strategic marketing or in aggressive lished, corporations say distributors don't bave the necbusiness development in these less-developed markets. essary skills. It may be smart for corporations to minimize risk when "The distributors didn't invest in business growth" At entering the markets, but a subsequent lack of investthe start, corporations often grant distributors national ment and managerial attention can seriously bamper exclusivity in order to encourage investment. In addition, performance. corporations and local distributors sometimes negotiate Multinationals don't set out to neglect tbese markets, contracts stipulating minimum levels of marketing inof course. Wbat's needed always changes during and vestment by the distributors. Nevertheless, multinational after market entry, but companies don't adjust their managers still don't think distributors invest enough. commitments accordingly. As a business grows in an in"The distributor Just wasn't ambitious enough." In some ternational market, marketing strategy evolves, and each cases, managers of multinationals attribute tbe sales sequential phase requires management resources specific LOCAL DISTRIBUTORS? > They carried product lines that complemented, rather than competed with, the multinationals' products. > They acted as if they were business partners with the international marketing organizations structured around product groups or market sectors, and regional management of marketing strategy flows naturally out of that reorganization. multinationals. They shared market Information with This happens for two reasons. First, networks of directly owned the corporations; they initiated projects with distributors national distributors are inefficient; they duplicate managerial in neighboring countries; and they suggested initiatives in resources at the country level and lead to missed opportunities their own or nearby markets. These managers risked in areas such as Information systems and promotional expendi- investing in areas such as training, infornnation systems, tures. Second, regionalization gives multinationals greater stra- and advertising and promotion in order to grow the tegic control. multinationals' businesses. For now, the effect that regionalization of marketing control Multinationals clearly prefer to control their international has on national distributors is unclear. But it seems probable marketing operations, so such characteristics can't guarantee a that some national distributors will become part of a mixed long-term role for even the most effertive national distributor distribution system, in which the multinational corporation But, at the very least, a distributor whose leaders participate will manage major customers directly, while other, indepen- actively in strategic marketing will be valuable to the multina- dent, distributors will focus on discrete segments of national tional and will be able to command a high price if the corpora- markets or smaller accounts. The emergence of global accounts, tion seeks to buy back its sales and distribution business. More generally speaking, though, the future of independent served directly by multinationals, highlights an economic truth of which many multinationals lose sight in their battles for distributors wilt be influenced by the growing regionalization control: independent local distributors often provide the best of marketing management. Many companies are developing means of serving local small and medium accounts. HARVARD BUSINESS REVIEW November-December 2OOO 133
  4. 4. Seven Rules of International Distribution to the task, different skills, and financial investment. Jtequirements at the outset are very different from those three to five years later. The multinational's product line and the distributor's business probably fit best at the point of market entry. As time passes, the fit deteriorates. The distributor may be less able to deliver growth as the business moves away from its core customer base. Nevertheless, I think there are ways in which local distributors can continue to contribute after market entry; the economic reasons for the existence of distributors do not disappear after subsidiaries are established. The key to solving the problems of international distribution in developing countries is to recognize that the phases are predictable and that multinationals can pian for them from the start in a way tbat is less disruptive and costly than the doomed beachhead strategy. (See the exhibit "Managing the Multinational-Distributor Partnership") Managing the Life Cycle ofthe International Distributor The multinationals I studied made trade-offs among three worthy objectives: wanting to control tbeir business expansion at a strategic level; partnering with local distributors, at least for the first years, to benefit from the locals'expertise; and minimizing costs and risks in these new ventures. These are all good objectives, but finding the correct balance among them at any particular time is tricky. In the beginning of market entry, partnerships with local distributors make good sense: distributors know tbe distinctive characteristics of their markets, and most customers prefer to do business with local partners. Changes during later phases of market entry, including a possible switch to directly controlled distribution, are usually corrective moves to redress imbalances that emerged during the initial phases, and many of these changes lead to new imbalances. The following guidelines caii help executives of multinationals anticipate and correct potential problems. 1. Select distributors. Don't let them select you. A foray into a new international market should be the result of a strategic decision based on an objective market assessment. But that's not how it usually happens. At almost every company I studied, initial moves into new countries occurred in reaction to proposals from potential distributors. "They would approach us at trade fairs or come directly to our office, and if they seemed convincing, we MANACtNG THE MULTtNATIONAL-DISTRIBUTOR PARTNERSHIP We follow two hypothetical multinational corporations (MNCs) as they enter new markets in developing countries. The markets and countries are comparable, but M NCI follows a beachhead strategy, reacting to problems as they come up. This strategy culminates in a serious disruption of business. In contrast, MNC2 retains control of marketing strategy from the outset and anticipates changes. Approached by an independent local distributor, MNCl agrees to test the market in the distributor's country. MNCl considers the distributor an appropriate partner because the distributor is already serving customers with products similar toMNCl's. tt views the distributor as a temporary market-entry vehicle. Seeking to avoid risk, MNCl makes a minimal financial commitment to the endeavor. It delegates sales and marketing responsibility to the independent distributor. Based on objective assessments, MNC2 chooses a market. Rather than seeking a distributor with a good "market fit," MNC2 looks for one with a good "company fit"- a culture and strategy compatible with Iv1NC2's own. It encourages the distributor's leaders to initiate marketing and development projects in cooperation with MNC2's management. MNC2makesa substantial commitment of corporate resources up front, despite uncertainty about the market's prospects. It retains control of marketing strategy and works with the local distributor on market development. Time* 134 HARVARD BUSINESS REVIEW November-December 2000
