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Distributor Contracts: Review and Refresh

By: Greg Seminara,Export Solutions
Topics: Distributor Contracts

Suppliers review their Distributor contracts for two reasons: At the start of a new distributor relationship or when the current distributor has resigned or failed. Most exporters simply revise their standard distributor contract with a new name and make a few minor adjustments when entering a new partnership. Export Solutions frequently reviews distributor contracts as part of our distributor identification process. The current financial crisis has created recent opportunities to analyze numerous distributor contracts. We do not pretend to be lawyers but our broad conclusion is that most current distributor contracts were written to reflect business practices of the 1990’s versus the business reality of 2016. Listed below are points for consideration as you seek to refresh or renew your distributor contracts.

Contract vs. Letter of Understanding
A Basic question: Do you really need a contract with all distributors in all countries? Formal contracts make sense when the manufacturer plans a strategic launch, supported by investments in trade and consumer activities. A contract is mandatory in transferring an established business from a direct organization to a third party or from one distributor to another. A Letter of Understanding may suffice in cases dealing with an opportunistic sale or testing a new product concept. The Letter of Understanding simply outlines the roles and responsibilities of each partner, expected outcome and plan of action, and ability for each party to exit the relationship without much complexity. In some situations, a manufacturer may elect to operate without a contract or other legally binding document. This may function in some countries, but in certain markets such as Puerto Rico (Law 75) a relationship with responsibilities is created with or without a formal written agreement.

Financial: Payment Terms, Currency, Pricing, & More
Our financial world has changed. We no longer compete in a world of 30 day payment terms, stable currency and prices, and easy credit. At least half of the severe distributor issues today relate to financial breakdowns versus traditional brand underperformance problems. Adequate treatment of this topic requires hours of discussion. Our fundamental suggestion is to huddle with your financial director and review the impact of the financial traumas of the last financial crisis. What are the lessons learned and how do we protect ourselves legally in the other countries where you conduct business?

Information Technology Requirements
Most industry participants would be utterly and completely lost without our computers. Yet most contracts do not specify any Information Technology requirements for our distributors. New contracts often specify that a distributor must handle designated EDI transaction sets, Electronic Funds Transfer, and online portal to share shipment and financial information. Data security and back-up requirements also warrant inclusion.

Global Retailer Impact
Retailers such as Carrefour, Walmart, and Metro maintain a presence in many adjacent countries. Their cross border sourcing activities create challenges for distributors, as retailers buying practices may interfere with protected territories. New contracts should address the role of Global Retailers and responsibilities for each partner to maintain the integrity of the territory.

Modern Supply Chain
Historical distributor contracts required minimum inventory levels of 8-12 weeks supply or more based upon long supply chains and challenging routes to market. Dominant supermarket chains today keep about three weeks in the pipeline. One week’s business on order, one week’s business in the warehouse, and one week’s business in-store. Leading edge retailers share point of sale data that can sync with supply chain solutions such as SAP. The right inventory level is the minimum amount for a distributor to maintain 98% service level or better.

Termination Clauses
Most distributor contacts are rarely revisited until the possibility (or probability) of termination becomes likely. Long term contracts lasting 5 years, with one year notification periods do not make business sense for the distributor or supplier. More realistic is a three year contract, with escape clauses for either the manufacturer or distributor to resign if minimum sales levels are not attained. Termination notification periods of 6 months to one year can be harmful for a brand. A better option is a 3 month notification period, with succession plans formalized at point of notification. The USA broker community has functioned with 30 day standard, renewable, contracts for at least 30 years.

Next Steps
Respectfully, most suppliers and distributors desire to avoid frequent contact with their lawyers. The financial realities of the last 12 months revealed that many distributors and manufacturers are not adequately protected. A review of existing contract templates to measure relevance for today’s business practices is warranted. Export Solutions advocates a balanced approach favoring commercial sensibilities.