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Framework for Pricing Global Distributors
Framework for Pricing Global
Distributors
Case of Distell in Wine Industry
Gintar
Annewil M. E. de Vries
IMBA Final Project
August 2013
Framework for Pricing Global
Distributors
Case of Distell in Wine Industry
International MBA Final Project Nyenrode Business University
Faculty: Marketing and Supply Chain Management
Faculty Supervisor: Prof. Dr. Venugopal Venkataraman
On behalf of:
Distell Group Limited: Mr. R. Lord (GM: Africa South East)
Gintar Breukelen, August 2013
ACKNOWLEDGEMENTS
We owe a debt of gratitude to Prof. Dr. Venugopal Venkataraman our faculty supervisor
and academic coach for the selfless commitment to guide and support us during the
whole IMBA program and especially when writing the Final Project.
We would like to extend our gratitude to Mr. Richard Lord for involving us in the inner
world of wine trade and sharing his immense knowledge and experience. It has been a
privilege to provide you with our view on the topic.
We also thank those who were willing to share their knowledge and expertise that made
this a much more valuable research.
We cannot forgo the opportunity to thank the inhabitants of Ginnewil the fabulous
group of IMBA 2013 for giving us the canvas to express our creativity, allowing to
cherish and amuse you. You will forever stay in our hearts.
A big thank you goes out to our families who supported us in all possible ways. We would
not be where we are without you.
And finally, we have to recognize the contributions of liquid inspiration the bold, full,
elegant wines that brought us both together and induced the fascination and love for the
industry.
Gintar and Annewil
A.k.a. Ginnewil
EXECUTIVE SUMMARY This study was done after recognizing the need for producers and exporters of bulk wine
to regain value that has shifted along the supply chain. The purpose of this research is to
find create a framework that would help Distell Group Limited in pricing their global
distributors.
Both secondary and primary research has been done to get a good insight of how royalties
are used in different industries. The reviewed literature focuses on royalties in the
franchising industry, elaborating on how different types of distribution networks
incorporate vertical constraints that suit the strategy of a company. Royalties are looked at
from the perspective of both parties holding the agreement.
Primary research has been done in the form of conducting interviews with experts from
the beverages industry in order to identify best practices. Valuable information has been
shared regarding the strategic use of royalties. The conceptual framework that was used to
identify factors that impact the pricing of global distributors helped to divide influencers in
three categories: market entry, relationship with the distributor, and external factors.
Following the analysis of primary and secondary research, a framework for pricing a global
distributor has been created. The deliverables for Distell include the framework, best
practices from Heineken and Baarsma, as well as a list of recommendations.
TABLE OF CONTENTS Acknowledgements
Executive Summary
1 Introduction and Background ................................................................................................. 1
1.1 Introduction ...................................................................................................................... 1
1.2 Global and South African Wine Trends ....................................................................... 2
1.2.1 Background South Africa ........................................................................................ 2
1.2.2 Bulk Export and its Impacts ................................................................................... 3
1.2.3 Value Shift Along the Supply Chain ...................................................................... 3
1.3 Reason for Research ......................................................................................................... 4
1.4 Distell Group Limited...................................................................................................... 5
1.5 Final Project Structure ..................................................................................................... 9
2 Problem Definition and Objective of the Research .......................................................... 10
2.1 Management Problem .................................................................................................... 10
2.2 Research Questions and Objective .............................................................................. 10
2.3 Conceptual Framework ................................................................................................. 11
3 Methodology ............................................................................................................................ 13
3.1 Introduction .................................................................................................................... 13
3.2 Research Design ............................................................................................................. 13
3.2.1 Secondary Research ............................................................................................... 13
3.2.2 Primary Research .................................................................................................... 13
3.3 Limitations of the Research .......................................................................................... 15
4 Literature Review .................................................................................................................... 16
4.1 Royalties in the Franchising Industry .......................................................................... 16
4.1.1 Introduction ............................................................................................................ 16
4.1.2 Types of Distribution ............................................................................................ 16
4.1.3 Vertical Restrains .................................................................................................... 18
4.1.4 Justification of Royalties ........................................................................................ 19
4.1.5 Two-Parts Mechanism ........................................................................................... 20
4.1.6 Relationship Between Royalty Fees and Royalty Rates .................................... 22
4.1.7 Determinants of Royalties..................................................................................... 23
5 Results, Analysis and Conclusions ........................................................................................ 25
5.1 Primary Research Findings and Analysis .................................................................... 25
5.1.1 Best Practices from Heineken and Baarsma ...................................................... 25
5.1.2 Distell ....................................................................................................................... 27
5.2 Conclusions ..................................................................................................................... 28
6 Recommendations .................................................................................................................. 32
Appendices ....................................................................................................................................... 35
Appendix A: Sample of Questions for Semi-Structured Interviews ................................... 35
Bibliography ..................................................................................................................................... 36
LIST OF FIGURES AND TABLES
Figure 1: Old World Wine Market Share in Volume Terms ....................................................... 2
Figure 2: New World Wine Market Share in Volume Terms ..................................................... 2
Figure 3: Top Distell Brands: Amarula, Scottish Leader, Savanna ............................................ 6
Figure 4: Global Presence of Distell............................................................................................... 6
Figure 5: The Supply Chain of Distell ............................................................................................ 8
Figure 6: Conceptual Framework ................................................................................................. 11
Figure 7: Four Types of Distribution Networks ........................................................................ 16
Figure 8: Distribution of Royalties within the Six Types of Retail Chains ............................. 21
Figure 9: Distribution of Royalty Rates within the Six Types of Retail Chains ..................... 21
Figure 10: Framework for Pricing a Global Distributor ........................................................... 31
Figure 11: Infographic of the Determinants of the Pricing Strategy ....................................... 34
Table 1: Estimated Transfer of New World Wine Value, 2001 vs. 2010 .................................. 4
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1 INTRODUCTION AND BACKGROUND
1.1 INTRODUCTION After the abolishment of the apartheid, South Africa was welcomed back to international
trade in 1994. The internationalization changed the structure of the economy and exporting
became a vast driver of the South African economy (Roux, 2013). In 2012 South Africa
exported a total of 409 million liters wine, and herewith earned the 8th place of largest wine
exporters worldwide (Analytix Business Intelligence, 2013).
The way South African companies export wine has changed significantly over the last five
years. In 2008, 45% of total wine export volume was in bulk, whereas in 2012 bulk wine
exports rocketed to 61% (Analytix Business Intelligence, 2013). The switch can be
attributed to the changing appetite of wine importers as well as cost efficiencies. The South
African wine producers benefited from increased export volumes - 25% increase from the
previous 12 months (based on the year ending on April 30, 2013) and more than triple the
total shipped in 2000 (Collins, 2013). The largest wine producing countries felt the growing
competition from South Africa (Love, 2013).
However, the new opportunity created additional challenges for South African wine
producers. Even though individually the prices of packaged and bulk wine increased during
2008-2012, the total price per liter dropped by 17% in two years to its lowest level 2012
(Analytix Business Intelligence, 2013). By switching from packaged wine exports to bulk
wine exports wine producers are losing out on a substantial share of their revenues.
