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W16700

WEIKANG PHARMACEUTICAL CO., LTD.: CHANNEL MANAGEMENT DILEMMA Jin-Song Huang, Qing-Qing Deng, and Li Zhuang wrote this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized, or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-10-28

In spring 2012, the issue of trans-boundary sales arose for China’s Weikang Pharmaceutical Co., Ltd. (Weikang). Sales of the company’s products were allocated to distributors in different regions, with each distributor enjoying a monopoly within that region (see Exhibit 1). However, issues had been arising with such a rigid demarcation of sales territory. One question was whether introducing competition between sales agents would lead to higher sales, or whether regional teams could co-operate and share best practices. Liu Cheng, sales director of Weikang, pondered the conflict between distributors from Nanning and Liuzhou, which had aroused great controversy. With each party sticking to its own view, the conflict seemed intractable, and now distributors from different regions were looking for a reasonable solution. It was time, he thought, for a meeting to discuss the company’s channel management. Profile of Weikang Weikang (a subsidiary of Weikang Business Group) was a high-technology enterprise under private management that focused on biomaterials used for medical applications. Since its establishment in 2005, the company had achieved rapid growth, with 300 employees and an annual operating income of ¥85.88 million.1 Its products were sold all over China and exported to many other countries. Sales of the company’s third-generation product, TISTAT, had exceeded 300 million units. Outstanding in the field of surgical hemostatic materials in China, TISTAT occupied 80 per cent of the market. The company’s sales revenue had maintained an annual increase of 130 per cent in the previous three years with an 80 per cent increase in its net profit. With client demand for its products increasing, Weikang’s market kept expanding rapidly. The company branched out to target surgical centres and maintained its unique advantage by providing professional services. Such an approach saw the company become a leader in the anti-hemorrhage and anti-adhesion fields. Product sales and promotion were conducted by regional distributors who visited the hospitals that used Weikang’s products. 1 ¥ = RMB = Chinese renminbi; all currency amounts are in ¥ unless otherwise specified; US$1 = ¥6.32 on March 21, 2012.

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This document is authorized for use only by Yissell Diaz in MBA 646 Fall 2201A taught by JANA RUTHERFORD, Barry University from Jan 2022 to Mar 2022.

Page 2 9B16A059 Made from natural plant fibre in a proprietary process, TISTAT was a water-soluble anti-hemorrhagic product that was fully absorbable by the body. Its main function was to stop bleeding, prevent post-surgical adhesion, and improve healing. As the company’s core product, TISTAT marked the culmination of many years’ research by the company. Officially coming into the market in August 2006, TISTAT had since obtained certification from the U.S. Food and Drug Administration and CE Marking from the European Union. It had been exported to over 20 countries and regions, including the United States, Mexico, Europe, and Southeast Asia. It had also obtained six domestic invention patents, two patents from America, and two more from Japan. Domestically, it was widely used in surgical operations in more than 800 hospitals as part of general surgery, obstetrics and gynecology, cardiac surgery, orthopedic surgery, neurosurgery, urinary surgery, and other procedures. Having been proven safe and reliable, it had gained recognition from both doctors and patients. Guided by a strategy defined by high quality, superior service, and high prices, and based on the first- level- distributor mode, Weikang operated according to the principles of direct supply to distributors, unified bidding and tendering, and no trade credit. It divided the market into different units in terms of hospitals or small regions, selecting for each unit distributors not only capable of selling products to hospitals, but also able to support the products’ promotion and publicity in the given region. Those distributors were authorized with a small range of rights and were offered incentives depending on their sales performances. They had to conduct transactions with the company on the spot, as well as pay margin fees. Product marketing was based on the strategy of channel promotion, supplemented by terminal promotion. Product publicity was supplemented by publicizing the company’s image. Product interest was supplemented by academic support. Review of the Event Li Zhong was the sole and exclusive Weikang distributor in Liuzhou, southern China. His success in sales was indicated by the fact that, as of the end of 2011, more than 100 of the 200 eligible hospitals conducting surgical operations used anti-hemorrhage products, and almost 60 per cent of those hospitals bought Weikang products from Zhong. By selling almost 40,000 units per year, his annual sales had reached ¥13 million (see Exhibit 2). After careful analysis of Liuzhou’s market, Zhong found that he had reached full sales penetration in this territory. However, there was a big market close at hand—Nanning, capital city of Guangxi Province. Like Liuzhou, Nanning was located in the Guangxi Zhuang Autonomous Region in South China. It was the capital city of Guangxi, and also the core city of the Beibu Gulf Economic Zone, which was a national economic zone. As the biggest city in Guangxi, with six districts and six counties under its rule, Nanning had an area of 22,112 square kilometres, and a population of 6,661,600 people, of which 3.44 million resided in the urban area. In 2011, Nanning’s gross domestic product reached ¥221.151 billion. (For further information on distributor clients in Nanning see Exhibit 3). The two biggest cities, Nanning and Liuzhou, were separated by Laibin, a much smaller city. According to city records, there were 2,631 medical institutions in Nanning, 1,165 in Liuzhou, and only 386 in Laibin, which meant that Nanning had more than double the number of medical institutions that Liuzhou had. Accordingly, Nanning was the largest potential market. For a distributor such as Zhong, who had saturated his local market, Nanning offered many new potential customers. Zhong investigated the total sales made by Sun Qiang, the company’s distributor in Nanning, and found that many potential new customers existed. For example, Nanning Second People’s Hospital, a Third Level

