Regardless of how a tech OEM selling through channels recognizes revenue (sell-in or sell-through), they should manage and incent channel players on a sell-through basis. Also, regardless of revenue recognition methodology, they have to continuously recalibrate reserves at the end of each month, for future discounts and possible returns. The only way to do this is by collecting and processing data (POS, inventory, claims) directly from channel partners, since these data are not internally available to the OEM.
Well, this is where things get really interesting. Leaving aside the mechanics of collecting and normalizing data formats, let's explore some other complexities which tend to multiply as the number of product SKUs, distributors, and channel programs grow.
Selling Chain Scenario
Tech OEMs typically ship large quantities of product to stocking distributors over multiple orders. These are often at different prices. This is especially true for markets like semiconductors or consumer electronics. Prices vary due to negotiated upfront discounts, product aging, seasonality or other market conditions.
Let us consider the case of an OEM called Acme Widgets making shipments to a new distributor Rhino Tech at different prices, as shown below:
- Invoice #1: 1000 units @ $120 ea. = $120,000
- Invoice #2: 5000 units @ $115 ea. = $575,000
- Invoice #3: 3000 units @ $122 ea. = $366,000
- Weighted Avg. Price: $118 ea.
- Another data point: Current Price (from Price Book): $121 ea.
Sometime later, OEM Acme Widgets receives a POS report from distributor Rhino Tech, which provides the following information:
- End Customer: Zeb Comp
- Product: SKU #456
- #Units: 2,500
- Resale Unit Price: $150
- Extended Resale: $375,000
- Unit Credit: $10
- Extended Credit: $25,000
They also report that they have 7,000 units of SKU #456 left in stock at the end of the reporting period.
Some key questions:
- Question 1: How should we value the POS transaction? The Resale Price - while interesting - is not the price on which to calculate revenue and incentives.
- Question 2: How do we know the quantities reported in Rhino's POS and Inventory report are correct?
- Question 3: How do we know that the back-end credit being claimed is correct? Once again that has a material impact on revenue and incentives.
- Question 4: What should we pay sales commissions on? Do we dare bring up commission splits?
Let's explore these one at a time.
How do we value POS & inventory?
So what is the value of the 2500 units reported in the POS transaction to Acme? Should it be valued at the current price? Latest ship price? Earliest ship price? Median price? Weighted average price? Getting the valuation right is important, since this is the value Acme will use to pay commissions to sales reps and volume rebates to Rhino. Similarly, the value of the remaining inventory needs to be calculated, since that is what reserves are based on.
Here are the results we would get using the various methods described above:
Current Price: (2500*$121 ea.) = $302,500
Latest Price: (2500*$122 ea.) = $305,000
Earliest Price: (2500*$120 ea.) = $300,000
Weighted Avg. Price (2500*$118 ea.) = $295,000
However, from an accounting perspective, the most correct way to deal with inventory movement is to assume that inventory moves on a First-In-First-Out (FIFO) basis. So the way to value the 2,500 units is to assume that 1,000 units came from Invoice #1 above and the remaining 1,500 is from Invoice #2. So the valuation works out to:
(1000 units * $120 ea.) + (1500 units *$115 ea.) = $292,500
So we can see that not using the correct methodology to value the transaction can lead to significant errors, especially if you multiply this error out across tens (or hundreds) of thousands of POS transactions and hundreds of SKUs per month!