Distribution Channels

By Mullins, J.W., Walker, O.C.

Edited by Paul Ducham

PRODUCT AVAILABILITY

The most important objective for any distribution channel is to make the product conveniently available for customers who want to buy it. For consumer goods, two aspects of availability must be considered. The first is to attain the desired level of coverage in terms of appropriate retail outlets. Because retailers differ in their sales volume, manufacturers need to weight the relative importance of each retailer on the basis of its percent of sales within the product category in question. The resulting figure is referred to as the percent of all commodity volume (ACV). For example, a packaged food item may be carried by only 40 percent of an area’s food stores. But it may have 70 percent ACV because it is handled primarily by supermarkets accounting for a large proportion of the total sales of such products. The second important aspect of availability for consumer products is the item’s positioning within the store. One way to measure performance here is the percentage of available shelf or display space devoted to the brand, weighted by the importance of the store.

For industrial products—and for assessing channel performance at the wholesale level for consumer products—the relevant issue of availability is whether the industrial cus- tomer or retailer has the opportunity to place an order and obtain the product when it is needed. This is a question of the adequacy of market coverage. Firms can assess coverage by measuring how often customers in a territory are called on by company or distributor salespeople and by the time required to fill and deliver an order (i.e., order cycle time). Cycle time measures are particularly relevant when dealers are able to purchase their requirements directly from a firm’s Web site, or when they are linked to a manufacturer via an electronic reorder system.

Product availability is an important objective for all distribution channels. The appropriate degree of availability varies with the characteristics of the product and the target customers, particularly the product’s importance to those customers and the amount of time and effort they will expend to obtain it. For example, consumer convenience goods, such as packaged foods and health products, demand immediate availability since most customers are unwilling to devote much effort to obtaining a particular brand. At the other extreme, immediate availability is less critical for unique and important products such as consumer specialty goods or major industrial equipment and installations.

Market and competitive factors also influence a firm’s ability to achieve a desired level of availability for its product. When demand is limited or when the brand holds a small relative share of the total market, wholesalers or retailers willing to carry it may be difficult to find. The firm may have to offer extra incentives and inducements to achieve an adequate level of product availability. On the other hand, a brand’s strong competitive position makes it easier to attain extensive retail coverage and shelf space. Also, as we’ll discuss in more detail later, firms can enhance at least some aspects of availability through effective use of the Internet.

CUSTOMER SERVICE REQUIREMENTS

A second channel objective, which is closely related to availability but broader in scope, is to achieve and maintain some target level of satisfaction in meeting the service requirements of target customers. This tends to be a particularly crucial objective for analyzer and defender businesses attempting to differentiate themselves from competitors on one or more service dimensions. Some service requirements that might be targeted for consumers, industrial end users, or other members of the distribution channel (e.g., the firm’s “intermediate customers” such as distributors or retailers) include:

1. Order cycle time, which refers to how long it takes the manufacturer to receive, process, and deliver an order.

2. Dependability, which relates to the consistency/reliability of delivery. This is probably the most important element of distribution service, especially for those using just-in-time delivery systems.

3. Communication between buyer and seller, which enables both parties to resolve problems at an early stage.

4. Convenience, meaning that the system is sufficiently flexible to accommodate the special needs of different customers.

5. Postsale services, which help the customer attain full benefits over the life of the product. Such service might include installation, user training, help lines to resolve technical glitches, repair, and spare parts availability. Such services can be particularly important in the distribution of consumer durable goods and technically complex industrial products, such as computer systems, major software applications, manufacturing machinery, and the like.

Monitoring customer complaints, and the ongoing measurement of customer (or channel member) satisfaction, retention, and loyalty levels are all appropriate measures of whether the firm is meeting its customer service targets. Monitoring customer complaints can also provide useful guidance for improving a firm’s product and service quality levels in the future. For example, Dell Computer monitors blogs criticizing the firm’s products or service and attempts to correct the problems discussed. The company also started Idea-Storm where customers offered more than 8,500 suggestions for improvement in the first year, voted on those suggestions 600,000 times, and left 64,000 comments. More than a dozen of those ideas have been implemented so far.

PROMOTIONAL EFFORT

Another common channel objective is to obtain strong promotional support from channel members for the firm’s product, including the use of local media, in-store displays, and cooperation in special promotion events. Gaining broad retailer support for in-store promotions is particularly important for low-involvement, convenience goods. Both the amount and quality of personal selling effort that channel members devote to particular products can be critical. Strong selling support is particularly important when (1) firms are marketing technically complex and expensive consumer durables or industrial goods, (2) the market is highly competitive, or (3) a differentiated defender is trying to sustain a competitive advantage based on superior product quality or customer service.

MARKET INFORMATION

Because of their proximity to the marketplace, middlemen are often relied on for fast and accurate feedback of information about such things as sales trends, inventory levels, and competitors’ actions. A high level of channel feedback is particularly important for firms in highly competitive industries characterized by rapid changes in product technology or customer preferences, such as the computer and fashion industries. Feedback is crucial for firms pursuing prospector business strategies since they depend on the early identification of new product and market development opportunities for their success.

COST-EFFECTIVENESS

Channels must be designed to minimize the costs necessary to attain the firm’s channel objectives. The cost-effectiveness of the distribution channel is of particular concern to businesses pursuing low-cost analyzer or defender strategies. However, there is often a trade-off between channel costs, particularly those associated with physical distribution activities such as transportation and inventory storage, and achieving high levels of performance on many of the other objectives we have examined, such as product availability and meeting customer service requirements. We will examine these trade-offs in more detail when we examine the pros and cons of alternative channel designs.

CHANNEL FLEXIBILITY

As Hallmark discovered, well-entrenched channels where the members have long-standing commitments or substantial mutual investments can be hard to change in response to shifting market or competitive conditions. Consequently, some firms, particularly those pursuing prospector strategies in new or rapidly growing or technically turbulent product categories, consider channel flexibility an important goal. A flexible channel is one where it is relatively easy to switch channel structures or add new types of middlemen (discount retailers and a direct-sales Web site in Hallmark’s case) without generating costly economic or legal conflicts with existing channel members

Designing Distribution Channels: What Kinds of Institutions Might Be Included?

There are four broad categories of institutions that a manager might decide to include in the distribution channel: merchant wholesalers, agent middlemen, retailers, and facilitating agencies. Each of these categories is defined in Exhibit 12.3 and discussed below.