These challenges sent SA wine producers and distributors in search of more sustainable
business models. The foreign markets were too important to loose (eNews Channel Africa,
2013), yet the low bulk wine prices made it difficult obtain a healthy profit. To improve
their revenue prospects, SA wine companies increased their involvement in foreign
markets. For example, Distell Group Limited transformed from a passive indirect exporter
into an active player in multiple African markets through joint-ventures and licensing
agreements (Distell Group Limited, 2012). The underlying motivation for them was that
there is a lot to be gained from direct investments into foreign markets (Lord (b), 2013). At
the same time, new expansion strategies require innovation in the pricing models for
foreign distribution partners that fairly compensate for the involvement of SA companies.
Whereas other industries provide a wide choice of pricing strategies for every possible
situation, little research has been done so far as to how best apply those strategies in the
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wine industry. SA companies often choose their pricing strategies based on a gut feeling
rather than extensive research. No one is sure if the chosen strategy is the best for the
given situation. We recognize this gap in academic research and will focus our final project
on investigating how companies can apply different pricing strategies when exporting wine.
We will look into the determinants of pricing global wine distributors, and also try to
establish the impact these determinants have on the pricing strategy.
1.2 GLOBAL AND SOUTH AFRICAN WINE TRENDS The global wine market has witnessed a period of major changes in recent years;; both the
global division of production and consumption changed substantially. Old World wine
producers have experienced declining market shares (Figure 1), while New World wine
producers have seen their shares rising (Figure 2), in both traditional European markets as
well as other parts of the world. The New World wine growth has altered the way wine is
valued in terms of flavor, variety, and national origin, and the way wine is traded
internationally (Labys & Cohen, 2006). Route to market has been transforming gradually,
and the developing capability to ship wine in bulk has brought along growing implications
on the wine industry (Rabobank, 2012).
1.2.1 BACKGROUND SOUTH AFRICA
Even though South African vines were planted right after the Dutch East India Company
landed in the Cape in the 17th century, in the wine industry South Africa is categorized as
New World wine producer (Spahni, 2000). After the release of political prisoners,
particularly the release of Nelson Mandela in 1990, South Africa was welcomed back to the
international trade market, allowing the local economy to grow steadily (Roux, 2013). This
Figure 2: New World Wine Market Share in Volume Terms (Labys & Cohen, 2006)
Figure 1: Old World Wine Market Share in Volume Terms (Labys & Cohen, 2006)
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drove the wine export to develop, reaching a total exported volume of 409 million liters in
2012 (Analytix Business Intelligence, 2013).
1.2.2 BULK EXPORT AND ITS IMPACTS
Globally, the increasing importance of bulk wine appears as the result of an evolution in
consumer demand in combination with the search for a more efficient way of supplying
foreign markets (Mariani, Pomarici, & Boatto, 2012). The financial downturn primarily
affected traditional wine importers in value, whereas non-traditional importers were
predominantly affected in volume. Six countries with a strong export orientation South
Africa, Australia, Chile, Argentina, New Zealand, and the United States together
comprise a quarter of the wine exports worldwide of which bulk wine makes up for 47 per
cent of total exports.
Executive manager at South African Wine Industry Information & Services Yvette van der
Merwe stresses that South Africa is present at the extreme of the global trend towards bulk
wine exports (eNews Channel Africa, 2013). Separate figures for South Africa are notably
above the average, where bulk wine in 2012 accounted for 61 per cent of total exports
(Analytix Business Intelligence, 2013). Moreover, it is to be expected that South Africa will
grow total exports to 500 million liters in 2013 (eNews Channel Africa, 2013);; this would
result in a 22 per cent growth compared to the record set in 2012.
1.2.3 VALUE SHIFT ALONG THE SUPPLY CHAIN
Like other New World wine producers, South Africa sees the shift from bottled to bulk as
a threat (eNews Channel Africa, 2013). The shift to bulk wine substantially impacts in what
way value is attributed along the supply chain. Instead of generating the majority of
revenues on the production site, a great amount of packaging value and wholesale margin is
now captured in the market where bulk wine is bottled and brought to market. This makes
it more difficult for South African wine producers to quantify the value of bulk wine (Lord
(a), 2013).
As presented in Table 1, Rabobank estimates the value of this shift accounting for well
over USD 1 billion annual revenue that is captured further along the supply chain, rather
than at the traditional source of production (Rabobank, 2012). Driven by deteriorating
margins, wine exporters are in search of an appropriate royalty contribution model to
regain value.
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Table 1: Estimated Transfer of New World Wine Value, 2001 vs. 2010 (Rabobank, 2012)
Bulk Bottled Total
2010 share 43% 57% 100%
2001 share 23% 77% 100%
2010 revenue USD 950,000 USD 5,180,000 USD 6,130,000
2010 revenue assuming 2001 share USD 508,140 USD 6,997,544 USD 7,505,683
Difference USD 441,860 USD 1,817,544 USD 1,375,683
To understand the distribution of the value of the product, it is important to understand
who has ownership control once bulk wine is being shipped to the destination market.
Generally, a great share of the explosive growth of bulk wine can be traced to export-
oriented brand owners shipping their products in large quantities to an overseas market,
(Rabobank,
2012). The other major category of bulk wine trade affects the profitability of the wine
producer and exporter to a larger extent. In this category bulk wine is sold and shipped to a
third independent party, where the bulk wine is then packaged and sold under an
independent brand, owned by the third party. Both the producer and the independent
wholesale importer or retailer capture the wholesale margin (Rabobank, 2012).
Conversely, for the upstream firm the brand owner exporting wine in bulk can
significantly save on transportation costs, glass and bottling expenses, import fees (Lord
(b), 2013), and also working capital and foreign exchange rates (Rabobank, 2012).
In short, major wine and alcohol corporations have changed their managerial tactics
through franchising and marketing. Due to the recent shifts in the market, it is found
challenging to come up with a model that helps to fairly regain or distribute the value that
was once captured by the wine producers and exporters. The New World wine producers
and exporters are therefore searching for an appropriate approach of charging royalty
contributions to their downstream firms (Lord (b), 2013)
GM Erhard Wolf confirmed there are constant discussions on consolidation and
collaboration in export markets (eNews Channel Africa, 2013). In this industry franchising
implies refining the predictability, reliability, and security of wine purchases (Labys &
Cohen, 2006).
1.3 REASON FOR RESEARCH There are several reasons why we have chosen to look into the pricing of wine export.
Firstly, the challenges that have been described above have formed a rising demand of
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sustainable pricing models. However, there is little research about pricing in the wine
industry. With the development of the recent trends it has become essential for wine
exporters to implement carefully tested models in order to sustain financial growth when
exporting wine in bulk.
The topic has been suggested by Distell Group Limited based on the current issues they
face in the company. The positives of bulk wine, e.g. savings in transportation costs and
lower import duties and tariffs, do not outweigh the negative consequences of lower
profitability as the mark up for bulk wine is significantly lower (Lord (b), 2013).
Distell is actively expanding throughout Africa a joint venture manufacturing facility is
currently being built in Ghana and new partnerships are under development in several
other countries (Lord (b), 2013). The company has very recently instated their first royalty
models (a specific pricing strategy that we will discuss in greater detail in later chapters) in
the test markets in Kenya and Zimbabwe (Marowa, 2013). The discussion of best pricing
options arises every time a new partnership is set and the lack of available research is felt.
