Orr Litchfield
Solicitors and Business Lawyers
Solicitors and Business Lawyers
In a previous article entitled “Entering new markets – Key legal & commercial issues” we explored the primary business methods used by companies to enter new markets. In this article we identify the key issues for companies to consider when appointing a distributor. In subsequent articles, we will discuss the primary issues in relation to the formulation of a distribution agreement, the maintenance of the distribution relationship and the ending of any such relationship.
In a typical distribution arrangement, a supplier of goods sells its goods to a distributor at a discount. The distributor will then sell the goods to customers at a profit. The supplier in any distribution arrangement may be a manufacturer or may itself be a distributor reselling another supplier’s goods. There may be limits as to what, how, when and where the distributor may sell the goods. The supplier and the distributor will usually enter into a detailed written distribution agreement.
The appointment of a distributor should enable a supplier to avoid a significant amount of direct administrative, marketing and establishment costs in addition to minimising business responsibilities and risks associated with entering new markets by passing those to the distributor. These may include such matters as setting up a permanent place of business overseas; dealing with regulatory licenses, consents and quality standards, local customs and legal issues; organising and controlling logistics from order handling, stock control and storage, to packing, despatch and delivery of goods; marketing and brand awareness in the distribution territory; and currency risk. However, it is important for a supplier to be aware that starting and maintaining a distribution relationship or network of distribution relationships is likely to involve a significant amount of administrative time and financial outlay, particularly at the outset, and is unlikely to absolve the supplier from all risks (for example, product liability).
Once you have made the decision to appoint a distributor, you should identify your overall personal, financial and business objectives and set realistic goals for the development of your business in the new markets and for the distributor, which correspond with your overall objectives.
Identifying your overall short, medium and long term objectives and specifying a series of goals to increase your prospects of achieving those objectives will help you to focus on your reasons for entering the relevant market and appointing a distributor; put the distribution arrangement in a proper working perspective enabling you to detach emotional issues from business ones and increase the likelihood of an outcome that you consider to be successful. It is worthwhile making the point that it is rare to achieve all of your goals as there is likely to be a conflict of interest between a supplier and a distributor on some key issues and you may have to compromise on some issues in order to complete the distribution agreement with your preferred distributor.
It may be that you review and revise your objectives and goals several times during the planning process both prior to and during any negotiations relating to your distribution agreement and related arrangements but it is important that you keep them in mind during the process and keep track of any changes that you make to your goals so that you can evaluate whether a proposed distribution agreement truly meets your objectives and goals. Determining objectives and setting goals early on when seeking to establish a distribution arrangement will help guide you through each step of the process. You may also wish to use them during the period of the distribution agreement in order to evaluate whether the distribution agreement is working in line with your objectives and goals. Trying to establish a distribution arrangement is likely to involve a significant amount of your time and effort as well as the costs of external professional advisers and will almost certainly involve a degree of heightened stress. There is little point in putting yourself through any of those if a proposed distribution arrangement does not meet your objectives or goals to a sufficient extent.
It is worthwhile spending time making a detailed list of the items and any questions, which you believe that you need to consider in connection with the proposed distribution agreement and arrangements before working your way through that list in detail. Preparing such a list and answering the questions, which you have raised, will force you to consider carefully some difficult personal, business and financial issues but can help provide you with a clearer view of the current status of your business in the relevant territory and the steps which you need to take in order to increase sales in that territory via the proposed distribution agreement and related arrangements or otherwise. In addition it is likely to assist you in identifying your objectives and goals in entering into the proposed distribution agreement and related arrangements. You need to determine the type of distribution agreement and arrangements that suit you.
Below is a list of some of the key issues, which a supplier may wish to consider when establishing a distribution arrangement. However, you should bear in mind that whilst many issues will be relevant to all or the majority of businesses engaging in distribution arrangements (whether as manufacturers, suppliers or master distributors), every business is unique, every business owner is unique, the majority of products are unique in one way or another and different markets may have different laws relating to distribution agreements (and the products to which they relate) and will almost certainly have different commercial customs, practices and product regulations.