Exhibit 12.3

MERCHANT WHOLESALERS

Some types of merchant wholesalers engage in a full range of wholesaling functions while others specialize in only limited services. But both buy goods from various suppliers (that is, they take title) and then resell those goods to their commercial customers, either industrial buyers or other resellers such as a retailer. They are compensated by the margin between the price they pay and the price they receive for the goods they carry. Approximately 400,000 merchant wholesalers are operating in the United States, including sales branches maintained by manufacturing firms.

AGENT MIDDLEMEN

The primary role of agent middlemen is to represent other organizations in the sale or purchase of goods or services. Agents do not take title to, or physical possession of, the goods they deal in. Instead, they specialize in either the buying or selling function. There are about 45,000 agent middlemen in the United States, of which manufacturer’s agents and sales agents are the two major types used by producers.

Manufacturer’s Agents or Manufacturer’s Reps  These usually work for several manufacturers, carry noncompetitive, complementary merchandise in an exclusive territory, and concentrate only on the selling function. They are important where a manufacturer’s sales are not sufficient to support a company salesperson in a particular territory. Manufacturer’s reps are common in the industrial equipment, automotive supply, foot- wear, and toy industries.

Sales Agents  In contrast, sales agents usually represent only one manufacturer and are responsible for the full range of marketing activities needed by that producer. Because they have a wider range of responsibilities, their commissions are much larger than those of manufacturer’s reps. Sales agents are used primarily by small firms or start-ups that have limited marketing capabilities. They are particularly common in the electronics, apparel, and home furnishing industries.

Brokers These are independent firms whose purpose is to bring buyers and sellers together for an exchange. Unlike agents, brokers usually have no continuing relationship with a particular buyer or seller. The producers of seasonal products such as fruits and vegetables and the real estate industry use brokers extensively.

E-Hubs  These emerging forms of business-to-business Internet sites serve the same major function as brokers; they help bring potential buyers and sellers together for an exchange. Also like a broker, the e-hub is usually compensated by commissions from one or both parties. Some hubs focus on broad product categories of frequently purchased goods and services that are not industry specific, such as office supplies, airline tickets, or janitorial supplies, and add value by giving buyers in a range of industries access to a “virtual catalog” of offerings from an array of suppliers. While the hub is not directly responsible for per- forming any of the physical distribution functions, such as transportation or storage, it may maintain relationships with third-party facilitating agencies such as UPS to help ensure that buyers get what they pay for in a timely manner. Examples of this kind of hub include W.W. Grainger and www.BizBuyer.com.

Other hubs are more industry-specific, bringing buyers and sellers together within a single product category. They create value by enabling one-stop shopping by purchasers. For example, www.PlasticsNet.com allows plastics processors to issue a single purchase order for hundreds of plastics products sourced from a diverse set of suppliers. Because the products they offer tend to be specialized, industry-specific hubs often work with established merchant wholesalers (distributors) in their industry to ensure product availability and reliable delivery. Other examples include SciQuest in the life sciences industry and Chemdex in specialty chemicals.

RETAILERS

Retailers sell goods and services directly to final consumers for their personal, nonbusiness use. Because retailers usually take title to the goods they carry, their compensation is the margin between what they pay for the merchandise and the prices they charge their customers. Retailing is a major industry in the United States, with over 1.6 million retail establishments.

Retail stores can be categorized in many different ways, such as by the type of merchandise carried (supermarkets, drugstores), breadth of product assortments (specialty or department stores), pricing policies (discount or specialty stores), or nature of the business’s premises (e-tailers, mail-order retailers, vending-machine operators, traditional stores). One useful classification scheme groups stores according to their method of operation— low margin/high turnover versus high margin/low turnover.

The former compete primarily on a price basis. To keep volume high while minimizing inventory investments, low-margin/high-turnover stores usually concentrate on fast- moving items—such as food, health and beauty aids, basic clothing items, and housewares—and carry a relatively limited selection in each product category. Examples of such retailers include mass-merchandise discounters, wholesale clubs, most supermarket and drug chains, and some specialty chains in such areas as women’s clothing, shoes, hardware, office supplies, and building supplies (e.g., Home Depot and Lowe’s).

To profit, low-margin/high-turnover retailers must minimize their costs. Their focus on standardized, prepackaged merchandise helps lower personnel costs by reducing or elimi- nating in-store sales assistance. It also enables them to centralize many purchasing and store operating decisions, thus reducing the number of administrative personnel needed. Many such operations—particularly the mass merchandisers—also minimize their capital investment by operating out of freestanding, no-frills facilities near major traffic arteries; locations where land costs, rents, and taxes are low. Many specialty store chains, however, operate out of sizable malls.

At the other extreme, high-margin/low-turnover retailers differentiate themselves with unique assortments, quality merchandise, good customer service, and a prestigious store image. They focus on shopping or specialty goods, usually carrying a narrow range of product categories but offering deep assortments of styles and sizes within each category. They also emphasize prestigious national brands or exclusive goods unavailable elsewhere. Tiffany’s, for example, carries many one-of-a-kind crystal and jewelry items. This category includes most department stores and upscale specialty stores.

NONSTORE RETAILING

These institutions fit the definition of a retailer, but we discuss them separately because they don’t have a fixed bricks-and-mortar physical location and most do not enable customers to personally inspect the merchandise or take immediate possession. This category includes direct selling (e.g., door-to-door sales and telemarketing), mail-order catalogs, TV shopping, vending machines, and Web sites.

There are several varieties of retail Web sites, including Web start-ups like Amazon .com and iTunes.com that exist solely on the Web and do not have any physical stores, Web sites developed by large catalog retailers (Lands’ End, L.L. Bean) to leverage their direct-delivery operations, and Web sites developed by established bricks-and-mortar retailers like Target and Tesco to leverage their brand names and customer service skills.

Historically, an established brand name and customer base typically enabled the catalog and bricks-and-mortar retailers to attract customers to their Web sites at lower cost than the Web start-ups. However, survey results suggest that retail Web sites in general have not done a great job of satisfying customers, particularly on basic customer service dimensions, although the bricks-and-mortar sites have been more successful at keeping those buyers coming back for repeat purchases than the start-ups.

