There are numerous ways in which manufacturers or owners of a product or service arrange to have it sold to the public or wholesalers further down the line of distribution. They may elect to sell "in house" by which outside and inside sales personnel seek to sell the product or service to the public or wholesalers. They may seek to use franchises who buy the product for resale to the public or other persons for a mark up. They may seek to sell directly over the internet, using no local personnel or hiring local personnel merely to service customer complaints.
But by far the most common method is to utilize "distributors" who normally are independent entities who seek sales, pay their own expenses of business, and either buy the product for resale at a mark up or simply process orders which are placed directly with the manufacturer and earn a commission predicated on placed or completed orders.
A start up manufacturing company or any company wanting to avoid the cost of setting up their own distribution (sales personnel, computers, supervisory personnel, materials, etc.) and/or not fully understanding the complex market they wish to enter may find it worthwhile to simply hire already existing experts (distributors) who make their living already selling similar or identical products in the markets sought to be exploited. Instead of spending hundreds of thousands a year to hire the best personnel in-house (if they are available) one can immediately hire an entire sales force and it appears a real bargain since guaranties are usually not part of the contract: one only pays for sales achieved.
From the distributor's point of view, they get access to a product line and normally the sales materials and support needed to sell the product, and have none of the headaches of production, research and development, etc, etc.
The ease and benefits of such an arrangement are one reason that tens of thousands of distributors exist in California alone and it is also a common method of business abroad. However, one very experienced distributor long represented by this firm, who had made many millions of dollars in his business and was considered one of the outstanding experts in his field, once commented to this writer that he would never advise his son to become a distributor. "You can't win in the long run. If you aren't good at sales, they eventually fire you. If you are good and build up their name and reputation, they figure it's cheaper to go in house once you have established the market and you are fired. You have to be good - but not too good. Sooner or later, you and the manufacturer will part ways and all the effort you made to build up good will - goes entirely to the manufacturer."
The essence of the problem is quite simple. The distributor does not own the product, does not "own" the territory absent a powerful contract which protects the distributor and few distributors go to the trouble and time necessary to create and negotiate an effective contract. But when all is said and done, the only protection a distributor has for the territory and good will the distributor may have created for the product and the manufacturer - is the contract between the distributor and the manufacturer.
This is well recognized by various nations in Europe which have passed laws not allowing a distributor to be terminated minus a severance package or unless for good cause. Such statutory protection does not exist in the United Stated. The only way a distributor can achieve protection is by negotiating a good contract which provides for the types of protections described below.
This article shall briefly describe the basic contractual protections any distributor in the United States should seek in negotiating a new distribution relationship. Manufacturers have their own criteria, of course, and should consult the separate article on this website for guidance on the contract they should be seeking to create.
THE BASIC TERMS OF THE STANDARD DISTRIBUTION AGREEMENT
Territory is everything to a distributor. This is the location and/or the type of product in which distributor is allowed to sell. If it is an "exclusive territory" it means that only the distributor is allowed to sell into the territory. A nonexclusive territory means that either the manufacturer or other agents or both can sell into the territory and this can be disastrous for a distributor since there is little of value to the distributor in this type of arrangement - the manufacturer can destroy distributor's business by simply underselling the distributor any time either directly or via another appointed distributor.
It is vital, thus, for the distributor to seek to have an exclusive territory, and that means exclusive to the point in which even the manufacturer or owner of the product is not allowed to sell into the territory.
A related but equally important issue is how the territory is to be protected from other persons selling into it, including other distributors who claim a customer is actually in "their" territory because inquiries were received directly from a customer.
OWNERSHIP OF PRODUCT: TERMS OF PAYMENT
The next important question is whether distributor must buy and resell the product and what credit terms, if any, are available for the distributor. Clearly the best situation is one in which distributor merely processes orders and gets free samples from the manufacturer as well as sales materials. Unfortunately, many manufacturers charge the distributor for not only samples, but for any products shipped, thus the distributor ends up as a customer of manufacturer, simply getting a larger discount on products purchased so that the distributor may resell at a profit.