First and foremost, you need to complete your due diligence so that you can determine your strategy in relation to the development of your business in the proposed new territory. It is likely that you will have carried out a certain level of due diligence when considering the alternative business methods that could be used to enter the relevant market. However, you are likely to require further due diligence before entering into a distribution agreement.
Inadequate due diligence prior to signing a distribution agreement is the greatest cause of breakdowns in distribution relationships and can become an expensive lesson. For example, it may result in the failure to properly develop the relevant territory or a legal dispute between a distributor and supplier. The majority of disputes in relation to distribution agreements are the result of some kind of commercial disappointment of one or both parties. Sometimes such disappointment is unavoidable. However, often it is the consequence of inflated expectations or exaggeration on the part of the distributor or supplier prior to or whilst negotiating the distribution agreement and practical arrangements, which could have been avoided or limited by due diligence. Due diligence also assists suppliers in creating better distribution agreements, because it weeds out inappropriate distributors long before wasting time finding that out through a time-consuming contract negotiation process or, worse, inadequate distribution arrangement
It is likely that you will have identified your overall financial and business objectives when considering the alternative business methods that could be used to enter the relevant market. Once you have made the decision to appoint a distributor, you should reassess those objectives and set realistic goals for the commencement and development of your business in the relevant market. Those goals should correspond with your overall objectives. You should have a clear business plan dealing with short term, medium term and long term goals. By way of example, it may be that you intend to work with a distributor in order to develop the market for your products for a period of time but, ultimately, establish your own presence in that market. In such a case, you need to ensure that you develop your own knowledge of the relevant market whilst working with the distributor.
You need to be clear in your mind as to why you are using a distributor at this time and the precise role which you wish the distributor to play now and in the future. This may vary depending on the nature of the product and the customs and practices in the relevant industry and territory in which the distributor will be working.
Consider what you wish your distributor to sell? Do you wish the distributor to sell the whole or part of a range of products? Will the distributor automatically be able to sell replacement or upgraded versions of those products or any other products, which you wish to be sold in the relevant territory?
Do you wish the distributor to sell your products in a single territory, multiple territories or part of a territory only? You should ensure that the distributor has the ability to operate a distribution business within the whole of the relevant territory and the resources to sell your products successfully and develop the business throughout the territory or territories. You may wish to impose minimum purchasing requirements and sales targets for each territory.
You need to consider how you wish the distributor to distribute your products in the relevant territory. For example, you may wish to limit the sales channels for certain distributors based on factors such as their experience, skillset and financial strength, whilst reserving other channels for other distributors or yourself?
You should be realistic as to the amount of time it will take to investigate the relevant market, prepare your strategy, locate an appropriate and willing distributor, complete a suitable distribution agreement and put in place the operational structure to enable the distribution business to start. Subject to matters such as market conditions, in general terms, the greater the amount of time you have to establish your distribution arrangements without external pressures, the more likely you are to achieve your goals.
The length of the distribution arrangements will typically be affected by factors such as the nature of the products, the extent to which the market for those products has already developed, the anticipated time it will take for a distributor to make a sufficient profit from the distribution arrangements, customs and practices within the relevant territory and competition in the relevant territory. It will also depend on the short, medium and long term goals of the supplier. The majority of distribution agreements are for 3 to 5 years, but they frequently contain minimum purchase and sales targets and termination provisions.