Many of the start-ups began life as “virtual” businesses that outsourced many of the physical distribution functions such as inventory storage and delivery. But because of the critical importance of good customer service for developing a satisfied and loyal customer base, some of those start-ups have begun developing their own physical distribution and fulfillment competencies to gain tighter control over those activities. For instance, Amazon.com has invested hundreds of millions of dollars in warehouses and inventory to help ensure fast, reliable delivery. As a result, repeat customers now account for the vast majority of Amazon.com ’s orders.

Similarly, bricks-and-mortar stores have sought more creative uses for their Web sites and other communication channels as their customers have changed the way they shop. A summary of survey results detailing some of these changes in shopping behavior is presented in Exhibit 12.4 The bottom line is that many customers who make their purchases within a store rely on the retailer’s Web site—as well as those of manufacturers and competing retailers and bloggers—to compare features, brands, and prices before they make a purchase.

To help in-store salespeople remain relevant as their customers use the Internet to become increasingly savvy, some retailers have revamped their job descriptions, training programs, and incentives. At Best Buy, for instance, 30 percent of store staff have been redeployed from specific departments to roam the entire store. Their job is to understand all the electronic gadgets in the store, how they work together, and how a customer can get the best performance from a product when she or he gets it home. To get those salespeople up to speed, the company has them meet with manufacturers’ reps, attend frequent training programs, and—when customers are scarce—play with the products.

Auction Sites Facilitate Retail Start-ups  Auction sites like eBay and China’s TaoBao not only provide a convenient way for consumers to sell possessions they want to get rid of, they also enable entrepreneurs to start new retail businesses with minimal capital and red tape. In the United States, nearly 500,000 people now make 25 percent or more of their annual incomes as retailers on eBay. But eBay-based start-ups are becoming even more popular in Europe where government regulations and scarce venture capital have historically posed problems for small retailers. Starting an eBay business is relatively easy for anyone with broadband and inventory and shipping software, which is readily available for a few thousand dollars. And European logistics companies such as Deutsche Post offer services tailored to small e-commerce operations. Consequently, more than 60,000 entre- preneurs in both Germany and Britain, 15,000 in France, and nearly 10,000 in Italy earn at least 25 percent of their income as eBay merchants. As a result, the diversity of products available to consumers and their price competitiveness are increasing rapidly.

Channel Design Alternatives

Deciding which channel members to include when designing a distribution system depends in part on whether the good or service is to be sold to Individual Consumers or organizational customers. Therefore, we begin our examination of alternative channel designs by enumerating the options available for distributing consumer versus industrial goods. But the choice also depends, as we’ll see in subsequent sections, on the firm’s competitive strategy and resources and therefore on the relative importance of the various channel objectives we discussed earlier.

Exhibit 12.4  How In-Store Purchasers Use the Internet

Percent of in-store shoppers . . . who:

69 Research products online before going to a store to make a purchase.

62 Have looked at least once at an online peer review before making a purchase.

61 Want to be able to scan bar codes and access information on other stores’ prices.

39 Compared a product’s features and price across retail outlets before buying.

9 Used a cell phone to text-message a friend or relation about a product while shopping.

INTENSIVE DISTRIBUTION

Consumer Goods and Services For consumer goods and services, achieving a desired level of product availability is largely a matter of gaining the cooperation of appro- priate numbers and types of retail outlets. A manufacturer can pursue three basic strategies of retail coverage—intensive, exclusive, or selective distribution (see Exhibit 12.7 ). The best strategy for a given product depends on the nature of the product, the target market pursued, and the competitive situation.

Intensive Distribution  Such a strategy uses the maximum possible number of retailers and is most appropriate for low-involvement, frequently purchased convenience goods such as candy, soft drinks, deodorants, and razor blades. This strategy maximizes product availability, which generates greater product recognition and more impulse buying. However, firms that adopt intensive distribution often experience implementation and cost problems. Individual retailers may be more reluctant to carry the product or to cooperate fully with the manufacturer’s marketing program than if they were given an exclusive right to carry the product in their territory. This was the problem Hallmark ran into with its traditional specialty retailers when the firm attempted to increase the intensiveness of its distribution by adding discounters and a Web site. Also, gaining cooperation from a large proportion of available retailers is a problem when total demand for the product is relatively small or when the brand is not the share leader in its product category.

Exclusive Distribution  This strategy relies on only one retailer or dealer in a given geographic territory. It is most appropriate when the product is a high-involvement specialty or shopping good. Exclusive distribution is also useful when a firm wants to differentiate its product on the basis of high quality, prestige, or excellent customer service. The main advantages of exclusive distribution are that the manufacturer can choose retailers whose clientele match its target market, and that there will be close cooperation in implementing the producer’s merchandising and customer service programs. Examples of products that are exclusively distributed include Ethan Allen furniture and Rolls-Royce automobiles. The major disadvantage of exclusive distribution is the risk involved in relying on a single retailer in a given territory.

Selective Distribution  This is a compromise between the other two extremes since it uses more than one but fewer than all available retailers in a geographic area. It is an appro- priate strategy for shopping goods. Most brands of automobiles are distributed this way.

Implications for Channel Design  In general terms, the greater the strategic importance of availability and the more intensive the desired level of retail coverage, the more likely wholesalers and/or agents are to be used. Intensive distribution requires large numbers of retail outlets, many of which are small, independently-owned operations. The personal selling, order processing, inventory storage, and delivery costs involved in servicing such a large network of retailers would be prohibitive for most manufacturers. Therefore, channel designs such as B and C in Exhibit 12.5 are most common for large, deep-pocketed firms seeking intensive distribution, while channel designs D and E are used by smaller firms needing intensive distribution. Firms with exclusive or selective distribution goals are likely to employ channel design B in order to interface directly with their retailers.

Industrial Goods and Services  In organizational markets, availability and customer service objectives tend to go together because it is order cycle time (the time it takes for customers to place orders and have the goods delivered to their plants or offices) and delivery dependability that tend to be most important for keeping customers satisfied. Historically, firms that wanted to provide fast and reliable delivery had to design channels with a relatively large number of “distribution points”—either wholesale distributors or company- owned warehouses and sales branches. Many distribution points were necessary to ensure adequate inventories would be available to avoid out-of-stock conditions and that those inventories would be close enough to the customer to allow quick delivery. Consequently, firms that tried to differentiate themselves on the basis of excellent customer service tended to rely on channels with substantial numbers of wholesale distributors, such as Channel B in Exhibit 12.6 (for companies that could afford a field salesforce) or Channel D (for those that could not). The reason, once again, had to do with the trade-offs between good customer service and physical distribution costs. Unless the producer was pursuing only a few very large customers or had sufficient sales volume and resources to make substantial invest- ments in warehouses and field salespeople, the selling, storage, and transportation functions necessary to provide quick and reliable service could usually be performed more efficiently by independent distributors. As we’ll see later, however, this historical trade-off between customer service levels and physical distribution costs is changing as the result of improved communication technologies and the logistical alliances they have made possible.