We hope our final project can be the first step in a larger research project that would
analyze available pricing strategies in the wine trade industry.
1.4 DISTELL GROUP LIMITED This research is done in partnership with Distell Group Limited who provided us with a
current
wines, spirits, ciders and ready-to-drinks. Distell has almost 5000 employees worldwide and
a turnover of R15.9 6 billion) in 2013 (Distell Group Limited, 2013). Their
wide portfolio includes global brands such as Savanna cider, Amarula one of the fastest
growing spirit brands in the world, fine wines Two Oceans, Fleur du Cap and
Durbanville Hills. Distell recently acquired a top Scotch whisky producer Burn Stewart
Distillers to strengthen their product portfolio and extend its global reach (Burn Stewart
Distillers, 2013).
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Distell has a wide reach in the markets around the world
with a strong focus on strengthening their presence in
Africa. Their head office is situated in Stellenbosch, South
Africa, Historically, South Africa, their home market,
represents the largest share of the annual revenue. The
Sub-Saharan markets, excluding South Africa, contributed
to slightly above half of their international revenue in 2013
(Distell Group Limited, 2013).
Supply Chain and Pricing Strategy
Figure 5. The strength of Distell lies in brand building
and distribution channels. There are two strategic choices when it comes to growing their
brands either horizontal growth by entering new markets or vertical growth through
investments into brand equity and new products. Distell relies on a network of 17 trading
depots and 27 TradeExpress distribution outlets in the domestic South African market
combined with two independent distribution agents (Distell Group Limited, 2012). When it
comes to foreign markets, Distell chooses their distribution approach from the five blocks
at the bottom of the supply chain. strategy is to unlock the opportunities in Africa
by bringing expertise and knowhow, and partnering in joint ventures with local distributors
(Distell Group Limited, 2013) (Lord (b), 2013). Joint venture partnerships allow Distell to
be closer to consumers, enhance price-competitiveness, reduce time-to-market, and
counter tariffs and high import costs (Distell Group Limited, 2013). Joint ventures are
currently active or under development in Angola, Kenya, Ghana, and Zimbabwe (Distell
Group Limited, 2013);; more are expected to be established in the nearest future.
Figure 3: Top Distell Brands: Amarula, Scottish Leader, Savanna
Figure 4: Global Presence of Distell (Distell Group Limited, 2012)
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Distell invests a lot into the joint venture partnerships. Investments vary from marketing
support, knowledge sharing, investment in manufacturing facilities, instating own brand
managers to help bring products to the market (Lord (b), 2013). Distell is searching for
pricing strategies how they could be better compensated for the investments in the export
markets. They have recently introduced royalty contributions in Kenya and Zimbabwe to
receive compensation for the use of branded products. According to Richard Lord (2013),
General Manager of Africa South East, the potential of royalties in the African market is
huge. For example, in the wine market a large share of revenue has been lost due to the
shift towards bulk wine export. By adding royalty payments to foreign distributors who
bottle regain some part of the lost revenue.
However, Distell needs to figure out how to set royalties that are fair to all stakeholders
(Lord (a), 2013).
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Figure 5: The Supply Chain of Distell (Lord (b), 2013)
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1.5 FINAL PROJECT STRUCTURE This final project has been structured as follows:
Chapter 2 describes the management problem and research objectives. Multiple research
questions are raised in order to solve the management problem. The structure of research
is depicted in a conceptual framework.
Chapter 3 is dedicated for methodology. There it is explained what methods and why have
been chosen for primary and secondary data collection, including the list of the names of
experts that have been selected to participate in the research.
Section 4 hosts the review of academic literature with a focus on royalties in the franchising
industry. This part provides a theoretical explanation for the need of royalties, how they
can be constructed, and factors that typically influence the degree of incorporation into the
shared-agreement.
The results of the research are analyzed and concluded in chapter 5;; whereas the final part
of the final project is designated for recommendations that could help Distell solve their
management problem.
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2 PROBLEM DEFINITION AND OBJECTIVE OF THE RESEARCH
2.1 MANAGEMENT PROBLEM Africa
in 2012 (Distell Group Limited, 2012). In order to be more competitive and build stronger
business relationships in the region, Distell established many joint ventures with its
partners. They have joint venture operations and investments in Tanzania, Kenya,
Zimbabwe, Mauritius, Angola, Nigeria and Ghana (Distell Group Limited, 2012). The joint
venture model allows Distell to move the last part of the supply chain bottling and
labeling to the end market, which has many benefits including countering high excise
duties, government tariffs, avoiding spoilage and having quicker response to market.
Through the joint venture business model, Distell exports wine in bulk to the partner
countries where it is then decanted and bottled under license. From the financial
perspective, on top of the price for the bulk wine Distell also receives royalty contributions
from JVs that bottle under license. The problem arises when Distell tries to establish a
royalty contribution margin that is both equitable and financially sustainable (Lord (a),
2013). Hence, the problem statement of this research can be summarized as follows:
There is no globally accepted benchmark that Distell could use to test the fairness
of their current royalty model. How should Distell price their global distributors?
2.2 RESEARCH QUESTIONS AND OBJECTIVE In order to find a solution to the management problem from section 2.1, we have
established the following research questions (RQs). Together, they provide the reader with
a full view of the problem on hand.
RQ 1:
RQ 2: How does the relationship between Distell and a global distributor look like? What
is the power balance?
RQ 3: How do external factors, such as consumer behavior, stability of currency, look like
in the operating country? How do these factors influenc
distributor?
The objective of this final project is to define a framework that would guide Distell when
pricing their global distributors. We will pay special attention on how lessons from
franchising models in other industries can be applied to wine distribution. We will also look
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into the experience of large international companies for it to serve as a benchmark for
Distell.
2.3 CONCEPTUAL FRAMEWORK A conceptual framework helps visualize the structure of the final project research. The lack
of pre-defined conceptual frameworks for pricing of global distributors has given us the
freedom to create a framework based on our experience and knowledge of the subject and
adapt it to the management problem on hand. We assume that there are three main
determinants in the pricing model for global distributors. Figure 6 displays the conceptual
framework and it is described in more detail below.
Firstly, there are many strategies of
how to enter a market, and they
have a direct impact on the pricing
decisions of global distributors.
We have discussed in section 1.4
the different distribution models
Distell can choose from. We will
proceed with a research focused
on establishing what strategies
Distell uses and how it effects
their pricing decisions. For
example, if Distell hires
contractors to bottle their wine in a foreign market (as they do with cider in Belgium (Lord
(a), 2013)) the pricing model will follow a simple agreed contract. However, we expect to
see the use of royalty models under licensing/franchising and joint ventures.
Secondly, pricing depends on the relationship between Distell and the global distributor. In
more detail, the pricing decisions are influenced by the power balance between the two
participants. After all, the final outcome is something both parties agree on in a
negotiation.
Finally, there are multiple external factors that have a direct effect when pricing a global
distributor. For example: an unstable currency increases the risks of operating in a foreign
market and may imply the need for Distell to adjust their pricing strategy to avoid losses.
The changing consumer behavior might provide opportunities for market growth through
pricing decisions i.e. gaining market share by offering less expensive wine. Distell only
Figure 6: Conceptual Framework
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the global distributor.
