Framework for Pricing Global Distributors

Framework for Pricing Global

Distributors

Case of Distell in Wine Industry

Gintar

Annewil M. E. de Vries

IMBA Final Project

August 2013

Framework for Pricing Global

Distributors

Case of Distell in Wine Industry

International MBA Final Project Nyenrode Business University

Faculty: Marketing and Supply Chain Management

Faculty Supervisor: Prof. Dr. Venugopal Venkataraman

On behalf of:

Distell Group Limited: Mr. R. Lord (GM: Africa South East)

Gintar Breukelen, August 2013

ACKNOWLEDGEMENTS

We owe a debt of gratitude to Prof. Dr. Venugopal Venkataraman our faculty supervisor

and academic coach for the selfless commitment to guide and support us during the

whole IMBA program and especially when writing the Final Project.

We would like to extend our gratitude to Mr. Richard Lord for involving us in the inner

world of wine trade and sharing his immense knowledge and experience. It has been a

privilege to provide you with our view on the topic.

We also thank those who were willing to share their knowledge and expertise that made

this a much more valuable research.

We cannot forgo the opportunity to thank the inhabitants of Ginnewil the fabulous

group of IMBA 2013 for giving us the canvas to express our creativity, allowing to

cherish and amuse you. You will forever stay in our hearts.

A big thank you goes out to our families who supported us in all possible ways. We would

not be where we are without you.

And finally, we have to recognize the contributions of liquid inspiration the bold, full,

elegant wines that brought us both together and induced the fascination and love for the

industry.

Gintar and Annewil

A.k.a. Ginnewil

EXECUTIVE SUMMARY This study was done after recognizing the need for producers and exporters of bulk wine

to regain value that has shifted along the supply chain. The purpose of this research is to

find create a framework that would help Distell Group Limited in pricing their global

distributors.

Both secondary and primary research has been done to get a good insight of how royalties

are used in different industries. The reviewed literature focuses on royalties in the

franchising industry, elaborating on how different types of distribution networks

incorporate vertical constraints that suit the strategy of a company. Royalties are looked at

from the perspective of both parties holding the agreement.

Primary research has been done in the form of conducting interviews with experts from

the beverages industry in order to identify best practices. Valuable information has been

shared regarding the strategic use of royalties. The conceptual framework that was used to

identify factors that impact the pricing of global distributors helped to divide influencers in

three categories: market entry, relationship with the distributor, and external factors.

Following the analysis of primary and secondary research, a framework for pricing a global

distributor has been created. The deliverables for Distell include the framework, best

practices from Heineken and Baarsma, as well as a list of recommendations.

TABLE OF CONTENTS Acknowledgements

Executive Summary

1 Introduction and Background ................................................................................................. 1

1.1 Introduction ...................................................................................................................... 1

1.2 Global and South African Wine Trends ....................................................................... 2

1.2.1 Background South Africa ........................................................................................ 2

1.2.2 Bulk Export and its Impacts ................................................................................... 3

1.2.3 Value Shift Along the Supply Chain ...................................................................... 3

1.3 Reason for Research ......................................................................................................... 4

1.4 Distell Group Limited...................................................................................................... 5

1.5 Final Project Structure ..................................................................................................... 9

2 Problem Definition and Objective of the Research .......................................................... 10

2.1 Management Problem .................................................................................................... 10

2.2 Research Questions and Objective .............................................................................. 10

2.3 Conceptual Framework ................................................................................................. 11

3 Methodology ............................................................................................................................ 13

3.1 Introduction .................................................................................................................... 13

3.2 Research Design ............................................................................................................. 13

3.2.1 Secondary Research ............................................................................................... 13

3.2.2 Primary Research .................................................................................................... 13

3.3 Limitations of the Research .......................................................................................... 15

4 Literature Review .................................................................................................................... 16

4.1 Royalties in the Franchising Industry .......................................................................... 16

4.1.1 Introduction ............................................................................................................ 16

4.1.2 Types of Distribution ............................................................................................ 16

4.1.3 Vertical Restrains .................................................................................................... 18

4.1.4 Justification of Royalties ........................................................................................ 19

4.1.5 Two-Parts Mechanism ........................................................................................... 20

4.1.6 Relationship Between Royalty Fees and Royalty Rates .................................... 22

4.1.7 Determinants of Royalties..................................................................................... 23

5 Results, Analysis and Conclusions ........................................................................................ 25

5.1 Primary Research Findings and Analysis .................................................................... 25

5.1.1 Best Practices from Heineken and Baarsma ...................................................... 25

5.1.2 Distell ....................................................................................................................... 27

5.2 Conclusions ..................................................................................................................... 28

6 Recommendations .................................................................................................................. 32

Appendices ....................................................................................................................................... 35

Appendix A: Sample of Questions for Semi-Structured Interviews ................................... 35

Bibliography ..................................................................................................................................... 36

LIST OF FIGURES AND TABLES

Figure 1: Old World Wine Market Share in Volume Terms ....................................................... 2

Figure 2: New World Wine Market Share in Volume Terms ..................................................... 2

Figure 3: Top Distell Brands: Amarula, Scottish Leader, Savanna ............................................ 6

Figure 4: Global Presence of Distell............................................................................................... 6

Figure 5: The Supply Chain of Distell ............................................................................................ 8

Figure 6: Conceptual Framework ................................................................................................. 11

Figure 7: Four Types of Distribution Networks ........................................................................ 16

Figure 8: Distribution of Royalties within the Six Types of Retail Chains ............................. 21

Figure 9: Distribution of Royalty Rates within the Six Types of Retail Chains ..................... 21

Figure 10: Framework for Pricing a Global Distributor ........................................................... 31

Figure 11: Infographic of the Determinants of the Pricing Strategy ....................................... 34

Table 1: Estimated Transfer of New World Wine Value, 2001 vs. 2010 .................................. 4

1

1 INTRODUCTION AND BACKGROUND

1.1 INTRODUCTION After the abolishment of the apartheid, South Africa was welcomed back to international

trade in 1994. The internationalization changed the structure of the economy and exporting

became a vast driver of the South African economy (Roux, 2013). In 2012 South Africa

exported a total of 409 million liters wine, and herewith earned the 8th place of largest wine

exporters worldwide (Analytix Business Intelligence, 2013).

The way South African companies export wine has changed significantly over the last five

years. In 2008, 45% of total wine export volume was in bulk, whereas in 2012 bulk wine

exports rocketed to 61% (Analytix Business Intelligence, 2013). The switch can be

attributed to the changing appetite of wine importers as well as cost efficiencies. The South

African wine producers benefited from increased export volumes - 25% increase from the

previous 12 months (based on the year ending on April 30, 2013) and more than triple the

total shipped in 2000 (Collins, 2013). The largest wine producing countries felt the growing

competition from South Africa (Love, 2013).

However, the new opportunity created additional challenges for South African wine

producers. Even though individually the prices of packaged and bulk wine increased during

2008-2012, the total price per liter dropped by 17% in two years to its lowest level 2012

(Analytix Business Intelligence, 2013). By switching from packaged wine exports to bulk

wine exports wine producers are losing out on a substantial share of their revenues.

These challenges sent SA wine producers and distributors in search of more sustainable

business models. The foreign markets were too important to loose (eNews Channel Africa,

2013), yet the low bulk wine prices made it difficult obtain a healthy profit. To improve

their revenue prospects, SA wine companies increased their involvement in foreign

markets. For example, Distell Group Limited transformed from a passive indirect exporter

into an active player in multiple African markets through joint-ventures and licensing

agreements (Distell Group Limited, 2012). The underlying motivation for them was that

there is a lot to be gained from direct investments into foreign markets (Lord (b), 2013). At

the same time, new expansion strategies require innovation in the pricing models for

foreign distribution partners that fairly compensate for the involvement of SA companies.

Whereas other industries provide a wide choice of pricing strategies for every possible

situation, little research has been done so far as to how best apply those strategies in the

2

wine industry. SA companies often choose their pricing strategies based on a gut feeling

rather than extensive research. No one is sure if the chosen strategy is the best for the

given situation. We recognize this gap in academic research and will focus our final project

on investigating how companies can apply different pricing strategies when exporting wine.

