O PTIMIZING C HANNEL C OMPENSATION T EXAS A&M – NAW R ESEARCH C ONSORTIUM B EST P RACTICES IN DEMONSTRATING VALUE AND CREATING FAIR COMPENSATION FOR CHANNEL PARTNERS

Current Members of the Consortium

OCC Consortium Member Profiles  14 members  3 manufacturing members (5 firms)  11 distributors (15 firms)  9 Lines of Trade  Bearings, Seals, and Lubrication Systems  Building Materials  Chemical  Electrical  Electronics and Industrial  Fluid Power  HVAC  Process Control and Automation Solutions  PVF / Industrial

Optimizing Channel Compensation (OCC) 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Channel Focus  To who do we create value in the channel?  Who is important to us in the channel?  Equally important is, to who are we important?

Channel Focus  The volume or spend is the typical criterion to decide important suppliers (e.g. top suppliers who account for 80% of business)  The volume or spend tells how important a supplier to distributor’s business but not the distributor’s importance to supplier  Need to go beyond volume in order to understand to who we are strategic  Mutual importance is the prerequisite to optimize channel compensation

Mutual importance – Criteria  From Distributor Perspective  Relative share of business  What % of business from supplier X?  What % of supplier X’s business is from distributor?  Relative difference is key  Supplier’s channel strategy  For a given supplier, % of direct business vs. distribution  Supplier’s distribution model  Intensive  Selective  Limited or Exclusive

Example Supplier ASupplier B Distributor business from $7 MM$8 MM % of distributor’s total business 17.5 %20% % of supplier’s (distribution) business with this distributor 20%9% Relative share of business (the absolute gap) 2.5%11% Mutual importanceHigh & Balanced Low & Unbalanced  Distributor’s total business = $ 40 MM Lower the gap, higher the mutual importance

Example Supplier ASupplier B Distributor business$7 MM$8 MM Relative share of business (the absolute gap) 2.5%11% Mutual importanceHigh & Balanced Low & Unbalanced Channel strategy75% direct 25% distribution 50% direct 50% distribution Distribution modelExclusiveIntensive  Who is the strategic supplier for this distributor?  To which supplier, is this distributor strategic? Mutual importance is the prerequisite to optimize channel compensation

Optimizing Channel Compensation 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Channel Pressure  End-customers call the shots on how distributors should be compensated in certain trades  Large customers go around distributors to direct negotiation with suppliers  Continuous pricing pressure Sales & Marketing Optimization Operational Excellence

Evolving Channel Value Proposition

SourceStockStoreSellShip Information Technology Human Resource Management Finance Management Support Services Key Performance IndicatorsSupply Chain Planning SupplierCustomer Business Process Framework

Support Services Supply Chain Planning Ship Sell Store Stock Source Inventory breadth Inventory depth FacilitiesSales forceServices Brand (Experience & Relationship) Delivery Market intelligence Credit HR Development IT resources Market coverage (footprint) Customer service Distributor Value Proposition

Supplier’s Value Proposition to Distributors Example – SKF

SKF Overview  Established 1907  Sales 2011 USD 9,960 million  Employees 46,039  SKF presence over 130 countries with production sites in 32 8% Changes in sales in local currency 15% Operating margin, level 27% Return on capital employed

Distributors essential to SKF Local Presence Flexibility to fulfil customer demands Multiplication of SKF presence in market Distributor sales people

Maintain customer relations Improve SKF brand awareness Value sell SKF offering Close to the customer Understand the customers needs

Communication Develops trust Increases market intelligence Optimises resource allocation

Investment Local Inventories People selling our product

Areas to support distributor growth Increased level of mutual engagement and joint activities toward final customers Equipping distributors' employees with arguments to defend the SKF value proposition Cost savings in supply chain and inventory level optimization Customer solution selling with the Certified programs and Solution Factory Pro-Active Selling Education Supply Chain Optimisation Differentiation

Pro Active Selling Development programs Structured follow up Collaboration

Education Development programs Structured follow up Collaboration Documented value tools

Supply Chain Optimisation Improving information flow Collaborative forecasting Maintain good service level

Differentiation Joint development of distributor services Knowledge sharing Utilising distributor reach for service provision

Industrial Distribution Strategy  Build sustainable and profitable customer relations in partnership with Distributors

Channel Value Creation Support Services Supply Chain Planning Ship Sell Store Stock Source Channel Partners Goal Value CreationManufacturer Product design Manufacturing capacity Product Mix Product Volume Inventory (FG and WIP) Plant locationsBrandDeliveryLead timeCredit HR Development IT resourcesVisibilityMarketing Product training & support Distributor Inventory breadth Inventory depth FacilitiesSales forceServices Brand (Experience & Relationship) Delivery Market intelligence Credit HR Development IT resources Market coverage (footprint) Customer service

