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Golden Rules for Selecting Foreign Distributors and Agents

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Jean G. Schtokal
Foster Swift Business & Tax Law News
June 30, 2020

CargoCompanies engaging foreign distributors or agents to assist with foreign sales growth, whether venturing to a foreign market for the first time or expanding to a new foreign market can benefit from some simple best practices and strategies that have proven successful across various industries and business sectors and across various markets and continents. Here are some Golden Rules to consider for your own company practices.

1. Be the Selector, not the Selectee. Select distributors; don’t let them select you.

The calls we get from clients with difficult foreign distributor or agent legal issues often involve situations that originate with the company using an agent or distributor that contacted the company and convinced the company to engage the agent or distributor for sales in the foreign territory. Sometimes the company will even confess that at the time, with few international sales, management felt “something was better than nothing” so the company was willing to take a chance.

The first thing to remember is that international sales have the real potential to exceed domestic sales, and very serious consideration and effort should go into mapping a strategy for international sales growth. There are ExporTech programs around the country designed specifically to help companies develop or hone their international sales growth business plans in a short period of time (over a 3 month period). Often, state economic development resources back these programs and they can be invaluable as a source of proven strategies and best practices for starting or jump starting international business plans.

By starting with a mindset of “something is better than nothing” your company can jeopardize the growth potential and financial returns achievable from international growth, where “a little something”, rather than all that can be achieved, becomes a self-fulfilling prophecy. Second, if you miss this “first” step, you never get to the “real first step” which is Golden Rule #2 below.   

2. Pick the Right Market. Find the market; then find the distributor/agent.

This is the “real first step”. If you select the distributor first you have a strong potential to completely miss or overlook the best first (or next) international market for international sales growth. Especially for companies focusing on just meeting orders from Nevada, let alone the Netherlands, the best first market is the best market that will ensure smooth success right from the start. Things like markets with ready demand, ease of adapting the product or service to regulatory and legal requirements in the territory, language capability, transparency, rules of law, whether there are import tariffs or export controls, etc. will factor in to the determination. A helpful resource in my practice for clients is globalEDGE’s Market Potential Index (MPI) (https://www.globaledge.msu.edu/mpi) Index.

By way of example, for a first time exporter with a disability accessibility product, it’s great that you have interest in your product from a potential distributor in China. However, considering the fact that Canada and most provinces passed a law similar to the Americans with Disabilities Act, there are fewer language barriers, a stronger rule of law, lower shipping costs, fewer export controls risks, easier access to records to conduct due diligence on potential distributors, etc. --are you missing the better and easier initial export market?

3. Keep your mind on the Goals. Decide your long term goals; build strong incentives for appropriate goals.

In negotiating terms for relationships with the foreign agents or distributors,

I try to focus clients on long term company goals and then build incentives in the contracts I draft for those goals to be achieved. One example is the measure of compensation. If the company’s long term goal is to expand the product line and attract new customers in the territory, not just repeat sales, then commission or discount arrangements with foreign agents and distributors need to be formulated to incentivize achievement of that goal over time.

4. Strive for a Good Ending. Starting at the beginning, think of the ending.

At the start, both foreign distributor or agent and the company have the hopes of a stable long term relationship. No one wants to start a new relationship thinking about how the parties can ruin the relationship. That’s the role of experienced international trade counsel. If this story will have an unhappy ending, what will that look like? This often leads us, on behalf of our US clients, to have our client describe realistic success based on country and market due diligence, and the skill set and expertise of the foreign partner. 

We then incorporate performance goals (from the mouth of the foreign partner about what can be accomplished in the market, and from our US client regarding its markers for success over the time of the relationship) into the contract. Better to know now going in that the foreign partner feels our client’s expectations are unrealistic, or the foreign partner’s expressions of market potential were mere puffing and not something the partner is willing to stand behind. On behalf of our foreign clients acting as distributors or agents for US companies, we tell them to think about what assistance will be required from the US company to achieve success in the market (that might be regular training, in-country presence for local trade shows, joint customer visits, input on product adaptability, etc). 

A good rule of thumb is that as much time is spent negotiating the financial aspects of the relationship, more time should be spent on how and when termination may occur and pre and post termination obligations of each party, taking into account a full understanding and appreciation of local law requirements in the foreign territory.

5. Remember Goldilocks and “just right.” Give the distributor/agent a job they can handle – objective performance standards, a territory that fits, and save additional products and market segments for later.

There is often a perceived natural harmony between the foreign partner asking for more territory, more product lines, all market segments and representing over ambitious sales potential and a US manufacturer or service provider’s hope and desire to “set it and forget it”. Once having selected the foreign market and agent or distributor, the US company would like to believe the hard work is over when it has in reality (just like marriage) just begun. We encourage our US manufacturer/service provider clients to spend time doing adequate and thorough due diligence on their foreign business partners.  This will pay dividends over the life of the contract and relationship.

By understanding the foreign partner’s capabilities and limitations, the role of each party can be defined in a way that can grow and change over time. One key is having early goals be realistic while the parties, with all their due diligence on each other in hand, start to “date” or get to know each other in practice.  Performance standards can grow over time based on mile markers (like initial sales growth and new customer generation).

The territory may start small or be limited to certain market sectors (where the foreign partner has proven expertise and a track record of success) and can grow to other geographic regions and related sectors based on a strong foundation and the early recipe for success (which usually involves more time and commitment than the US company anticipates). Sometimes this Golden Rule can even result in the realization that the parties are in fact not a good match (the foreign distributor or agent will need more assistance from the company than the company is willing to provide, or upon reflection,

the company may realize that the foreign agent or distributor does not have the strengths that match the company’s weaknesses in the new market).

6. Be smart. Protect your intellectual property and know the U.S. laws and foreign laws that will apply to the relationship.

Finally, we strive, based on past experience, to avoid having our clients repeat mistakes and avoid problems when the fact set indicates high risk for certain legal issues to arise. Just like experienced heart surgeons, experienced international trade counsel knows that being as healthy as possible going into surgery is important, and once you venture into new territory fixing anything likely to cause problems in the future is the best recipe for a healthy outcome. If the US company has not protected its intellectual property in the US, that is the first step to internationalizing IP protection. Ensuring proper protections by using international treaties and conventions should be explored and weighed against using local filing and protection systems.

Understanding the nature and other business interests of your foreign partner can also allow you to put contractual protections in place, and build in contractual disincentives including dispute resolution provisions, to keep all parties “honest”. If there are objections to reasonable protections requested by the US company, that is a red flag that needs more due diligence and digging. 

In the end, the application of certain US laws will follow US products and services wherever they go, and regardless of contract provisions proclaiming that US laws apply, certain foreign laws will apply to the relationship and the US company must understand those and how they may affect the relationship and the contract. 

Often, those implications will affect product and service pricing, and the ability to terminate the relationship so it’s best to understand them up front and take them into account in all aspects of foreign market growth plans – from due diligence up front, to building a contract and relationship that can grow and be beneficial to both parties over time and in the case of changing international, geopolitical and legal terrain.

If you have further questions about this article, contact Jean Schtokal at (517) 371-8276 or at jschtokal@fosterswift.com.