We will look into the determinants of pricing global wine distributors, and also try to

establish the impact these determinants have on the pricing strategy.

1.2 GLOBAL AND SOUTH AFRICAN WINE TRENDS The global wine market has witnessed a period of major changes in recent years;; both the

global division of production and consumption changed substantially. Old World wine

producers have experienced declining market shares (Figure 1), while New World wine

producers have seen their shares rising (Figure 2), in both traditional European markets as

well as other parts of the world. The New World wine growth has altered the way wine is

valued in terms of flavor, variety, and national origin, and the way wine is traded

internationally (Labys & Cohen, 2006). Route to market has been transforming gradually,

and the developing capability to ship wine in bulk has brought along growing implications

on the wine industry (Rabobank, 2012).

1.2.1 BACKGROUND SOUTH AFRICA

Even though South African vines were planted right after the Dutch East India Company

landed in the Cape in the 17th century, in the wine industry South Africa is categorized as

New World wine producer (Spahni, 2000). After the release of political prisoners,

particularly the release of Nelson Mandela in 1990, South Africa was welcomed back to the

international trade market, allowing the local economy to grow steadily (Roux, 2013). This

Figure 2: New World Wine Market Share in Volume Terms (Labys & Cohen, 2006)

Figure 1: Old World Wine Market Share in Volume Terms (Labys & Cohen, 2006)

3

drove the wine export to develop, reaching a total exported volume of 409 million liters in

2012 (Analytix Business Intelligence, 2013).

1.2.2 BULK EXPORT AND ITS IMPACTS

Globally, the increasing importance of bulk wine appears as the result of an evolution in

consumer demand in combination with the search for a more efficient way of supplying

foreign markets (Mariani, Pomarici, & Boatto, 2012). The financial downturn primarily

affected traditional wine importers in value, whereas non-traditional importers were

predominantly affected in volume. Six countries with a strong export orientation South

Africa, Australia, Chile, Argentina, New Zealand, and the United States together

comprise a quarter of the wine exports worldwide of which bulk wine makes up for 47 per

cent of total exports.

Executive manager at South African Wine Industry Information & Services Yvette van der

Merwe stresses that South Africa is present at the extreme of the global trend towards bulk

wine exports (eNews Channel Africa, 2013). Separate figures for South Africa are notably

above the average, where bulk wine in 2012 accounted for 61 per cent of total exports

(Analytix Business Intelligence, 2013). Moreover, it is to be expected that South Africa will

grow total exports to 500 million liters in 2013 (eNews Channel Africa, 2013);; this would

result in a 22 per cent growth compared to the record set in 2012.

1.2.3 VALUE SHIFT ALONG THE SUPPLY CHAIN

Like other New World wine producers, South Africa sees the shift from bottled to bulk as

a threat (eNews Channel Africa, 2013). The shift to bulk wine substantially impacts in what

way value is attributed along the supply chain. Instead of generating the majority of

revenues on the production site, a great amount of packaging value and wholesale margin is

now captured in the market where bulk wine is bottled and brought to market. This makes

it more difficult for South African wine producers to quantify the value of bulk wine (Lord

(a), 2013).

As presented in Table 1, Rabobank estimates the value of this shift accounting for well

over USD 1 billion annual revenue that is captured further along the supply chain, rather

than at the traditional source of production (Rabobank, 2012). Driven by deteriorating

margins, wine exporters are in search of an appropriate royalty contribution model to

regain value.

4

Table 1: Estimated Transfer of New World Wine Value, 2001 vs. 2010 (Rabobank, 2012)

Bulk Bottled Total

2010 share 43% 57% 100%

2001 share 23% 77% 100%

2010 revenue USD 950,000 USD 5,180,000 USD 6,130,000

2010 revenue assuming 2001 share USD 508,140 USD 6,997,544 USD 7,505,683

Difference USD 441,860 USD 1,817,544 USD 1,375,683

To understand the distribution of the value of the product, it is important to understand

who has ownership control once bulk wine is being shipped to the destination market.

Generally, a great share of the explosive growth of bulk wine can be traced to export-

oriented brand owners shipping their products in large quantities to an overseas market,

(Rabobank,

2012). The other major category of bulk wine trade affects the profitability of the wine

producer and exporter to a larger extent. In this category bulk wine is sold and shipped to a

third independent party, where the bulk wine is then packaged and sold under an

independent brand, owned by the third party. Both the producer and the independent

wholesale importer or retailer capture the wholesale margin (Rabobank, 2012).

Conversely, for the upstream firm the brand owner exporting wine in bulk can

significantly save on transportation costs, glass and bottling expenses, import fees (Lord

(b), 2013), and also working capital and foreign exchange rates (Rabobank, 2012).

In short, major wine and alcohol corporations have changed their managerial tactics

through franchising and marketing. Due to the recent shifts in the market, it is found

challenging to come up with a model that helps to fairly regain or distribute the value that

was once captured by the wine producers and exporters. The New World wine producers

and exporters are therefore searching for an appropriate approach of charging royalty

contributions to their downstream firms (Lord (b), 2013)

GM Erhard Wolf confirmed there are constant discussions on consolidation and

collaboration in export markets (eNews Channel Africa, 2013). In this industry franchising

implies refining the predictability, reliability, and security of wine purchases (Labys &

Cohen, 2006).

1.3 REASON FOR RESEARCH There are several reasons why we have chosen to look into the pricing of wine export.

Firstly, the challenges that have been described above have formed a rising demand of

5

sustainable pricing models. However, there is little research about pricing in the wine

industry. With the development of the recent trends it has become essential for wine

exporters to implement carefully tested models in order to sustain financial growth when

exporting wine in bulk.

The topic has been suggested by Distell Group Limited based on the current issues they

face in the company. The positives of bulk wine, e.g. savings in transportation costs and

lower import duties and tariffs, do not outweigh the negative consequences of lower

profitability as the mark up for bulk wine is significantly lower (Lord (b), 2013).

Distell is actively expanding throughout Africa a joint venture manufacturing facility is

currently being built in Ghana and new partnerships are under development in several

other countries (Lord (b), 2013). The company has very recently instated their first royalty

models (a specific pricing strategy that we will discuss in greater detail in later chapters) in

the test markets in Kenya and Zimbabwe (Marowa, 2013). The discussion of best pricing

options arises every time a new partnership is set and the lack of available research is felt.

We hope our final project can be the first step in a larger research project that would

analyze available pricing strategies in the wine trade industry.

1.4 DISTELL GROUP LIMITED This research is done in partnership with Distell Group Limited who provided us with a

current

wines, spirits, ciders and ready-to-drinks. Distell has almost 5000 employees worldwide and

a turnover of R15.9 6 billion) in 2013 (Distell Group Limited, 2013). Their

wide portfolio includes global brands such as Savanna cider, Amarula one of the fastest

growing spirit brands in the world, fine wines Two Oceans, Fleur du Cap and

Durbanville Hills. Distell recently acquired a top Scotch whisky producer Burn Stewart

Distillers to strengthen their product portfolio and extend its global reach (Burn Stewart

Distillers, 2013).

6

Distell has a wide reach in the markets around the world

with a strong focus on strengthening their presence in

Africa. Their head office is situated in Stellenbosch, South

Africa, Historically, South Africa, their home market,

represents the largest share of the annual revenue. The

Sub-Saharan markets, excluding South Africa, contributed

to slightly above half of their international revenue in 2013

(Distell Group Limited, 2013).

Supply Chain and Pricing Strategy

Figure 5. The strength of Distell lies in brand building

and distribution channels. There are two strategic choices when it comes to growing their

brands either horizontal growth by entering new markets or vertical growth through

investments into brand equity and new products. Distell relies on a network of 17 trading

depots and 27 TradeExpress distribution outlets in the domestic South African market

combined with two independent distribution agents (Distell Group Limited, 2012). When it

comes to foreign markets, Distell chooses their distribution approach from the five blocks

at the bottom of the supply chain. strategy is to unlock the opportunities in Africa

by bringing expertise and knowhow, and partnering in joint ventures with local distributors

(Distell Group Limited, 2013) (Lord (b), 2013). Joint venture partnerships allow Distell to

be closer to consumers, enhance price-competitiveness, reduce time-to-market, and

counter tariffs and high import costs (Distell Group Limited, 2013). Joint ventures are

currently active or under development in Angola, Kenya, Ghana, and Zimbabwe (Distell

Group Limited, 2013);; more are expected to be established in the nearest future.