Appointing the right distributor for you and your products is vital and, accordingly, it is important to take a considerable amount of time identifying the appropriate distributor. The appointment of a reliable, well-connected distributor with local experience and a good understanding of the market can be a relatively low cost and quick entry route into a new territory. Whilst the roles of the supplier and distributor may vary, the distributor will usually take full responsibility for the import of your goods and take ownership of the goods it buys from the supplier. The distributor will also have a significant amount of freedom to do what he wishes with such goods, which means you must trust them to develop your brand in the relevant territory. You need to examine a variety of legal, business and financial issues including the following:
(a) Track record of your distributor -You should investigate the track record of the potential distributor, for example, does the distributor have a track record of service commitment? Has it been recognised within its own industry? Does it track customer satisfaction levels? Is its business expanding? How good are the service level agreements it offers to customers?
(b) Customer references for your distributor – You should obtain customer references and, as part of this process, find out the identity and nature of the potential distributor's existing customers, their level of satisfaction with the distributor, the customers’ views of the distributor's strengths and weaknesses, and how the distributor deals with problems;
(c) Working environment and methods of your distributor – You should see the distributor at work, for example, by visiting each potential distributor, looking at their working environment, asking about staff retention and turnover, and checking their IT systems and equipment, management processes and quality assurance procedures;
(d) Regulatory issues affecting your distributor – You should determine whether the distributor has a good knowledge and understanding of relevant local legislation and regulations, how it will comply and how it will deal with any problems, if they arise;
(e) Financial stability of your distributor – You should check the financial stability of the distributor. For example, if it is a limited company, obtain copies of its recent accounts, request bank references and consider getting a report from a credit checking agency; and
(f) Sub-distribution - Ask your potential distributor whether they plan to appoint sub-distributors or sub-contract any of their work and apply the same checks to any sub-distributors or sub-contractors, where possible.
Distribution arrangements usually involve a significant level of complexity as a stepping stone to the growth of your business in a new market. It is worthwhile involving your lawyers as part of your team during the planning stage in order to identify potential legal issues, which may affect any distribution arrangements (or any other business method which you use to enter a new market). In addition to identifying relevant issues, this may avoid or reduce wasting precious time and human resources and operational delays now or at a later date, particularly where the proposed distribution arrangements (or any alternative business method of entering a new market) prove to be unsuitable or impossible. The best distribution agreements start long before sitting down with a written distribution agreement.
It is also important that any distribution agreement is not simply left to the external lawyer to prepare and negotiate in isolation. The best distribution agreements will be the consequence of teamwork incorporating the legal skills of your lawyers with the commercial knowledge of your team. When you are entering a new overseas market, it is likely that you will need to deal with the laws and regulations of at least 2 jurisdictions. You and your lawyer will need to be able to work with a suitable local lawyer in order to deal with the allocation of risks and responsibilities between the parties.
A supplier with a proper distributor recruitment process will usually have thought through its objectives for its distribution business carefully. Where appropriate, these objectives can be clearly articulated, which typically assists the supplier in making any discussions with distributors more efficient and productive for both parties. The parties will be able to determine whether there is any mutual interest at an early stage of the relationship (or, equally, if there is a lack of real interest).
The contract negotiation process is consistently smoother when suppliers have thought through their strategy and plans carefully, and considered fully what they require from their distributor and the make-up of their ideal distributor, before they start to look for that distributor.
Ultimately every decision to appoint a distributor and every distribution arrangement is based on individual circumstances. However, the earlier you create your strategy and more thoroughly you prepare and carry out your due diligence, the better your chances are of making any distribution arrangement work. In order to maximise your return, you need to be in control of the process from start to finish, which requires detailed thought, preparation and planning. Determining your objectives and setting your goals early on when seeking to enter a new market and appoint a distributor and creating a viable plan and keeping it up to date means that you will be ready to take advantage of any good opportunity to develop your business.
Whatever stage of the process you have reached, we can help you to understand the different legal and related commercial issues when entering into a distribution arrangement in a new market, to choose the option that is right for you and to help you develop your business.
If you would like more information about entering into a distribution arrangement or would like to discuss a potential or existing entering into a distribution agreement, please contact us by telephone on +44 (0)20 3126 4520 or +45 38 88 16 00 or by email at enquiries@orrlitchfield.com
