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Impact of purchasing systems contracts on distributors and procedures
Impact of Purchasing Systems Contracts on Distributors and Producers Marsha A. Scheidt I. Fredrick Trawick John E. Swan Under systems contracting the buyer is supplied with all of his MRO items from a single source. This article discusses some important marketing strategy implications of systems contracting for both the manufacturer tor of MRO items.
and industrial distribu-
INTRODUCTION A key factor in planning industrial marketing strategy is the procedures and processes used by organizations to carry out the buying function. The industrial marketer must plan his strategy in light of how his customers buy. Systems contracting, a buying procedure that has received little published attention, is the focus of this article. The essence of purchase systems contracting is that the buyer arranges for a single source of supply for his MRO (maintenance, repair, operating) supplies under a stockless purchasing concept where the industrial dis-
Address correspondence to: Professor I. Fredrick Trawick, Associate Professor of Marketing, The University of Alabama in Birmingham, University Station, Birmingham, Alabama 35294 Industrial Marketing Management 11, 283-289 (1982) 0 Elsevier Science Publishing Co., Inc., 1982
52 Vanderbilt
Ave., New York, New York 10017
tributor carries the required inventory. Systems contracting has some extremely important strategic marketing implications for both the industrial distributor and manufacturer of MRO items. For example, the single source arrangement under systems contracting should be a boom to the industrial distributor that lands the business and a bust for those that do not. In this article we will explain purchase systems contracting and discuss possible strategies for industrial distributors and manufacturers in meeting the challenges and opportunities presented by systems contracting. SYSTEM CONTRACTING
PROCEDURES
Systems contracting is a purchasing technique whose objective is the elimination of the high costs of acquisition and possession of low value, repetitive use, MRO supplies for the industrial buyer while maintaining competitive prices and limited-term price protection. There are many benefits accruing to the industrial customer from the use of systems contracting. First, there is a reduction of time spent in MRO source selection. After selection of a single source of MRO items, there is less 283 0019-8501/821040283-07/$02.50
daily need for continual distributor selection and evaluation. In addition, this system provides a simplified point of need-direct to distributor requisitioning system. The distributor will fill all orders by an authorized customer employee. Secondly, the customer shifts inventory to the distributor. Therefore, duplication of inventory is eliminated, and the cost to the customer of carrying the inventory is substantially reduced while improving return on investment and stock turnover. Finally, systems contracting does not focus on the price of one item. Instead, the focus is on reduction of total inventory costs through provision of the most efficient service. There are also many benefits accruing to the industrial distributor and to the manufacturer. First, there is a reduction of operating costs since most systems contracts are for two years or longer. This long-term factor brings about several operating benefits. Distributors and manufacturers are able to better forecast in advance by line item the quantity needed by customers. This forecasting ability has allowed distributors to increase inventory turn-over to a factor of six or more [l] as opposed to an average of two. Another operating cost benefiting from the length of the contract is sales expenses. Ordinary sales expenses of bidding for the lowest price, weekly social sales calls, and competitive sales maneuvering tactics will all be reduced. Systems contracting evolves around the idea of solving customer problems in the supply of MRO inventory. There are also two benefits especially relevant to the industrial distributor. First, there is a reduction in paperwork. The customer orders from a catalogue and per-
I. FREDRICK TRAWICK is Associate Professor of Marketing at the University of Alabama in Birmingham. He received his Ph.D. from the University of Georgia. Fred does consulting, teaching, and research in the industrial marketing area and has published several articles in the field. MARSHA SCHEIDT is an Alabama in Birmingham. Accounting, Birmingham coauthored a Conference
MBA from the University of She is currently an instructor of Southern College. She has Paper on Sale Force Research.
JOHN E. SWAN is the Birmingham Business Associates Professor of Marketing at the University of Alabama in Birmingham. His DBA is from Indiana University. He has authored articles for the Journal of Marketing, Journal of Marketing Research, and other publications. Dr. Swan serves on the editorial board of the Journal of Marketing Research and the Journal of Business Research.