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Page 3 9B16A059 1st Class hospital next to Laibin, was using products by the competitor Johnson & Johnson Medical (China) Ltd. (Johnson & Johnson). Nanning Second People’s Hospital was a large polyclinic hospital, providing medical treatment, medical education, scientific research, emergency care, disease prevention services, health-care service, and rehabilitation. The hospital saw more than 600,000 outpatients and 15,000 in- patients per year. Zhong saw this hospital as the best prospect for gaining sales in this new territory. However, as one of the top 500 global companies—whose medical equipment and technologies had obtained authoritative certifications in China—his competitor Johnson & Johnson had an established reputation with both doctors and patients. Johnson & Johnson also had a strong professional sales and marketing team, which had been recognized as an industry leader. However, Zhong was not deterred. He contacted the director of the department for medical devices at Nanning Second People’s Hospital. He did not open by pitching his product at their first meeting. Instead, he enquired about the hospital’s use of hemostatic products and its main supplier. He learned that the hospital bought its current range of hemostatic products for ¥350, the same price offered by Qiang, Weikang’s distributor in Nanning. He also found that after being rejected several times, Qiang never returned. At the end of their meeting, Zhong and the director arranged a time for their next meeting. Zhong arrived to the next meeting fully prepared. After a detailed introduction to the characteristics and function of Weikang’s products, especially their advantages as compared with those of Johnson & Johnson’s, he offered to sell his products for ¥330. This figure was lower than the standard that Weikang had set for its distributors, but because distributors were assessed by their annual sales volume, as long as sales were up, the loss caused by the low price could be made up by the year-end bonus. Although competitive, the price was not sufficient enough to change the director’s mind. Therefore, in the following days Zhong targeted the hospital’s vice president in charge of medical equipment. Six months later, Weikang’s hemostatic products were finally being used in Nanning Second People’s Hospital. Zhong calculated that nearly 7,000 operations were carried out in Nanning Second People’s Hospital each year, which consumed at least 7,000 units of the product, for an annual turnover of more than ¥200 million. At such a rate, expanding into the rest of the territory was well worth the effort. Meanwhile, news of the hospital’s new supplier travelled fast around the city. Of course, the news reached Qiang, the company’s official Nanning distributor, who became furious that the client he failed to win had been converted by someone from the same company. Qiang examined the distribution agreement he had signed with Weikang, phoned Xie Kun, the manager of the South China region directly, and complained that Liuzhou’s distributor had ignored the rules of the distribution agreement. He claimed that this issue had not only caused him economic loss, but also disturbed his market, and thus he recommended that Zhong’s trans-boundary sales behaviour be severely dealt with. Two weeks later, he filed a second complaint against Zhong’s behaviour, this time to the company’s sales department, and also discussed the incident with colleagues. AT THE MEETING Cheng tried to resolve the conflict between the distributors in Nanning and Liuzhou, and saw it as an opportunity for further discussion about the company’s channel management. After all, the entire

For the exclusive use of Y. Diaz, 2022.

This document is authorized for use only by Yissell Diaz in MBA 646 Fall 2201A taught by JANA RUTHERFORD, Barry University from Jan 2022 to Mar 2022.