  5. 5. Seven Rules of International Distribution would be inclined to go ahead because the marginal cost was low and the distributor was bearing most of the risk," says an executive from Loctite, the Connecticutbased specialty adhesives company acquired by German chemical giant Henkel in 1997. In fact, the most eager potential distributors may be precisely the wrong people to partner with. As one executive from a leisure and sporting goods firm says, "In tributor because of a more systematic and thorough assessment of potential partners" the Loctite executive says. Even the distributor search is market-led: Loctite contacts the largest potential customers and asks them to name their preferred suppliers. 2. Look for distributors capable of developing markets, rather than those with a few obvious customer contacts. The choice of distributors and the terms ofthe The key to solving the problems of international distribution in developing countries is to recognize that the phases are predictable and that multinationals can plan for them. many cases, we end up with the distributors that also serve our two major competitors, because they're in the strongest positions, by far, with the retailers. Those distributors certainly have the market contacts, but they also want to control the category and keep us three multinationals in balance." Incumbent distributors with strong positions in the status quo are more likely to deliver a sales plateau, given their desire to maintain the market structure. Loctite now focuses first on identifying the country, then finding a distributor. "Being market-led rather than distributor-led often results in our selecting a better dis- Dissatisfied with performance after initial sales growth, MNCl buys back distribution rights, but the negotiations are tougher than expected. MNCl eventually sets up a distribution subsidiary in the country, but the former distributor dumps inventory into the market, making it difficult for the corporation to sell profitably Business is disrupted. Because the distributor has contracted to furnish detailed n-iarket and financial performance data, MNC2 can exploit its global competitive advantages in the local market MNC2 establishes a regional marketing organization, with a team in the new country, and builds links among distributors, thus leveraging synergies and economies across the company and maximizing global share. HARVARD BUSINESS REVIEW November-December 2000 relationships should serve the multinational's long-term goals. "The most obvious distributor is not necessarily the best partner for the long term," says a Loctite executive. Like most companies expanding internationally, Loctite used to look for partners with the best "market fit," meaning those already serving major customer prospects with similar product lines. But, says the executive, "The closeness ofthe market fit can be a liability as well as an asset, because the distributors represent the market's status quo, and we are selling a replacement technology and attempting to change the market." The answer lies in the choice of partners. "We increasingly look for what we have come to call 'company fit'-a partner with a culture and a strategy we feel comfortable with, in terms ofthe investment they'll make, the training they'll give their people, and the support they'll ask from us," says the Loctite executive. "In many cases, this leads us to partners who have no experience of our market. The first couple of times, this felt risky, but our success with some of these partnerships has made us bolder in choosing distributors." In effect, this means bypassing the obvious choice - a distributor who has the right customers and can therefore generate quick sales - in favor of a partner with a greater willingness to invest and an acceptance of an open relationship that draws on the multinational's experience in marketing its own products. 3. Treat the local distributors as long-term partners, not temporary market-entry vehicles. Structure the relationships so that distributors become marketing partners willing to invest in long-term market development. One traditional way of doing this is to grant national exclusivity to a distributor, although such an agreement can become unproductive if confiicts of interest arise once entry is established. A more effective solution is to create an agreement with strong incentives for appropriate goals, such as customer acquisition or new product sales. After all, the local distributor is the de facto marketing arm of the multinational in its country. Unfortunately, many companies actively signal to distributors that their intentions are only for the short
  6. 6. Seven Rules of International Distribution term, drawing up contracts that allow them to buy back distribution rights after a few years. Such a strategy does avert one problem - it prevents a distributor from claiming that the multinational partner reneged on an earlier promise-but it creates other problems. Even with such a contract, a distributor might simply decide not to sell back the rights and might well be backed up in the local courts. In many countries, regulations favor local businesses over foreign vendors, so the multinational could face a protracted struggle over distribution rights. Additionally, under a short-term agreement, a local distributor doesn't have much incentive to undertake long-term business development. The Asia-Pacific manager of a consumer goods company reported that several national distributors, acting in the belief that sales revenues were the key to the reacquisition price, had cut prices, boosting overall revenues but undermining the company's market positioning strategies. 