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forms most of the paperwork duties. Secondly, cash flow is improved. Since the billing is usually semi-monthly direct to the customer’s accounts payable department, payment is received within one to two days after invoice presentation. INDUSTRIAL DISTRIBUTOR AND MANUFACTURER IMPLICATIONS After understanding the benefits derived from systems contracting, the distributor and the manufacturer must be aware of the resources necessary to consider the use of systems contracting and must determine if the organization’s objectives coincide with the systems contracting philosophy. Both the distributor and manufacturer must be willing to adapt their organization to systems contracting. For the distributor, floor layout, shelving plan, packing, delivery, billing functions, and suppliers must be functionally evaluated for efficiency. Also, all members of the sales force in the total channel of distribution must become specialized for systems contracting since the sales force used will play a crucial role in the success of systems contracting. The financial strength of the manufacturer, distributor, and customers must be adequate to support a long-term inventory contract. If the industrial distributor and manufacturer have the necessary interest and resources for the use of systems contracting, the distributor and manufacturer will now want to consider options for the marketing of systems contracting to the industrial customer. Industrial distributors and manufacturers may select either a passive or aggressive approach to systems contracting to the industrial customer. For the passive marketing option, the industrial customer initiates the systems contract. On the other hand, for aggressive marketing, the industrial distributor or manufacturer initiates and pushes the systems contracting concept. There are advantages as well as disadvantages for each option. Passive Systems
Marketing
Passive marketing of systems contracting occurs when the distributor and manufacturer are capable of systems contracting, but they leave the responsibility of initiating systems contracting to industrial customers. There are three advantages for the use of a passive strategy. First, the manufacturer and distributor will avoid costly and time consuming presentation costs. Only interested customers will suggest systems contracting to the distributor or manufacturer. Second, since the customer proposes the contract. the distributor and manufacturer will have
little difficulty in convincing the customer’s employees of the benefits of systems contracting. Purchasing department employees will probably know the organizational impact and consequences of this new system on their jobs. The distributor’s and manufacturer’s task of implementation will be considerably easier. The third advantage is that each customer will have a tailor-made systems contract. The customer proposes the system; therefore, less systems contract research time is required for the distributor or manufacturer. However, there are distinct disadvantages for the use of passive marketing. First, since pure systems contracting is not widely understood, it is unlikely that most industrial customers will take the time to research possible benefits of systems contracting. Secondly, purchasing department managers are frequently opposed to systems contracting believing they may lose their jobs or influence [2]. These managers may not present systems contracting favorably to top management. The third disadvantage is that industrial customers would be required to actively search for industrial distributors who were able to systems contract their MRO items. If other rival distributors were actively soliciting systems contracts, failure to do the same could place the distributors and the manufacturer at a competitive disadvantage. If an industrial distributor and manufacturer are both passive in the marketing of systems contracting, both lose the opportunity. If the distributor uses aggressive marketing and the manufacturer uses passive marketing, the distributor may seek manufacturers who are willing to invest the resources necessary to use aggressive marketing.
Aggressive Systems Marketing Given the disadvantages of the passive approach, a second approach is aggressive marketing of systems contracting whereby an industrial distributor and manufacturer are capable of systems contracting and actively seek customers with whom to contract. Hannaford [3] believes that aggressive selling will increase: More vendors should adopt systems contracting. . . . This problem of supplier selection could be solved in part by distributor-supplier taking a more aggressive posture in selling and implementing systems. As the demand (for systems contracting) becomes more apparent to vendors, the likelihood of an aggressive response should be increased. There are major advantages to using aggressive marketing techniques. First, the distributor and manufacturer assume the role of marketer, not grudgingly accepting an
unproven customer idea [2]. Sales, promotion, and persuasion are the responsibilities of the distributor and/or manufacturer. Second, the marketers can stress serviceoriented costs savings. In passive marketing, the customer retains the advantage of focusing on low item prices as well as costs. In aggressive marketing, the distributor can counter customer objections to less than competitive prices. Third, aggressive marketing places the industrial distributor in the position of channel captain. The distributor becomes the most important link in the channel, if he can build a reliable channel of distribution based on the stringent requirements of systems contracting. Finally seller-designed programs reduce inefficiencies thrust upon distributors and manufacturers who agree to whatever form of system is desired by each of their customers. One standardized yet flexible arrangement makes more operational sense than a unique format for each customer [2]. Users of aggressive marketing of systems contracting must also be aware of the disadvantages of aggressive marketing. One disadvantage is that many industrial distributorships are owner-managed with little professional expertise [4]. Their managerial resources may not be strong enough to support an aggressive selling of systems contracting. The manufacturer must be able to seek out distributors who are willing to systems contract. If a distributor does not have the capacity to systems contract, but his organization can be developed to use systems contracting, the manufacturer may desire to invest resources in the distributor. One of the most important resources to develop is the sales force used in the channel of distribution. A second disadvantage is the development of one flexible systems contract for all customers. This contract will incur formulation expenses for the distributor. The third disadvantage is that the selling expenses will initially be greater. The aggressive approach requires additional sales force tasks. Top management of the distributor and manufacturer must sell systems contracting to the top management of the industrial customer [2]. There are two reasons for the use of top management of the distributor and manufacturer: their knowledge of the distributor’s capabilities and the need to present systems contracting to the top management personnel of the customer. Top customer management should be receptive to the cost (not price) reductions made possible through systems contracting. Another additional sales force task will be to redirect the tasks of the distributor’s and manufacturer’s salesmen [5]. New tasks will be to gain the acceptability of customer personnel who will directly 285
work with the systems contract as well as to act as the communications line between the customer and the distributor. Lower level purchasers can be especially hostile since they react to systems contracting with fear of the loss of their jobs. The sales force must educate the customer’s employees on the concepts and methods of systems contracting. Also, the sales force must be able to quickly solve any problems arising with the systems contracting and be aware of any possible expansion of the systems contract with the customer. Which Approach? If a distributor and manufacturer have the resources for a systems contract, then the aggressive approach for the systems contracting is the better choice. The cost disadvantages listed for aggressive marketing occur at the inception of a systems contract. These costs typically produce a two-year single source contract for MRO supplies with no negotiation needs, competitive prices, and the opportunity to expand items covered under the systems contract. The disadvantages of passive marketing illustrate the risks associated with the loss of a systems contract to another distributor. Since the contract is locked -in for two years, the distributor and manufacturer who lost the contract are out of the market for the systems customer for at least that length of time. Within the two years, the distributor and the customer under the systems contract will gain valuable information on the capabilities and needs of each other. Once a distributor or manufacturer misses a chance at a systems contract, the opportunity to service that customer may be forgone for quite a long time. Therefore, the long-run benefits of aggressive systems marketing outweigh the short-run expenses.
