An Appetite For Stuffing

As the standard-bearers responsible for bringing revenue in, salespeople like to believe they’re always operating with the company’s best interests in mind – and that the company is returning the favor. Yet some large manufacturers, anxious about making good on promises to Wall Street, sometimes artificially inflate revenue or product unit volume numbers by offering big discounts to distributors to pump extra inventory down the channel at quarter’s end. It’s called channel stuffing and, as Petro Tsareharadsky of the Channel Practice Leader for Carlson Marketing Group notes, when manufacturers come to depend on channel stuffing to hit projections, the long-term consequences for the balance sheet – and sales incentive programs – can be serious.

“When channel stuffing occurs, distributors wind up with more product than they would normally have,” Tsareharadsky says. “As long as the marketplace and the demand is high enough that the vast amounts of inventory are consumed through the next quarter, everything is fine. It’s when you have tough economic times, such as we’ve seen recently, that after a while there’s only so much inventory you can push to make every quarter goal. The first time you did it, maybe it took you a week into the next quarter to recover and start selling new inventory. Pretty soon you have two weeks, three weeks and then by the time you’re pushing quarter N it takes you six weeks to get rid of everything you signed up for as a backlog.”

As a result, Tsareharadsky explains, a domino effect occurs in which the price continues to go down and manufacturers and distributors wind up decreasing their average sale prices, in the process eroding everyone’s cash flow. “It also reinforces a very negative behavior with distributors in the sense that they’re saying: OK, I need to wait for you to get desperate enough and then I’ll buy,” he says.

Now add to the mix the so-called gray market – a separate channel outside the normal distributors that consists of brokers who operate internationally. When channel stuffing reaches a point where even at a discounted rate distributors can no longer absorb more product, then manufacturers may turn to gray market brokers. But this is a Faustian bargain, Tsareharadsky says.

“Gray market brokers may be willing to take on that extra inventory,” he says, “but they don’t want a 15% discount, they want a much bigger discount. The manufacturer needs to move the product, so the deal is struck. The broker then goes to sell the product internationally and guess who else is interested in buying the product – the same distributors. The distributor, however, now gets the product at a better price than what the manufacturer was offering. And the distributor isn’t the only one who’s available to buy the product. So are the resellers who typically sell to end users. So at the end of the day this gray channel is able to sell the product to the formal, authorized approaches of distributor and reseller.”

So even though channel stuffing helps the manufacturer satisfy product unit volume projections, profit margins suffer. As an unintended consequence, the company’s own sales force winds up competing with the gray market brokers who, having bought at deep discounts, can offer customers better prices than even the manufacturer’s own reps.

So what does all this have to do with sales incentives? Tsareharadsky explains that managers might try to counter all this wheeling and dealing by creating sales incentives, but the effort just winds up costing the company even more.

“It becomes a situation of confrontational tactics,” he says, “where sales reps are trying to make as much as they can, based on the activity that flows through the proper channels. The VP of sales and sales manager then add in an accelerator to push their sales force to increase sales activity as much as possible, but at the end of the day they’re really doing that not so much to sell the product as to keep the salespeople. The real effect is a double negative – in addition to selling the product through alternate channels at a lower price, the manufacturer also increases the price of the sale by offering accelerators for the channels they’re already supposed to be selling through.”

So what’s a savvy company to do about channel stuffing and the resulting downward pressure on price and margins? Tsareharadsky’s suggestions will appear in next month’s Incentive Newsletter.