Six Rules for Negotiating a Better Distribution Agreement
When distributors and suppliers are courting one another, several priorities emerge: greater sales, better profit margins, enhanced market share, expanded geographic coverage, and more. The often tedious and boring details of a distribution agreement capture the attention of neither distributor nor supplier. So long as the relationship flourishes, most parties spend little time reading or reviewing words in the distribution agreement, usually stuffed into a dark filing cabinet. If the glamour of the relationship begins to fade, one or both parties likely hunts for the agreement and begins to review the document more closely.
Once the distributor or manufacturer examines the distribution agreement for options, flaws previously overlooked become obvious. Minor problems with the document emerge as major issues. Without quick management attention, the distribution relationship easily fades. Once that happens, more people begin to study the agreement. Minor blemishes in the relationship grow in scope and importance. The relationship begins to unravel.
Don't let details set forth in a distribution agreement become a distraction, or worse, a source of growing frustration. Spend incremental management time on growing the distribution relationship, sales and profits. Eliminate common problems while negotiating the agreement. By not inserting problems into the agreement, management can spend its time on the most important issues: developing and expanding the relationship between the supplier and distributor. Here are six rules to follow when negotiating that next distribution agreement.
Balance in a distribution agreement ensures that neither party holds unfair power over the other. Both parties should have the opportunity to terminate the agreement under similar conditions. If one party may terminate the agreement on 60 days notice without penalty, the other party should have the same opportunity.
An experienced party rarely inserts imbalance into a distribution agreement. Parties are sometimes not aware of bias while negotiating the contract. When problems arise in the relationship between the distributor and the manufacturer, both parties are likely to study the agreement in detail. Once either party detects bias in the agreement, it serves to increase friction in the relationship. That unnecessary friction works against sales and sales growth. One-sided agreements are a ticking time bomb. Avoid explosions easily by ensuring that the agreement contains no clause that favors one party over the other.
2. Due Diligence
During several years of managing relationships and contracts between distributors and suppliers, both as a distributor and supplier, I have concluded that lack of due diligence is the leading cause of failure in those relationships. The courtship between distributors and suppliers is very much akin to the courtship between brides and grooms. During courtship, both parties observe the best attributes and often ignore the worst attributes of their prospective mates.
After a distributor and supplier sign a distribution agreement and begin building a relationship, both parties must learn and truly understand the strengths and weaknesses of their partners. If inadequate due diligence was performed, parties will discover new problems with their partners. Too often, those problems come as an unpleasant surprise. Avoid those unpleasant surprises by performing sincere due diligence.
What is sincere due diligence? Don't just listen to a prospective distributor or supplier and watch its polished presentations. Interview customers. Interview current and prior employees. Investigate how people in purchasing rate the prospective partner in terms of service, quality and integrity. Interview customers' personnel in engineering, quality, manufacturing and procurement. It is difficult for a prospective distributor or supplier to hide poor past performance. However, if parties do not question customers and staff, it is impossible to detect poor practices, service and quality until after the agreement is in full effect. Negative inputs gathered while conducting due diligence can be disappointing. However, those same revelations gathered once the contract governs the relationship can be shocking and costly.
3. Annual Termination and Semiautomatic Renewal
Calling for annual termination and semiautomatic renewal is a routine procedure among experienced players. In these cases, there is a provision in the agreement calling for termination of the agreement at the end of the first full calendar year of service and each year thereafter. Terms and conditions allow either party to submit a Notice of Intention to Not Renew 30 days prior to the end of the calendar year.
When a distributor agreement calls for annual termination with semiautomatic renewal, both parties have the opportunity to withdraw from the agreement without proving cause. Using this methodology, performance – not a collection of words in the agreement – holds the partnership together. Seasoned partners always prefer to have performance as the binding force in the partnership.
4. Comparison with Proven Industry Agreements
Parties make most mistakes with distribution agreements based upon lack of experience negotiating agreements. Most large companies with years of experience with agreements rarely sign contracts with errors. Many mistakes are the result of one partner attempting to gain advantage over the other partner by inserting a bias into the agreement favoring the party with greater experience.
There are several methods by which to level the playing field during negotiation. First, solicit a model agreement from your industry's distributor association. Many distribution associations provide a model agreement free of charge or at modest cost to their members (National Electronic Distributors Association, Material Handling Equipment Distributors Association, etc.). The model is a good baseline from which to compare the agreement under negotiation.
Second, alert your network of friends in the industry. Although it is unlikely that a direct competitor would lend a copy of its distributor agreement, friends at indirect competitors usually have no fear of sharing an agreement that has proven to be problem free.
5. Four Eyes versus Two Eyes
A root cause that leads suppliers and distributors into litigation upon termination is often a poorly worded distribution agreement. Most of the time, litigation could be avoided with better construction of the contract. Most distribution contracts benefit from review by people experienced with creating and negotiating contracts. Sometimes attorneys review the contracts. Sometimes sales managers with distribution agreement experience review the contracts. The best results come when both a legal professional and a seasoned sales manager review the distribution agreement.
When a legal professional and not a seasoned sales manager review a distribution agreement, the resulting document can be legally acceptable, but commercially ineffective. When a seasoned sales manager and not an attorney review a contract, the resulting agreement can be commercially effective, but legally unacceptable. Hence, when only two eyes review a distribution agreement, problems can arise. When, however, four eyes review an agreement, two from an attorney and two from a seasoned sales manager, the probability of a legal skirmish upon termination diminishes greatly. Four eyes are better than two.
6. Cause and Convenience
Any distributor or supplier that has been involved in a legal dispute
at the end of a distribution relationship often regrets the absence
of at least one clause in the agreement.
Termination for convenience is often one of those missing clauses. Parties may terminate an agreement for cause or for no cause at all. An agreement should spell out termination under both conditions. Both the supplier and the distributor must have the opportunity to terminate for cause and convenience: 1) the distributor may terminate the agreement for cause; 2) the distributor may terminate the agreement for convenience; 3) the supplier may terminate the agreement for cause; and 4) the supplier may terminate the agreement for convenience.
Termination for cause proceeds smoothly so long as both parties agree to the source and responsibility of the cause, and agree to dissolve the agreement and relationship. Unfortunately, it's often difficult to agree to cause in the real world without protracted discussion, sometimes involving attorneys. Extended discussion consumes management time. Involvement of attorneys consumes both management time and money. Save time and money, while minimizing frustration by including a termination for convenience clause.
Write the distribution agreement in a balanced fashion. Be sure to perform adequate due diligence. Allow for annual termination with semiautomatic renewal. Compare the next distribution agreement with other proven contracts. Have the contract reviewed by both a seasoned sales manager and an attorney. Include the opportunity for both parties to terminate for convenience.
This article first appeared in the November 2009 issue of Industrial Distribution magazine. Glen Balzer is president of New Era Consulting, a marketing and sales consulting firm. He has created, upgraded, and managed marketing and sales organizations for distributors and suppliers around the world during the past 30 years. He has integrated divisions of companies upon merger and acquisition.
Contact him through his Web site: www.neweraconsulting.com