Page 4 9B16A059 company—both staff and distributors—was quite concerned about the incident. So, all regional managers and sales department managers were summoned to discuss the matter. Seven regional managers and four representatives from the sales department attended. Cheng explained the issue completely and handed the matter over to the managers to find a solution. Cheng stressed that the solution should be both suitable and reasonable. However, despite the fact that all managers present knew about the incident and had strong opinions, no one wanted to speak publicly about the issue. So, Cheng asked Ma Jie, the sales manager supervisor for Guangxi, for his opinion. Jie stated that cross-boundary sales should be strictly controlled. He argued that the action of Liuzhou’s distributor not only severely violated the agreement the company had signed with its distributors (see Exhibit 4), but also disturbed the market price system. In addition, the lower price offered to Liuzhou was likely to put distributors in Nanning at risk of losing other clients, which could affect sales of the products in all of Nanning. If all distributors in Nanning competed by offering lower prices, the company’s present price system would be in tatters. Vicious competition would exert a negative influence on sales in other areas of Guangxi, and might even spread to other provinces. Jie then used Xurisheng Iced Black Tea to illustrate his point. Cross-boundary sales had led Xurisheng’s market share to drop from 70 per cent to 30 per cent in 2001. The company had held a major promotion for distributors. The company would award to the distributors a ¥300 human-powered tricycle for every 50 units sold, a bicycle worth ¥180 for every 30 units of iced black tea sold, and gift cards for sales of less than 30 units. Those distributors who accomplished a sales volume of ¥1 million would be awarded a car worth ¥36,000. This policy had unprecedented effects. Some distributors purchased 10,000 units at a time, which they managed to sell within a short time, and then asked for more products. However, 10,000 units was more than the distributor’s domestic market needed, so the products were sold to other areas at lower prices, which were rationalized by including the value of the awards into the overall cost. Eventually, Xurisheng’s low-price strategy evolved into a price war. Not long after the promotion, Xurisheng Iced Black Tea became hard to sell in the affected areas because second-level dealers had overstocked the product. The price for each unit of iced black tea fell to ¥33, while the manufacturer’s suggested price was over ¥40. Jie then accused cross-boundary sales of causing huge damage to both the company’s pricing and sales systems. He urged the company to deal severely with the behaviour of Liuzhou’s distributor, proposing that Zhong forfeit his gains from cross-boundary sales, especially the year-end bonus, to compensate for losses in Nanning. Zhong should also be ordered to withdraw from Nanning’s market, to be fair to Nanning’s authorized distributor. In response, Kun, the manager of the South China region, offered a different opinion. Both Nanning and Liuzhou were his responsibility, and he felt that since Zhong had increased the company’s market share in Nanning, sales volumes across the whole South China region had started to climb. This was, according to him, not only beneficial to the Liuzhou distributor, but also the company—or at least harmless to the company, because its total sales were rising. Even if some Nanning-based clients had been won by Liuzhou’s distributor, both distributors were selling the same company’s products, so the company’s profit would increase. What’s more, he added, Li Zhong’s achievement had greatly encouraged distributors in other places to cultivate vacancies in the market. Severe punishment would discourage other distributors who were enthusiastic about improving sales. In the end, that would have a negative effect on sales. He pointed out that some companies, such as Mentholatum, were doing well by ignoring cross-boundary sales.

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This document is authorized for use only by Yissell Diaz in MBA 646 Fall 2201A taught by JANA RUTHERFORD, Barry University from Jan 2022 to Mar 2022.