the distributor in the form of sales training (both product knowledge and salesmanship training), technical support, advertising and sales promotion assistance, and, in several cases, increased margins [4]. ” This increase in support should partially offset initial expenses incurred by the industrial distributor. Entering Systems Contracting After selection of the marketing option, the industrial distributor will want to select manufacturer suppliers as well as potential industrial customers with whom to enter a systems contract. The distributor must use criteria for evaluation of suppliers as well as customers. Manufacturers must be able to deliver consistent quality of a determined quantity of items in the necessary time frame. Manufacturers must also be financially sound because distributors will be depending on these firms for the supply of inventory under contract with the industrial customer. Alternative manufacturers must be evaluated for occasional special or emergency deliveries. The distributor must select potential customers on the basis of the size of inventory needed. The selection of customers could be from both current and potential customers. The quantity of MRO supplies needed by the customer should be sufficient to justify a systems contract. Also, the distributor must select customers whose needs an MRO contract could meet. Additionally, the distributor must select financially sound customers. If the customer is having difficulty in payment of accounts payable or the selling of finished goods, a two-year systems contract would not be a good alternative for the distributor until those problems are corrected. After selection of potential customers, the top distributor management team should contact the top management
The long run benefits of aggressive systems marketing outweigh the short run expenses. In addition, one special advantage of aggressive marketing is that the manufacturer will rely more on the distributor. The trend in the relationship between manufacturers and industrial distributors is that “as firms have increased their reliance on industrial distributors, they have also tended to increase the amount of support given 286
of the proposed customer to discuss the possibility of a systems contract arrangement. At the presentation, the distributor’s team should present a resource evaluation of the distributor, a list of systems benefits to the customer, slides of the distributor’s warehouse, and a catalogue of available supplies [6]. It is very important that the cata-
logue be easy to follow and have pictures of all items available since employees of the customer will fill out information on orders. The distributor’s team should also present the flexible systems contract of the distributor with appropriate flowcharts, customer usage patterns of MRO supplies, and contingency plans for either special orders or emergencies. In the presentation of the systems contract, the team must have sufficient information to present cost savings to the user of systems contracting. The team must also stress that the implementation of a systems contract will take from six months to a year [ 11. A distributor must have stock of sufficient quantity to avoid stockouts as they create a loss of confidence for the customer which is a key basis of systems contracting. MANUFACTURERS’ ROLE IN SYSTEMS CONTRACTING Up to this point we have stressed the impact that systems contracting can have on both the industrial distributor and his manufacturer suppliers. Because systems contracting introduces such a fundamental change in the channel of distribution, a number of the manufacturer’s policies toward distributors will need to be reconsidered. In this section we will touch on some possibilities for strategy and the marketing mix. In terms of strategy, the market may be segmented by the use/non-use of systems contracting because of differences in the marketing mix required by systems contracting. It may be feasible to build market share by capturing systems contracting business. Market measurement and forecasting may be easier to carry out because of the programmed nature of the method. In addition to ideas for strategy, we feel that systems contracting can have an important influence on promotion, pricing, product, distribution, and marketing control. Promotion The manufacturer may use advertising to stimulate primary demand for the systems contracting concept and secondary demand for his products through distributors that handle the manufacturer’s products. Primary demand advertising could be directed at both user customers and distributors to promote the basic concept of systems contracting. At the secondary demand level two opportunities exist. The manufacturer could communicate to distributors that he might want to gain as customers his capabilities to support distributors engaged in systems contracting. For existing distributors, the manufacturer could advertise information concerning the bene-
fits of systems contracting to the industrial customer while requesting that the customer contact the manufacturer’s distributor for additional information. The sales force will play a crucial role for the manufacturer in systems contracting. The manufacturer must educate and involve his salespeople in the concepts and company policy regarding the systems contracting approach, as the salespeople must be prepared to aid the distributor in competing for contracts. First, the salesperson must insure that inventory of the distributor is of sufficient quantity and acceptable quality to be considered for a contract. Secondly, the salesperson must help the distributor by affording good service to both the distributor and his customer. Third, the salesperson might be required to aid the distributor in the initial negotiations by communicating the manufacturer’s actual capabilities in such areas as inventory, delivery time, ability to fill rush orders, and price quoting for typical MRO items. Finally, if the manufacturer’s distributor has a systems contract that is supplied by a competing manufacturer, our manufacturer’s sales force may desire to win the systems business by providing better delivery, inventory, service on rush orders, and higher quality product specifications. Price The important price under systems contracting would be the total price on the basket of items included under the systems contract. The distributor price that would tend to be most important to his customer would be the aggregate price for the entire set of items included under the systems contract. If the distributor and/or manufacturer prices lost competitive parity, this would produce little short run response (since manufacturers price increases can be passed onto the distributor’s customer). However, at least annually, customers with similar operations in different locations will be comparing supplier performance under the different systems contracts. At this point, noncompetitive prices could become apparent to the buyer with adverse consequences for both the distributor and manufacturer. The danger then is that in the short run prices can be increased with little, if any, loss of business. However, if prices drift out of line, the entire contract could be in danger. Another pricing consideration is that the buyer and distributor will be interested not in price but the total cost (price plus other acquisition costs) of the entire systems contract. The routinization and rationalization of the buyer-distributor transactions will result in efficiencies 207
and cost savings. That is the essential concept motivating systems contracting. Can that idea be carried back an additional step in the channel to distributor-supplier transactions? We think so. The distributor can probably sell a larger volume of his supplier products on a more constant basis. That should lower the supplier’s per unit costs of serving the distributor. The savings could be allocated to providing increased profits and/or savings to both the distributor and supplier.
