Combining Route-to-Market Models to Solve Operational Challenges

November 26, 2008 – 2:13 pm by Anthony DeLuca

Globalization, market maturation, new customer segments and increased competition are forcing high tech companies to expand into new markets. Often, these evolving market expansions demand innovative go-to-market strategies that compel channel management teams to develop new operational competencies. High tech companies have utilized the Original Equipment Manufacturer (OEM) model to respond to expansion pressures, however, this model involves a significant departure from core route-to-market approaches. In particular, optimizing the OEM sales coverage model becomes critical, not only so that a company’s sales organization continues to deliver robust sales, but also to retain the benefits of solid execution in three key operational areas: timely sales crediting, accurate revenue recognition, and visibility to the ultimate end customer.

For comparison, this article will study three different go-to-market strategies: 1) Direct Sales Model; 2) Multi-Tier Distribution System; and 3) OEM Model.
    
1) Direct Sales Model: Balancing Knowledge and Costs

 

Dissecting the benefits of the direct sales model with regard to end customer knowledge, sales crediting and revenue recognition highlights the equilibrium between superior end customer knowledge and time to market.  When exploring sale crediting in this model, note that Company A’s end customer is apparent to the sales organization, so assigning compensation involves setting up a system of governance concerning sales accounts. Sales coverage is executed on a one-to-one basis – one sales person (or sales team) to each customer. Using GAAP standards, revenue recognition is also straightforward. Revenue can be recognized when the sale price is fixed or determinable and the ability to collect payment is probable. Given that the sales team conducted the sale, the sale price is known. Collection of payment can be modeled by creating allowance for returns according to past historical trends. Finally, the direct interaction between the sales organization and the end customer allows for a deep understanding of their needs in order to sell them the next solution.

The drawbacks of the direct sales route-to-market include a significantly longer time to realize a targeted return on investment and higher costs due to recruiting, training and monitoring a sales force. In today’s high tech market, most companies would prefer to share the expense of a sales force with a partner.  Also, market penetration and coverage will be constrained by the size of the sales organization.

2) Multi-tier Distribution Model: Information Roadblock

The multi-tier distribution go-to-market strategy mitigates many of the direct sales model’s limitations. Due to reduced recruitment and training, time to market is faster and less expensive. Distributors also lessen the cost of operational staff and systems while freeing up working capital by assuming inventory risk. Additionally, market coverage is no longer restricted by the sales organization’s capacity because Company A can simply add more distributors.  Simply put, it gives Company A’s sales force the global reach required to remain competitive in the high tech market.  Similar to the direct sales model, this route to market seems to have limited sale crediting issues given the availability POS (point-of-sale) information. However, new challenges arise concerning revenue recognition and end customer knowledge. As examined in Charlie Lin’s post “Options and Strategies for Effective Revenue Recognition for Distribution Sales”, Company A has three options for recognizing revenue in this model:

1. Recognizing revenue at sale of Company A to the Distributor or VAR with an allowance for returns (same as the practice under the direct sales model)
2. Recognizing revenue at sale of Company A to the Distributor or VAR with reverse entry at period-end for unsold inventory
3. Deferring revenue equal to the Distributor and VAR’s inventory and recording revenue at sale to End Customer

All three methods involve investing in systems and controls which will create a capability to forecast sales, maintain accurate and timely sales and inventory data, and reconcile current conditions with past trends.

In this scenario, Company A’s engagement with the end customer is removed, creating a problem attaining critical customer knowledge. This presents an information roadblock that obstructs Company A’s ability to assess and respond to their customers’ needs. This lack of flexibility will impede Company A’s growth, especially in the high tech arena.

Interestingly, a hybrid of the two routes to market illustrated in Figure 3 present a reasonable solution to the lack of end customer knowledge, while increasing market coverage. The direct sales team can engage and respond to the most profitable or inventive customers, leaving the less important customers to the distribution channel. Revenue recognition can still be realized depending on the channel that produced the sale. However, this creates the potential for serious channel conflict. This channel conflict effectively manifests itself in the sale crediting area. If a VAR sells into a direct sales team member’s account, does the sales organization receive compensation? A defined set of processes and systems re essential to avoid any potential channels conflict problems between resellers and the direct sales team.