The Impact of the Internet on Availability and Customer Service  Some analysts argue that the Internet will lead to the “death of distance”; the geographic locations of sellers and their customers will no longer be relevant when they engage in transactions in cyberspace. Consequently, they argue that the Internet will facilitate the availability of all sorts of goods and services—both consumer and industrial. Keep in mind, though, that there are two aspects of availability from the customer’s point of view. The first has to do with product search: identifying available alternatives, collecting information about them, and placing an order. The second concerns product acquisition or order cycle time: how long it takes to gain physical possession of the product at the location where it is to be used or consumed.

Web sites, whether sponsored by the manufacturer (as is the case with Hallmark’s site) or by wholesalers, retailers, or e-tailers who are members of the distribution channel, have clearly enhanced the search aspect of availability. Potential customers can learn about available brands, compare features and prices, and make purchases any time of the day or week without ever getting up from their computer. And in many product categories, “aggregator” sites, or e-hubs, bring together many buyers and sellers under one virtual roof, enabling potential customers to compare alternatives and decide on a final purchase all at one site.

On the other hand, the Internet is not much help with the acquisition or physical distribution aspects of availability, at least not in most product categories. While it can help coordinate inventories and delivery schedules among channel members, it can’t help move the physical product from the producer to the customer’s home or plant, unless the product, like music or books, can be delivered in digital form. In fact, many e-tailers, such as RedEnvelope, outsource inventory storage and delivery activities to an established wholesaler or order fulfillment specialists. Therefore, channels incorporating traditional bricks-and-mortar wholesalers and retailers with the ability to provide quick delivery likely have a competitive advantage on the acquisition/order cycle time dimension, particularly for consumer convenience and impulse items, fashion goods and big-ticket durables that need to be tried out or tried on before purchase, and industrial components where quick and reliable delivery are critical.

Exhibit 12.5

Exhibit 12.6

Exhibit 12.7

TRANSACTION COST ANALYSIS

One of the most vexing questions facing a manager who must rely on independent agents, wholesalers, and/or retailers is how to get them to do what he or she thinks is best for the product. This is particularly important when it comes to achieving high levels of promotional effort within the channel, collecting timely market information, and servicing customers after the sale. Achieving these objectives requires substantial effort and expense on the part of the middleman, but many of the benefits accrue to the manufacturer or service producer.

As we’ll see, firms can attempt to control the activities related to these objectives by writing detailed legal contracts, such as franchise agreements, or to motivate voluntary effort from their channel members by providing appropriate incentives, such as coopera- tive advertising allowances or liberal service cost reimbursements. In many cases, though, firms can gain better control of such activities by using more direct, vertically integrated distribution channels, such as Channel A in Exhibits 12.5 and 12.6 . It’s easier to control a company salesforce and company-owned warehouses, retail outlets, or Web sites than it is to monitor the behaviors of many independent middlemen and find acceptable replacements for those who perform poorly.

The replacement problem is particularly difficult when an intermediary must invest in specialized (or transaction-specific) assets, such as extensive product training or specialized capital equipment, in order to sell the manufacturer’s good or service effectively. It’s more difficult to find—or to develop—replacement channel members when such specialized assets are required. Thus, the theory of transaction cost analysis (TCA) argues that when substantial transaction-specific assets are involved, the costs of using and administering independent channel members are likely to be higher than the costs of managing a company salesforce and/or distribution centers. This is because TCA assumes independent channel members will pursue their own self-interest—even at the expense of the manufacturer they represent—when they think they can get away with it. For instance, they might provide only cursory postsale service or expend too little effort calling on smaller accounts because they are unlikely to earn big commissions from such activities. Because independent intermediaries are more likely to get away with such behavior when it is difficult for the manufacturer to monitor or replace them, the transaction cost of using independent agents or wholesalers under such circumstances is likely to be high.

Recently, though, both managers and researchers have questioned TCA’s assumption that independent intermediaries will always put their own short-term interests ahead of those of the manufacturer when they can avoid getting caught and replaced. Many argue that when both manufacturer and intermediary believe their relationship can be mutually beneficial for years into the future, norms of trust and cooperation can develop. Such beliefs and norms are essential for the development of effective long-term relationships and alliances among channel partners.

COST-EFFECTIVENESS

As pointed out earlier, firms often face a trade-off between high product availability and short order cycle times on one hand and higher distribution costs on the other. To service the large number of retailers necessary to provide intensive distribution of consumer products typically requires many salespeople, widely dispersed warehouses, and large inventories. Similarly, guaranteeing fast and reliable delivery to organizational customers, especially smaller ones, demands a relatively large number of wholesale distribution points. Therefore, the manager’s task is to design a marketing channel that minimizes physical distribution costs subject to the constraint of achieving some target level of product availability and customer service.

Make-or-Buy Decisions  One issue that has a bearing on distribution costs is the choice among different types of institutions at each channel level. Would the firm be better off financially performing the functions necessary to achieve the desired level of customer service itself in a vertically integrated system or could independent intermediaries perform them more efficiently? In other words, for a given service level, are more direct, vertically integrated channel designs—such as Channels A and B in Exhibit 12.5 or Channel A in Exhibit 12.6 —more cost-effective than channels incorporating independent wholesalers and/or agent middlemen?

To answer this question, the manager needs to compare the relative costs of performing the necessary selling, storage, order processing, and transportation functions across the various alternative institutions for different levels of sales volume. For instance, at each sales level the margins that would have to be paid to wholesale distributors could be compared to the costs the firm would incur if it took over the sales and distributive functions necessary to support that level of volume. Similarly, the costs of maintaining a company salesforce can be compared to the commissions earned at various volume levels by external agents, such as manufacturer’s reps.