Product Procedures must be specified in the systems contract for handling new product introduction or replacement of old products by the manufacturer. If a new industrial machine replaces an old machine, the salesperson for the manufacturer must remember to have applicable MRO items for the new machines incorporated in the systems contract. A similar situation occurs with replacement MRO items. Specified procedures can prevent bottle necks or possible reluctance on the part of buyer personnel to incorporate product changes expeditiously. On the other hand, if a product must be deleted, the process becomes easier for the distributor since the buyer typically accepts the risk of discontinued products.
Channel of Distribution Whether a manufacturer adopts an exclusive, selective, or intensive distribution strategy we argue that he should actively support the distributor in attempts to secure systems contracts with industrial users. Whenever one of the manufacturer’s distributors gets a contract, the market is locked up for that customer. Increasing use of systems contracting may tend to increase concentration at the distributor level. As a distributor gains experience with systems contracting, that particular distributor should be able to win additional systems contracts. Unsuccessful distributors may be forced out of business. Hence, it is important that a manufacturer support distributors using systems contracts in order to increase sales of the manufacturer’s products. One likely result of systems contracting is that it would tend to strengthen the power of the industrial distributor at the expense of the manufacturer. The manufacturer may find it more difficult to deal directly with the industrial buyer as the buyer will be contractually obligated to the distributor for purchases. This relationship could increase conflict because of the loss of manufacturer power. A second generalization is that the distributor may become a more important customer to the manufac208
turer as sales volume increases. Therefore, good relations and close cooperation are necessary between the manufacturer and the distributor. Additionally, there may be an increased long-run commitment to the channel arrangement since the manufacturer could not switch distributors easily without a resulting loss of customers served by those distributors.
Control As mentioned above, the manufacturers may lose some control over distributors in systems contracts. However, it is to the manufacturer’s advantage that the relationship between the distributor and the industrial user be effective. If there are problems in the relationship the manufacturer might regain some control by using his resources when problems occur. Another potential control problem which may arise is that under systems contracting the supplier manufacturer may loose contact with and feedback from buyers. This may occur because the manufacturer’s salespersons will deal more with the industrial distributor and less with the industrial user. Given the importance of system contracts, a method should be devised for an ongoing evaluation of existing systems contract performance, as well as monitoring the gain or loss of contracts as each is considered for renew al.
SUMMARY Systems contracting offers many benefits to the industrial distributor, manufacturer, and customer. If the distributor and manufacturer have the necessary resources for systems contracting, then the sales force becomes the crucial element in marketing the systems contract to customers. There are two marketing strategies available for the distributor and/or manufacturer to employ in selling systems contracting to the customer: passive or aggressive marketing. In order to facilitate maximum benefits to the distributor, manufacturer, and customer, the authors recommend the use of aggressive marketing. In the use of aggressive marketing of systems contracting, the role of the distributor and manufacturer dramatically changes. It is important to note the impact of systems contracting on the role of the manufacturer. Efficient use of advertising, the sales force, and pricing strategies augment the success of systems contracting. Changes in products supplied to the customer must be specified in the procedures of systems contracting. The manufacturer’s role is also changed in the channel of distribution, regardless of the distribution strategy utilized. Finally, a
manufacturer’s control over distributors is likely to decrease as the manufacturer’s dependence upon the distributor will increase as all members of the channel deal almost exclusively with the distributor.
Hannaford, W.illiam J., Vendor Perceptions of Contractual Systems, Journal of Purchasing and Materials Management, 10: 17-32 (1974). Hannaford, William J., How Effective Is Systems Purchasing? Purchasing, Summer, 15: 13-19 (1979). Webster, Frederick Marketing Strategy,
REFERENCES I. Anderson, Ernest L., Jr., Systems Contracting: What It Is, Systems Conrrucring, Management Bulletin, American Management Association, New York, No. 63: 3-6 (1965).