Page 5 9B16A059 Xie emphasized that fair competition between suppliers would motivate distributors to explore new markets. Xie explained that these concerns had motivated his slow response to Qiang’s complaint. Tao Ran, manager of the East China region and a victim of cross-boundary sales, disagreed. He believed that if the behaviour of Liuzhou’s distributor was left unpunished, it would sharpen the conflict between distributors in Liuzhou and Nanning. If the Nanning distributor allied with other distributors to fight back, the fallout would be destructive to the company’s sales and marketing system. If the Liuzhou distributor took control of too many markets, his bargaining power could become overstretched. Joining the hospitals to contend against the company, and threatening to cancel distributorship, would cause a great challenge that could harm the company’s management of distributors, and possibly result in great loss. Su Jia, manager of the sales department in Guangdong, a neighbouring province of Guangxi, felt that the Liuzhou distributor was not in the wrong. He blamed the Nanning distributor for not seizing the market and claimed that it was his poor sales skills that provided the opportunity for the Liuzhou distributor, clearly evidenced by the failure to win Nanning Second People’s Hospital as a client. Also, Nanning’s distributor was selling a competitor’s products, which was an indication of low devotion to Weikang. Although Liuzhou’s distributor had broken the regional sales contract to some extent, he had nonetheless made a great contribution to the company in terms of extending its market. If the Nanning distributor was not able to carry out his job, he should not blame those who would replace him. Furthermore, Liuzhou’s distributor had taken away vacancies in Nanning’s market, not current clients. It would be perfectly acceptable for the company to re-divide distributors’ sales scopes according to their abilities, so as to enhance the entire company’s sales volume. As for Zhong’s behaviour, he remarked, the company should tread lightly. Serious punishment might dampen other distributors’ enthusiasm to explore new markets. Yang Rui, sales department manager in Sichuan Province, rebutted him by saying that although the Nanning distributor’s current clients had not been affected, some hospitals in Nanning had apparently begun to bargain for lower prices. This would definitely lead to internal conflicts among distributors, which would arouse conflicts between distributors and the manufacturer, if the issue was not addressed. Consequently, sales managers would be torn between two alternatives: explore new markets or choose new distributors. Regarding the issue of selling competing products, that was a different question from cross-boundary sales and it should be treated separately. Faced with the same difficult position, Huang Xing, manager of the Northwest China region, agreed with Rui, pointing out that if the company did not control this type of action and it became common practice among distributors, the damage to the company as a whole would be immeasurable. In addition, if all distributors colluded together to cheat the company out of sales commissions, or obtained lower prices for the company’s products with the excuse of competition, the company’s sales performance and reputation would suffer damage. Cross-boundary sales also made it difficult to create sales plans. Some regions could have trouble engaging in this practice, which would again cause imbalances in regional development and thus lead to more vacancies in various markets. Li Yang, sales manager from Hunan Province, opposed punishing the Liuzhou distributor. He cited two reasons: first, the company could not afford to offend distributors, such as the Liuzhou distributor, who contributed a large volume of sales and profits to the company each year, and still remained active in his work. Losing such people would be a great loss to the company. Second, although cross-boundary sales could do great harm to the sales and marketing system of some products, such as iced black tea and other fast-moving consumer goods, the damage to Weikang’s products was not likely to be great because the markets for its products were mainly hospitals, for which the boundaries were quite clear. Moreover,

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Page 6 9B16A059 communication among hospitals was minimal, so product information was unlikely to flow from one client to another. Therefore, severe punishment was unnecessary. Liu Xing, manager of the North China region, commented that benign cross-boundary sales competition could help strengthen the distributors’ sense of crisis and motivate them to explore vacancies in the market. However, a malignant distributor engaged in underhanded competition would damage the company’s price system and sales system, making management more difficult. Therefore, the entire process should be controlled. He suggested that the company could send some staff members to supervise and offer guidance to regions where many vacancies existed in the market. Sales managers of such regions should also provide an analysis of the vacancies, as well suggest as corresponding strategies. He believed that neither severe punishment nor ignoring the matter would help the company’s development. However, Xing’s argument did not persuade the other sales managers. The problem of market vacancies and channel conflicts did not belong to distributors alone; every sales manager was involved. Now that the issue had become an urgent debate, no one wanted to come to a hasty decision. Although a definite answer had not yet been found, Cheng was satisfied with the result of the discussion. He instructed all relevant staff to survey the opinions of distributors and salespersons as to how to deal with cross-border operations, and submit a detailed survey report within one week. SURVEY REPORT AND LIU CHENG’S THOUGHT PROCESS After Cheng received the survey report (see Exhibit 5), he read it with care and careful consideration. Problems did exist in the company’s sales channels. Faced with such a great difficulty as a cross-border operation, how should the company proceed?

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This document is authorized for use only by Yissell Diaz in MBA 646 Fall 2201A taught by JANA RUTHERFORD, Barry University from Jan 2022 to Mar 2022.

Page 7 9B16A059

EXHIBIT 1: SALES TERRITORY AND DISTRIBUTORS IN EACH REGION

Sales Region Territory Number of Distributors Northern China

Beijing, Tianjin, Hebei, Shanxi, Inner Mongolia 6

Eastern China Shanghai, Shandong, Anhui, Jiangsu, Zhejiang, Fujian, Jiangxi

10

Southern China

Guangdong, Guangxi, Hainan 10

Northwestern China

Shaanxi, Ningxia, Xinjiang, Qinghai, Gansu, Tibet

20

Northeastern China

Liaoning, Jilin, Heilongjiang 10

Southwestern China

Chongqing, Yunnan, Guizhou, Sichuan 25

Central China Hunan, Hubei, Henan 10

Source: Company files.

EXHIBIT 2: NUMBER OF DISTRIBUTOR CLIENTS AND SALES VOLUME FOR EACH PRODUCT IN LIUZHOU

Client Classification Number Product Sales Volume (million/year)

Important client 9 TISTAT, Surgicel, Gelatin Sponge

7

Large client 10 TISTAT, Surgicel, Gelatin Sponge

4

Ordinary client 25 TISTAT, Surgicel, Gelatin Sponge

2

Source: Company files.