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3 METHODOLOGY
3.1 INTRODUCTION The following chapter discusses the choice and design of the research that is used in this
final project. A qualitative exploratory research has been selected as the best approach to
and provide a detail description of data that will be collected.
3.2 RESEARCH DESIGN In order to understand the constituents of the royalty model, a qualitative exploratory
approach has been chosen for this research. An exploratory research can be conducted in
three ways: (a) literature review, (b) interviews with experts, and (c) group interviews
(Saunders, Lewis, & Thornhill, 2009). Knowing that there is a shortage of available
information on the topic of pricing of global distributors and royalties in the wine industry,
we have chosen to explore both primary and secondary research. Saunders, Lewis, &
Thornhill (2009) argue that group interviews might be highly productive and in-depth due
to group interactions and free-flowing discussions. On the other hand, managing a good
flow of a discussion and relatively equal contribution is sometimes difficult. We recognize
that conducting a group interview with the employees and partners of Distell could provide
phenomenal discussions;; unfortunatelly, due to not being able to be physically present in
South Africa we have decided not to use group interviews for the research. Hence, the
research is based on literature review and expert interviews.
3.2.1 SECONDARY RESEARCH
A thorough review of the academic research will be done in order to understand the widely
accepted categories of pricing global distributors. A special attention will be paid to find
generalized models in franchising and royalties in France, Spain and the US. Firstly, a
special focus will be placed in finding the relationships and the logic behind the variables
that constitute the royalty models. By understanding the construction of existing models we
expect to be able to translate and adapt the model to the wine industry.
3.2.2 PRIMARY RESEARCH
The primary research will take the form of interviews with experts from the beverage trade
industry. The interviews will be used to confirm key secondary research findings, discover
pricing strategies in their line of work, and, most importantly, bridge the gap of adapting
pricing from other areas to the wine industry.
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Semi-structured and in-depth interviews with experts from the beverage industry will be
used to gather data. These types of interviews have been chosen because the collected
information is
(Saunders, Lewis, & Thornhill, 2009). These research
methods will allow us to obtain sensitive information on what strategies are used to design
royalty models and the underlying rationale for choosing specific factors over others.
We have prepared a large list of questions to be used for semi-structured interviews. Open
ended questions were preferred in order to allow the interviewee share their opinion on the
issue. Given the expertise and background of individual interviewees, only those questions
that were relevant were used. The discussions were enhanced with many impromptu
questions that suited the situation. See appendix A for a list of sample questions that were
used in the interviews and in-depth discussions.
We have selected to interview experts from three following areas:
Distell employees who can share the information about internal processes, market
entry strategies, and current royalty models that are used inside the company. They
are also currently involved in the expansion projects across Africa that could help
us better understand the relationships between Distell and their distributors. The
interviewees have been selected by the representative of Distell, Richard Lord
(General Manager: Africa South East). The list of experts includes:
Richard Lord himself, who has been generously sharing his knowledge on
the issue;;
Kevin Nagle, GM: East Africa, who coordinates the project in Kenya.
The interviews will be conducted over-the-phone because the parties cannot be
present in the Netherlands.
that act as distributors markets where royalty model is currently
used. We have to keep in mind that Distell introduced royalty models very recently
and there is little experience to be found from the partners. However, they can
provide us with a better perspective on the relationship between Distell and the
distributors, with the aim to understand how and why the relationship influences
the royalty model. They can also provide us with a better picture of the power
balance between Distell and their company. Richard Lord has suggested we speak
to Donna Marowa, Brand Manager at Afdis -
Zimbabwe. The interview will be conducted over-the-phone.
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For benchmarking purposes, a select group of experts from similar industries will
be interviewed. These experts represent large corporations in the wine and beer
industry, or work independently. Their experience will provide alternative strategies
for royalty models as well as insights to the European market. The interviewees are
selected using personal networks and include experts based in the Netherlands. We
will have in-depth interviews with Ana van Gilst, Business Analyst at Heineken
International, and Joost Hagen, Business Development Manager at Baarsma Wine
Group Holding. The interviews will be conducted face-to-face at the Nyenrode
University or over-the-phone if the parties cannot be present on campus.
3.3 LIMITATIONS OF THE RESEARCH The limitations of the final project might originate from a limited sample size of
interviewees. It has proven difficult to arrange for a larger and more diverse sample due to
limited amount of time for the research. Furthermore, it is unclear to what extent the
royalty models used in Europe and USA can be applied to Africa where business culture is
significantly different.
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4 LITERATURE REVIEW
4.1 ROYALTIES IN THE FRANCHISING INDUSTRY
4.1.1 INTRODUCTION
Offering products and services in global markets, firms work with different operating
modes that carry varying degrees of ownership. International markets can be served
through non-exclusive dealers, direct or indirect exports, franchise agreements or
licensing (Lord (b), 2013) joint ventures, and wholly owned subsidiaries (Terpstra &
Sarathy, 1999). Franchising is recognized as a method of distribution rather than
categorized as an industry (Bruno & Davey, 1984). The franchise system of distribution has
been customized in the supply of divergent products and services. Changes in the global
economic setting such as reduced trade barriers, enhanced homogeneity, and stronger
integration across national borders have offered new market opportunities for franchising
(Sashi & Karuppur, 2001). Even though the franchising industry has grown notably over
the years, key questions regarding strategies on how to gain economic value from the
relationship with franchisees linger unsettled.
4.1.2 TYPES OF DISTRIBUTION
Very recently it has been examined which factors play a role to firms in France when
deciding on the incorporation of royalties in distribution contracts. The research first
makes a distinction of distribution networks to specify the different types of networks. As
demonstrated in Figure 7, the initial classification sets apart four types of distribution
networks based on the agreement between downstream and upstream firms. Fadairo (2013)
later refined this existing model into a model that distinguishes six types of distribution
networks. Nonetheless, the distribution networks are presented in an ascending order of
integration: License;; Concession;; Franchise;; and Commission-based affiliation (Chaudey &
Fadairo, 2006). As the level of integration of networks increases, the degree of constraints
and coercion imposed on the downstream firm intensifies (Fadairo, 2013).
Figure 7: Four Types of Distribution Networks (Chaudey & Fadairo, 2003)
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The hierarchy in the traditional four types of contracts can be described as follows: in a
license agreement, the retailer has mandate to operate under a same brand name under
conditions set by the upstream firm. In a concession the downstream firm operates under
the same conditions as the license agreement, yet the distributor offers a limited number of
retailers the right to sell one or several products. Also, concessions typically offer
exclusivity in terms of territory and supply. Note that the French concession is a
distribution contract equivalent to what is known as a traditional franchising contract in the
United States (Fadairo, 2013). Franchise contracts are defined as a concession, yet the
transmission of concept and know-how is central to this type of vertical contract. As stated
by Fadairo (2013), the European version of franchising is similar to business format
franchising in the United States. A commission-based affiliation agreement is like a
franchise contract except the downstream firm does not own its stock;; neither does the
the turnover.
The more recent network additions are based on the proportion of franchised versus
integrated units. Based on the existing Franchise network a distinction is made between
slightly mixed with owned retail outlets (Franchised slightly mixed), and highly mixed with
owned retail outlets (Franchised highly mixed). The sixth network type that enhanced the
four dimensional model is Predominantly Integrated (Fadairo, 2013).