3) OEM Partners: Customer or Channel?

In examining the issues of sales crediting, revenue recognition and end customer knowledge, the question becomes how to retain the benefits of the three models discussed above in an OEM* model. Crucial to addressing these issues is Company A’s viewpoint of its OEM Partner. Company A has two options:

A) OEM Partner as End Customer

 

This appears to be the obvious solution, particularly concerning sales crediting and revenue recognition. In both matters, Company A retains the benefits of the direct sales models.  However, similar to the multi-tier system, Company A lacks critical information about the true end-user of their products. More specifically, Company A runs the serious risk of a dependency on its partner to provide point-of-sale data regarding the true end-users of its product. Company A’s partner may be unwilling, due fear of being circumvented, or unable, due to a lack of systems, processes and people, to provide critical end customer information. Company A’s clear and continuous communication with its OEM partners is critical in this model.

B) Hybrid OEM Model

In this instance, Company A’s OEM sales team not only sells to the OEM partners, but also actively participates in transactions throughout the distribution system (figure 5). This resolves the end customer knowledge problem by retaining the direct model’s benefits of direct engagement. As above, revenue could still be recognized at the point of sale to the OEM partners. Costs associated with the direct sales model can be controlled through strategic relationships with distributors, VARs, and the OEM partner’s sales organization. For instance, a contractual agreement with the OEM partner could outline how Company A’s sales organization will participate in the transaction as a technical advisor or product specialist, but not actively seek potential prospects to avoid potential channel conflict implications. Both the partner and Company A’s sales teams should work together to close the sales. Close communication between the sales organizations is essential for this model to work correctly. The downside of this solution, however, is that Company A’s sales team receives credit for sales they did not influence, resulting in inordinately high compensation payments.

To prevent unwarranted compensation, Company A must deploy its sales organization in such a manner that it will not unduly compensate them. Many high tech companies have employed a claiming methodology for their sales teams to receive compensation. For revenue that Company A’s sales organization felt it influenced, it can submit a claim to the sales operations team, stating that it influenced the decision of end user. In order to substantiate their claim, Company A’s sales team must provide sufficient collateral, such as an invoice statement, in order to receive compensation. This collateral can be verified against point-of-sale data collected by the OEM partner, eliminating unjustified compensation payments.

A potential drawback to the “claiming” methodology involves the sales teams’ time spent authenticating that they did in fact influence the transaction. Certainly, Company A would prefer to have their sales teams focusing on selling more products, not pursuing invoices and other collateral to verify their already-closed sales. Sales operations teams can dedicate more bandwidth in terms of processes, systems and people to applying a system of checks and balances to ensure that proper credit is assigned. Company A’s operation team can also install systems that work with their OEM partners to ensure the completion and verification of the sale. Also, Company A’s sales operations organization can reach downstream to the end user to further substantiate any sales claims.

Though the strategies illustrated above are admittedly simplified to highlight the challenges concerning various route-to-markets, they demonstrate how to combine seemingly disparate models to arrive at an innovative solution. In our example, Company A took aspects of the direct and multi-tier sales models to devise a route-to-market that possessed substantial benefits over the straight OEM model. Each company will inevitably face strategic decisions involving resource deployment to optimize the go-to-market approach, and this flexibility and adaptability are vital to success. As the high tech industry continues to evolve by expanding into previously untouched markets, the capability to combine sales models, or design new routes to market, will be essential for continued success.

*Note: To avoid confusion over the usage of the “OEM” term, OEM will refer to the manufacturer of the product, not the reseller. For example in the figure, Company A is the OEM while Company A’s partner is an OEM Client.

Contributors: Sanjay Shitole and Julien Guillot

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