This not only requires funding for buying the product, but collection efforts by the distributor and credit checks of customers since the distributor will soon be out of business if the customer does not pay.
Equally troubling is the danger of damage to goods in transit, for if the distributor is buying for resale, then quite often the risk is transferred at the manufacturer's plant and the distributor takes on the added headache of arranging effective shipment and insurance for same.
The new distributor, thus, should only seek to earn a commission from sales and have the manufacturer sell directly to the customer with distributor merely earning a commission. The alternative is to the benefit of the manufacturer who thus transfers the risk of resale entirely to distributor and simply has one good customer - the distributor - in that particular territory.
But assuming that the manufacturer is selling directly to the customer, the distributor must negotiate and achieve good contractual terms so that the customer can not end up buying directly from the manufacturer and thus cut out the distributor. Often unscrupulous manufacturers will offer customers a special low discount (cutting out the distributor's share of the markup) and the customer will be delighted to buy direct. That must be prohibited in the contract.
TERM OF THE CONTRACT AND TIME TO BUILD THE MARKET
It is not cheap to create a new territory. Often months or even years are necessary to educate the potential customers of the value of the product and during that period few sales occur and the distributor works for almost nothing hoping for eventual market share. A wise distributor will build into the contract a "start up" time to develop the market so that no cancellation of the distribution agreement can occur for a long enough period of time. The worst thing that can happen is that after all the sacrifice one is just beginning to develop a market - and the term of the contact is over.
This dovetails into the more general question of term of the distribution agreement. Recall that once the contract is over, your business is over. The key is exclusive territory and time to exploit it. As a distributor, you should seek as long a contract period as possible, ideally as long as your sales are maintained. As a manufacturer, the goal is to be able to terminate the contract and go in-house once the distributor has created the market. A good compromise is performance criteria so that the distributor gets to keep the market for so long as certain sales are achieved. (Be careful here, for a manufacturer, by price manipulation, can effectively end any such contract by simply upping the price. A smart distributor will get some guaranty of price alteration limits at the same time that the term is negotiated.)
At a minimum the distributor should seek a "three and three." That is, a guaranteed non-cancellable contract for three years which is renewed for three years if criteria are met. The best is a permanent distribution agreement by which, if certain criteria are met, the contract is automatically renewed for so long as sales are kept at that level.
COSTS OF SALES
Samples and sales materials can be very expensive and a good distributor will seek to have access to a plentiful supply since sales will depend largely on convincing customers and nothing is so convincing as good product samples. The distributor should carefully review the likely needs for materials, web support, etc, etc, and seek to have same delivered without cost.
CUSTOMER SERVICE: RETURNED GOODS
It is not unusual for half of a good distributor's time to be spent on servicing the customer, interacting with the customer to assure satisfaction, and assisting in return of defective goods or obtaining training and training materials, such as manuals. Manufacturers are often at odds with distributors in this regard and a common area of dispute is how to satisfy customers and who is primarily responsible for this area. This should be placed in the contract and expect the terms to be of vital importance to your profitability.
REPRESENTING COMPETING PRODUCTS
Most manufacturers want undivided loyalty from distributors and will insist that no competing product may be sold by the distributor. Indeed, the law often imposes a "duty of loyalty" by which a distributor must act in the best interest of the manufacturer in all of its efforts and it is hard to see how such a duty can be reconciled with the dual loyalty inherent in representing a competing product.
If the distributor determines to represent a product that competes, THAT MUST BE IN THE CONTRACT or the manufacturer can later claim this breach of duty and sue for breach of the contract. Equally vital, if the products offered by the manufacturer alter over time, either through improvements or new products developed, the contract must provide for how this can effect already existing lines of the distributor.
Many distributors represent a dozen or more manufacturers, often in the same field but not identical competing products. If one of your manufacturers begins to sell a competing product, how is this to be handled?