Figure 3: Top Distell Brands: Amarula, Scottish Leader, Savanna

Figure 4: Global Presence of Distell (Distell Group Limited, 2012)

7

Distell invests a lot into the joint venture partnerships. Investments vary from marketing

support, knowledge sharing, investment in manufacturing facilities, instating own brand

managers to help bring products to the market (Lord (b), 2013). Distell is searching for

pricing strategies how they could be better compensated for the investments in the export

markets. They have recently introduced royalty contributions in Kenya and Zimbabwe to

receive compensation for the use of branded products. According to Richard Lord (2013),

General Manager of Africa South East, the potential of royalties in the African market is

huge. For example, in the wine market a large share of revenue has been lost due to the

shift towards bulk wine export. By adding royalty payments to foreign distributors who

bottle regain some part of the lost revenue.

However, Distell needs to figure out how to set royalties that are fair to all stakeholders

(Lord (a), 2013).

8

Figure 5: The Supply Chain of Distell (Lord (b), 2013)

9

1.5 FINAL PROJECT STRUCTURE This final project has been structured as follows:

Chapter 2 describes the management problem and research objectives. Multiple research

questions are raised in order to solve the management problem. The structure of research

is depicted in a conceptual framework.

Chapter 3 is dedicated for methodology. There it is explained what methods and why have

been chosen for primary and secondary data collection, including the list of the names of

experts that have been selected to participate in the research.

Section 4 hosts the review of academic literature with a focus on royalties in the franchising

industry. This part provides a theoretical explanation for the need of royalties, how they

can be constructed, and factors that typically influence the degree of incorporation into the

shared-agreement.

The results of the research are analyzed and concluded in chapter 5;; whereas the final part

of the final project is designated for recommendations that could help Distell solve their

management problem.

10

2 PROBLEM DEFINITION AND OBJECTIVE OF THE RESEARCH

2.1 MANAGEMENT PROBLEM Africa

in 2012 (Distell Group Limited, 2012). In order to be more competitive and build stronger

business relationships in the region, Distell established many joint ventures with its

partners. They have joint venture operations and investments in Tanzania, Kenya,

Zimbabwe, Mauritius, Angola, Nigeria and Ghana (Distell Group Limited, 2012). The joint

venture model allows Distell to move the last part of the supply chain bottling and

labeling to the end market, which has many benefits including countering high excise

duties, government tariffs, avoiding spoilage and having quicker response to market.

Through the joint venture business model, Distell exports wine in bulk to the partner

countries where it is then decanted and bottled under license. From the financial

perspective, on top of the price for the bulk wine Distell also receives royalty contributions

from JVs that bottle under license. The problem arises when Distell tries to establish a

royalty contribution margin that is both equitable and financially sustainable (Lord (a),

2013). Hence, the problem statement of this research can be summarized as follows:

There is no globally accepted benchmark that Distell could use to test the fairness

of their current royalty model. How should Distell price their global distributors?

2.2 RESEARCH QUESTIONS AND OBJECTIVE In order to find a solution to the management problem from section 2.1, we have

established the following research questions (RQs). Together, they provide the reader with

a full view of the problem on hand.

RQ 1:

RQ 2: How does the relationship between Distell and a global distributor look like? What

is the power balance?

RQ 3: How do external factors, such as consumer behavior, stability of currency, look like

in the operating country? How do these factors influenc

distributor?

The objective of this final project is to define a framework that would guide Distell when

pricing their global distributors. We will pay special attention on how lessons from

franchising models in other industries can be applied to wine distribution. We will also look

11

into the experience of large international companies for it to serve as a benchmark for

Distell.

2.3 CONCEPTUAL FRAMEWORK A conceptual framework helps visualize the structure of the final project research. The lack

of pre-defined conceptual frameworks for pricing of global distributors has given us the

freedom to create a framework based on our experience and knowledge of the subject and

adapt it to the management problem on hand. We assume that there are three main

determinants in the pricing model for global distributors. Figure 6 displays the conceptual

framework and it is described in more detail below.

Firstly, there are many strategies of

how to enter a market, and they

have a direct impact on the pricing

decisions of global distributors.

We have discussed in section 1.4

the different distribution models

Distell can choose from. We will

proceed with a research focused

on establishing what strategies

Distell uses and how it effects

their pricing decisions. For

example, if Distell hires

contractors to bottle their wine in a foreign market (as they do with cider in Belgium (Lord

(a), 2013)) the pricing model will follow a simple agreed contract. However, we expect to

see the use of royalty models under licensing/franchising and joint ventures.

Secondly, pricing depends on the relationship between Distell and the global distributor. In

more detail, the pricing decisions are influenced by the power balance between the two

participants. After all, the final outcome is something both parties agree on in a

negotiation.

Finally, there are multiple external factors that have a direct effect when pricing a global

distributor. For example: an unstable currency increases the risks of operating in a foreign

market and may imply the need for Distell to adjust their pricing strategy to avoid losses.

The changing consumer behavior might provide opportunities for market growth through

pricing decisions i.e. gaining market share by offering less expensive wine. Distell only

Figure 6: Conceptual Framework

12

the global distributor.

13

3 METHODOLOGY

3.1 INTRODUCTION The following chapter discusses the choice and design of the research that is used in this

final project. A qualitative exploratory research has been selected as the best approach to

and provide a detail description of data that will be collected.

3.2 RESEARCH DESIGN In order to understand the constituents of the royalty model, a qualitative exploratory

approach has been chosen for this research. An exploratory research can be conducted in

three ways: (a) literature review, (b) interviews with experts, and (c) group interviews

(Saunders, Lewis, & Thornhill, 2009). Knowing that there is a shortage of available

information on the topic of pricing of global distributors and royalties in the wine industry,

we have chosen to explore both primary and secondary research. Saunders, Lewis, &

Thornhill (2009) argue that group interviews might be highly productive and in-depth due

to group interactions and free-flowing discussions. On the other hand, managing a good

flow of a discussion and relatively equal contribution is sometimes difficult. We recognize

that conducting a group interview with the employees and partners of Distell could provide

phenomenal discussions;; unfortunatelly, due to not being able to be physically present in

South Africa we have decided not to use group interviews for the research. Hence, the

research is based on literature review and expert interviews.

3.2.1 SECONDARY RESEARCH

A thorough review of the academic research will be done in order to understand the widely

accepted categories of pricing global distributors. A special attention will be paid to find

generalized models in franchising and royalties in France, Spain and the US. Firstly, a

special focus will be placed in finding the relationships and the logic behind the variables

that constitute the royalty models. By understanding the construction of existing models we

expect to be able to translate and adapt the model to the wine industry.

3.2.2 PRIMARY RESEARCH

The primary research will take the form of interviews with experts from the beverage trade

industry. The interviews will be used to confirm key secondary research findings, discover

pricing strategies in their line of work, and, most importantly, bridge the gap of adapting

pricing from other areas to the wine industry.

14

Semi-structured and in-depth interviews with experts from the beverage industry will be

used to gather data. These types of interviews have been chosen because the collected

information is

(Saunders, Lewis, & Thornhill, 2009). These research

methods will allow us to obtain sensitive information on what strategies are used to design

royalty models and the underlying rationale for choosing specific factors over others.

We have prepared a large list of questions to be used for semi-structured interviews. Open

ended questions were preferred in order to allow the interviewee share their opinion on the

issue. Given the expertise and background of individual interviewees, only those questions

that were relevant were used. The discussions were enhanced with many impromptu

questions that suited the situation. See appendix A for a list of sample questions that were

used in the interviews and in-depth discussions.

We have selected to interview experts from three following areas:

Distell employees who can share the information about internal processes, market

entry strategies, and current royalty models that are used inside the company. They

are also currently involved in the expansion projects across Africa that could help

us better understand the relationships between Distell and their distributors. The

interviewees have been selected by the representative of Distell, Richard Lord

(General Manager: Africa South East). The list of experts includes:

Richard Lord himself, who has been generously sharing his knowledge on

the issue;;

Kevin Nagle, GM: East Africa, who coordinates the project in Kenya.