EXHIBIT 3: NUMBER OF DISTRIBUTOR CLIENTS AND SALES VOLUME FOR EACH PRODUCT IN

NANNING

Client Classification Number Product Sales Volume (million/year)

Important client 7 TISTAT, Surgicel, Gelatin Sponge

5

Large client 9 TISTAT, Surgicel, Gelatin Sponge

2.5

Ordinary client 25 TISTAT, Surgicel, Gelatin Sponge

1.5

Source: Company files.

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This document is authorized for use only by Yissell Diaz in MBA 646 Fall 2201A taught by JANA RUTHERFORD, Barry University from Jan 2022 to Mar 2022.

Page 8 9B16A059

EXHIBIT 4: PRODUCT DISTRIBUTION AGREEMENT (EXCERPT) Party A: Beijing Weikang Pharmaceutical Co., Ltd. Party B: Guangxi Nanning Feida Business Trade Co., Ltd. In accordance with Contract Law of the People’s Republic of China and Trademark Law of the People’s Republic of China and relevant laws and regulations, this product distribution agreement is made and entered into by and between Party A and B through friendly consultation on the basis of mutual benefit and willingness. Article 1: Party A hereby appoints Party B as its distributor for the sale and distribution of Party A’s Products, which include TISTAT, surgicel, gelatin sponge, in and throughout the city of Nanning in Guangxi Zhuang Autonomous Region. In accordance with this Agreement, Party A grants Party B the right to sell the products hereby mentioned under the terms of this Agreement. This right to sell only applies to the following described territory: Nanning, Capital City of Guangxi Zhuang Autonomous Region. Article 2: The term of this Agreement commences on 6th May 2009 and terminates on 6th May 2014. Article 3: Rights of Party A Party B is entitled to develop terminal distributors throughout Nanning as a way to build a distribution network for the products of Party A, and promote the products in accordance with regulations set by Party A. Party B has the right to require Party A to take disciplinary action against distributors in other areas who sell products in Party B’s territory in Nanning without its permission. Party B is entitled to acquire support from Party A’s information system. Party B is entitled to acquire support from Party A as is provided in Party A’s advertisements for product distribution and marketing publicity. Party B is entitled to require professional services from Party B in its daily operation. As far as business operations in Party B’s territory are concerned, Party B is entitled to the right to make suggestions to Party A to adjust certain regulations in the management operating system. Article 6: Obligations of Party B Party B shall commence sales and distribution of products within ten days after this Agreement is made effective. Party B shall abide by relevant sales systems and regulations set by Party A, and thereto shall be subject to the supervision of Party A. Party B shall protect the brand image, trademarks, management and operating system and regulations of Party A from being infringed. And in the event of any infringement, Party B shall assist Party A to take legal action and other measures. Party B shall not provide its distribution rights and products of Party A to a third party or any other industries without permission of Party A. Party B shall not use or sell publicity materials and products with logos outside the authorized areas.

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Page 9 9B16A059

EXHIBIT 4 (CONTINUED) Party B shall provide accurate and complete information about its stock, sales and deposit statements of the products and other promotional products to Party A on a regular basis. Party B shall not sell similar products at similar prices to those of Party A’s. Party B shall only sell the products of Party A throughout its appointed distribution territory. It shall not sell the products to other areas. Party B shall warrant an annual sales volume of no less than 5 million RMB. Daily stocks of Party B shall not be less than 50% of its purchases. In the event of any breach of the terms of this Agreement, Party A is entitled to cancel the distribution rights of Party B, and take back its distribution card and other relevant certifications. In this case, Party B shall settle accounts with Party A immediately without protest. Article 7: Payment and Delivery Party B shall order products from Party A according to sales of the products in the territory ten days in advance via fax, letter, or email. Party A shall reply within three workdays upon receipt of the order, and shall immediately arrange to deliver goods by train or other means of transportation to the agreed location of Party B on the agreed date at the expense of Party B. Insurance should be at the expense of Party A. Party B shall pay 80% of the total amount when placing an order with Party A, upon receipt of which Party A shall agree to deliver the goods. The rest of the order should be paid within 7 days. If Party B fails to make payment within the said timeframe, Party A shall have the right to refuse to deliver the ordered goods. Promptly upon receipt of the products, Party B shall examine the items to determine whether they are opposite to the order or in short supply. If no objection to the type and the quantity is raised …