In a global aspect, the stability of political, economic, and currency dimensions affect the
selection of type of network to operate in, and the cost of governance. Fluctuations in
these areas make it difficult to predict future business prospects and carry an increased risk
of doing business in unstable areas. It is therefore suggested that firms work with low
ownership arrangements that leave room for flexibility when operating in an uncertain
environment (Anderson & Gatignon, 1986). When expanding to unfamiliar markets that
are perceived unstable, franchisors may prefer entering the market supplying small
quantities and negotiate higher royalties to cover extra costs out of precaution, and be
equipped with an exit strategy (Hagen, 2013).
In order to successfully develop collaborative strategies it is important to anticipate
potential consequences of adopting different strategies and to find the suitable operating
mode to service the local market. The design of an appropriate strategy depends on the
nature of the product, and the characteristics of an organization and a country (Jain, 1989).
In some situations it may be favorable for firms to systematize strategies, whereas other
18
situations require a localized approach. All contractual arrangements are typically
incorporated in a share-agreement.
4.1.3 VERTICAL RESTRAINS
Distribution contracts often feature a set of contractual provisions. It is examined that the
presence of royalties in retail contracts are very common (Blair & Lafontaine, 2005) and
serve as one of the most significant vertical restraints (Fadairo, 2013). Vertical restraints are
contractual restraints binding companies from different layers of the supply chain, such as a
supplier to the distributor or the distributor to the retailer. The three most common
vertical restraints are recognized as those relating to payment (franchise fee, royalties),
provisions limiting the rights of the distributor (price-ceiling, price-floor, exclusive dealing),
and provisions limiting the rights of both the distributor and the manufacturer (exclusive
territories) (Rey & Caballero-Sanz, 1996). In general, vertical restraints are used to prevent
a downstream firm from underinvesting in the promotion of a brand (Chaudey, Fadairo, &
Normand, 2005).
Vertical restraints that refer to payment, as proposed by Rey and Tirole (1986), are briefly
described below to clarify the differences in payment structures relevant to distribution
contracts in the franchising industry.
Traditional linear pricing is simply based on a payment proportional to the ordered
quantity. However, vertical restraints allow upstream firms to depart from such uniform
pricing agreement.
Provisions such as a franchise fee an initial lump sum are typically added to the uniform
wholesale price and form a two-part tariff. The second commonly used form of non-linear
pricing includes rebates on the ordered quantity, known as quantity discounts.
Transparency along the supply chain is hey when developing non-linear pricing models.
Another vertical restraint is the implementation of royalties. As discussed by Fadairo
(2013), this type of payment is either imposed as a percentage of downstream sales
measured either in units or in revenues or as an ongoing fixed fee independent on the
downs
be monitored transparently (Rey & Vergé, 2005).
Motivations for vertical restraints and their implications on economic welfare have been
widely debated for years. Some believe vertical agreements to be incomparable to
agreements between competing firms and that such settlements only appear when it helps
19
(Rey & Vergé, 2005).
4.1.4 JUSTIFICATION OF ROYALTIES
The agency theory is widely recognized in the study of vertical restraints in the franchising
industry. Literature explains that the two-sided contract between an upstream firm and a
retailer creates an agency relationship as the upstream firm (the principal) gives the
downstream firm (the agency) permission to commercially exploit its brand (Chaudey,
Fadairo, & Normand, 2005) (Fadairo, 2013). Both players expect the agreement to yield
mutually satisfying results. However it can occur that one participant maximizes personal
interests at the expense of an optimal result for both players, reminding of the well-known
problems of coordination that justify the use of vertical restraints. When the contract,
designed by the principal, is accepted the agency is pushed into adopting behavior that is in
the profits of the distributor, a moral hazard arises downstream. Although the number of
sales can be quant
the total residual claimant seems to be the driving incentive for the retailer (Fadairo, 2013),
a lower royalty rate would motivate the downstream firm to achieve higher sales.
Consequently, the principal may design a distribution contract that excludes royalties, yet
includes a somewhat greater initial fee. This scenario suggests the agent bears most of the
wealth effect of its activities, reducing monitoring costs;; however, it should be taken into
account that it can also lead to inefficient risk bearing and free-riding by the franchisee
(Brickley, Dark, & Weisbach, 1991). Not considered in the agency theory are royalty fees;;
the ongoing payments from the downstream firm to the upstream firm, independent of the
downstream turnover.
The agency theory presents two justifications for royalties in share-contracts. The first
addresses the demand to protect the downstream firm from risks, particularly the critical
function of the final demand in the market. In such situations, the royalty rate incorporated
in the share-contract links to the level of risk sharing. The second justification addresses
the incentive in the context of a two-sided moral hazard. Sinc
moral hazard can potentially arise, as the downstream firm has no full transparency in the
effort made by the upstream firm in network
name (Fadairo, 2013). In this context the royalties serve as a motivation to the upstream
firm to stimulate its efforts in building and supporting its image.
20
A recent study demonstrated that irrespective of the type of network, royalties are justified
by the transmission of concepts and know-how, and ongoing support in advertising and
promotional campaigns (Fadairo, 2013). Though, it is evinced that more powerful networks
impose more constraining contracts (Chaudey, Fadairo, & Normand, 2005).
4.1.5 TWO-PARTS MECHANISM
The price of franchise rights is typically a combination of an initial franchise fee and an
ongoing royalty payment (Dant & Berger, 1996). According to Shane (1998), royalty
payments are an incentive for franchisors to monitor the system and coordinate the
franchise chain (Lal, 1990). Additionally, inclusion of a royalty in the price of franchise
rights is used to align the interest of the franchisor with the franchisee given that both
aspire to maximize sales (Lal, 1990). Furthermore, franchisors use royalty rates as an
instrument to spread the risk (Morgan & Stoltman, 1997). The upfront fee typically
represents the intangible assets of the franchisor such as brand image, expertise, franchisor
services, reputation and training programs (Windsperger, 2001). Similarly, a renewal fee is
sometimes imposed by the franchisor on extending an expired contract (Frazer, 1998).
Although existing literature lacks rationale guidelines that illustrate a justified structure of
these components (Kaufmann & Dant, 2001) (Sashi & Karuppur, 2001), the complex
structure of royalties is later discussed in more detail.
It is believed by some that these price components act as a mechanism and should regulate
(Kaufmann & Dant, 2001)
and provide the right incentive by systematically modifying the franchise fee and the royalty
rate (Blair & Kaserman, 1982). Others perceive that the two-parts mechanism should
reflect the level of investment the franchisor devotes to building its brand and training its
retailers to support their brand suitably (Bordonaba-Juste, Lucia-Palacios, & Polo-
Redondo, 2011) (Kaufmann & Dant, 2001).
The distribution of royalty rates and royalties fee plus rate are presented per type of
distribution, in ascending order of integration, in Figure 8 and Figure 9 respectively
(Fadairo, 2013). The distribution of royalty rates and the distribution of royalties appear to
be relatively similar in all types of distribution networks.
21
The significance of the initial fee and the royalty rate should vary from system to system.