The results of this analysis typically vary by the amount of sales projected. For physical distribution activities to be handled efficiently in-house, the firm’s products must generate sufficient sales volume to achieve economies of scale. At lower volume levels, independent wholesale distributors are usually less costly because they can spread their fixed costs across the many different suppliers they represent, and the aggregated sales of all those suppliers’ products enable greater scale economies.

Similarly, the fixed costs of using external agents are lower than those of using a company salesforce because there is usually less administrative overhead and agents do not receive a salary or reimbursement for selling expenses. But costs of using agents tend to rise faster as sales volume increases because agents usually receive larger commissions than company salespeople. Thus, agents are typically more cost-efficient at lower levels of sales but less so as volumes increase. This helps explain why agents tend to be used by smaller firms or by larger firms in their smaller territories where sales are too low to justify a company salesforce.

Supply Chain Management—The Impact of New Technologies and Alliances  Recent developments may be changing the historical trade-offs between distribution costs and customer service levels. New data collection, communication, Materials Handling, and transportation technologies are enabling firms to reengineer their distribution processes in ways that increase customer service levels while simultaneously reducing costs. These new processes are commonly referred to as supply chain management (although consumer package goods firms that distribute through supermarkets have labeled them efficient consumer response [ECR] programs).

Much of the resulting improvement in customer service on dimensions such as order cycle time and dependability has been due to the electronic interchange of sales and inventory data—and the development of computerized ordering systems—between manufacturers and their channel partners. Sales information from a retailer’s checkout scanners can be sent directly to either a wholesaler’s or a manufacturer’s computer, which figures out when to replenish each product and schedules deliveries to appropriate warehouses or stores. It is even possible to track each individual package via Radio Frequency Identification (RFID) tags and wireless technology as it moves through a distribution channel. And, as we saw in the relationship between DHL Exel and Océ, logistics service firms or transportation agencies such as trucking or airfreight companies may also be included in these supply chain alliances to facilitate timely order processing and delivery.

Logistical alliances based on electronic data interchange are often able to reduce the total amount of inventory needed via improved coordination of the stocks kept at various levels in the distribution channel, quicker order processing, and speedier delivery. Thus, the number of wholesale distribution points required to provide a given level of customer service is often reduced. These reductions cut inventory carrying costs (the costs of capital tied up in inventory), storage costs, and damage to the stock. In most cases such reductions in inventory costs are more than sufficient to offset the costs of the computers and telecommunications equipment and the more costly modes of fast transportation usually involved in logistical alliances. For example, one study suggests that widespread adoption of such systems could reduce the average length of time it takes dry grocery products, such as cake mixes, soups, and pasta sauces, to reach the ultimate consumer from more than 100 days down to only 60 days. It is estimated that this would save consumers about 11 percent of their current grocery bills.

Another potential benefit of improved logistical cooperation in the food industry is the reduction of “shrink”—the amount of perishable food that is thrown away because of spoilage. It is estimated that about $20 billion worth of food is dumped by retailers each year in the United States alone. By improving the speed of order delivery, the monitoring and forecasting of consumer demand, and thereby reducing inventories and the size of in-store displays, Stop & Shop—a grocery chain owned by Holland’s Ahold—was able to cut shrink by a third in 2007, saving over $50 million, eliminating 36,000 tons of rotten food, and improving customer satisfaction with the freshness and quality of the chain’s produce.

MULTICHANNEL DISTRIBUTION

Companies are increasingly using multiple channels. Some use dual (two-channel) distribution systems—as, for example, when a manufacturer of industrial goods uses wholesalers to sell small accounts and its own salesforce to handle large accounts. An increase in the number of target segments typically forces many companies to use more than two channels. For example, a manufacturer of brake fluid distributes its product ( a) directly to General Motors, Ford, and BMW for use in new cars; ( b) through major oil companies that wholesale the fluid to their retail stations for use in servicing cars; and ( c) through auto parts wholesalers to retail auto parts stores to reach do-it-yourself customers.

Multichannel systems can create conflict and control problems. Conflicts can arise if different channel members try to pursue the same customer segment, and multiple channels are harder for the manufacturer to coordinate and control than a simpler system. Nevertheless, such systems often provide more complete market coverage with greater efficiency, which can provide a competitive advantage.

A variation of multichannel systems is the hybrid system. While multichannel systems employ separate channels to reach different target segments (e.g., service stations versus do-it-yourselfers), the members of a hybrid system perform complementary functions for the same customer segment. As Exhibit 12.8 indicates, for example, a supplier might rely on its own Web site and salespeople to contact customers and generate sales, employ an independent wholesaler or fulfillment organization to deliver the goods, and then use a company help line and independent service centers to provide service after the sale. Some analysts expect such hybrid systems to become the most common channel design in the future, largely because the Internet is making it easier to effectively coordinate a large number of functional specialists. Also, by outsourcing or offshoring some of those specialized functions, firms can often provide a given level of customer service more efficiently. Channel Design for Global Markets When designing marketing channels to reach customers in more than one country, the manager faces a couple of additional issues. First, when entering a new national market for the first time, he or she must decide on an entry strategy. Subsequently, a decision must be made whether to rely on middlemen in the firm’s home country that specialize in selling to foreign markets or to deal directly with foreign middlemen who operate in those markets.

Exhibit 12.8

MARKET ENTRY STRATEGIES

There are three major ways of entering a foreign country—via export; by transferring technology and the skills needed to produce and market the goods to an organization in a foreign country through a contractual agreement; and through direct investment.

Exporting is the simplest way to enter a foreign market because it involves the least commitment and risk. It can be direct or indirect. The latter relies on the expertise of domestic international middlemen: export merchants, who buy the product and sell it overseas for their own account; export agents, who sell on a commission basis; and cooperative organizations, which export for several producers, especially those selling farm products. Direct exporting uses foreign-based distributors/agents or operating units (branches or subsidiaries) set up in the foreign country.

Contractual entry modes are nonequity arrangements that involve the transfer of technology and/or skills to an entity in a foreign country. In licensing, a firm offers the right to use its intangible assets (technology, know-how, patents, company name, trademarks) in exchange for royalties or some other form of payment. Licensing is less flexible and provides less control than exporting. Further, if the contract is terminated, the licensor may have developed a competitor. It is appropriate, however, when the market is unstable or difficult to penetrate.

