The outlook for industrial distribution next year is positive. Pembroke Consulting's recent research for the National Assn. of Wholesaler-Distributors, titled NAW Economic Forecast 2004, indicates that industrial distributors will see revenues grow 5.1 percent next year and that industry-wide employment will grow a modest 1.1 percent.

A return to growth always is welcome news, but the deteriorating health of manufacturer-distributor relations means that both parties will have to take some tough medicine to benefit from the economic rebound ahead.

In my client work, I've been asking distributors and manufacturers to choose a word to describe their relationships. Frequently, I hear words like "tense," "frustrating" and "uncertain." When I probe deeper, the answers lean toward the blame game. Some blame the economy and global competition; others point to irrational customers with unrealistic expectations.

INDUSTRIAL DISTRIBUTION's recent 57th Annual Survey of Distributor Operations offers compelling results that validate the state of manufacturer-distributor relations. Nearly two-thirds of the distributors surveyed indicated that supplier loyalty has declined, and nearly half of the distributors confessed that their own loyalty had waned. Industrial distributors may represent as many as 100 manufacturers at a time, but a majority of respondents considered a very few to be true partners.

Manufacturer-distributor relations are in a sorry state because the fundamental relationship is changing. The relationship is built on a few simple exchanges. Distributors provide access to customers, and manufacturers supply products to sell. Manufacturers help distributors earn a margin for their services, and distributors help manufacturers grow their market share. Each party provides value to the other and gets something back in return. Yet, as expectations begin to change, the longstanding deal is deteriorating.

Manufacturers are finding that large customers want direct relationships, and that squeezes the distributor's traditional role. Web sites allow customers of all sizes to access information directly and bypass the distributor's sales force. Manufacturers face global competition built on low-cost production and supply chain economics. However, what most distributors continue to offer manufacturers by way of service is increasingly undifferentiated and becoming more like a commodity. Manufacturers continue to seek brand building as their product differentiation erodes, and they generally don't figure distributors into these plans.

Distributors also are backing away from the deal. In ID's survey, more than 80 percent of distributors agreed that finding and delivering new value-added is a matter of long-term survival. In the past, new value-added has been good news for manufacturers, because the value was added to their products, making them more desirable to customers. Sales increased and price premiums were supported.

However, the survey points out that distributors now attribute 19 percent of top-line revenue to services sold "unbundled" from products. This isn't necessarily bad news for manufacturers, and many distributors state that their suppliers want them to sell services. Nonetheless, as services come into play, the relationship changes, since distributors then are selling their own capabilities, not their supplier's products.

Traditional distributor growth strategies also are chipping away at the relationship. Seventy-five percent of distributors in the survey stated that they will grow by adding new customers and 42 percent said they will add new product lines. From the manufacturer's perspective, these objectives amount to shifting business they already have from one distributor to another — or a lowering commitment to their products and brands among distributors they thought they already had won over.

While many symptoms have been evident for some time, there is a cumulative effect — the perception that distributors are less effective as a marketing channel. Judging by ID's survey results and my own conversations, the perception gap is wide and growing. To remedy the situation, several actions may need to be taken:

Spend volume incentives on more productive behaviors. The ugly truth about volume discounts and rebates is that they do little to improve supply chain efficiencies and almost never deliver long-term sales growth. At best, they assuage large distributor-customers seeking to leverage their buying power. At worst, they encourage distributors to hold extra inventory. Moreover, distributors have been known to load up on one supplier and then shift to another when trigger points are reached. None of these behaviors yield tangible value-added benefits for the end-customer.

Manufacturers should first identify the higher-level results they expect their best distributor partners to deliver. Then, pricing policies should be designed to reward distributors that take concrete actions to build brands, lower supply chain costs, speed new product launches, etc. The most effective programs offer distributors a choice: either step up to deliver new results, or operate at a lower level of investment and commitment.

Distributors that opt-in incur higher costs, but also have access to incremental incentives. Those that opt-out make a decision to focus on different end-customer value offerings. Both opt-in and opt-out distributors, and their manufacturers, are refocused on end-customers — a result that only strengthens the supply chain.

Some industrial manufacturers have begun to refocus their channel programs and incentives. Tiered distribution programs are one example. These programs, and others like them, work because they make expectations and rewards very clear. The manufacturer-distributor relationship evolves to a higher level of professionalism, with choices offered and more consistent channel management built in.

Trade point-of-sale information for increased partnering. Many distributors loathe sharing customer data with their suppliers. As middlemen, they view the customer relationship as the last line of defense. In business, being paranoid can be an effective strategy for survival, and distributors should be careful about sharing customer data and information.

However, today's hyper-competitive markets require breakthrough thinking if true differentiation is to be achieved in the end-customer's eyes. Distributors that figure out how to pool resources with their best suppliers and leverage each other's strengths will capture a stronger position to compete and win.

A new manufacturer-distributor relationship must be built on a new exchange. Distributors that are willing to pony up real-time customer data can require suppliers to ship to front-end orders instead of back-end replenishment. The result can be higher levels of efficiency and lower investment in warehouses and related assets. By using direct customer data, suppliers can make better strategic decisions and plan more effectively.

This is tough medicine and it's not for everyone. Distributors should start by identifying their best partners and building on the existing relationship. Over time, a program can be offered to other suppliers as inducement to step up to a higher level of commitment.

In my experience with clients, the best examples of trading point-of-sale data for tangible results can be found in strategic sourcing initiatives pursued by large distributors. Most of these programs stop short of real-time data or limit visibility to customer identity. Manufacturers receive valuable market data, but it is either aggregated to regional levels or organized by product categories. At most, this is a first step towards a truly integrated, efficient, next-generation supply chain.

Reexamine trust. Invariably, distributors that experience declining relations with their suppliers complain that a hard-earned "trust" has been lost, most likely forever. Asked to explain this viewpoint, they state that suppliers can't be counted on to act as they have in the past, or that they've lost direct access to senior management. These perspectives are entirely valid because most distributors are entrepreneurs with their own capital at risk, and because all distributors operate on thin margins easily evaporated by supplier actions.

However, trust issues are, by definition, a soft characterization of the problems underlying the manufacturer-distributor tension. Examples are commonplace, but hard to make relevant to actual decision-making. Still, trust issues remain a very visible and emotional component of relationship issues and they are worth exploring.

There are two problems with characterizing relationship issues as matters of trust. First, manufacturers invariably react defensively to gripes positioned as trust issues, even if they're legitimate. Trust implies a personal bond and an inflexible commitment. Manufacturers are often corporate organizations driven by Wall Street pressures. They feel a need to control their own destinies and do not want to be encumbered with noncompetitive arrangements. Right or wrong, claims of lost trust often trigger a defensive response.

Second, trust is both a condition and an outcome of partnership. Trust is achieved when a successful exchange is accomplished. If the value expected by either party changes, the terms of the relationship also must change. In this context, trust must not be wielded as a barrier to change, but rather as something that must be revisited, reinvented and rebuilt.

Finally, don't let the treatment kill the patient. Distributors and manufacturers still need each other, and the relationship will survive — even if it changes. Companies that recognize the relationship is changing, and focus on creating a new exchange, will find competitive advantage and new profits as the economy rebounds. While attention to the relationship is important, it isn't the final driver of success. Too much focus on the relationship can mean too little focus on the end customer. If customers figure out that partnering suppliers can't get it together, they surely will go elsewhere.