The interviews will be conducted over-the-phone because the parties cannot be

present in the Netherlands.

that act as distributors markets where royalty model is currently

used. We have to keep in mind that Distell introduced royalty models very recently

and there is little experience to be found from the partners. However, they can

provide us with a better perspective on the relationship between Distell and the

distributors, with the aim to understand how and why the relationship influences

the royalty model. They can also provide us with a better picture of the power

balance between Distell and their company. Richard Lord has suggested we speak

to Donna Marowa, Brand Manager at Afdis -

Zimbabwe. The interview will be conducted over-the-phone.

15

For benchmarking purposes, a select group of experts from similar industries will

be interviewed. These experts represent large corporations in the wine and beer

industry, or work independently. Their experience will provide alternative strategies

for royalty models as well as insights to the European market. The interviewees are

selected using personal networks and include experts based in the Netherlands. We

will have in-depth interviews with Ana van Gilst, Business Analyst at Heineken

International, and Joost Hagen, Business Development Manager at Baarsma Wine

Group Holding. The interviews will be conducted face-to-face at the Nyenrode

University or over-the-phone if the parties cannot be present on campus.

3.3 LIMITATIONS OF THE RESEARCH The limitations of the final project might originate from a limited sample size of

interviewees. It has proven difficult to arrange for a larger and more diverse sample due to

limited amount of time for the research. Furthermore, it is unclear to what extent the

royalty models used in Europe and USA can be applied to Africa where business culture is

significantly different.

16

4 LITERATURE REVIEW

4.1 ROYALTIES IN THE FRANCHISING INDUSTRY

4.1.1 INTRODUCTION

Offering products and services in global markets, firms work with different operating

modes that carry varying degrees of ownership. International markets can be served

through non-exclusive dealers, direct or indirect exports, franchise agreements or

licensing (Lord (b), 2013) joint ventures, and wholly owned subsidiaries (Terpstra &

Sarathy, 1999). Franchising is recognized as a method of distribution rather than

categorized as an industry (Bruno & Davey, 1984). The franchise system of distribution has

been customized in the supply of divergent products and services. Changes in the global

economic setting such as reduced trade barriers, enhanced homogeneity, and stronger

integration across national borders have offered new market opportunities for franchising

(Sashi & Karuppur, 2001). Even though the franchising industry has grown notably over

the years, key questions regarding strategies on how to gain economic value from the

relationship with franchisees linger unsettled.

4.1.2 TYPES OF DISTRIBUTION

Very recently it has been examined which factors play a role to firms in France when

deciding on the incorporation of royalties in distribution contracts. The research first

makes a distinction of distribution networks to specify the different types of networks. As

demonstrated in Figure 7, the initial classification sets apart four types of distribution

networks based on the agreement between downstream and upstream firms. Fadairo (2013)

later refined this existing model into a model that distinguishes six types of distribution

networks. Nonetheless, the distribution networks are presented in an ascending order of

integration: License;; Concession;; Franchise;; and Commission-based affiliation (Chaudey &

Fadairo, 2006). As the level of integration of networks increases, the degree of constraints

and coercion imposed on the downstream firm intensifies (Fadairo, 2013).

Figure 7: Four Types of Distribution Networks (Chaudey & Fadairo, 2003)

17

The hierarchy in the traditional four types of contracts can be described as follows: in a

license agreement, the retailer has mandate to operate under a same brand name under

conditions set by the upstream firm. In a concession the downstream firm operates under

the same conditions as the license agreement, yet the distributor offers a limited number of

retailers the right to sell one or several products. Also, concessions typically offer

exclusivity in terms of territory and supply. Note that the French concession is a

distribution contract equivalent to what is known as a traditional franchising contract in the

United States (Fadairo, 2013). Franchise contracts are defined as a concession, yet the

transmission of concept and know-how is central to this type of vertical contract. As stated

by Fadairo (2013), the European version of franchising is similar to business format

franchising in the United States. A commission-based affiliation agreement is like a

franchise contract except the downstream firm does not own its stock;; neither does the

the turnover.

The more recent network additions are based on the proportion of franchised versus

integrated units. Based on the existing Franchise network a distinction is made between

slightly mixed with owned retail outlets (Franchised slightly mixed), and highly mixed with

owned retail outlets (Franchised highly mixed). The sixth network type that enhanced the

four dimensional model is Predominantly Integrated (Fadairo, 2013).

In a global aspect, the stability of political, economic, and currency dimensions affect the

selection of type of network to operate in, and the cost of governance. Fluctuations in

these areas make it difficult to predict future business prospects and carry an increased risk

of doing business in unstable areas. It is therefore suggested that firms work with low

ownership arrangements that leave room for flexibility when operating in an uncertain

environment (Anderson & Gatignon, 1986). When expanding to unfamiliar markets that

are perceived unstable, franchisors may prefer entering the market supplying small

quantities and negotiate higher royalties to cover extra costs out of precaution, and be

equipped with an exit strategy (Hagen, 2013).

In order to successfully develop collaborative strategies it is important to anticipate

potential consequences of adopting different strategies and to find the suitable operating

mode to service the local market. The design of an appropriate strategy depends on the

nature of the product, and the characteristics of an organization and a country (Jain, 1989).

In some situations it may be favorable for firms to systematize strategies, whereas other

18

situations require a localized approach. All contractual arrangements are typically

incorporated in a share-agreement.

4.1.3 VERTICAL RESTRAINS

Distribution contracts often feature a set of contractual provisions. It is examined that the

presence of royalties in retail contracts are very common (Blair & Lafontaine, 2005) and

serve as one of the most significant vertical restraints (Fadairo, 2013). Vertical restraints are

contractual restraints binding companies from different layers of the supply chain, such as a

supplier to the distributor or the distributor to the retailer. The three most common

vertical restraints are recognized as those relating to payment (franchise fee, royalties),

provisions limiting the rights of the distributor (price-ceiling, price-floor, exclusive dealing),

and provisions limiting the rights of both the distributor and the manufacturer (exclusive

territories) (Rey & Caballero-Sanz, 1996). In general, vertical restraints are used to prevent

a downstream firm from underinvesting in the promotion of a brand (Chaudey, Fadairo, &

Normand, 2005).

Vertical restraints that refer to payment, as proposed by Rey and Tirole (1986), are briefly

described below to clarify the differences in payment structures relevant to distribution

contracts in the franchising industry.

Traditional linear pricing is simply based on a payment proportional to the ordered

quantity. However, vertical restraints allow upstream firms to depart from such uniform

pricing agreement.

Provisions such as a franchise fee an initial lump sum are typically added to the uniform

wholesale price and form a two-part tariff. The second commonly used form of non-linear

pricing includes rebates on the ordered quantity, known as quantity discounts.

Transparency along the supply chain is hey when developing non-linear pricing models.

Another vertical restraint is the implementation of royalties. As discussed by Fadairo

(2013), this type of payment is either imposed as a percentage of downstream sales

measured either in units or in revenues or as an ongoing fixed fee independent on the

downs

be monitored transparently (Rey & Vergé, 2005).

Motivations for vertical restraints and their implications on economic welfare have been

widely debated for years. Some believe vertical agreements to be incomparable to

agreements between competing firms and that such settlements only appear when it helps

19

(Rey & Vergé, 2005).

4.1.4 JUSTIFICATION OF ROYALTIES

The agency theory is widely recognized in the study of vertical restraints in the franchising

industry. Literature explains that the two-sided contract between an upstream firm and a

retailer creates an agency relationship as the upstream firm (the principal) gives the

downstream firm (the agency) permission to commercially exploit its brand (Chaudey,

Fadairo, & Normand, 2005) (Fadairo, 2013). Both players expect the agreement to yield

mutually satisfying results. However it can occur that one participant maximizes personal

interests at the expense of an optimal result for both players, reminding of the well-known

problems of coordination that justify the use of vertical restraints. When the contract,

designed by the principal, is accepted the agency is pushed into adopting behavior that is in

the profits of the distributor, a moral hazard arises downstream. Although the number of

sales can be quant

the total residual claimant seems to be the driving incentive for the retailer (Fadairo, 2013),

a lower royalty rate would motivate the downstream firm to achieve higher sales.

