Selling through sales and distribution channels of various types is very important to many software and hardware companies. Yet channel programs, specifically channel discount structures, are often thrown together quickly and haphazardly. Usually without looking at any real hard data. Let’s examine some of the key items that are advisable to consider when structuring a channel discount program:
Channel Discount Norms in Technology Market Segments
The absolute first place to start when considering channel discounts is to survey the SPECIFIC market that you are entering. As illustrated in the diagram below, there are myriad combinations of market and channel. So by this I mean look at similar products being sold through the EXACT profile of channel partners you are considering selling through. For example for consumer software, retail gross margins of 15-18% are common. Whereas for a specific VAR segment, the normal discount structure may be in the 25-40% range.
If your discounts fall too far below the market norm, your program will likely fail. If discounts are set much higher than the market norm (without good reason), your company will be “giving money away”. Thus leaving considerable profits on the table. It is very important to do upfront research on actual conditions in your market segment and target channel partners. Don’t just “assume” discount structures are the same as some other market segment you’ve been in previously!
Preferably, you will want to find out what your direct competitors are offering in terms of a channel program. This may seem obvious. But I see often in my consulting practice many companies using their theories or experience to decide what the right discount structure SHOULD be. Instead, it’s critical to use objective data gleaned from the current situation. This often ends up being the primary reason for a painful “restart” of their channel program at a later date. Or worse, deciding simply to sell only via direct sales, eliminating channels altogether.
Product and Pricing Strategy (Street Price)
Channel discount structures cannot be constructed in a vacuum. They are but one component of your overall marketing mix of product, pricing, promotion, and distribution strategy. As such, they must be consistent with the overall goals you establish for the product. For example, maybe you are seeking to penetrate a new market or a new channel. In this case, it may be wise to be more aggressive with your discount structure than the market norms. This may enable you to gain market share and shelf space. Conversely, what if your market is more mature and you are in a harvest mode on a particular product line? Here it may be wise to minimize channel discounts to maximize profitability. In any event, make sure you consider channel discounts early in any product planning phase as part of your overall product marketing strategy.
Type of Tech Distribution Channel
As discussed above, there are many different types of partners for software and hardware companies that fall into the category of “channel resellers”. This includes computer/electronics retail, mass-market retail, value-added resellers (VARs), Systems Integrators (SI), Online Resellers, Domestic Distributors, International Distributors, manufacturer reps, and many more. Each of these reseller types is quite different from the others. And each adds different types and levels of value to your distribution systems. Yet everyone that you distribute through will be competing with the others (as well as your direct sales force), at least indirectly.
Multi-channel Software or Hardware Pricing Equity
It’s important if you are selling through more than one channel (including direct sales) to attempt to equalize the street prices charged by the various channel types. This isn’t easy. The best way to do this is to use a “value-based” approach. A simple method is to consider the costs incurred and value added by the various types of resellers in delivering your products to the target customer.
For example, consider VARs which provide technical support, pre-sales consulting, customization, and other services. They may need a higher level of discount to achieve an adequate profit margin than a retailer simply providing shelf space might. In reality, the retailer is likely to have the lowest street price. However, it is important to try to minimize this gap with other channel partner types. Otherwise, the VAR who may be providing important value-added services to a segment of your customers may be driven out of the market. If they refuse to sell your product due to lack of margin, this usually is not in your company’s interests.
Volume-based channel discount pricing is often a huge mistake
Unlike the value-based approach described above, the most common channel pricing practice is a volume-driven discount model. This, unfortunately, causes inequities in channel pricing between different partner types. New entrants to the channel often use this approach. It seems like an obvious thing to do. Why wouldn’t you want to incentivize volume sales by giving the biggest discounts to the largest volume sellers? This may work if you have a monolithic reseller channel. One where all the players have the same business model and offer the same value-add.
But in a more complex channel, it otherwise will quickly cause problems. The resellers possessing the lowest cost structure will quickly dominate the market. Again, they usually also provide the lowest value-add to your customers. This drives the higher-cost/higher value-add resellers away. This may be ok with you depending on the specifics of your product and market. Just make sure you explicitly consider this possibility and its consequences. BEFORE embarking on a volume-driven channel discount strategy. Once you’ve done it, it’s difficult to undo, and much damage may already be done.
Channel Partner Value Added
As mentioned above, one question that I recommend considering explicitly up front is this: what is the key value-add that you are seeking from the channel? Is it pre-sales consulting, installation services, customization, post-sale technical support, shelf space, and inventory for immediate customer access? Or is it one of many other possible factors? Make sure you understand which channel value-adds are most important to you! Then build protections into your discount structure for the reseller type who best provides this value.
Components of Channel Discount Structure
It’s often not wise to offer a single, monolithic discount level for all resellers. How you structure your discount components should be closely tied to your product and pricing strategy. What you are trying to accomplish with your overall channel strategy? For example, if you are trying to manage your street price to a certain level, it can be dangerous to offer a large discount to certain types of resellers. Those who may pass that discount on as a lower street price. Yet this segment of resellers (for example, retailers) may be an important, high-volume channel for your product type. In this case, it may be wise to offer additional, conditional discounts for activities that you value.
As an example, How can keep your street price up but incentivize a high level of activity through retail? One way is to offer a higher level of additional discount for approved co-op marketing activities. Consider a segmented discount structure driven by costs and value-add. Rather than one based on volume. This is often the most effective structure to maximize multi-channel sales. This will also limit discount-driven reductions in street prices. This behavior ultimately can severely reduce profit levels and incentives to sell in the long run. This affects not only all channel partners but ultimately the vendor as well, if not properly controlled.
SUMMARY
Creating a channel discount strategy and structure should NOT be a theoretical or “personal preference” exercise. It should be an objective exercise based on a realistic view of market conditions. And it should include collection and analysis of ALL available market data. What you hope to accomplish with your discount strategy is important. But the overwhelmingly most important factor in creating your discount strategy should be what is ACTUALLY happening in your segment of the channel. As well as a complete, objective analysis of what will work best for your company.
Try not to create a structure based on what you’d like to see for the channel. Don’t default to what has worked for you before, in a different company or different market conditions. Focus on creating a pragmatic, workable strategy upfront based on facts on the ground. This will help you avoid an unsuccessful channel entry and the painful program restructuring needed downstream. If you are inexperienced in the channel game, seeking outside assistance may help you avoid experiencing one of these painful false starts that happen frequently to new channel entrants.
That’s my view of how best to create a channel discount structure. I welcome you to post a comment with your thoughts on this important tech company management decision.
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Good article – thanks,
A great article, Phil. Glad I saw it come by my screen. In my last role, I had to completely rebuild the company’s global reseller channel. As you note, for a range of reasons, of which pricing and discounting were a major aspect, a lot of damage had been done.
This was the second time I found myself doing a price model overhaul. I’ve had colleagues look at me askance when I comment -pricing- is the hardest business problem I’ve had to figure out. Your article–which is highly credible–alludes to all many of the interwoven challenges a business faces when partnering with a channel. And, that, is -after- you’ve addressed the first challenge: what should I even charge for my product(s) in the first place.
I have worked at the top of the food chain, been a buyer, then a reseller, then back as a software publisher with channel. I find I really enjoy the B2B software/SaaS reseller environment. Perhaps its because of all the disparities you describe.
Loved it (must be a reseller-nerd)