After years of complaining that they are not being adequately compensated for design work, distributors are finally being heard. "Suppliers have absolutely recognized that their manufacturer's reps and distributors have to be compensated for demand creation," says David West, vice president of field marketing and engineering services for  Arrow Electronics. "It's become a common theme: These services add value, and these efforts have to be rewarded."

"Demand creation" programs are supposed to reward distributors for getting a supplier's component designed into an OEM product. To support these programs, distributors  hire high-priced field applications engineers (FAEs) to help OEMs select—and often customize—components. For example, distributor Avnet recently helped Safetran Systems, a maker of signal-, train- and telecommunications-control  systems, to program a Xilinx FPGA. Safetran engineers were having trouble with the timing in their design:  Avnet engineers, who were trained to use Xilinx programming tools, helped Safetran engineers through the process. "The Avnet engineer spent only a week working with us, but it saved our team an entire month in getting to market," says Brian Hogan, a Safetran product development manager.

A supplier may reward a distributor that wins a position for its component in an OEM product in one of several ways. The supplier can prevent other distributors from undercutting the price offered by the distributor that assists with the design win. Or it can award the design-win distributor a hefty profit margin on volume sales of the winning component.

Or it may not. Thanks to the prevalence of outsourcing and the migration of manufacturing overseas, distributors may not see a penny for their efforts. A contract manufacturer may substitute another part at the last minute. Or the OEM or its subcontractor may buy the part directly from the supplier or from another distributor. Factor in manufacturing's shift to Asia, and the aforementioned problems only get worse. OEMs and CMs in Asia prefer to procure their parts from local suppliers and local distributors, which are not necessarily the distributor that assisted with design work done in North America.

But several market trends are prompting suppliers to step up support for their distributors. The first is the latest boom-and-bust cycle, from which the industry is still recovering. During the upturn of the late 1990s, suppliers backed off their demand-creation programs because "components were designing themselves in," says one chip maker. But when the bust came, suppliers found that distributors had, in turn, backed away from hawking their parts. Suppliers also had concentrated on their biggest customers during the boom. These customers, many of whom were in the telecommunications market, fell the hardest when the market dropped. Now the suppliers have begun to realize they need distributors to help reach small and midsize customers.

"The best way to guarantee capture of our demand-creation efforts overseas is by having our own tracking system."—Greg Provenzano, president, Memec Americas

So suppliers are increasingly stepping up to the plate. Many suppliers that never offered demand-creation programs before are now doing so. Others are improving their tracking systems, so distributors have a better chance of capturing the sales a design win generates. And many are restructuring compensation plans to reward a distributor for a design win even if that distributor does not capture the production sale. Suppliers are finally recognizing their distributors' design efforts provide value and are rewarding them appropriately. For example, Arrow has seen sales associated with design wins—of the component that was designed in, plus other components that work with it—increase by more than 40 percent in the last two years, says West.

Connector maker Molex, which has never offered a demand-creation program before, began making a limited number of proprietary products eligible for design registration (see box, "A Primer on Demand Creation," below) in October. The intent of the program is to get Molex's new parts to market faster, says Eric Sussman, Molex's director for Americas distribution. "We have a limited number of direct salespeople, and the revenue we derive from distribution is very significant," Sussman says.

Molex is one of about 15 suppliers carried by distributor Sager Electronics that have launched demand-creation programs over the last year, says P. J. Murphy, Sager's vice president of sales for the eastern United States. "We've seen the number of programs grow by leaps and bounds," he says. Of Sager's 80 suppliers, 24 now offer formal registration programs.

Not only are suppliers launching more programs, but they are also investing in technology to help bolster design revenue. One of the main reasons distributors don't get compensated for their engineering support is that they or their supplier simply lose track of a component as it winds its way through the supply chain. Even if an OEM specifies a component in its design, CMs may change the part number for inventory-tracking purposes. Or the OEM's design team in North America fails to communicate with its purchasing team in Asia: Part A gets designed in, but part B is purchased. The distributor that helped with the design work loses, because its compensation is tied directly to the end purchase.

Historically, the onus has been on distributors to track design wins. Many component makers sold only one or two key parts to a vertically integrated global customer, so tracking was easy to do, says West. But outsourcing and globalization of the supply chain has made it much more difficult. Continents and time zones separate OEMs' engineering and purchasing teams. The components specified by a design team in North America may not be the components purchased in Asia. And suppliers are now facing more competition: OEMs and CMs based in Asia prefer to buy from Asian suppliers.

"Generations of salespeople have been conditioned to focus on the order point versus the entire supply chain. We need some cultural shifts here."—Frank Robertazzi, vice president, worldwide geographic sales, semiconductor products, Agilent

Many suppliers are establishing centralized IT systems to try to track their parts better. These central systems were virtually nonexistent in the supplier community three or four years ago, says Chris Miller, director of Arrow's field applications engineering. "Now, suppliers have made this a top priority."

Suppliers are also allowing distributors to link with their databases—through the Internet and other methods—and see who assisted with a design, where the product is being manufactured, component prices, inventory levels and other data. With this kind of visibility, if a product's manufacturing is outsourced, distributors can work with their suppliers' salespeople wherever components are purchased. "This gives distributors seamless visibility from design through procurement, and this enables them to close the deal," says Frank Robertazzi, Agilent's vice president of worldwide geographic sales for semiconductor products.