Consequently, the principal may design a distribution contract that excludes royalties, yet

includes a somewhat greater initial fee. This scenario suggests the agent bears most of the

wealth effect of its activities, reducing monitoring costs;; however, it should be taken into

account that it can also lead to inefficient risk bearing and free-riding by the franchisee

(Brickley, Dark, & Weisbach, 1991). Not considered in the agency theory are royalty fees;;

the ongoing payments from the downstream firm to the upstream firm, independent of the

downstream turnover.

The agency theory presents two justifications for royalties in share-contracts. The first

addresses the demand to protect the downstream firm from risks, particularly the critical

function of the final demand in the market. In such situations, the royalty rate incorporated

in the share-contract links to the level of risk sharing. The second justification addresses

the incentive in the context of a two-sided moral hazard. Sinc

moral hazard can potentially arise, as the downstream firm has no full transparency in the

effort made by the upstream firm in network

name (Fadairo, 2013). In this context the royalties serve as a motivation to the upstream

firm to stimulate its efforts in building and supporting its image.

20

A recent study demonstrated that irrespective of the type of network, royalties are justified

by the transmission of concepts and know-how, and ongoing support in advertising and

promotional campaigns (Fadairo, 2013). Though, it is evinced that more powerful networks

impose more constraining contracts (Chaudey, Fadairo, & Normand, 2005).

4.1.5 TWO-PARTS MECHANISM

The price of franchise rights is typically a combination of an initial franchise fee and an

ongoing royalty payment (Dant & Berger, 1996). According to Shane (1998), royalty

payments are an incentive for franchisors to monitor the system and coordinate the

franchise chain (Lal, 1990). Additionally, inclusion of a royalty in the price of franchise

rights is used to align the interest of the franchisor with the franchisee given that both

aspire to maximize sales (Lal, 1990). Furthermore, franchisors use royalty rates as an

instrument to spread the risk (Morgan & Stoltman, 1997). The upfront fee typically

represents the intangible assets of the franchisor such as brand image, expertise, franchisor

services, reputation and training programs (Windsperger, 2001). Similarly, a renewal fee is

sometimes imposed by the franchisor on extending an expired contract (Frazer, 1998).

Although existing literature lacks rationale guidelines that illustrate a justified structure of

these components (Kaufmann & Dant, 2001) (Sashi & Karuppur, 2001), the complex

structure of royalties is later discussed in more detail.

It is believed by some that these price components act as a mechanism and should regulate

(Kaufmann & Dant, 2001)

and provide the right incentive by systematically modifying the franchise fee and the royalty

rate (Blair & Kaserman, 1982). Others perceive that the two-parts mechanism should

reflect the level of investment the franchisor devotes to building its brand and training its

retailers to support their brand suitably (Bordonaba-Juste, Lucia-Palacios, & Polo-

Redondo, 2011) (Kaufmann & Dant, 2001).

The distribution of royalty rates and royalties fee plus rate are presented per type of

distribution, in ascending order of integration, in Figure 8 and Figure 9 respectively

(Fadairo, 2013). The distribution of royalty rates and the distribution of royalties appear to

be relatively similar in all types of distribution networks.

21

The significance of the initial fee and the royalty rate should vary from system to system.

Different contractual provisions serve different franchising contracts based on the type of

relationship between distributor and retailer and the intentions of the upstream firm, which

designs the contract. These payment structures all directly affect how joint profit is shared

and indirectly affect the targets that determine this joint profit (Rey & Vergé, 2005).

Less frequently used in distribution contracts are flat franchise fees. Opposed to the more

common percentage-based royalties royalty rates a flat continuing franchise fee is a

fixed amount that the franchisee periodically pays to the franchisor. Frazer (1998) explored

that franchises that use fixed rates have different characteristics to franchises that

incorporate royalty rates. The research evinced that flat fees are typically implemented in

less complex systems that are less expensive to purchase. Franchisors that use flat fees

appear less committed: they offer less ongoing support;; invest less in monitoring activities;;

and have a higher outlet growth rate (Frazer, 1998).

In comparison, franchisors that charge royalty rates are stimulated to provide more

ongoing support and provide better monitoring in order to help downstream firms to

maximize their sales;; and franchisors that charge fixed ongoing fees are motivated to sell

more franchised outlets in order to increase their income and will therefore offer less

complex and less expensive concepts to downstream markets (Frazer, 1998).

Figure 9: Distribution of Royalty Rates within the Six Types of Retail Chains (Fadairo, 2013)

Figure 8: Distribution of Royalties within the Six Types of Retail Chains (Fadairo, 2013)

22

4.1.6 RELATIONSHIP BETWEEN ROYALTY FEES AND ROYALTY RATES

It has been investigated by many which factors show a positive or negative correlation to

the existence or level of royalties in a franchise distribution contract, what influence

royalties have on components of the contractual agreement, and the relationship between

royalty fees and royalty rates (Lafontaine, 1992) (Kaufmann & Dant, 2001) (Sashi &

Karuppur, 2001) (Blair & Lafontaine, 2005) (Chaudey, Fadairo, & Normand, 2005)

(Bordonaba-Juste, Lucia-Palacios, & Polo-Redondo, 2011) (Fadairo, 2013).

If it would be known beforehand what exact demand will be generated by operating under

satisfy parties on both ends of the vertical agreement (Blair & Kaserman, 1982).

Unfortunately, this is not the case since the expected demand for the product is affected by

(Lafontaine & Shaw, 1996). However

when the demand depends on the value the trademark carries, royalty payments are more

effective to insure the maintenance of brand equity (Blair & Kaserman, 1982). The

question remains how these provisions vary relative to each other.

It seems generally accepted that the greater the portion of the value extracted through a

royalty rate, the smaller the remainder that can be extracted through the franchise fee.

Subsequently, anything that reduces royalties should increase initial fees (Kaufmann &

Dant, 2001). These assumptions support the negative relationship between a franchise fee

and royalties. Lafontaine and Shaw (1996) found a notable negative relationship between

the initial fee and the royalty rate;; however, when those using ongoing fixed payments were

taken out of the study this relationship turned positive. Even though research has been

conducted aiming to identify a negative correlation, existing literature does not provide

convincing backing of the existence of a negative relationship between the franchise fee

and the royalty rate.

Though adjustments are made relatively infrequent (Lafontaine & Shaw, 1996), a study by

Lafontaine and Kaufmann (1994) revealed that modifications to the royalty rate percentage

and franchise fee have moved hand in hand throughout the years. According to

Mathewson and Winter (1985), lower franchise fees and lower royalty rates are expected

for franchisors with a low degree of brand equity. Brand equity has demonstrated to be an

important factor that influences the relationship between the franchise fee and the royalty

rate. When an overseas firm, operating under license, exceeds the sales targets, the

upstream firm often incentivizes the distributor by providing discounts in order to

23

stimulate higher sales, get a higher market share, and build equity in that country (Van

Gilst, 2013) (Hagen, 2013).

Lafontaine (1992) reasoned that franchisors do not use the franchise fee to collect rent but

rather to recover expenses such as recruiting and training. Essentially, franchisors may

systematically differ in the level of support they offer their franchisees in the vertical

agreement. Franchisors who keep high pre-selection criteria and provide high quality

training may also offer high levels of ongoing support. Though the levels of support

accepted by the downstream firm can vary from welcoming, any assistance to not accepting

any support to from the franchisor (Hagen, 2013).

Hence, when franchise fees are used to collect reimbursement for initial training costs, and

royalties are implemented to gain value from both the brand and the ongoing support, this

would result in a positive relationship between franchise fees and royalty rates (Kaufmann

& Dant, 2001)

e rents

from the downstream firm, yet either represents brand benefits or the expenses originated

from providing initial training and ongoing support. Therefore, the difficulty arises when

deciding on an appropriate initial fee when a franchise fee is not used to collect the excess

value net of royalties.

4.1.7 DETERMINANTS OF ROYALTIES

It has been investigated which factors are of weight in the decision to include royalties in

distribution contracts. Evidence was provided that certain variables increase the probability

of royalties being incorporated in vertical agreements.

Agrawal and Lal (1995) concluded that royalty rates appear to positively impact brand

name investment by franchisors and negatively impact the level of service franchisees offer.