Different contractual provisions serve different franchising contracts based on the type of
relationship between distributor and retailer and the intentions of the upstream firm, which
designs the contract. These payment structures all directly affect how joint profit is shared
and indirectly affect the targets that determine this joint profit (Rey & Vergé, 2005).
Less frequently used in distribution contracts are flat franchise fees. Opposed to the more
common percentage-based royalties royalty rates a flat continuing franchise fee is a
fixed amount that the franchisee periodically pays to the franchisor. Frazer (1998) explored
that franchises that use fixed rates have different characteristics to franchises that
incorporate royalty rates. The research evinced that flat fees are typically implemented in
less complex systems that are less expensive to purchase. Franchisors that use flat fees
appear less committed: they offer less ongoing support;; invest less in monitoring activities;;
and have a higher outlet growth rate (Frazer, 1998).
In comparison, franchisors that charge royalty rates are stimulated to provide more
ongoing support and provide better monitoring in order to help downstream firms to
maximize their sales;; and franchisors that charge fixed ongoing fees are motivated to sell
more franchised outlets in order to increase their income and will therefore offer less
complex and less expensive concepts to downstream markets (Frazer, 1998).
Figure 9: Distribution of Royalty Rates within the Six Types of Retail Chains (Fadairo, 2013)
Figure 8: Distribution of Royalties within the Six Types of Retail Chains (Fadairo, 2013)
22
4.1.6 RELATIONSHIP BETWEEN ROYALTY FEES AND ROYALTY RATES
It has been investigated by many which factors show a positive or negative correlation to
the existence or level of royalties in a franchise distribution contract, what influence
royalties have on components of the contractual agreement, and the relationship between
royalty fees and royalty rates (Lafontaine, 1992) (Kaufmann & Dant, 2001) (Sashi &
Karuppur, 2001) (Blair & Lafontaine, 2005) (Chaudey, Fadairo, & Normand, 2005)
(Bordonaba-Juste, Lucia-Palacios, & Polo-Redondo, 2011) (Fadairo, 2013).
If it would be known beforehand what exact demand will be generated by operating under
satisfy parties on both ends of the vertical agreement (Blair & Kaserman, 1982).
Unfortunately, this is not the case since the expected demand for the product is affected by
(Lafontaine & Shaw, 1996). However
when the demand depends on the value the trademark carries, royalty payments are more
effective to insure the maintenance of brand equity (Blair & Kaserman, 1982). The
question remains how these provisions vary relative to each other.
It seems generally accepted that the greater the portion of the value extracted through a
royalty rate, the smaller the remainder that can be extracted through the franchise fee.
Subsequently, anything that reduces royalties should increase initial fees (Kaufmann &
Dant, 2001). These assumptions support the negative relationship between a franchise fee
and royalties. Lafontaine and Shaw (1996) found a notable negative relationship between
the initial fee and the royalty rate;; however, when those using ongoing fixed payments were
taken out of the study this relationship turned positive. Even though research has been
conducted aiming to identify a negative correlation, existing literature does not provide
convincing backing of the existence of a negative relationship between the franchise fee
and the royalty rate.
Though adjustments are made relatively infrequent (Lafontaine & Shaw, 1996), a study by
Lafontaine and Kaufmann (1994) revealed that modifications to the royalty rate percentage
and franchise fee have moved hand in hand throughout the years. According to
Mathewson and Winter (1985), lower franchise fees and lower royalty rates are expected
for franchisors with a low degree of brand equity. Brand equity has demonstrated to be an
important factor that influences the relationship between the franchise fee and the royalty
rate. When an overseas firm, operating under license, exceeds the sales targets, the
upstream firm often incentivizes the distributor by providing discounts in order to
23
stimulate higher sales, get a higher market share, and build equity in that country (Van
Gilst, 2013) (Hagen, 2013).
Lafontaine (1992) reasoned that franchisors do not use the franchise fee to collect rent but
rather to recover expenses such as recruiting and training. Essentially, franchisors may
systematically differ in the level of support they offer their franchisees in the vertical
agreement. Franchisors who keep high pre-selection criteria and provide high quality
training may also offer high levels of ongoing support. Though the levels of support
accepted by the downstream firm can vary from welcoming, any assistance to not accepting
any support to from the franchisor (Hagen, 2013).
Hence, when franchise fees are used to collect reimbursement for initial training costs, and
royalties are implemented to gain value from both the brand and the ongoing support, this
would result in a positive relationship between franchise fees and royalty rates (Kaufmann
& Dant, 2001)
e rents
from the downstream firm, yet either represents brand benefits or the expenses originated
from providing initial training and ongoing support. Therefore, the difficulty arises when
deciding on an appropriate initial fee when a franchise fee is not used to collect the excess
value net of royalties.
4.1.7 DETERMINANTS OF ROYALTIES
It has been investigated which factors are of weight in the decision to include royalties in
distribution contracts. Evidence was provided that certain variables increase the probability
of royalties being incorporated in vertical agreements.
Agrawal and Lal (1995) concluded that royalty rates appear to positively impact brand
name investment by franchisors and negatively impact the level of service franchisees offer.
It is therefore of great importance that the right balance is found that both incentivizes
franchisors to invest in building brand equity and motivates franchisees to carry out the
appropriate level of service. In such situations cross-cultural differences can become
hazardous when a message is conveyed wrongly or simply misunderstood. Sashi and
Karuppur (2001) explained that cultural diversity could also challenge to measure the
performance of franchisees in global markets.
A recent study revealed that factors such as the age, the size and the internationalization of
the network are of no influence to the probability of royalties. Against the expectations of
24
negative influence on the probability of having royalties in the distribution contract
(Fadairo, 2013).
Since royalty payments may be affected by political instabilities, franchising may not be
preferred in uncertain environments. Nevertheless, franchisors can lower the risk and
attempt to regain control by incorporating a higher initial fee and combining this with
lower royalty installments (Sashi & Karuppur, 2001).
Subsequently, in environments with economic uncertainty where demand fluctuations are
high, franchisors may also favor setting a higher franchising fee and charge lower royalty
payments to reduce risks. Especially when demand fluctuations are pooled with high
inflation and high interest rates, the risk of doing business accelerates and the expected
return is likely to be affected by the high uncertainty level (Sashi & Karuppur, 2001).
Fluctuations of a local currency against the main international currencies are expected to
affect the value of the investment and the collection of ongoing payments. Firms can
attempt to reduce risks by tracking movements in the foreign exchange market. Similar to
other uncertain situations, foreign exchange risk can be lowered by implementing higher
initial fee (Sashi & Karuppur, 2001).
More generic statements learn that royalty rates will decrease as the significance of
conclusion (1988) that downstream firms know that the higher the payment, the higher the
return on investment will be.
25
5 RESULTS, ANALYSIS AND CONCLUSIONS
5.1 PRIMARY RESEARCH FINDINGS AND ANALYSIS
5.1.1 BEST PRACTICES FROM HEINEKEN AND BAARSMA
This section provides a synthesis of findings from primary research interviews. As part of a
benchmarking study, we have interviewed experts from Baarsma and Heineken to get
better insights on the use of royalties in the international beverage industry. We will discuss
the key elements per interviewee.
