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Manufacturing in an Economic Downturn: Overcoming the Distribution Flu

Manufacturing in an Economic Downturn: Overcoming the Distribution Flu

(November 22, 2011)

A healthy distribution network is essential to a manufacturer’s or dealer’s business. An efficient factory, turning out perfect products, does the manufacturer no good if distributors aren’t waiting in the wings, ready to turn the products into income. By the same token, distributors need good support from their manufacturer. When the system works, it is the picture of health.

But an economic downturn can be like the flu – catch it and you’ll be miserable. Symptoms of the economic flu can be severe. The manufacturer and the dealer both want to cut costs, increase efficiency, and stay in the black. The pressure to do so in a downturn is intense. The dealer may lobby for extensions on payment terms, relief from inventory or parts stocking requirements, or for extra advertising funds from the manufacturer.

A manufacturer’s first impulse may be to trim its distribution network. Does the manufacturer really need three distributors in South Carolina? Do all the distributors have to carry the same products? Trimming or consolidating a distribution network might appear to be just the drug to beat the manufacturer’s flu. However, it is not nearly as simple as it sounds. Any number of laws significantly impact the rights and obligations of each, complicating changes.

First, state statutes frequently limit the rights of manufacturers in certain types of industries to terminate a distributor or change a distribution relationship. For example, most states have very similar statutes regulating motor vehicle manufacturers and dealers. These statutes might limit a manufacturer’s ability to terminate dealers, add new dealers within a certain distance of existing dealers, sell vehicles directly to customers, "coerce" dealers into taking products or offering services, or unreasonably interfere with the sale, transfer, or relocation of a dealership.

Similar statutes affect other industries, typically including farm equipment, industrial equipment, beer distribution, and others. The restraints in these types of statutes vary from state to state, but commonly include the following:

  • Significant advance written notice to the distributor (typically between two and four months)
  • Opportunity for the distributor to cure any breach
  •  "Good cause" for termination, which is typically defined in the statute and does not depend on what a manufacturer considers good cause
  • Required repurchase of certain inventory from the distributor or assumption of lease obligations

Second, even for industries without a specific statutory regime that governs the relationship between a manufacturer and a distributor, laws of general application may come into play. For example, many states have "unfair and deceptive trade practices" — laws of broad application that can be applied to many different business situations, including disputes between manufacturers and dealers. These laws can be particularly dangerous for the unwary, as penalties for violations can be stiff. In addition, the law of many states will imply a "duty of good faith and fair dealing" in all contracts.

Finally, and not surprisingly, federal laws may regulate relationships between a manufacturer and a distributor. These statutes relate to motor vehicles (the Automobile Dealer’s Day in Court Act), petroleum dealers (the Petroleum Marketing Practices Act), and soft drink distribution (the Soft Drink Interbrand Competition Act). The mere existence of state and federal laws such as these, complete with lengthy notice periods, make it abundantly clear that trimming the distribution network may not be easy for a manufacturer.

From the dealer’s point of view, asking a manufacturer to increase its financial support, to extend payment terms, or to forgo payments is similarly problematic. Many states have enacted laws that require sellers to uniformly price their goods to distributors (e.g., the South Carolina Price Discrimination Act), as does the federal Robinson-Patman Act. Preferentially changing payment terms for some distributors could conceivably run afoul of those statutes.

In non-price-related actions, though, the manufacturer and the distributor may find common ground. A manufacturer and distributor can agree on a reduced purchase schedule, amended sales goals, extended delivery schedules, reduced parts inventory, and the like. While these might not be the designer drugs that cure the flu, these steps might at least help reduce the patient’s temperature.

As one might suspect, these laws are not uniform across states, and even federal laws might be interpreted differently by different courts. Manufacturers seeking to change their distribution networks and distributors seeking changes in their relationships with their manufacturers are well advised to seek legal guidance concerning the scope and effects of any applicable laws before they act.


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Jonathan Heyl
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Natalma M. McKnew
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