Optimizing Channel Compensation 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Alignment Supplier Distributor Business Objectives Supplier Distributor Performance Supplier Market Share Revenue Product driven Distributor ProfitabilityCash Flow Market driven  Supplier performance  Distributor performance  Product performance  Customer performance

Supplier performance through stratification Real-world Example

Supplier Stratification Framework Low Profitability High Spend Volume Collaborative Relationship Hard to Do Business With Custom Vendors High Profitability High Spend Volume Collaborative Relationship Easy to Do Business With Strategic Vendors Low Profitability Low Spend Volume Limited Relationship Hard to Do Business With Transactional Vendors High Profitability Low Spend Volume Limited Relationship Easy to Do Business With Emerging Vendors Supplier Profitability Supplier Loyalty Ease of Doing Business Growth Potential

Real World Example Key Statistics Data timeline2011 (12 months) # Total Vendors117 Annual Spend $$ 269 MM # invoices15,689

Supplier Stratification Model

Supplier Stratification – Real World Example

Distributor performance through inventory & customer stratification Real-world Example

Customer Stratification Model  High Profitability  No Relationship  Low Cost to Serve  Low Volume Opportunistic Customers  High Profitability  Sustained Relationship  Low Cost to Serve  High Volume Core Customers  Low Profitability  No Relationship  High Cost to Serve  Low Volume Marginal Customers  Low Profitability  Sustained Relationship  High Cost to Serve  High Volume Service Drain Customers Customer Loyalty (Life) Customer Profitability Customer Buying Power Cost To Serve (CTS)

Customer Stratification – Real World Example

Inventory Stratification Model Revenue & Hits GMROII

Inventory Stratification – Real World Example

Supplier-Inventory-Customer Alignment A LIGNMENT

Better Alignment Supplier-Inventory-Customer Alignment Real World Example

Low Alignment Supplier-Inventory-Customer Alignment Real World Example

Supplier and Distributor Performance Alignment Example – L&W Supply

L&W SUPPLY: Overview Founded Locations Largest Specialty Dealer in North America Largest customer for our suppliers 45

L&W’s History with TAMU  Consortia Member Sales & Marketing Optimization Optimizing Distributor Growth & Market Share Best Practices in Customer Service – Talent Incubator Lab Optimizing Channel Compensation  Capabilities assessment in  Implemented Inventory Stratification in 2011  Received PAID “Award of Distinction” in 2012  Currently implementing Customer Stratification

THE L&W TRANSFORMATION Branded Customer Experience Corporation Federation 47

Distributor / Manufacturer: Inventory Management & Replenishment Jan 2011 – Dec 2011  Inventory Stratification Supplier/L&W collaborated in the development of an Inventory Stratification process across shared key product categories  Process Improvements Aligned processes with Supplier’s customer service center and L&W’s purchasing agents to streamline replenishment and delivery processes Supplier /L&W instituted a 3PL tendering process to improve service to the branches Supplier/L&W evaluated order sizes and adjusted the shaping of purchase orders to increase pool opportunities, thus increased frequency of deliveries to the branches  Increased Visibility to Demand and Availability of Product Supplier/L&W coordinated process to enable increased visibility to slow moving inventory Supplier/L&W coordinated process improvement and training of existing processes unfamiliar to L&W enabling improved visibility to manufacturers product availability. L&W provides Supplier daily demand data for future demand projections in Supplier’s S&OP planning process.

 Shared Benefits Alignment of service level policies for A&B items improved product availability & service lead times resulting in increased sales Supplier reports lower costs via better asset utilization, more efficient order processing at CSC, fewer shipping errors and additional capacity utilization at plants during increased demand cycles Re-investment of more A&B to Supplier came from substantial reduction of C&D. C&D fell from 52% of inventory to 44% in 12 months. GMROII improves double digit %.  Challenges L&W change management for full adoption of new replenishment process and tools L&W data challenges on fully capturing GMROII (Supplier acceptance) Supplier’s Sales Management questioning L&W’s commitment to inventory Supplier’s Supply Chain/Mfg. building consensus internally with sales leaders Distributor / Manufacturer: Inventory Management & Replenishment Jan 2011 – Dec 2011

Distributor / Manufacturer: Alignment for Growth October Present  Field Sales Alignment Competitive Market Pricing Participation in Regional Sales Meetings Product Knowledge events at vendor plants  Leveraging vendor expertise to collectively grow the market National training by vendors to educate L&W teams on best practice selling Customer webinars and training to educate the market on coming trends  Value Stream Mapping and Continuous Improvement events Collaborative efforts to identify waste/inefficiency in the process  Joint Marketing to create awareness and demand Developing processes for getting leads to the field Partnership with vendors on various national and local marketing efforts Identifying unique ways to engage customers together