Heineken
We have conducted two interviews with Ana van Gilst, Business Analyst at Heineken. Due
to the fact that it was not feasible for her to meet us in person, Ana agreed to answer all
questions over the phone.
Heineken charges royalties in the Scandinavian markets where local partners have full
responsibility over production, distribution, marketing and sales of Heineken. Heineken is
not involved in the operations within these markets;; it provides the brand, raw products,
and collects royalties royalties are fixed on produced volume rather than on sales. Low
in markets where sales
data is not fully transparent. Due to lack of transparency in the market, Heineken has opted
for an ongoing royalty payment based on agreed volume sales. When KPI targets are
reached, Heineken provides discounts to stimulate higher levels of sales.
Heineken s strategy is calibrated for horizontal growth with the goal to increase their
market share and have their brand in as many markets as possible. When the contract has a
low degree of integration, Heineken adds the royalty payments to the wholesale price
without specifying the exact royalty amount to the foreign distributor. The fairness of the
royalty can be benchmarked internally with similar markets. As a foundation of their
revenue, reasonable characteristics of a royalty model for Heineken are based on volume
rather than revenue. This approach is justified in situations when sometimes the product is
not generating a lot of revenue due to a relative expensive local market price. And since
Heineken does not control the prices this may not be highly profitable for Heineken, yet
being present in that market and building brand equity is highly valuable.
When Heineken decides to work with a distributor that already uses a well-established
distribution network with many channels, they pose higher royalties on the distributor, for
the downstream firm will have less difficulties and lower costs of bringing their brand to
26
the market. There is a twofold rationale behind this explaining that otherwise Heineken
would have to forfeit a part of the royalties to cover advertising and promotion (A&P)
expenses, and the international reach of the brand that carries great power in negotiation.
Lastly, Ana explained that royalties are renegotiated annually and simultaneously adjusts the
royalty payment in accordance with inflation.
Baarsma Wine Group Holding
The interview with Joost Hagen, Business Development Manager at Baarsma Wine Group
Holdings took place at Nyenrode campus in Breukelen, the Netherlands, as planned.
Baarsma, who also acts as an exporter and producer of wine in other settings, has
eliminated as many middlemen from the value chain as they ought viable. In the
Netherlands, Baarsma is in direct contact with large retailers that offer their products to the
market. Joost explained that the minimum margin a distributor requires is 10 percent.
Retailers have become very strong in the European markets and often have a list of
requirements which amounts to 4 or 5 percent of revenue. This additional percentage
required by the retailer is pushed upwards by the distributor Baarsma in this case and
added to their margin when negotiating with the upstream firm. In the European market
networks are 100 percent transparent about margins and costs, it is said that Baarsma
cannot fix a deal if their partners do not open their books. Joost acknowledged that in
other environments different practices apply.
In terms of splitting margins with retailers, Joost stressed that it takes economies of scale to
generate greater margins. Higher volumes pair with benefits and strengthen your
in
trading, Baarsma requires a minimum of 10 percent and explains these are commonly
considered fair margins in the industry.
When operating in unstable markets, Baarsma goes in with small quantities and takes an
extra margin probably set as 10 percent - as insurance for the unforeseen. In such
uncertain markets, Baarsma preselects a distributor that has sufficient experience in
bringing international brands to the market and aims for a relative transparent deal. Being
suspicious to operating in a high-risk market, Baarsma shows little commitment and has
their exit strategy ready.
Lastly, recent changes in consumer behavior were brought to our attention. Joost
confirmed that nowadays wine is primarily purchased with the intention to be consumed
within 48 hours, oppose to storing a large share of wine being purchased for later use. This
27
impacts the way Baarsma approaches the market. Marketing and advertising of wine
becomes more important.
5.1.2 DISTELL
The following section presents the key elements from our interviews with Richard Lord,
General Manager Africa South East at Distell;; Donna Marowa, Brand Manager at African
Distillers;; and Kevin Nagle, General Manager East Africa. These discussions had an
rrent pricing strategies, and how
relationships with their partnerships look like.
Distell, Richard Lord
Distell uses own brands to enter new markets and focuses on vertical expansion. According
to Richard, contracts usually end up being between licensing and joint venture. New
African markets have been identified and the preparation for entry has begun. As
mentioned in section 1.4, Distell has set up royalty agreements with their distributors in
Zimbabwe (Afdis) and Kenya (KWAL), in which Distell owns minority share. The royalty
rates that are implemented vary between 1 and 15 percent. When Distell invests large
amounts in advertising and promotion to market a product abroad, they feel comfortable
charging a higher royalty rate. Distell assumes part of the risk, as also risk sharing taken
into consideration. Nevertheless, Distell is uncertain of the fairness of the level of royalties
that should be charged under which circumstances.
Distell does not have a final saying in setting the price for the end consumer, they play an
distribution margin and retail margin have been added. Largely, pricing is a factor of the
market, the retailer must ensure not to exceed the willingness to pay in the local market.
Distell is committed to strengthen their relationship with their partners. Contributions
cover for A&P expenses and are offered towards specific brands identified as drive brands,
or to fill a gap that has evolved in a portfolio. Besides offering support in A&P, Distell also
provides product, merchandising, and in some instances sales and marketing training.
Technical training is also provided where local manufacturing is taking place.
Afdis, Donna Marowa
The interview we conducted with Donna was over the phone. Donna Marowa works for
Donna shared that Distell covers 100 percent of A&P expenses for brands. Distell
28
is highly invested in building the relationship with their distributor in key markets Kenya,
Zimbabwe etc. In Zimbabwe, Distell provides numerous financial and non-financial
incentives for Afdis (in which Distell owns a 50% share). The non-financial incentives
include sharing their knowhow and experience currently 4 experts are in Zimbabwe to
consult in the production of a new bottling plant. Together with another shareholder,
Distell is expected to contribute largely to the costs of the new cider plant. Various KPIs
are set;; upon achieving targets, Afdis receives discounts. Finally, Distell started the royalty
contract only in July 2013. Before that, even though without extra compensation, Distell
still covered 100 percent of the A&P costs.
Distell, Kevin Nagle
The contact with Kevin emerged in to communication via email. Due to time constraints,
we were not able to discuss all topics. The findings that we extracted from our contact with
Kevin made us realize we cannot extract much more additional information. Much of what
he said was a confirmation of previous findings discussed by Richard and Donna. Kevin
shared that there is an option to renegotiate determinants of the contract annually.
5.2 CONCLUSIONS The conclusions of this research are a synthesis of interviews, academic literature findings
and the conceptual framework. To start with, we look back to the problem statement that
was defined in section 2.1: There is no globally accepted benchmark that Distell could
use to test the fairness of their current royalty model. How should Distell price their
global distributors? When it comes to judging the fairness of pricing strategies, we cannot
find a unanimous global standard. The fairness of pricing depends on the environmental
and company specific factors, which, if assessed correctly, lead to a fair solution. We shall
discuss these factors in the following sections, dividing them into three core determinants
of pricing of global distributors from the conceptual framework: market entry strategy,
relationship with the distributor, and external factors.
Market Entry Strategy
Our research shows that the market entry strategy is defined by the underlying goals of
expansion and the chosen contract type. The academic literature concludes that firms
focusing on horizontal growth typically charge lower initial fees and design less complex
systems. This approach matches the profile of franchisors that implement flat ongoing
royalties and aim to grow geographically in order to mainly increase their revenue.