Purchasing November, Journal of
E., Jr., The Role of the Industrial Distributor Journal of Marketing, July, 40: lo-16 (1976).
in
5. Hannaford, William J., Systems Selling: Problems and Benefits for Buyers and Sellers, Industrial Marketing Management, June, 213: 139-146 (1976). 6. Bolton, Ralph A., Systems Contracting. A New Purchasing American Management Association, New York, 1966.
Technique.
289
and industrial distribu-
INTRODUCTION A key factor in planning industrial marketing strategy is the procedures and processes used by organizations to carry out the buying function. The industrial marketer must plan his strategy in light of how his customers buy. Systems contracting, a buying procedure that has received little published attention, is the focus of this article. The essence of purchase systems contracting is that the buyer arranges for a single source of supply for his MRO (maintenance, repair, operating) supplies under a stockless purchasing concept where the industrial dis-
Address correspondence to: Professor I. Fredrick Trawick, Associate Professor of Marketing, The University of Alabama in Birmingham, University Station, Birmingham, Alabama 35294 Industrial Marketing Management 11, 283-289 (1982) 0 Elsevier Science Publishing Co., Inc., 1982
52 Vanderbilt
Ave., New York, New York 10017
tributor carries the required inventory. Systems contracting has some extremely important strategic marketing implications for both the industrial distributor and manufacturer of MRO items. For example, the single source arrangement under systems contracting should be a boom to the industrial distributor that lands the business and a bust for those that do not. In this article we will explain purchase systems contracting and discuss possible strategies for industrial distributors and manufacturers in meeting the challenges and opportunities presented by systems contracting. SYSTEM CONTRACTING
PROCEDURES
Systems contracting is a purchasing technique whose objective is the elimination of the high costs of acquisition and possession of low value, repetitive use, MRO supplies for the industrial buyer while maintaining competitive prices and limited-term price protection. There are many benefits accruing to the industrial customer from the use of systems contracting. First, there is a reduction of time spent in MRO source selection. After selection of a single source of MRO items, there is less 283 0019-8501/821040283-07/$02.50
daily need for continual distributor selection and evaluation. In addition, this system provides a simplified point of need-direct to distributor requisitioning system. The distributor will fill all orders by an authorized customer employee. Secondly, the customer shifts inventory to the distributor. Therefore, duplication of inventory is eliminated, and the cost to the customer of carrying the inventory is substantially reduced while improving return on investment and stock turnover. Finally, systems contracting does not focus on the price of one item. Instead, the focus is on reduction of total inventory costs through provision of the most efficient service. There are also many benefits accruing to the industrial distributor and to the manufacturer. First, there is a reduction of operating costs since most systems contracts are for two years or longer. This long-term factor brings about several operating benefits. Distributors and manufacturers are able to better forecast in advance by line item the quantity needed by customers. This forecasting ability has allowed distributors to increase inventory turn-over to a factor of six or more [l] as opposed to an average of two. Another operating cost benefiting from the length of the contract is sales expenses. Ordinary sales expenses of bidding for the lowest price, weekly social sales calls, and competitive sales maneuvering tactics will all be reduced. Systems contracting evolves around the idea of solving customer problems in the supply of MRO inventory. There are also two benefits especially relevant to the industrial distributor. First, there is a reduction in paperwork. The customer orders from a catalogue and per-
I. FREDRICK TRAWICK is Associate Professor of Marketing at the University of Alabama in Birmingham. He received his Ph.D. from the University of Georgia. Fred does consulting, teaching, and research in the industrial marketing area and has published several articles in the field. MARSHA SCHEIDT is an Alabama in Birmingham. Accounting, Birmingham coauthored a Conference
MBA from the University of She is currently an instructor of Southern College. She has Paper on Sale Force Research.
JOHN E. SWAN is the Birmingham Business Associates Professor of Marketing at the University of Alabama in Birmingham. His DBA is from Indiana University. He has authored articles for the Journal of Marketing, Journal of Marketing Research, and other publications. Dr. Swan serves on the editorial board of the Journal of Marketing Research and the Journal of Business Research.
