Michael Schanker Director of Marketing Zyme Solutions

Rachel Bell Director Protiviti

The Sarbanes-Oxley Act (SOX) has placed companies’ revenue-related processes under a more powerful magnifying glass than ever before. This increased scrutiny is uncovering areas of financial vulnerability for many companies.

For manufacturers that sell through distribution channels, SOX has helped expose the poor inventory and sales data received from channel partners (distributors, retailers, and resellers). These reports are often replete with errors, leaving manufacturers susceptible to making poor strategic decisions and losing revenue. A recent study by the Alliance for Gray Market and Counterfeit Abatement (AGMA) found that more than 20% of all point-of-sale data reported by channel partners contains inaccuracies, missing, or incorrectly completed fields. This leaves manufacturers susceptible to financial misstatements and poor strategic decision-making.

Manufacturers are increasingly aware of the problem of poor channel data and its financial implications, and many are cleaning up this data in order to achieve Sarbanes-Oxley compliance. But compliance alone is not the only reason companies are striving for more accurate data. Although SOX has brought this problem to the fore, there are bigger issues at stake. Complete and accurate channel data is critical for managing companies’ price protection, rebate, and other channel incentive programs, which, if managed poorly, can lead to overpayment and financial leakage. The data is also relied on for calculating sales commissions, determining the effectiveness of marketing and promotion activities, and forecasting demand and supply chain needs.

Risks of Bad Data
Why is channel data so vulnerable to error? Partners submit sales and inventory data to manufacturers in diverse ways, such as through Excel spreadsheets or via e-mail or fax. Partners often do not place a high priority on reporting and may send the data late, incomplete, or not at all. The data itself is prone to miscalculations, typos in SKU numbers, and inconsistent naming conventions. Moreover, if a partner’s reporting calendar differs from yours, data may not be properly aligned. Manual re-processing and reporting also increase the risk of error. Consequently, a manufacturer’s channel data is rarely complete and accurate enough to provide insight into operational aspects of the channel or to stop the financial leakage associated with overpayments of rebates and partner program claims.

Today, companies are realizing that poor channel data exposes them to significant financial and operational risks they had not previously considered, including:

• Revenue risks. Are you recognizing the proper amount of revenue and related reserves?

For example, if a company recognizes revenue on sell-in to the channel, it should set up sufficient reserves against returns, or risk over-reporting its revenue. If it recognizes revenue on sell-through to the customer, it must know exactly how much product has been sold. In either case, the data received from partners must be highly reliable to ensure accurate revenue recognition.

• Inventory risks. Could more inventory be returned and written off than you expect? Do you know how much inventory is actually in the channel?

• Partner claims risks. Are you overpaying partner claims for incentive programs like rebates and price protection?

Industry research shows that while companies spend up to 20 percent of their total revenue on partner incentive programs, between 10 and 15 percent of partner claims against these programs can prove to be invalid. For a $1 billion company, this translates to $20 million per year paid out for erroneous claims, which is no small change.

The controls companies employ today to manage these risks are basic at best, generally tedious, and largely inadequate. Rather than examining transactions line for line, managers tend to read reports at a high, superficial level and look for “ballpark reasonableness”. But what may not be considered is how a seemingly immaterial difference might be concealing significant financial issues. For example, this could be the case if the numbers reported by distributors result in significant differences that when netted together result in an immaterial difference for reporting purposes but in reality suggest underlying operational problems. By taking a closer look, the company can bring errant partners into line, and ensure that partner-reported channel data is accurate and reliable.

Do you know how reliable your channel information is? In our experience, executives are often unaware of the level of review performed over partner information. Middle managers may acknowledge that processes are rudimentary and unsophisticated, but many are disinclined to pursue or champion improvements if they believe other companies experience the same issues and that it’s simply a necessary part of business. Now with the scrutiny imposed by Sarbanes-Oxley, this issue is gaining broader attention, and strategy-minded companies are putting controls in place to obtain higher-quality data.

How to Improve Your Data
The key to a comprehensive improvement in channel visibility and compliance is to maintain a standardized, regular process for collecting, analyzing and following up on partner-reported data. There are a number of elements to this, including:

• Allowing partners to submit data in any format, to maximize the number of partners who submit data.

