Thursday, May 14, 2009

Terms of Entitlement, Endearment, or Engagement?Paul Gurizzian and Gene Metheny

Motor vehicle service-parts OEMs spend between 5% and 10% of revenue on dealer terms & conditions. For the OEM, terms & conditions are critical to driving sales growth and supply chain performance. For the dealer, terms & conditions profoundly impact profitability and fixed operations behavior. Finally, terms & conditions can be a prime determinant of the end-customer service experience. The premise of this article is that terms & conditions are important, yet for many OEMs the program has not fundamentally changed in many, many years while virtually everything else in the environment has changed.

First, a definition: By terms & conditions we mean order types, order cut-off times, order-to-delivery times, order frequency, transportation modes, transportation charges, referral patterns, return allowances, and an assortment of premiums, discounts and surcharges.

Broadly, terms & conditions strategies fall into one of three categories:
  1. Traditional Terms – an approach from the past, but still being used at roughly half of OEMs;
  2. Incentive Terms - an approach of the present and being used at roughly the other half of OEMs; and
  3. Performance Terms – an approach for the future that is being used by a few OEMs.

Traditional terms are the least effective in motivating dealers to achieve today’s OEM objectives, but that was not always the case. When traditional terms were first developed, the OEM’s primary objective was an inward focus on controlling costs. So, they designed terms & conditions that encouraged dealers to buy and stock lots of parts (through stock order discounts), hold on to these parts whether they sold or not (limited return allowances), and discouraged emergency ordering (surcharges and lack of discounts). Why? - Because those behaviors reduced complexity and controlled costs for OEM operations.

But times change and, therefore, OEM objectives have changed. The trouble is that in many cases terms & conditions have not changed. Over the years OEMs have expanded their views beyond focusing on their own distribution networks. There has been greater recognition of system-wide costs and impacts on the end-customer. There’s an increased appreciation for the role of dealer inventory as a critical element in enabling the total supply chain to satisfy the end-customer and support the brand. Consider, for example, the fact that about half of the OEMs in NASPC and EAC now have a Retail Inventory Management program and, as a consequence, they both control and bear the risk of dealer inventory. Finally, the need to secure higher growth from the same, or lower, terms & condition spend has increased with competition.

As OEM objectives have shifted, and the incentives designed to achieve these objectives have been added, the traditional terms have become simply holdovers with a hodge-podge of adders - in many cases, more of entitlements than effective incentives.

Incentive terms have been an effective first step at motivating dealers to help address current objectives. Rather than just offering standard stock order discounts, return allowances, etc., OEMs are now linking incentives to what they assume are good dealer practices – high stock order utilization, dealer participation in OEM training, RIM compliance, etc. By virtue of tying payments to incentive-related metrics, the objectives are made more explicit and directly rewarded. Incentive terms motivate input. Incentive terms & conditions are better than traditional, but not the best.

Most recently, OEMs are realizing that dealers could “check all the boxes” in terms of incentive compliance and still the not move the needle in terms of bottom-line revenue growth and/or efficiency improvements. To address this, some OEMs have found performance terms to be more effective in achieving OEM objectives.

Performance terms are a method of setting outcome targets, measuring dealer performance, and rewarding results. While incentive terms focus on rewarding inputs, performance terms focus on rewarding results. Think of this as paying for performance rather than paying for good efforts.

Performance terms metrics can be controlled by the parts manager (e.g., parts sales growth, dealer loyalty, etc.) or in some cases controlled by the service manager (e.g., service satisfaction, fixed first visit, etc.). Ideally, these performance metrics are a balanced set of measures that drive the right dealer behavior to satisfy the customer and grow the business.

Linking payments to performance metrics requires careful thought. While the concept is simple, for a metric to become a performance measure tied to OEM payments it needs to be filtered through a rigorous framework. The icon below is a starting framework for 1) selecting possible metrics, and 2) the availability of robust data, often from individual dealer management systems, which is a potential constraint to implementing performance terms.

By the way, performance terms do not need to be all or nothing. Some OEMs use a combination of all three, depending on objectives, dealers, and the availability of data to calculate metrics.

In closing, how do you know if you are a candidate for implementing performance terms? “Agree” responses to the following list of three litmus test statements suggest you are ready for change. On the other hand, “Disagree” responses mean incentive terms are likely the best solution for your current environment.
  1. Current terms & conditions are not driving the right dealer behaviors to encourage growth and satisfy the end-customer.
  2. OEM and dealers are ready for the change management effort and emotion associated with varying dealer payouts based on performance.
  3. Dealers are prepared to share with the OEM point-of-sale information from their dealer management systems.

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