284
forms most of the paperwork duties. Secondly, cash flow is improved. Since the billing is usually semi-monthly direct to the customer’s accounts payable department, payment is received within one to two days after invoice presentation. INDUSTRIAL DISTRIBUTOR AND MANUFACTURER IMPLICATIONS After understanding the benefits derived from systems contracting, the distributor and the manufacturer must be aware of the resources necessary to consider the use of systems contracting and must determine if the organization’s objectives coincide with the systems contracting philosophy. Both the distributor and manufacturer must be willing to adapt their organization to systems contracting. For the distributor, floor layout, shelving plan, packing, delivery, billing functions, and suppliers must be functionally evaluated for efficiency. Also, all members of the sales force in the total channel of distribution must become specialized for systems contracting since the sales force used will play a crucial role in the success of systems contracting. The financial strength of the manufacturer, distributor, and customers must be adequate to support a long-term inventory contract. If the industrial distributor and manufacturer have the necessary interest and resources for the use of systems contracting, the distributor and manufacturer will now want to consider options for the marketing of systems contracting to the industrial customer. Industrial distributors and manufacturers may select either a passive or aggressive approach to systems contracting to the industrial customer. For the passive marketing option, the industrial customer initiates the systems contract. On the other hand, for aggressive marketing, the industrial distributor or manufacturer initiates and pushes the systems contracting concept. There are advantages as well as disadvantages for each option. Passive Systems
Marketing
Passive marketing of systems contracting occurs when the distributor and manufacturer are capable of systems contracting, but they leave the responsibility of initiating systems contracting to industrial customers. There are three advantages for the use of a passive strategy. First, the manufacturer and distributor will avoid costly and time consuming presentation costs. Only interested customers will suggest systems contracting to the distributor or manufacturer. Second, since the customer proposes the contract. the distributor and manufacturer will have
little difficulty in convincing the customer’s employees of the benefits of systems contracting. Purchasing department employees will probably know the organizational impact and consequences of this new system on their jobs. The distributor’s and manufacturer’s task of implementation will be considerably easier. The third advantage is that each customer will have a tailor-made systems contract. The customer proposes the system; therefore, less systems contract research time is required for the distributor or manufacturer. However, there are distinct disadvantages for the use of passive marketing. First, since pure systems contracting is not widely understood, it is unlikely that most industrial customers will take the time to research possible benefits of systems contracting. Secondly, purchasing department managers are frequently opposed to systems contracting believing they may lose their jobs or influence [2]. These managers may not present systems contracting favorably to top management. The third disadvantage is that industrial customers would be required to actively search for industrial distributors who were able to systems contract their MRO items. If other rival distributors were actively soliciting systems contracts, failure to do the same could place the distributors and the manufacturer at a competitive disadvantage. If an industrial distributor and manufacturer are both passive in the marketing of systems contracting, both lose the opportunity. If the distributor uses aggressive marketing and the manufacturer uses passive marketing, the distributor may seek manufacturers who are willing to invest the resources necessary to use aggressive marketing.
Aggressive Systems Marketing Given the disadvantages of the passive approach, a second approach is aggressive marketing of systems contracting whereby an industrial distributor and manufacturer are capable of systems contracting and actively seek customers with whom to contract. Hannaford [3] believes that aggressive selling will increase: More vendors should adopt systems contracting. . . . This problem of supplier selection could be solved in part by distributor-supplier taking a more aggressive posture in selling and implementing systems. As the demand (for systems contracting) becomes more apparent to vendors, the likelihood of an aggressive response should be increased. There are major advantages to using aggressive marketing techniques. First, the distributor and manufacturer assume the role of marketer, not grudgingly accepting an
unproven customer idea [2]. Sales, promotion, and persuasion are the responsibilities of the distributor and/or manufacturer. Second, the marketers can stress serviceoriented costs savings. In passive marketing, the customer retains the advantage of focusing on low item prices as well as costs. In aggressive marketing, the distributor can counter customer objections to less than competitive prices. Third, aggressive marketing places the industrial distributor in the position of channel captain. The distributor becomes the most important link in the channel, if he can build a reliable channel of distribution based on the stringent requirements of systems contracting. Finally seller-designed programs reduce inefficiencies thrust upon distributors and manufacturers who agree to whatever form of system is desired by each of their customers. One standardized yet flexible arrangement makes more operational sense than a unique format for each customer [2]. Users of aggressive marketing of systems contracting must also be aware of the disadvantages of aggressive marketing. One disadvantage is that many industrial distributorships are owner-managed with little professional expertise [4]. Their managerial resources may not be strong enough to support an aggressive selling of systems contracting. The manufacturer must be able to seek out distributors who are willing to systems contract. If a distributor does not have the capacity to systems contract, but his organization can be developed to use systems contracting, the manufacturer may desire to invest resources in the distributor. One of the most important resources to develop is the sales force used in the channel of distribution. A second disadvantage is the development of one flexible systems contract for all customers. This contract will incur formulation expenses for the distributor. The third disadvantage is that the selling expenses will initially be greater. The aggressive approach requires additional sales force tasks. Top management of the distributor and manufacturer must sell systems contracting to the top management of the industrial customer [2]. There are two reasons for the use of top management of the distributor and manufacturer: their knowledge of the distributor’s capabilities and the need to present systems contracting to the top management personnel of the customer. Top customer management should be receptive to the cost (not price) reductions made possible through systems contracting. Another additional sales force task will be to redirect the tasks of the distributor’s and manufacturer’s salesmen [5]. New tasks will be to gain the acceptability of customer personnel who will directly 285
work with the systems contract as well as to act as the communications line between the customer and the distributor. Lower level purchasers can be especially hostile since they react to systems contracting with fear of the loss of their jobs. The sales force must educate the customer’s employees on the concepts and methods of systems contracting. Also, the sales force must be able to quickly solve any problems arising with the systems contracting and be aware of any possible expansion of the systems contract with the customer. Which Approach? If a distributor and manufacturer have the resources for a systems contract, then the aggressive approach for the systems contracting is the better choice. The cost disadvantages listed for aggressive marketing occur at the inception of a systems contract. These costs typically produce a two-year single source contract for MRO supplies with no negotiation needs, competitive prices, and the opportunity to expand items covered under the systems contract. The disadvantages of passive marketing illustrate the risks associated with the loss of a systems contract to another distributor. Since the contract is locked -in for two years, the distributor and manufacturer who lost the contract are out of the market for the systems customer for at least that length of time. Within the two years, the distributor and the customer under the systems contract will gain valuable information on the capabilities and needs of each other. Once a distributor or manufacturer misses a chance at a systems contract, the opportunity to service that customer may be forgone for quite a long time. Therefore, the long-run benefits of aggressive systems marketing outweigh the short-run expenses.
