Managing High-Risk Distributor Risks (Part I of II)
Companies will often rely on a network of distributors to help sell their products in emerging markets. From a business economics standpoint, engaging a distributor is often more cost efficient than investing in a sales force in a new market. As a result, companies may enter a new market by relying on distributors, and if successful, may invest in the future by establishing its own sales force.
Relying on a network of distributors, however, creates its own set of compliance challenges and risks. Remember my profound grasp of the obvious, a company has less control over its distributors than its own employees (at least hopefully). As a consequence, a company has to monitor its distributors and adopt proactive strategies to identify potential problems and then follow up on specific issues.
This sounds easier in theory than in practice. A risk mitigation strategy has to include a comprehensive assessment of risks, drafting and negotiation of specific contractual provisions providing access to distributor business transactions and associated services, including logistics and customer end-use pricing information. Distributors are often uncomfortable supplying such information and this can hinder a company’s ability to monitor distributor performance.
Assuming that your company can secure access to important information from the distributor, companies have to monitor and implement a high-risk auditing program for distributors. Internal audit may help in this area but, as a general matter, internal audit is usually too busy to implement an ongoing and continuous monitoring and auditing program.
By auditing, I do not mean on-site-rip-the-organization apart financial and compliance audit. Instead, companies have to design a remote program based on access to financial and compliance information from the distributor.
Such a program requires the company to identify its high-risk distributors. Most companies will be able to risk rank their distributors using a basic formula consisting of annual revenue and CPI for the country in which the distributor is located. Of course, there may be some nuances here when a distributor operates from one location and distributes into multiple countries. The distributor risk formula can take that into account by dividing revenues and countries of distribution into country-specific ratios. For example, if a company sells to a distributor located in Morocco, and the distributor sells 30 percent of its annual revenues/product to a different country and 70 percent in-country in Morocco, the formula would be based on 30 percent times the CPI for the different country, and 70 percent times the Morocco CPI.
Assuming that we have identified our high-risk distributors and prioritized them based on a risk ranking formula, we will want to focus on the following:
(1) Definition of exact distribution chain and reliance on sub-distributors or agents to distribute our company’s products or related services, including interactions with government officials involved in sales/purchases by the government and/or regulatory and customs interactions on our company’s behalf;
(2) Anti-corruption risks created by distribution chain and outflow of money and/or credits by our company to the distributor through marketing fund allowance programs or similar marketing support programs;
(3) Review of transactions for unusual sales from a pricing, logistics or customer perspective;
(4) Potential sanctions risks through resale of goods or provision of related services by sub-distributors to prohibited individuals and organizations;
(5) Confirmation of distributor participation in company training programs (or comparable training program); and
(6) Confirmation of distributor completion of any compliance requirements under written contract with company, including annual certification or distributor code documentation obligations, ensuring compliance by sub-distributors and other members of distribution network.