It is therefore of great importance that the right balance is found that both incentivizes

franchisors to invest in building brand equity and motivates franchisees to carry out the

appropriate level of service. In such situations cross-cultural differences can become

hazardous when a message is conveyed wrongly or simply misunderstood. Sashi and

Karuppur (2001) explained that cultural diversity could also challenge to measure the

performance of franchisees in global markets.

A recent study revealed that factors such as the age, the size and the internationalization of

the network are of no influence to the probability of royalties. Against the expectations of

24

negative influence on the probability of having royalties in the distribution contract

(Fadairo, 2013).

Since royalty payments may be affected by political instabilities, franchising may not be

preferred in uncertain environments. Nevertheless, franchisors can lower the risk and

attempt to regain control by incorporating a higher initial fee and combining this with

lower royalty installments (Sashi & Karuppur, 2001).

Subsequently, in environments with economic uncertainty where demand fluctuations are

high, franchisors may also favor setting a higher franchising fee and charge lower royalty

payments to reduce risks. Especially when demand fluctuations are pooled with high

inflation and high interest rates, the risk of doing business accelerates and the expected

return is likely to be affected by the high uncertainty level (Sashi & Karuppur, 2001).

Fluctuations of a local currency against the main international currencies are expected to

affect the value of the investment and the collection of ongoing payments. Firms can

attempt to reduce risks by tracking movements in the foreign exchange market. Similar to

other uncertain situations, foreign exchange risk can be lowered by implementing higher

initial fee (Sashi & Karuppur, 2001).

More generic statements learn that royalty rates will decrease as the significance of

conclusion (1988) that downstream firms know that the higher the payment, the higher the

return on investment will be.

25

5 RESULTS, ANALYSIS AND CONCLUSIONS

5.1 PRIMARY RESEARCH FINDINGS AND ANALYSIS

5.1.1 BEST PRACTICES FROM HEINEKEN AND BAARSMA

This section provides a synthesis of findings from primary research interviews. As part of a

benchmarking study, we have interviewed experts from Baarsma and Heineken to get

better insights on the use of royalties in the international beverage industry. We will discuss

the key elements per interviewee.

Heineken

We have conducted two interviews with Ana van Gilst, Business Analyst at Heineken. Due

to the fact that it was not feasible for her to meet us in person, Ana agreed to answer all

questions over the phone.

Heineken charges royalties in the Scandinavian markets where local partners have full

responsibility over production, distribution, marketing and sales of Heineken. Heineken is

not involved in the operations within these markets;; it provides the brand, raw products,

and collects royalties royalties are fixed on produced volume rather than on sales. Low

in markets where sales

data is not fully transparent. Due to lack of transparency in the market, Heineken has opted

for an ongoing royalty payment based on agreed volume sales. When KPI targets are

reached, Heineken provides discounts to stimulate higher levels of sales.

Heineken s strategy is calibrated for horizontal growth with the goal to increase their

market share and have their brand in as many markets as possible. When the contract has a

low degree of integration, Heineken adds the royalty payments to the wholesale price

without specifying the exact royalty amount to the foreign distributor. The fairness of the

royalty can be benchmarked internally with similar markets. As a foundation of their

revenue, reasonable characteristics of a royalty model for Heineken are based on volume

rather than revenue. This approach is justified in situations when sometimes the product is

not generating a lot of revenue due to a relative expensive local market price. And since

Heineken does not control the prices this may not be highly profitable for Heineken, yet

being present in that market and building brand equity is highly valuable.

When Heineken decides to work with a distributor that already uses a well-established

distribution network with many channels, they pose higher royalties on the distributor, for

the downstream firm will have less difficulties and lower costs of bringing their brand to

26

the market. There is a twofold rationale behind this explaining that otherwise Heineken

would have to forfeit a part of the royalties to cover advertising and promotion (A&P)

expenses, and the international reach of the brand that carries great power in negotiation.

Lastly, Ana explained that royalties are renegotiated annually and simultaneously adjusts the

royalty payment in accordance with inflation.

Baarsma Wine Group Holding

The interview with Joost Hagen, Business Development Manager at Baarsma Wine Group

Holdings took place at Nyenrode campus in Breukelen, the Netherlands, as planned.

Baarsma, who also acts as an exporter and producer of wine in other settings, has

eliminated as many middlemen from the value chain as they ought viable. In the

Netherlands, Baarsma is in direct contact with large retailers that offer their products to the

market. Joost explained that the minimum margin a distributor requires is 10 percent.

Retailers have become very strong in the European markets and often have a list of

requirements which amounts to 4 or 5 percent of revenue. This additional percentage

required by the retailer is pushed upwards by the distributor Baarsma in this case and

added to their margin when negotiating with the upstream firm. In the European market

networks are 100 percent transparent about margins and costs, it is said that Baarsma

cannot fix a deal if their partners do not open their books. Joost acknowledged that in

other environments different practices apply.

In terms of splitting margins with retailers, Joost stressed that it takes economies of scale to

generate greater margins. Higher volumes pair with benefits and strengthen your

in

trading, Baarsma requires a minimum of 10 percent and explains these are commonly

considered fair margins in the industry.

When operating in unstable markets, Baarsma goes in with small quantities and takes an

extra margin probably set as 10 percent - as insurance for the unforeseen. In such

uncertain markets, Baarsma preselects a distributor that has sufficient experience in

bringing international brands to the market and aims for a relative transparent deal. Being

suspicious to operating in a high-risk market, Baarsma shows little commitment and has

their exit strategy ready.

Lastly, recent changes in consumer behavior were brought to our attention. Joost

confirmed that nowadays wine is primarily purchased with the intention to be consumed

within 48 hours, oppose to storing a large share of wine being purchased for later use. This

27

impacts the way Baarsma approaches the market. Marketing and advertising of wine

becomes more important.

5.1.2 DISTELL

The following section presents the key elements from our interviews with Richard Lord,

General Manager Africa South East at Distell;; Donna Marowa, Brand Manager at African

Distillers;; and Kevin Nagle, General Manager East Africa. These discussions had an

rrent pricing strategies, and how

relationships with their partnerships look like.

Distell, Richard Lord

Distell uses own brands to enter new markets and focuses on vertical expansion. According

to Richard, contracts usually end up being between licensing and joint venture. New

African markets have been identified and the preparation for entry has begun. As

mentioned in section 1.4, Distell has set up royalty agreements with their distributors in

Zimbabwe (Afdis) and Kenya (KWAL), in which Distell owns minority share. The royalty

rates that are implemented vary between 1 and 15 percent. When Distell invests large

amounts in advertising and promotion to market a product abroad, they feel comfortable

charging a higher royalty rate. Distell assumes part of the risk, as also risk sharing taken

into consideration. Nevertheless, Distell is uncertain of the fairness of the level of royalties

that should be charged under which circumstances.

Distell does not have a final saying in setting the price for the end consumer, they play an

distribution margin and retail margin have been added. Largely, pricing is a factor of the

market, the retailer must ensure not to exceed the willingness to pay in the local market.

Distell is committed to strengthen their relationship with their partners. Contributions

cover for A&P expenses and are offered towards specific brands identified as drive brands,

or to fill a gap that has evolved in a portfolio. Besides offering support in A&P, Distell also

provides product, merchandising, and in some instances sales and marketing training.

Technical training is also provided where local manufacturing is taking place.

Afdis, Donna Marowa

The interview we conducted with Donna was over the phone. Donna Marowa works for

Donna shared that Distell covers 100 percent of A&P expenses for brands. Distell

28

is highly invested in building the relationship with their distributor in key markets Kenya,

Zimbabwe etc. In Zimbabwe, Distell provides numerous financial and non-financial

incentives for Afdis (in which Distell owns a 50% share). The non-financial incentives

include sharing their knowhow and experience currently 4 experts are in Zimbabwe to

consult in the production of a new bottling plant. Together with another shareholder,

Distell is expected to contribute largely to the costs of the new cider plant. Various KPIs

are set;; upon achieving targets, Afdis receives discounts. Finally, Distell started the royalty

contract only in July 2013. Before that, even though without extra compensation, Distell

still covered 100 percent of the A&P costs.