Franchising grants the right to use the company’s name, trademarks, and technology. Also, the franchisee typically receives help in setting up the franchise. It is an especially attractive way for service firms to penetrate foreign markets at low cost and to couple their skills with local knowledge and entrepreneurial spirit. Host countries are reasonably receptive to this type of exporting since it involves local ownership. American companies have largely pioneered franchising, especially such fast-food companies as McDonald’s, Pizza Hut, Burger King, and Kentucky Fried Chicken. In recent years foreign franchisers have entered the United States—largely from Canada, England, and Japan—in a variety of fields, including food, shoe repair, leather furniture, and home furnishings.

Other contractual entry modes include contract manufacturing, which involves sourcing a product from a manufacturer located in a foreign country for sale there or elsewhere (auto parts, clothes, and furniture). Contract manufacturing is most attractive when the local market is too small to warrant making an investment, export entry is blocked, and a quality licensee is not available. A turnkey construction contract requires the contractor to have the project up and operating before releasing it to the owner. Coproduction involves a company’s providing technical know-how and components in return for a share of the output, which it must sell. Countertrade transactions include barter (direct exchange of goods—hams for aircraft), compensation packages (cash and local goods), counterpur- chase (delayed sale of bartered goods to enable the local buyer to sell the goods), and a buy- back arrangement in which the products being sold are used to produce other goods. Overseas direct investment can be implemented in two ways—through joint ventures or sole ownership. Joint ventures involve a joint ownership arrangement (such as between a U.S. firm and one in the host country) to produce and/or market goods in a foreign country. Today, joint ventures are common because they avoid quotas and import taxes and satisfy government demands to produce locally. They also have the advantage of sharing investment costs and gaining local marketing expertise. For example, Sir Richard Branson’s Virgin Books Ltd. recently partnered with a group of Indian entrepreneurs, who were running a comics distribution business, to form a new venture called Virgin Comics LLC. The joint venture plans to build India into a multibillion-dollar comic book market by combining Virgin’s capital and production expertise with the Indians’ distribution system to appeal to the country’s 500 million teenagers with mythic tales and possibly animated movies and TV shows. There may also be substantial opportunities to export some of the firm’s offerings to the West via Virgin’s established retail channels.

A sole ownership investment entry strategy involves setting up a production facility in a foreign country. Direct investment usually allows the parent organization to retain total control of the overseas operation and avoids the problems of shared management and loss of flexibility. This strategy is particularly appropriate when the politics of the situation require a dedicated local facility.

High risks are associated with direct investment. Nevertheless, direct investments everywhere are accelerating because companies have concluded that capturing and retain- ing customers demands constant innovation and a rapid, flexible response to the dynamics of the environment.

CHANNEL ALTERNATIVES

Two major types of international channel alternatives are available to a domestic producer. The first involves the use of domestic middlemen who provide marketing services from a domestic base and the second is the use of foreign middlemen.

Domestic Middlemen  While convenient to use, these may suffer from a lack of knowledge about a specific foreign market and their inability to provide the kind of local representation offered by foreign-based middlemen. The more common merchant middlemen (those taking title) include the export merchant, who takes physical posses- sion of the goods (mostly manufactured), has a broad line, and sells in his own right; the export jobber, who handles mostly bulky and raw materials (but does not take physical control of them); and trading companies, which sell manufactured goods to developing countries and buy back raw materials and unprocessed goods.

Agent middlemen include brokers; buying offices (primarily concerned with searching for and purchasing merchandise upon request); selling groups (an arrangement by which various producers cooperate to sell their goods overseas); the export management company, which operates in the name of its principal; and the manufacturer’s export agent (MEA), which specializes in only a few countries and has a short-term relationship with its clients.

Foreign Middlemen  In contrast to dealing with domestic middlemen, a manufacturer may decide to deal directly with foreign middlemen. This shortens the channel, thereby bringing the manufacturer closer to the market. A major problem is that foreign middlemen are some distance away and therefore more difficult to control than domestic ones. Since many foreign middlemen, especially merchant middlemen, are prone to act independently of their suppliers, it is difficult to use them when market cultivation is needed.

Wholesalers around the world, while performing similar functions, vary tremendously in size, margins, and service quality. A broad generalization is that the less developed a country, the smaller the wholesaler and the more fragmented the wholesale channels. In recent years, however, the emergence of wholesaler-sponsored voluntary chains has tended to consolidate distribution power in the hands of a smaller number of wholesalers. Also, there is a worldwide trend of vertical integration from the wholesale or retail level to the manufacturer. And the growth of national wholesalers in many countries has made it easier for manufacturers to distribute their product(s) nationwide.

Retail Structures in Foreign Countries  These vary tremendously across countries because of differences in the cultural, economic, and political environments; for example, a generalization is that the size of retail stores increases as gross national product per capita increases. Both European and Japanese retailing are following a path similar to that pioneered by the United States with respect to store size, self-service, discounting, automation (use of electronic checkout counters), expansion of national chains, and direct marketing. And in some cases the effectiveness and efficiency of retailers in developing nations are being improved with the help of training programs, promotional materials, and inventory planning advice from large multinational manufacturers. A good example of this sort of proactive approach to improving the retail distribution of a firm’s products in foreign lands is provided by Procter & Gamble’s program to increase its revenues in rural China, as discussed in Exhibit 12.9

It is also becoming increasingly possible to promote and sell goods and services directly over the Internet almost anywhere. The online population was estimated to be 1.46 billion in the year 2008, with 248 million in North America, 384 million in Europe, 520 million in the Asia-Pacific region, 39 million in South America, 51 million in Africa, and 42 million in the Middle East. As we have seen, however, while the Internet enables firms to contact customers and generate orders, they must still rely on foreign middlemen to carry out the necessary physical distribution functions.

Channel Design for Services

Producers of services also face the problem of making their outputs available to targeted customer segments. In some cases, this results in forward vertical integration involving decisions about branch outlets—as in bank services that are accessible through branch banks (some of which may be located in supermarkets) and automatic tellers. Another example is a hospital that establishes outpatient clinics to serve the specific health needs of various community segments, such as high-stress or drug- or alcohol-dependent groups.

Ordinarily, the marketing of services does not require the same kind of distribution networks as does the marketing of tangible goods. Marketing channels for services tend to be short—direct from the creator or performer of the service to the end user—hence the emphasis on franchising.