the distributor in the form of sales training (both product knowledge and salesmanship training), technical support, advertising and sales promotion assistance, and, in several cases, increased margins [4]. ” This increase in support should partially offset initial expenses incurred by the industrial distributor. Entering Systems Contracting After selection of the marketing option, the industrial distributor will want to select manufacturer suppliers as well as potential industrial customers with whom to enter a systems contract. The distributor must use criteria for evaluation of suppliers as well as customers. Manufacturers must be able to deliver consistent quality of a determined quantity of items in the necessary time frame. Manufacturers must also be financially sound because distributors will be depending on these firms for the supply of inventory under contract with the industrial customer. Alternative manufacturers must be evaluated for occasional special or emergency deliveries. The distributor must select potential customers on the basis of the size of inventory needed. The selection of customers could be from both current and potential customers. The quantity of MRO supplies needed by the customer should be sufficient to justify a systems contract. Also, the distributor must select customers whose needs an MRO contract could meet. Additionally, the distributor must select financially sound customers. If the customer is having difficulty in payment of accounts payable or the selling of finished goods, a two-year systems contract would not be a good alternative for the distributor until those problems are corrected. After selection of potential customers, the top distributor management team should contact the top management
The long run benefits of aggressive systems marketing outweigh the short run expenses. In addition, one special advantage of aggressive marketing is that the manufacturer will rely more on the distributor. The trend in the relationship between manufacturers and industrial distributors is that “as firms have increased their reliance on industrial distributors, they have also tended to increase the amount of support given 286
of the proposed customer to discuss the possibility of a systems contract arrangement. At the presentation, the distributor’s team should present a resource evaluation of the distributor, a list of systems benefits to the customer, slides of the distributor’s warehouse, and a catalogue of available supplies [6]. It is very important that the cata-
logue be easy to follow and have pictures of all items available since employees of the customer will fill out information on orders. The distributor’s team should also present the flexible systems contract of the distributor with appropriate flowcharts, customer usage patterns of MRO supplies, and contingency plans for either special orders or emergencies. In the presentation of the systems contract, the team must have sufficient information to present cost savings to the user of systems contracting. The team must also stress that the implementation of a systems contract will take from six months to a year [ 11. A distributor must have stock of sufficient quantity to avoid stockouts as they create a loss of confidence for the customer which is a key basis of systems contracting. MANUFACTURERS’ ROLE IN SYSTEMS CONTRACTING Up to this point we have stressed the impact that systems contracting can have on both the industrial distributor and his manufacturer suppliers. Because systems contracting introduces such a fundamental change in the channel of distribution, a number of the manufacturer’s policies toward distributors will need to be reconsidered. In this section we will touch on some possibilities for strategy and the marketing mix. In terms of strategy, the market may be segmented by the use/non-use of systems contracting because of differences in the marketing mix required by systems contracting. It may be feasible to build market share by capturing systems contracting business. Market measurement and forecasting may be easier to carry out because of the programmed nature of the method. In addition to ideas for strategy, we feel that systems contracting can have an important influence on promotion, pricing, product, distribution, and marketing control. Promotion The manufacturer may use advertising to stimulate primary demand for the systems contracting concept and secondary demand for his products through distributors that handle the manufacturer’s products. Primary demand advertising could be directed at both user customers and distributors to promote the basic concept of systems contracting. At the secondary demand level two opportunities exist. The manufacturer could communicate to distributors that he might want to gain as customers his capabilities to support distributors engaged in systems contracting. For existing distributors, the manufacturer could advertise information concerning the bene-
fits of systems contracting to the industrial customer while requesting that the customer contact the manufacturer’s distributor for additional information. The sales force will play a crucial role for the manufacturer in systems contracting. The manufacturer must educate and involve his salespeople in the concepts and company policy regarding the systems contracting approach, as the salespeople must be prepared to aid the distributor in competing for contracts. First, the salesperson must insure that inventory of the distributor is of sufficient quantity and acceptable quality to be considered for a contract. Secondly, the salesperson must help the distributor by affording good service to both the distributor and his customer. Third, the salesperson might be required to aid the distributor in the initial negotiations by communicating the manufacturer’s actual capabilities in such areas as inventory, delivery time, ability to fill rush orders, and price quoting for typical MRO items. Finally, if the manufacturer’s distributor has a systems contract that is supplied by a competing manufacturer, our manufacturer’s sales force may desire to win the systems business by providing better delivery, inventory, service on rush orders, and higher quality product specifications. Price The important price under systems contracting would be the total price on the basket of items included under the systems contract. The distributor price that would tend to be most important to his customer would be the aggregate price for the entire set of items included under the systems contract. If the distributor and/or manufacturer prices lost competitive parity, this would produce little short run response (since manufacturers price increases can be passed onto the distributor’s customer). However, at least annually, customers with similar operations in different locations will be comparing supplier performance under the different systems contracts. At this point, noncompetitive prices could become apparent to the buyer with adverse consequences for both the distributor and manufacturer. The danger then is that in the short run prices can be increased with little, if any, loss of business. However, if prices drift out of line, the entire contract could be in danger. Another pricing consideration is that the buyer and distributor will be interested not in price but the total cost (price plus other acquisition costs) of the entire systems contract. The routinization and rationalization of the buyer-distributor transactions will result in efficiencies 207
and cost savings. That is the essential concept motivating systems contracting. Can that idea be carried back an additional step in the channel to distributor-supplier transactions? We think so. The distributor can probably sell a larger volume of his supplier products on a more constant basis. That should lower the supplier’s per unit costs of serving the distributor. The savings could be allocated to providing increased profits and/or savings to both the distributor and supplier.