Distell, Kevin Nagle

The contact with Kevin emerged in to communication via email. Due to time constraints,

we were not able to discuss all topics. The findings that we extracted from our contact with

Kevin made us realize we cannot extract much more additional information. Much of what

he said was a confirmation of previous findings discussed by Richard and Donna. Kevin

shared that there is an option to renegotiate determinants of the contract annually.

5.2 CONCLUSIONS The conclusions of this research are a synthesis of interviews, academic literature findings

and the conceptual framework. To start with, we look back to the problem statement that

was defined in section 2.1: There is no globally accepted benchmark that Distell could

use to test the fairness of their current royalty model. How should Distell price their

global distributors? When it comes to judging the fairness of pricing strategies, we cannot

find a unanimous global standard. The fairness of pricing depends on the environmental

and company specific factors, which, if assessed correctly, lead to a fair solution. We shall

discuss these factors in the following sections, dividing them into three core determinants

of pricing of global distributors from the conceptual framework: market entry strategy,

relationship with the distributor, and external factors.

Market Entry Strategy

Our research shows that the market entry strategy is defined by the underlying goals of

expansion and the chosen contract type. The academic literature concludes that firms

focusing on horizontal growth typically charge lower initial fees and design less complex

systems. This approach matches the profile of franchisors that implement flat ongoing

royalties and aim to grow geographically in order to mainly increase their revenue.

Evidently, franchisors that use this strategy appear less committed and offer less, if any,

29

support for the franchisee. On the other hand, franchisors that charge royalty rates are

motivated to provide a higher level of ongoing support and design better monitoring in

order to assist downstream firms to maximize their sales. These upstream firms are mostly

focused on developing brand equity.

We discovered that Heineken aim of their presence in the Scandinavian markets coincides

limited, and their compensation comes from ongoing flat royalties. To the contrary, Distell

is actively involved in their focus markets (i.e. Zimbabwe) in order to strengthen the equity

of their brand portfolio. Joint venture contracts are preferred and allow for a closer

monitoring of the foreign distributor. Distell provides extensive financial and non-financial

support in terms of A&P, knowhow and experience, which allows them to negotiate higher

royalty rates.

Relationship with Distributor

Four drivers of the relationship with distributor have been determined during the research:

transparency, financial and non-financial incentives, and balance. A combination of them

characterizes the relationship between the upstream and downstream firms, and has an

effect on the subsequent pricing of the global distributor.

One of the most significant findings that determine the relationship between both parties

of the vertical agreement is transparency. It is proven that royalties are only effective when

s sales can be monitored transparently. Literature suggests opting for a

combination of higher initial fees and lower loyalty rates when transparency is low.

Furthermore, secondary research findings conclude that t

commitment, expressed by the level of financial and non-financial incentives, has a direct

effect on the relationship between the two companies. The stronger the bond between

partners, the higher the incentives. The pricing of the distributor, i.e. the royalty rate, is

positively correlated with the level of support, and reflects the size of incentives.

The power balance has a very strong impact on how the distributor is going to be priced.

in the focus

market gives them more power. In those instances, the relationship becomes stronger;;

moreover, Baarsma can dictate the type of pricing for the partnership with the upstream

firm, which often includes full transparency.

30

When put in practice, we found evidence of the above factors at Heineken. Due to low

transparency of the Scandinavian partners Heineken charges a fixed fee for the use of their

nonexistent financial-incentives. Heineken does, however, have a very powerful brand that

allows them to exert a higher amount of fixed royalties from local distributors.

Firstly, Distell is highly invested in the partnerships by offering financial and non-financial

incentives, such as sharing knowhow, co-funding production facilities, subsidizing A&P

and marketing etc. Naturally, Distell has a significant amount of power from their high

equity brands, yet in some instances the trade network of the distributor challenges the

balance. Only transparency is lagging behind, yet as Distell has a minority stake in their

joint venture operations, they get enough information about the performance of their

partners. To sum up, Distell creates very interlinked and strong relationships with their

distributors, which in turn allows to charge higher royalties.

External Factors

We found from academic literature that when operating in countries with unstable

currencies or governments, upstream companies often try to reduce risk by increasing the

upfront fee and lowering the ongoing royalties. In order to reduce risk, Baarsma chooses

for short-term contracts and low volumes when entering unstable markets and always has

an exit strategy.

We found little academic evidence to support our hypothesis of changing consumer

behavior having a significant effect on the way global distributors are priced. However, the

trends in the market indicate that the consumer behavior is changing towards appreciation

and consumption of wine. Whereas previously wine was bought with the intention to age it

and consume at a later time, these days majority of wine is purchased for immediate

consumption. Hence, branded wines become increasingly important in the sales phase and

producers with higher brand equity gain more power.

In conclusion, the literature study and primary research has helped us understand the

different factors that influence and shape the pricing of global distributors. We have

created a framework displayed in Figure 10 that shows the relationships between the

determinants.

31

Figure 10: Framework for Pricing a Global Distributor

32

6 RECOMMENDATIONS Based on the company profile, the different approaches to growth that Distell can adopt,

the market conditions in which Distell operates in, and considering future opportunities in

the industry, we have come up with recommendations that Distell can consider when

implementing pricing strategies for their global distributors. Five divergent guidelines are

developed aimed to cover a wide range of future possibilities for Distell.

Our first recommendation taps into fine-

level of uncertainty. When operating in local markets that carry high levels of risk due to

the influence of external factors, Distell may favor to adjust their contractual agreements in

a way that reduces risk. Increasing the upfront fee and setting lower royalty rates can cover

the risk partially. Moreover, contracts with a lower duration can help lower the risk as well,

and exit strategies could be in place before signing the contract.

Secondly, we recommend continuing vertical expansion through building brand equity.

Royalty rates should be combined with ongoing support and close monitoring in focus

markets for Distell. Appropriate incentives such as providing discounts and additional

financial and non-financial support will motivate the downstream company to perform

better.

The next recommendation includes a different approach to expand in the market, namely a

horizontal strategy where Distell focuses on growth in sales. We suggest applying this

strategy in less complex systems in relatively stable markets where Distell is less interested

in operating themselves. To complement the less complex systems, we suggest only take

lower priced wines that have potential to reach high levels of sales and volume. We also

recommend keeping the upfront fee relatively low, therefore lowering the barrier to entry,

which is expected for systems of low complexity. Royalties should be fixed and based on

targeted sales volume. This approach is designed to grow sales and requires low levels of

ongoing support from Distell, yet, it is recommended to invest in training the downstream

the market.

The fourth recommendation aims to leave a larger footprint in Europe. Currently Distell is

active in Europe, however, we believe that there is much more potential for Distell to

grow. As Distell would intensify its presence in Europe, the company must be prepared to

stretch their level of transparency to full measures, which is a common prerequisite in this

environment. Distell must be willing to open up their books to achieve the highest level of

transparency and fairly split the margin with other parties involved.

33

We recommend Distell to set up their European headquarter in Amsterdam to work on

building brand equity in the European markets. The ease of doing business in the

Netherlands is high, and Amsterdam is logistically well connected to the rest of Europe.

Additionally, the long established trading line between the Cape and Amsterdam goes back

to the 17th century.

Lastly, we recommend Distell using the framework for pricing global distributors (Figure

10) whenever deciding on how to price current and new partners. Figure 11 provides the

reader with a more visual depiction of the elements that shape the pricing model and can

be used as a quick reference.

34

Figure 11: Infographic of the Determinants of the Pricing Strategy

35

APPENDICES

APPENDIX A: SAMPLE OF QUESTIONS FOR SEMI-STRUCTURED

INTERVIEWS

How does Distell price their foreign partners?

Please share your experience in working with pricing of distributors?

How, in general, is the royalty type (upfront fee vs. royalty rate) and size decided?

What factors do you look at when negotiating royalties?

What support do you receive from Distell?

Is there any additional support that you would like to receive from Distell?

Describe how the current relation between Distell and distributor motivates to reach

for higher sales results.

perspective?

How do you evaluate fairness?

To what extent does the existing royalty model affect the market price of Distell's

products? Who sets the market price?

In general, do you think that royalties are an efficient instrument to coordinate the

distribution system? Please share with us if you have an alternative model in mind.

How does Distell support their brands in a foreign market?

In your words, how would you explain the rationale behind the royalty margin?

