Overview of Distribution Supply Chain Options

26 March 2018 Dashboard Insights Blog
Authors: Kathleen E. Wegrzyn

When determining how to sell a product in the marketplace, there are a number of supply chain options from which to choose, each with its own set of legal implications. However, the primary consideration in determining how to sell a product should be what makes the most sense from a business perspective (for example, if the product requires technical assistance, a large inventory or warranty and other repair work, having these responsibilities outsourced to a distributor may be the most practical solution).

Here is a high-level summary of the available ways to sell product:

 

Employment Relationship:

Overview.  Supplier employs salespeople to sell the product directly to the ultimate customer.  The costs and risks associated with this structure are higher, as more resources are needed to implement it.  The margin generally is the highest because there is no intermediary.

Compensation.  The employee is paid a salary (which may be commission-based).

Credit Risk.  Supplier bears the credit risk as to the ultimate customer.

Control.  Supplier retains the relationship with the ultimate customer and has complete control of the sales activities, including pricing.

Termination.  Termination follows local labor laws.  In most states in the United States, the employee may be terminated at will.

Sales Agency Agreement:

Overview.  Supplier contracts with an independent contractor, who solicits orders from the ultimate customer.  Supplier is able to accept or reject the orders.

Compensation.  Supplier pays a commission to the sales representative, which is often a percentage of the invoice value of the accepted orders that the sales representative solicited.

Credit Risk.  Supplier bears the credit risk as to the ultimate customer.  (If it is unclear if the relationship is one of a distributorship or a sales representative, this factor will likely be determinative.)

Control.  Supplier retains nearly-complete control of the sales activities, including pricing.  However, the sales representative may have the relationship with the ultimate customer.

Termination.  A few jurisdictions have statutory protections against terminating sales representatives, but, in large part, termination is unrestricted by law, provided that the sales representative is paid timely for any outstanding commissions.

Distributor:

Overview.  Supplier contracts with a distributor, who purchases the product from the Supplier for re-sale in the contractually-prescribed territory.  Many states have statutes requiring that the Supplier compensate a distributor for warranty work done by the distributor at statutorily-prescribed rates.

Compensation.  Distributor resells the product at a markup, with such profit being the only compensation.

Credit Risk.  Distributor bears the credit risk as to the ultimate customer.

Control.  Supplier’s control of the sales activities (including pricing) is limited by antitrust and other principles.  Further, the distributor maintains the relationship with the ultimate customer.

Termination.  The termination or non-renewal of a distributor is often restricted by statute (particularly in certain industries, like motor vehicles, industrial or construction equipment, and agricultural equipment), and may require the buy-back of inventory or may prohibit any termination without good cause.

Franchisee:

Overview.  Supplier (called the franchisor) contracts with a franchisee, who (i) may purchase product from Supplier for re-sale in the contractually-prescribed territory and/or (ii) operates a local business that, to the outside world, is indistinguishable from Supplier’s locations.  This model is a hybrid between a distributorship and a license arrangement, and it involves additional statutorily-prescribed factors (which usually include the payment of a franchise fee by the franchisee to the Supplier and a heavy reliance by the franchisee on the trademarks of Supplier).  This model requires franchise disclosures akin to securities offering circulars, and state-by-state registration.

Compensation.  Franchisee resells the product at a markup, with such profit generally being the only compensation.

Credit Risk.  Franchisee bears the credit risk as to the ultimate customer.

Control.  Supplier’s control of the sales activities (including pricing) is limited by antitrust and other principles. The franchisee maintains the relationship with the ultimate customer, although, as a practical matter, the goodwill generated accrues primarily to the supplier.  Supplier must also exercise quality control over the franchisee’s operations.

Termination.  The termination or non-renewal of a franchise is heavily regulated, making termination difficult in the absence of good cause.

Licensee:

Overview.  Supplier (called the licensor) contracts with a licensor, who licenses Supplier’s intellectual property and technology to manufacture and sell the product.

Compensation.  Licensee receives the revenue generated from the sales of the licensed product, while Supplier receives a royalty, typically based on the revenue generated from the sales of licensed products.

Credit Risk.  The licensee bears the credit risk to the ultimate customer.

Control.  Supplier typically has very little control over the sales activities and maintains no relationship with the ultimate customer.

Termination.  Unless the licensing relationship also satisfies the elements of a franchise, then issues surrounding term/termination are purely a matter of contract.

Some of the legal relationships described above are more difficult to leave than a marriage.  Given this, a supply chain that is carefully and thoughtfully designed on the front-end can save a supplier a great deal of headache (and legal fees) on the back-end.

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