A further issue is representing competing products after the end of the contract. Many contracts provide a "cooling off" period in which the distributor may not represent a similar or competing product and quite often the severance package described below is made contingent on not representing a competing product.
The wise distributor will thus carefully determine how a product fits in with an entire line of products represented or to be eventually represented by the distributor to discover how the business will be effected by termination and the invocation of a noncompete clause. One successful distributor who rejected a profitable contract was quite happy he did, for if he had been terminated he would have had to give up even more profitable lines. Do not let desire for one product disrupt the entire line of products that may be in your future.
There are some statutory protections against noncompetes in some states, including California, but those normally apply only to former employees and reasonable restrictions to protect trade secrets are allowed. This area is an important one to carefully negotiate at the beginning of the relationship and the key question is what products are "competing," what happens if the product line alters and how long and in what physical area any restriction on competition will last.
Sooner or later the distributor will be terminated. Either the manufacturer will go in house or another, apparently better means of distribution will arise. The only protection a distributor has is contractual: what terms in your contract protect you from termination and for how long; and what payments may be due upon termination.
Clearly, the longer the contract, the better. Some contracts provide for an "endless" term so long as certain sales levels are maintained. Other contracts allow for renewal if and only if the parties agree - which is equivalent to having no protection since either side can simply refuse to agree.
A critical factor is what happens to sales already booked upon termination of the contract. This is probably the most hotly contested issue and the one leading to the most litigation. The typical clause provides for payment of commissions for already booked orders but too often the manufacturer "rebooks" existing orders, claiming some alteration in them, and states no commission is due. Ideally, the distributor would like to continue receiving commissions from orders to clients found by distributor but few manufacturers allow that in the contract. This is the provision that the intelligent distributor will spend much time negotiating since the right severance provisions increases the chance that the contract will not be terminated since the cost would be "too high" for the manufacturer.
DEFECTS AND RETURN CREDIT
Assuming defective or substandard good are delivered, the distributor should have a process by which they are handled so that the good will of the customer is not lost. Quite often the manufacturer will care little due to high volume of other customers but that particular customer is a vital one for the distributor. This can lead to friction as the distributor insists on protection of a customer that the manufacturer refuses to take seriously. Precise terms with time dead lines for when defective products are to be accepted for credit, etc, must be in the distribution agreement.
A key aspect is what power, if any, the distributor has to accept or approve return of products. Most distributors wish to have "control" of their accounts but few manufacturers will grant significant authority to distributors to approve returns.
STANDARD CONTRACT TERMS
And, of course, those terms in any contract recommended as seen in the articles on the web on Arbitration of Business Disputes as well as Binding Contracts and Legal Actions Predicated on Breach of Contract should be included. Be sure to include such standard clauses as part of your contract.
Each relationship between a manufacturer and distributor is unique in many ways and good legal advice is needed to hone the discussions and contract to the particular issues and product. The above criteria are, however, good starting points for the distributor first reviewing a proposed relationship.
THE PLIGHT OF DISTRIBUTORS
One can make a great deal of money as a successful distributor and the start up cost is often quite low. No research and development, no manufacturing facilities, no huge staff, no patent lawyers or trade mark issues. One does need to learn the product and, perhaps, learn how to service the customer, but the usual complex and expensive requirement of developing a product and manufacturing same is someone else's problem.
But the downside is one "owns" next to nothing. One has one's own expertise, perhaps, and whatever protection is in the contract - but once the contract is over, that portion of your business is gone forever. And the market and reputation you build up for the product is not "yours" but belongs to the manufacturer or product owner that provides the product and at the end of the contract, absent remarkable contract provisions, all that value is in their pocket, not yours.
The important aspect for your own business is to keep as many lines of products active as possible, be ready to switch once the contract is over, and do not become "wedded" to one product since it and your business may be terminated once the contract expires.
However, very good money can be made in such an arrangement so long as the distributor keeps in mind that no matter how long they represent a company, their connection is only as good as the distribution agreement they negotiate.