Some services require the use of longer channels, however. Health care services use a variety of channel systems other than the traditional fee system employed by many doctors and hospitals in selling directly to the consumer. Health Maintenance Organizations (HMOs) sometimes use a vertically integrated system, where consumers pay a monthly charge to an organization (such as Baptist Medical Systems-HMO, Inc.) that coordinates the services of all the health care needs of its constituents. Hotels rely increasingly on indirect channels for their bookings. Intermediaries include travel agents who may deal directly with a hotel or contact another intermediary holding blocks of rooms, sales representatives who represent a number of noncompeting hotels or resorts, airlines that provide tour packages that include hotels, and automated reservation services that main- tain a computerized inventory of available rooms travel agents can tap into for a fee, e-hubs that enable business buyers to reserve rooms online, and “name-your-own-price” sites such as www.priceline.com where hotels can dispose of excess capacity if potential buyers offer an acceptable price.

Channel Management Decisions

Designing the perfect channel to accomplish the firm’s objectives is one thing; getting the middlemen to carry the product and perform the desired functions is another. In recent years manufacturers—and in some cases large wholesalers and retailers—have developed vertical marketing systems (VMSs) to improve coordination among channel members, thereby improving their performance. Greater coordination and cooperation in VMSs have led to greater marketing effectiveness and distribution economies by virtue of their size, bargaining power, and the elimination of duplicated functions. As a result, VMSs have become the dominant form of channel arrangement, particularly in the distribution of consumer goods and services.

This section discusses the various types of VMSs and how firms can develop and maintain such systems. Next, we examine the Sources of Power and the inducements and incentives that channel members use to gain the support of other system members. Finally, we identify possible sources of conflict in VMSs and some resolution mechanisms that firms use to preserve cooperation within their channels.

Exhibit 12.9  Procter & Gamble and the Chinese Government Work to Improve Rural Retailers

Since Procter & Gamble, the consumer package goods giant, first introduced Head & Shoulders, Pampers, and many other brands to mainland China in 1988, it has enjoyed steady growth. The firm racked up $2.5 billion in revenues in fiscal 2006, and its wholly owned China business unit employs 6,300 people, many of whom work in the firm’s extensive sales and wholesale distribution network.

While much of P&G’s past growth came from large retailers in China’s biggest cities, company managers expect that future growth will come from the rural countryside where there are more than 700 million potential first-time buyers for many of P&G’s products. Since family incomes in the countryside average less than one-third of those in the cities, however, P&G has been developing new Brand Extensions and packaging to lower costs and prices, and to appeal to rural cultural preferences.

Since retail stores in rural China tend to be small, numerous, and unsophisticated, the firm has also had to expand its distribution network to reach them. The firm relies on a group of wholesale subdistributors and their vans to deliver a variety of P&G products as well as sales aids like posters, display racks, and the like to hundreds of small shops. And the firm signed an agreement with China’s Commerce Ministry in 2007 whereby P&G promises to help renovate existing retail outlets, design and build new ones, and train local shopkeepers in some 10,000 small villages in the art of retailing. The government supports the program as a means of reducing the flow of counterfeit goods and spurring economic development in the countryside, while P&G hopes that improving the effectiveness and efficiency of China’s rural retailers will lower its distribution costs and gain increased local promotion of its many brands.

VERTICAL MARKETING SYSTEMS

Firms attempt to develop and manage integrated distribution systems in one of four ways: (1) a corporate VMS, which involves a vertically integrated system; (2) a contractual VMS, which formulates agreements spelling out a coordinated set of rights and obligations for members of the system; (3) an administered VMS, in which one firm uses its economic position or expertise to provide inducements for cooperation from other members; or (4) a relational VMS, where cooperation between two or more channel partners is based on norms of mutual trust and the expectation that cooperation will increase the total system’s success and thereby make all members better off in the long term. Each of these four types is shown in Exhibit 12.10 and discussed next.

Corporate VMSs  In these systems firms achieve coordination and control through corporate ownership. In most cases, this is the result of forward integration by a manufac- turer of the functions at the wholesale—and perhaps even the retail—levels. For example, many industrial firms have their own salesforces, warehouses, or branch sales offices. Backward integration occurs when a retailer or wholesaler assumes ownership of institu- tions that normally precede them in their distribution channels. Such integration is common among large supermarket chains.

The primary advantage of these systems is the tight control they provide over personal selling, promotion, distribution, and customer service activities. Such control is particularly important when the product is technically complex; when specialized knowledge or facilities are needed to sell, distribute, and/or service the product; and when few capable independent middlemen are available. Corporate VMSs are not without their disadvantages, which include the large capital investment required and less flexibility than conventional systems.

Contractual VMSs  In such systems independent firms at different levels of production and distribution coordinate their programs through contracts that spell out the rights and duties of each party. The intent is to obtain greater economies and market impact than they could achieve alone. Contractual VMSs have had the greatest growth of any channel system in recent years. There are many kinds of contractual systems, but the three basic types are wholesaler-sponsored voluntary chains, retailer cooperatives, and franchise systems.

Wholesaler-sponsored voluntary chains are formed by getting independent retailers to sign contracts in which they agree to standardize their selling practices and to purchase a certain portion of their inventories from the wholesaler. The Independent Grocers Alliance (IGA), Western Auto, and Ben Franklin are among the best-known wholesaler-sponsored voluntaries.

Retailer cooperatives are groups of independent retailers who form their own co- operative chain organizations. Typically, they agree to concentrate their purchases by forming their own wholesale operations. In many cases they also engage in joint advertising, promotion, and merchandising programs. Profits are passed back to the member retailers in proportion to their purchases. Such cooperatives are particularly common in the grocery field, where Associated Grocers and Certified Grocers are examples.

In franchise systems, a channel member can coordinate two successive stages in the distribution channel by offering franchise contracts that give others the right to participate in the business provided they accept the agreement terms and pay a fee. Such contracts usually specify a variety of operational details—including which members of the system will perform specific functions and how—as well as mechanisms to evaluate members’ performance and to terminate members who fail to perform adequately.

Franchising has great versatility. Such systems operate in almost every business area and cover a wide variety of goods and services. There are four major types of franchise systems.

1. Manufacturer–retailer franchise systems account for the largest number of franchisees and the largest volume of sales and are common in the automotive (Chrysler and Ford) and petroleum industries (Exxon, Shell, and BP).