 Project Management Dedicated project management resources for key initiatives Common scorecards for measuring success Regularly scheduled leadership calls / meetings  Shared Benefits Commitment to joint sharing of the reduced costs through process improvements Formalized pricing management process to keep focus on selling and not negotiating Growth oriented program incentives  Challenges L&W Internal Supplier Internal Distributor / Manufacturer: Alignment for Growth October Present

Alignment to Shareholder Value Financial Drivers Supplier Stratification (Strategic) Inventory & Value-add stratification (A items) Customer Stratification (Core) Optimal Channel Value Proposition Days Payables Outstanding (DPO) Days Of Inventory (DOI) Days Sales Outstanding (DSO) GMROII Resource Utilization Cost to Serve Gross MarginRONANet Margin Spend Percentage Market Share Market Penetration

Optimizing Channel Compensation 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Relationship – Key ingredients Top management commitment PeopleProcessTechnologyCommunication

Vision and Strategy Supply Chain Planning Store & Ship SourceStock Sell Support Services Value Proposition & Customer Service EnableImplement People, Process, Technology & Metrics Customer Internal Business Processes Financial Learning & Growth Balanced Scorecard Source: Adapted from Kaplan and Norton’s Balanced Scorecard

Optimizing Channel Compensation 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Compensation Drivers Purchase-side Spend volume / $ Product mix Time-bound promotions Payment terms Freight policies Inventory holding Sell-side Sales volume / $ Product mix Customer mix Market segment mix Time-bound promotions Situation-specific special pricing (SPA) Joint Activities Product lifecycle management Advertising (co-op and promotion) Business development activities Exclusivity Training & Development Field support / joint-sales calls

Compensation Mechanisms Rebate Chargeback Bid pricing Ship-and-debit Earned income Sheltered income Special pricing authorizations (SPA)

Effect of compensation on ROI (Example – New Product Development) with distribution as channel partners  Return on Investment (ROI) (Revenue – COGS – Distributor compensation – Operating expenses) (Net Assets)  Customer Service & Market Reach without distributors in the process  Return on Investment (ROI) (Revenue – COGS – Direct expenses – Operating expenses) (Net Assets)  Customer Service & Market Reach 59

EXAMPLE

Channel compensation – Example  Distributor’s value proposition  Improve customer retention for a given supplier  Distributor’s action plan  Define retention metrics  Measured the base line & set the targets  Through focused sales effort, improved retention

Core Customer Retention Metrics 50% 39% 11% OPPORTUNISTICCORE MARGINALSERVICE DRAIN % 35% 12% 55% 33% 12% Year 1 Year 2Year 3Year 4 Retention Internal Defection External Defection

Customer conversion through focused sales effort OPPORTUNISTICCORE MARGINALSERVICE DRAIN % 7% 1% Year 1 Year 2 Core Opportunistic to Core Marginal to Core Service Drain to Core

Channel compensation – Example  Channel compensation from supplier  Changed distribution strategy from ‘intensive’ to ‘selective’ model  Better payment terms

EXAMPLE

Generating Growth Framework

Growth Strategy 1 Growth Drivers 2 Best Practices 3 Growth Mechanism 4 Metrics 5

PRODUCT LIFE CYCLE Alliance & Compensation

EXAMPLE

Quantifying Value (Supplier Performance) – Real World Example  Distributor Profile  Industry – Automotive components to dealers  Revenue – $ 400 MM +  # Locations – 17  # SKUs – 2,500 +  # Suppliers – 16  Best Practice  Quantify value addition in channel  Determine % of additional safety stock due to supplier lead time variation beyond agreed variation

Linking to shareholder value Basic Input Parameters P&L and Bal. Sheet Lead Time LT Var. % of re- investment Expected Turns Additional Revenue RONA GMROII Turns EBITDA Average Inventory Safety Stock Re-invest ? YES NO

Results Vendor Number International / Domestic Agreed Safety Stock $ Actual Safety Stock $ Additional Safety Stock $ 50160Domestic 3,006,102 4,741,632 1,735, International 2,326,274 3,340,528 1,014, Domestic 1,207,422 2,182, , International 470, , , International 489, , , Domestic 267, , , International 196, , , International 472, , , Domestic 177, ,369 37, Domestic 72,992 99,067 26, International 35,282 55,702 20, Domestic 12,276 30,330 18, Domestic 22,775 34,130 11, International 5,635 13,064 7, International 7,558 10,820 3, Domestic 1,716 1, Grand Total$ 8,771,650$ 13,649,321$ 4,877,671 36%

Channel Compensation Benefits  Channel Compensation  COGS adjustment to compensate additional carrying cost  Quantified performance information for annual negotiation – leading to  improved delivery performance hence customer service  working capital  Additional safety stock reduced to 13% in the following quarter

Optimizing Channel Compensation 1. Channel Focus 2. Channel Value 3. Channel Alignment 4. Channel Relationship 5. Channel Compensation

Questions and Discussion