Yet tracking remains primarily the distributors' responsibility. Distributors that specialize in creating demand have developed their own tracking software and systems. "We've found that the best way to guarantee that we capture our demand-creation efforts overseas is by having our own tracking system," says Greg Provenzano, president of Memec Americas, which derives 75 percent to 85 percent of its revenue from proprietary parts and parts covered by demand-creation programs. And because distributors for decades have tracked supply chain engagements involving thousands of parts around the world, their systems are pretty good. For example, Avnet, a distributor for Agilent semiconductors, tracked a deal into China and found that a subcontractor had designed Agilent out of the end product. Agilent alerted the members of its sales team in China, who then called on the subcontractor. "We were able to recapture that business," Robertazzi says. Tracking enables suppliers and distributors to be proactive in such situations, he says.

Even with accurate tracking, there's no guarantee the distributor that provided design support will end up with the volume sale. First, only one in three designs even reaches production, according to distributors. Second, neither the customer nor its subcontractor is under any obligation to purchase production volumes from the distributor that helped with the design. Finally, there is sometimes conflict within a distributor itself, because each regional division operates as its own profit-and-loss center. One regional branch of a distributor (North America, for example) might win the design, but another branch (such as Asia) might get the actual order. So the sales credit and compensation go to Asia. There's also the risk that the American distributor that helped with the design will lose the order altogether if the customer buys the part directly from the supplier.

"Unfortunately, if the distributor doesn't make the sales transaction, it doesn't get the margin," says Jim Goudreau, director, Americas distribution business, National Semiconductor. Yet there is value in the design work distributors do, he notes.

So suppliers are increasingly offering compensation packages not entirely tied to the end sale. "That's where suppliers are really working now," says Jeff Ittel, president of Cilicon, Avnet's semiconductor division. "They honor and reward the demand creation, regardless of where the production takes place." Some suppliers pay a flat fee for design work, whether or not the capture materializes. National Semiconductor compensates its distributors for winning a set number of designs. "We tell them they need to get x number of design wins, and if they hit that goal, we'll pay," says Goudreau.

Suppliers also are staggering their margin structure, depending on the type of account distributors manage and how much service they provide, according to Andy Bryant, president of Avnet Electronics Marketing Group. Margins are lowest in accounts in which distributors mostly fill orders but do little design work, says Bryant. They are higher in accounts in which both design and fulfillment services are provided. "And in distribution's sweet spot—the customer the supplier doesn't reach at all—the margin goes even higher," he says.

Suppliers also frequently split commissions, awarding a portion to the distributor with the design win and a portion to the distributor that captures demand. The amount varies: Some splits are 80 percent to one distributor and 20 percent to the other; others are 50-50. Molex's new program splits commissions among distributors and goes one step further: "We are asking that one third of that commission go to the distributor's sales engineers, in the form of a cash payment," says Sussman. "They have to see a direct benefit for their efforts. If they do, it will be an added incentive for the program to take hold, and frankly, if we are funding this program, we want to direct where those funds go."

But even within the same distribution company, it can be difficult to ensure that the commission ends up in the right hands. A lingering problem is that of franchises: suppliers authorizing a distributor to sell their parts. Franchises have historically been granted on a regional basis, meaning that in many cases, a distributor with a design win in North America can't pursue an order that will be transacted in China, because the distributor is not authorized to sell that part in China. So some suppliers are granting worldwide franchises. "We are spending a lot of time on the globalization factor," says John Simari, director, worldwide distribution, for Texas Instruments. "Arrow and Avnet are authorized everywhere we have a common business, and Memec in most parts of Asia. If they do the work, that at least positions them to win the business in Asia."

But what about distributors that don't have a global presence or aren't authorized in a specific region? Suppliers more often are granting distributors "spot franchises"—authorizing them to sell products to a specific customer or CM regardless of region, says Memec's Provenzano. "They are working hard to continue the design activity we do in the Americas," he says.

Whether suppliers will maintain their enthusiasm for demand-creation programs, distributors say, remains to be seen. "If you look at the history of our business, it is very cyclical, and in some respects, we've made the same mistakes over and over again," says Provenzano. "But that last downturn was so severe that nobody is going to forget it." Distributors point to two leading chip makers, which they won't name publicly, that backed off their design programs during the boom: Both lost market share (not entirely because of the state of the economy) and have since made a 180-degree turn. "I don't think the pendulum will swing back the other way," Provenzano says.

Compensation models will continue to evolve, as suppliers and distributors work to make sure these programs are fair. "There is talk about completely dissociating demand creation from orders," says Simari. Yet suppliers and distributors make most of their money from actually selling high volumes of parts.

It's going to take a fundamental change in the way the channel views its business, says Robertazzi. "Generations of salespeople have been conditioned to focus on the order point versus the entire supply chain," says Robertazzi. "We need some cultural shifts here. The overall supply chain is best served only if all links are served."

How do you handle complex compensation problems? Give us the details at feedback@eb.reedbusiness.com.

Barbara Jorgensen (bjorgensen@reedbusiness.com) is a senior editor at EB.