4. Support market entry by committing money, managers, and proven marketing ideas. To retain strategic control, multinationals must commit adequate corporate resources. This is especially true during market entry, when corporations are least certain about their prospects in new countries. Traditionally, multinationals have demonstrated commitment by sending in technical and sales personnel or offering training to distributor employees. Such support is good, of course, but more experienced corporations now go further and do things earlier. In markets regarded as strategically important, they've started to take minority equity stakes in autonomous distribution companies. Although this increases exposure without achieving control, it opens the door to cooperative marketing based on shared information, thus increasing the advantage and effectiveness of both the multinational and the local partner. Sometimes multinationals invest in distributors in ways that don't lead to co-ownership but that demonstrate solid commitments to the relationships. A global leader in hydraulics components, for example, now manufactures products according to the local technical standards in a new market and bears some ofthe associated investment costs. Formerly, the company would have sold products with incompatible specifications or paid extra to manufacture specialty items. For many corporations, such commitments in uncharted markets with independently owned distributors represent unacceptable risks. But most multinationals already have effective controls for managing independent distributors in home markets, and these might also be successful with international distributors. Additionally, experienced multinationals have discovered that early commitment of resources leads to better relationships with local distributors, thus enhancing business performance. One European telecom company, for example. 136 invested heavily in a service organization; the company wanted to shift the distributor's focus away from selling equipment (a relatively easy task) and toward selling service (a more difficult one). The result has been higher sales revenues and a more productive partnership with local distributors. I find it curious that multinationals are reluctant to commit resources at early stages. Once they've tested the market, multinationals almost invariably increase their commitments. My research uncovered only rare instances of corporations withdrawing from countries they'd entered. So making a commitment early isn't really a new strategy. 5. From the start, maintain control over marketing strategy. An independent distributor should be allowed to adapt a multinational's strategy to local conditions. But multinationals should convene and lead planning sessions and exercise authority about which products to sell, how to position them, and budgeting. If corporations provide solid leadership for marketing, they will be in a position to exploit the full potential of a global marketing network. Multinationals committed to maintaining early control over marketing strategy find that it's important to have employees on-site. Some send a few employees to work full-time at the local distributor's offices. Others establish country or regional managers who can keep a close watch on both distributor performance and customer needs. "We used to give far too much autonomy to distributors, thinking that they knew their markets," says one manager. "But our value proposition is a tough one to execute, and time and again we saw distributors cut prices to compensate for failing to target the right customers or to sufficiently train salespeople." 6. Make sure distributors provide you with detailed market and financial performance data. A multinational's ability to exploit its competitive advantages in an emerging market depends heavily on the quality of information it obtains from the market. In many countries, the distribution organizations are the only sources of such information. A contract with a distributor must therefore require detailed market and financial performance data. Not having these data can lead to serious problems. A global leader in hydraulic components, for example, did not know tbat its Hong Kong distributor was achieving almost half its sales revenues within mainland China, nor that the products were being sold for about half of their Hong Kong price. When the multinational acquired the Hong Kong business and established a subsidiary, it also found itself saddled with a demand for drastic price reductions in Hong Kong, an active parallel importing problem, and discontented customers in China complaining about the lack of service support. HARVARD BUSINESS REVIEW November-tDecember 2000
  7. 7. Seven Rules o f I n t e r n a t i o n a l The reaction to a request for market and financial data reveals a lot about a distributor. Most distributors, of course, regard data like customer identification and price levels as key sources of power in their relationships with suppliers. Several multinational executives said that the willingness of potential distributors to provide such information was a prime indicator of whether successful relationships could be achieved. 7. Build links among national distributors at the earliest opportunity. Although a multinational's primary focus after entering a new country is establishing a customer base there, the company should create links among its national distributors as soon as possible. The links may take the form of a regional corporate office or an independent network such as a distributor council. The transfer of ideas within local markets can improve performance and result in greater consistency in the execution of international strategies. One executive of a sportswear company explained that although distributor councils originated for defensive reasons-to minimize the risks of diversion or parallel importing-other benefits have accrued: "Once the distributors started talking, they also started planning. HARVARD BUSINESS REVIEW November-December 2000 Distribution We soon had regional initiatives for new products, with successful design based on the local market, and the scale required to make them profitable. There was also a noticeable decrease in the variation between products manufactured by our national licensees." Multinationals need to do a better job of selecting and working with local distributors. In particular, they must understand that distributors are implementers of marketing strategy, rather than marketing departments in the country-market. The result will be better working relationships, fewer plateaus and crises, and more consistent growth in market share and sales revenues. Once corporations understand that they can control their international operations through better relationship structures rather than simply through ownership, they might also find longer-term roles for local distributors within a regionalized approach to global strategy. ^ Reprint ROO6O3 To order reprints, see the last page of this issue. Join HBR's authors and readers in the HBR Forum at www.hbr.org/foruni to discuss this article. 137

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