• Performing reconciliation analyses on partner-reported data on a weekly basis, to make sure that discrepancies don’t fester.

• Tracking partner compliance with self-reporting requirements on a weekly scorecard that is shared with partners.

• Performing quarterly onsite reviews for selected partners, including physical inventory procedures and interviews of key personnel.

• Creating proper financial incentives for compliance by linking partner self-reporting requirements with partner incentive programs such as rebates, price protection and special pricing.

• Increasing the number of partners that comply with self-reporting requirements through a thorough, structured outreach program.

While these steps can yield a stronger, more effective process, there’s a reason why most companies still have rudimentary, manual processes: It takes time, expertise, and technology to make the necessary improvements.

To improve data, companies can consider several options:

• They can bolster their accounting staff to cleanse and validate the data manually. This can involve adding significant headcount, and requires lead time to get employees adequately trained on the new process.

• They can purchase or build technology to automate some of the work, although analysts will still be required to follow up on exceptions and analyze the data. This solution also assumes partners are providing channel data in electronic form, which isn’t always the case.

• They can re-design their business processes in conjunction with one or both of the options above; for example, building better ways to conduct partner follow-up for missing or late data.

• They can require their partners to conform to standard data submission methods such as EDI. This is difficult to do when dealing with smaller partners, especially outside of the United States, that are not able to comply due to cost and resource pressures.

All of these options take time to develop and require significant outlay of effort and funding, which can be impractical for many companies. Generally speaking, they only make sense for the largest companies with the luxury of size and budget to build new systems, add headcount, or enforce distributor standardization.

Consider the Use of Specialists
Another option may be less obvious: outsourcing the data gathering and reporting to specialists. Specialists can help companies ramp up quickly and scale the effort to fit with the companies’ needs without the company making significant permanent investment in headcount and technology. Engaging specialists also allow for deep expertise to be leveraged quickly when the company needs it.

Companies will likely vary in the degree of improvement effort required. Some may only need specialists to perform the routine gathering and analyses of partner data to produce accurate reporting each period, while other companies may also require assistance with changing internal processes or performing further investigation into any significant variances. Using qualified specialists can help companies to quickly deploy resources rather than displace internal ones to investigate potential issues. Moreover, using independent specialists can also provide company partners the assurance and comfort that come with using qualified and objective third parties to perform the work.

When companies use outsourced specialists to handle the reconciliation of channel data and reporting, they also generally benefit from the economies of scale that an outsourced specialist can bring to bear. The cost of these services can be surprisingly economical and cost-beneficial relative to the other options. It is a good idea to use specialist firms that have obtained a SAS 70 certification, which provides greater assurance to companies about the completeness and accuracy of the reporting provided by their specialty firm. It will also save the company time and effort that would otherwise be required to assess the use of outside service providers as part of on-going internal controls and Sarbanes Oxley compliance.

Better Data Yields Tangible Benefits
More accurate data and improved channel visibility will provide not only greater assurance for financial reporting and internal control (and therefore SOX compliance), it will also lead to a number of other tangible benefits, including:

• More effective partner incentive programs. With improved programs, you can stop the financial leakage associated with erroneous partner claims and start using improved data to design more effective programs.

• Improved understanding of your end customers and their buying patterns. Knowledge of your customers leads to improved marketing, sales, and product planning.

• Better demand planning/supply chain planning. With an accurate view of inventory, you can base forecasts on real numbers rather than guesswork.

• Better product management. Knowing your buyers and their spending habits, and how much product is in inventory, will lead to more nimble timing of new product introductions, smoother product transitions, and more strategic pricing actions.

• Increased accuracy with sales compensation calculations, which helps to avoid overpayment of commissions.

• The ability to understand the relative effectiveness of your channel partners, reward the best, and drop the lesser performers.

• Improved partner satisfaction and retention, which helps to build lasting relationships.

Regardless of the improvement options a company may pursue, building both greater reliance and efficiency should be the company’s focus for better channel reporting and stronger partner programs. Companies will see the results of their efforts in their bottom line.