Product Procedures must be specified in the systems contract for handling new product introduction or replacement of old products by the manufacturer. If a new industrial machine replaces an old machine, the salesperson for the manufacturer must remember to have applicable MRO items for the new machines incorporated in the systems contract. A similar situation occurs with replacement MRO items. Specified procedures can prevent bottle necks or possible reluctance on the part of buyer personnel to incorporate product changes expeditiously. On the other hand, if a product must be deleted, the process becomes easier for the distributor since the buyer typically accepts the risk of discontinued products.
Channel of Distribution Whether a manufacturer adopts an exclusive, selective, or intensive distribution strategy we argue that he should actively support the distributor in attempts to secure systems contracts with industrial users. Whenever one of the manufacturer’s distributors gets a contract, the market is locked up for that customer. Increasing use of systems contracting may tend to increase concentration at the distributor level. As a distributor gains experience with systems contracting, that particular distributor should be able to win additional systems contracts. Unsuccessful distributors may be forced out of business. Hence, it is important that a manufacturer support distributors using systems contracts in order to increase sales of the manufacturer’s products. One likely result of systems contracting is that it would tend to strengthen the power of the industrial distributor at the expense of the manufacturer. The manufacturer may find it more difficult to deal directly with the industrial buyer as the buyer will be contractually obligated to the distributor for purchases. This relationship could increase conflict because of the loss of manufacturer power. A second generalization is that the distributor may become a more important customer to the manufac208
turer as sales volume increases. Therefore, good relations and close cooperation are necessary between the manufacturer and the distributor. Additionally, there may be an increased long-run commitment to the channel arrangement since the manufacturer could not switch distributors easily without a resulting loss of customers served by those distributors.
Control As mentioned above, the manufacturers may lose some control over distributors in systems contracts. However, it is to the manufacturer’s advantage that the relationship between the distributor and the industrial user be effective. If there are problems in the relationship the manufacturer might regain some control by using his resources when problems occur. Another potential control problem which may arise is that under systems contracting the supplier manufacturer may loose contact with and feedback from buyers. This may occur because the manufacturer’s salespersons will deal more with the industrial distributor and less with the industrial user. Given the importance of system contracts, a method should be devised for an ongoing evaluation of existing systems contract performance, as well as monitoring the gain or loss of contracts as each is considered for renew al.
SUMMARY Systems contracting offers many benefits to the industrial distributor, manufacturer, and customer. If the distributor and manufacturer have the necessary resources for systems contracting, then the sales force becomes the crucial element in marketing the systems contract to customers. There are two marketing strategies available for the distributor and/or manufacturer to employ in selling systems contracting to the customer: passive or aggressive marketing. In order to facilitate maximum benefits to the distributor, manufacturer, and customer, the authors recommend the use of aggressive marketing. In the use of aggressive marketing of systems contracting, the role of the distributor and manufacturer dramatically changes. It is important to note the impact of systems contracting on the role of the manufacturer. Efficient use of advertising, the sales force, and pricing strategies augment the success of systems contracting. Changes in products supplied to the customer must be specified in the procedures of systems contracting. The manufacturer’s role is also changed in the channel of distribution, regardless of the distribution strategy utilized. Finally, a
manufacturer’s control over distributors is likely to decrease as the manufacturer’s dependence upon the distributor will increase as all members of the channel deal almost exclusively with the distributor.
Hannaford, W.illiam J., Vendor Perceptions of Contractual Systems, Journal of Purchasing and Materials Management, 10: 17-32 (1974). Hannaford, William J., How Effective Is Systems Purchasing? Purchasing, Summer, 15: 13-19 (1979). Webster, Frederick Marketing Strategy,
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5. Hannaford, William J., Systems Selling: Problems and Benefits for Buyers and Sellers, Industrial Marketing Management, June, 213: 139-146 (1976). 6. Bolton, Ralph A., Systems Contracting. A New Purchasing American Management Association, New York, 1966.
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