How do external factors affect the pricing of global distributor?

How transparent are you in your pricing decisions?

How does Distell approach the export market? Vertical vs. horizontal growth?

36

BIBLIOGRAPHY Agrawal, D., & Lal, R. (1995). Contractual arrangements in franchising: an empirical

investigation. Journal of Marketing Research , 32, 213-221.

Analytix Business Intelligence. (2013). South African wine exports analysis 2008 - 2012. Cape

Town: SAWIS.

Anderson, E., & Gatignon, H. (1986). Models of foreign entry: a transaction cost analysis

and propositions. Journal of International Business Studies , 17, 1-27.

Blair, R. D., & Kaserman, D. L. (1982). Optimal Franchising. Southern Economic Journal , 49

(2), 494-505.

Blair, R. D., & Lafontaine, F. (2005). The Economics of Franchising. New York: Cambridge

University Press.

Bordonaba-Juste, V., Lucia-Palacios, L., & Polo-Redondo, Y. (2011). An analysis of

franchisor failure risk: evidence from Spain. Journal of Business & Industrial Marketing , 26 (6),

407-420.

Brickley, J. A., Dark, F. H., & Weisbach, M. S. (1991). An agency perspective on

franchising. Financial Management , 20 (1), 27-35.

Brickley, J. A., Smith, C. W., & Zimmerman, J. L. (2009). Managerial Economics and

Organizational Architecture (5th ed.). New York, New York, United States: McGraw-

Hill/Irwin.

Bruno, R. R., & Davey, G. P. (1984). FRANCHISING: BUSINESS REVIEW. Journal of

Consumer Marketing , 1 (4), 47 - 56.

Burn Stewart Distillers. (2013, April 15). Press. Retrieved August 15, 2013, from Burn

Stewart Distillers: http://www.burnstewartdistillers.com/pages/burn-stewart-distillers-

press

Chaudey, M., & Fadairo, M. (2003). Franchising and the Alternative Contracts to Organise

Vertical Restraints Evidence from Agency Econometrics within French Networks. EMNet

Conference on "Economics and Management of Franchising Networks" (pp. 1-14). Vienna:

CREUSET, Université Jean Monnet de Saint-Etienne, France.

37

Chaudey, M., & Fadairo, M. (2006). Restrictions verticales et externalité intra-marque en

matière d'effort promotionnel: un test empirique sur données françaises. Revue d'Economie

Politique , 6, 807-830.

Chaudey, M., Fadairo, M., & Normand, M. (2005). Vertical Restraints and Reputation of

Networks: Evidence from Franchising. EMNet-Conference (pp. 1-26). Budapest: CREUSET,

Université Jean Monnet de Saint-Etienne.

Collins, G. (2013, May 14). South Africa Wine Exports Setting Records on China Demand.

(P. Sillitoe, Ed.) New York, New York, United States: Bloomberg.

Dant, R. P., & Berger, P. D. (1996). Modeling coopertative advertising decisions in

franchising. Journal of the Operational Research Society , 47 (9), 1120-1136.

Distell Group Limited. (2012). Integrated Annual Report.

Distell Group Limited. (2013, August 21). News. Retrieved August 29, 2013, from Distell:

http://www.distell.co.za/runtime/popcontentrun.aspx?pageidref=3599

eNews Channel Africa. (2013, Augustus 2). Record bulk wine exports could give industry a

hangover. Johannesburg, Gauteng Province, South Africa.

Fadairo, M. (2013). Why include royalties in distribution contracts? Evidence from France.

International Journal of Retail & Distribution Management , 41 (8), 566-583.

Frazer, L. (1998). Motivations for franchisors to use flat continuing franchise fees. Journal of

Consumer Marketing , 15 (6), 587-597.

Hagen, J. (2013, August 23). Royalties and margins within Baarsma Wine Group Holding.

(G. Galvanauskaite, & A. M. De Vries, Interviewers) Breukelen, Utrecht, The Netherlands.

Jain, S. C. (1989). Standardization of international marketing strategy: some research

hypotheses. Journal of Marketing , 53 (1), 70-79.

Kaufmann, P. J., & Dant, R. P. (2001, May 25). The pricing of franchise rights. Journal of

Retailing , 537-545.

Labys, W. C., & Cohen, B. C. (2006). Trends versus cycles in global export shares. The

Australian Journal of Agricultural and Resource Economics , 50, 527-537.

Lafontaine, F. (1992). Contract theory and franchising: some empirical results. Rand Journal

of Economics , 23 (2), 263-283.

38

Lafontaine, F., & Kaufmann, P. J. (1994). The evolution of ownership patterns in franchise

systems. Journal of Retailing , 70 (2), 97-113.

Lafontaine, F., & Shaw, K. L. (1996). The dynamics of franchise contracting: evidence from panel

data. National Bureau of Economic Research, Industrial Organization. Cambridge, MA:

National Bureau of Economic Research.

Lal, R. (1990). Improving channel coordination through franchising. Marketing Science , 9

(4), 299-318.

Lord (a), R. (2013, July 14). General Manager Africa South East at Distell Group Limited.

(G. Galvanauskaite, & A. M. De Vries, Interviewers) Capetown, South Africa.

Lord (b), R. (2013, August 15). General Manager Africa South East at Distell Group

Limited. (G. Galvanauskaite, & A. M. De Vries, Interviewers)

Love, T. (2013, July 15). Why the world doesn't want Australia's cheaper wine anymore.

Melbourne, Victoria, Australia.

Mariani, A., Pomarici, E., & Boatto, V. (2012, November 19). The international wine trade:

Recent trends and critical issues. Wine Economics and Policy , 24-40.

Marowa, D. (2013, August 27). Brand Manager at African Distillers Limited. (G.

Galvanauskaite, & A. de Vries, Interviewers)

Mathewson, G. F., & Winter, R. A. (1985, October 28). The economics of franchise

contracts. Journal of Law and Economics , 503-526.

Morgan, F., & Stoltman, J. (1997). Vicarious franchisor liability: marketing and public

policy implications. Journal of Business & Industrial Marketing , 12 (5), 297-314.

Norton, S. W. (1988). An empirical look at franchising as an organizational form. Journal of

Business , 61 (2), 197-314.

Quinn, B. (1999). Control and support in an international franchise network. International

Marketing Review , 16 (4/5), 345-362.

Rabobank. (2012). The Incredible Bulk: The Rise in Global Bulk Wine Trade. Food &

Agribusiness Research and Advisory. Utrecht: Rabobank International Utrecht Branch.

Rey, P., & Caballero-Sanz, F. (1996, November 1). The Policy Implications of Economic

Analysis of Vertical Restraints. Economic Papers (119), pp. 1-57.

39

Rey, P., & Tirole, J. (1986). The Logic of Vertical Restraints. American Economic Review (76),

921-939.

Rey, P., & Vergé, T. (2005). The Economics of Vertical Restraints. Advances of the Economics

of Competition Law (pp. 1-49). Rome: University of Toulouse (I.D.E.I. and GREMAQ).

Robson, C. (2002). Real World Research (2nd edn). Oxford: Blackwell.

Roux, A. (2013, July 11). South Africa in the global context. Economics in Emerging Countries,

RSA as case study. (I. 2013, Interviewer) Stellenbosch: Stellenbosch University.

Sashi, C. M., & Karuppur, D. P. (2001). Franchising in global markets: towards a

conceptual framework. International Marketing Review , 19 (5), 499-524.

Saunders, M., Lewis, P., & Thornhill, A. (2009). Research Methods for Business Students (5th edt).

Harlow: Pearson.

Shane, S. A. (1998). Making new franchise system work. Research notes and

communications. Strategic Management Journal , 19 (7), 697-707.

Spahni, P. (2000). The International Wine Trade (2nd ed.). Cambridge, England: Woodhead

Publishing Limited.

Terpstra, V., & Sarathy, R. (1999). International Marketing (8th ed.). Hinsdale, Illinois:

Dryden Press.

Van Gilst, A. (2013, August 16). The use of royalties in Heineken. (G. Galvanauskaite, &

A. M. De Vries, Interviewers) The Netherlands.

Windsperger, J. (2001). The fee structure in franchising: a property rights view. Economics

Letters , 73 (2), 219-226.