Evidently, franchisors that use this strategy appear less committed and offer less, if any,
29
support for the franchisee. On the other hand, franchisors that charge royalty rates are
motivated to provide a higher level of ongoing support and design better monitoring in
order to assist downstream firms to maximize their sales. These upstream firms are mostly
focused on developing brand equity.
We discovered that Heineken aim of their presence in the Scandinavian markets coincides
limited, and their compensation comes from ongoing flat royalties. To the contrary, Distell
is actively involved in their focus markets (i.e. Zimbabwe) in order to strengthen the equity
of their brand portfolio. Joint venture contracts are preferred and allow for a closer
monitoring of the foreign distributor. Distell provides extensive financial and non-financial
support in terms of A&P, knowhow and experience, which allows them to negotiate higher
royalty rates.
Relationship with Distributor
Four drivers of the relationship with distributor have been determined during the research:
transparency, financial and non-financial incentives, and balance. A combination of them
characterizes the relationship between the upstream and downstream firms, and has an
effect on the subsequent pricing of the global distributor.
One of the most significant findings that determine the relationship between both parties
of the vertical agreement is transparency. It is proven that royalties are only effective when
s sales can be monitored transparently. Literature suggests opting for a
combination of higher initial fees and lower loyalty rates when transparency is low.
Furthermore, secondary research findings conclude that t
commitment, expressed by the level of financial and non-financial incentives, has a direct
effect on the relationship between the two companies. The stronger the bond between
partners, the higher the incentives. The pricing of the distributor, i.e. the royalty rate, is
positively correlated with the level of support, and reflects the size of incentives.
The power balance has a very strong impact on how the distributor is going to be priced.
in the focus
market gives them more power. In those instances, the relationship becomes stronger;;
moreover, Baarsma can dictate the type of pricing for the partnership with the upstream
firm, which often includes full transparency.
30
When put in practice, we found evidence of the above factors at Heineken. Due to low
transparency of the Scandinavian partners Heineken charges a fixed fee for the use of their
nonexistent financial-incentives. Heineken does, however, have a very powerful brand that
allows them to exert a higher amount of fixed royalties from local distributors.
Firstly, Distell is highly invested in the partnerships by offering financial and non-financial
incentives, such as sharing knowhow, co-funding production facilities, subsidizing A&P
and marketing etc. Naturally, Distell has a significant amount of power from their high
equity brands, yet in some instances the trade network of the distributor challenges the
balance. Only transparency is lagging behind, yet as Distell has a minority stake in their
joint venture operations, they get enough information about the performance of their
partners. To sum up, Distell creates very interlinked and strong relationships with their
distributors, which in turn allows to charge higher royalties.
External Factors
We found from academic literature that when operating in countries with unstable
currencies or governments, upstream companies often try to reduce risk by increasing the
upfront fee and lowering the ongoing royalties. In order to reduce risk, Baarsma chooses
for short-term contracts and low volumes when entering unstable markets and always has
an exit strategy.
We found little academic evidence to support our hypothesis of changing consumer
behavior having a significant effect on the way global distributors are priced. However, the
trends in the market indicate that the consumer behavior is changing towards appreciation
and consumption of wine. Whereas previously wine was bought with the intention to age it
and consume at a later time, these days majority of wine is purchased for immediate
consumption. Hence, branded wines become increasingly important in the sales phase and
producers with higher brand equity gain more power.
In conclusion, the literature study and primary research has helped us understand the
different factors that influence and shape the pricing of global distributors. We have
created a framework displayed in Figure 10 that shows the relationships between the
determinants.
31
Figure 10: Framework for Pricing a Global Distributor
32
6 RECOMMENDATIONS Based on the company profile, the different approaches to growth that Distell can adopt,
the market conditions in which Distell operates in, and considering future opportunities in
the industry, we have come up with recommendations that Distell can consider when
implementing pricing strategies for their global distributors. Five divergent guidelines are
developed aimed to cover a wide range of future possibilities for Distell.
Our first recommendation taps into fine-
level of uncertainty. When operating in local markets that carry high levels of risk due to
the influence of external factors, Distell may favor to adjust their contractual agreements in
a way that reduces risk. Increasing the upfront fee and setting lower royalty rates can cover
the risk partially. Moreover, contracts with a lower duration can help lower the risk as well,
and exit strategies could be in place before signing the contract.
Secondly, we recommend continuing vertical expansion through building brand equity.
Royalty rates should be combined with ongoing support and close monitoring in focus
markets for Distell. Appropriate incentives such as providing discounts and additional
financial and non-financial support will motivate the downstream company to perform
better.
The next recommendation includes a different approach to expand in the market, namely a
horizontal strategy where Distell focuses on growth in sales. We suggest applying this
strategy in less complex systems in relatively stable markets where Distell is less interested
in operating themselves. To complement the less complex systems, we suggest only take
lower priced wines that have potential to reach high levels of sales and volume. We also
recommend keeping the upfront fee relatively low, therefore lowering the barrier to entry,
which is expected for systems of low complexity. Royalties should be fixed and based on
targeted sales volume. This approach is designed to grow sales and requires low levels of
ongoing support from Distell, yet, it is recommended to invest in training the downstream
the market.
The fourth recommendation aims to leave a larger footprint in Europe. Currently Distell is
active in Europe, however, we believe that there is much more potential for Distell to
grow. As Distell would intensify its presence in Europe, the company must be prepared to
stretch their level of transparency to full measures, which is a common prerequisite in this
environment. Distell must be willing to open up their books to achieve the highest level of
transparency and fairly split the margin with other parties involved.
33
We recommend Distell to set up their European headquarter in Amsterdam to work on
building brand equity in the European markets. The ease of doing business in the
Netherlands is high, and Amsterdam is logistically well connected to the rest of Europe.
Additionally, the long established trading line between the Cape and Amsterdam goes back
to the 17th century.
Lastly, we recommend Distell using the framework for pricing global distributors (Figure
10) whenever deciding on how to price current and new partners. Figure 11 provides the
reader with a more visual depiction of the elements that shape the pricing model and can
be used as a quick reference.
34
Figure 11: Infographic of the Determinants of the Pricing Strategy
35
APPENDICES
APPENDIX A: SAMPLE OF QUESTIONS FOR SEMI-STRUCTURED
INTERVIEWS
How does Distell price their foreign partners?
Please share your experience in working with pricing of distributors?
How, in general, is the royalty type (upfront fee vs. royalty rate) and size decided?
What factors do you look at when negotiating royalties?
What support do you receive from Distell?
Is there any additional support that you would like to receive from Distell?
Describe how the current relation between Distell and distributor motivates to reach
for higher sales results.
perspective?
How do you evaluate fairness?
To what extent does the existing royalty model affect the market price of Distell's
products? Who sets the market price?
In general, do you think that royalties are an efficient instrument to coordinate the
distribution system? Please share with us if you have an alternative model in mind.
How does Distell support their brands in a foreign market?
In your words, how would you explain the rationale behind the royalty margin?
How do external factors affect the pricing of global distributor?
How transparent are you in your pricing decisions?
How does Distell approach the export market? Vertical vs. horizontal growth?
36
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