2. Manufacturer–wholesaler franchise systems are exemplified by the soft-drink industry; Coca-Cola and Pepsi sell syrup concentrate to franchised wholesale bottlers that then carbonate, bottle, sell, and distribute soft drinks to retailers in their territories. In recent years, however, Coca-Cola has acquired several of its larger and previously independent bottlers to gain control over its distribution channel.

3. Wholesaler–retailer franchise systems are similar to wholesaler-sponsored voluntary chains, but the retail franchisees agree to conduct and coordinate their operations according to detailed standards specified by the franchise agreement. Examples include Rexall drugstores and SuperValu supermarkets.

4. Service sponsor–retailer franchise systems are the most familiar to consumers. Examples include McDonald’s, Burger King, and Kentucky Fried Chicken in fast foods; Holiday Inn and Ibis Hotels in lodging; Hertz and Avis in car rentals; Midas and Precision Tune in auto repair; and Manpower in employment services.

The popularity of franchise systems from a customer’s point of view derives from their ability to deliver consistent quality at a convenient location and a reasonable price. From the franchiser’s perspective, such systems provide a legal basis for exercising some control over franchisees without the large capital investments required by a vertically integrated system. On the other side, franchisees can gain access to the franchiser’s operational expertise, brand recognition, and loyal customers in exchange for providing local capital and management oversight.

Administered VMSs  Firms using this system coordinate the necessary activities at successive stages of distribution through the informal guidance and influence of one of the parties (rather than through ownership or contractual agreements). The administrator is typically the manufacturer, but in some cases the role is performed by a large retailer or wholesaler, such as Tesco or Wal-Mart. Usually, the administration of such systems develops a detailed merchandising program in which the manufacturer spells out shelf-space arrangements, a promotional calendar, pricing policies, and guidelines for other activities to be followed by its wholesalers and retailers.

To encourage the other members of the distribution channel to go along with its merchandising program, the channel administrator typically relies on its superior economic or expert power (as described in a later section) to provide incentives for cooperation. Therefore, administered VMSs are typically designed and managed by the most power- ful member. As a result, however, the performance outcomes that are rewarded may be more reflective of the powerful member’s objectives than of the interests of the system as a whole. And there is often a tendency for the administrator to use its power to “share the pain” when economic conditions are tough but to “hog the gain” during the good times.

Relational VMSs  Relational VMSs also rely on economic rewards—and often contractual agreements, as well—to specify what is expected of each channel member and to provide incentives for cooperation. However, in relational systems what is expected of each partner may change by mutual agreement as market or competitive conditions change, and the economic incentives depend more on the long-term market success of the entire system than on the power and largess of the strongest member.

As we have seen, such relational systems or alliances are often more effective and efficient than more traditional systems. This is largely because of the extensive and rapid sharing of information, cost savings resulting from better coordination of activities and less duplication of efforts, and the cooperative search for innovative ways for the system to gain a competitive advantage over other systems.

However, the open sharing of internal operating data and innovative ideas for improving efficiency and sales performance requires substantial mutual trust and long-term commitments from each partner. Trust tends to build slowly. Thus, the partners in a relational system must typically have some history of satisfying experiences with one another to provide a foundation for trust and a history of mutually rewarding performance outcomes to motivate continued commitment for the long haul.

SOURCES OF CHANNEL POWER

As mentioned, the channel leader in an administered VMS typically coordinates the actions of other members by exercising power over them. Channel member A has power over channel member B to the extent that A can get B to do something that B would not do if left alone.

The power of any firm within a distribution channel is inversely proportional to how dependent the other channel members are on that firm. Thus, the extent of Firm A’s power over Firm B is determined by A’s ability to deliver rewards desired by B, and by B’s ability to attain those rewards outside of a relationship with A (that is, by the alternatives open to B). Thus, sources (or bases) of power within channel relationships include the following:

● Economic power exists when channel members perceive that a firm can mediate economic rewards for them if they follow its directives.

● Coercive power is based on a perception that one channel member will punish another for failure to cooperate. It is the inverse of economic power, since such punishments usually take the form of a reduction in or withholding of economic rewards. For example, a manufacturer might threaten to withdraw a retailer’s exclusive territorial rights if the retailer’s performance does not meet expectations.

● Expert power stems from a perception that one channel member has special knowledge or expertise that can benefit other members of the system. Because of the reputations of firms like Unilever and Procter & Gamble as savvy marketers, middlemen are often willing to abide by their merchandising suggestions.

● Referent power is based on the belief that the benefits generated are likely to continue. A channel member that has earned substantial profits from a manufacturer over the years may be willing to accede to its suggestions or requests, without demanding any additional rewards.

● Legitimate power flows from the belief that one channel member has the right to make certain decisions or demands and to expect compliance from other members. Legitimate power is usually the result of ownership or contractual agreements, but in some instances it is based on moral authority or common beliefs about what is right and proper. For example, most middlemen would agree that a food manufacturer has the right to print expiration dates on its packages and to expect middlemen to remove outdated packages from the shelves as a means of protecting the product’s quality and the consumer’s health.

Of course, economic rewards and expertise are exchanged among partners in relational VMSs as well, but such exchanges tend to be relatively symmetrical—both parties benefit— rather than being dominated by one powerful member. Therefore, when one party in a relational VMS accedes to the requests or suggestions of a partner, that response often reflects the partner’s referent power, a belief that the relationship will continue to be mutually beneficial in the future.

CHANNEL CONTROL STRATEGIES

Two strategies used by manufacturers to improve their perceived economic power and to gain better cooperation from channel members are a pull and a push strategy.

Pull Strategy  When pursuing this strategy, a manufacturer focuses primarily on building selective demand and Brand loyalty among potential customers through media advertising, consumer promotions, extended warranties and customer service, product improvements, Line Extensions, and other actions aimed at winning customer preference. Thus, by building strong consumer demand, the manufacturer increases its ability to promote economic rewards in the form of large sales volumes to its channel members in return for their cooperation. A share leader or most prestigious brand in its category has substantial power to influence other channel members, particularly if the product is in the growth stage of its life cycle.

But what if the manufacturer is introducing a new product with no past sales history? In such situations, the manufacturer must convince prospective channel members that its marketing program can quickly build strong customer demand and loyalty for the new brand. Such efforts at persuasion are most likely to be successful when the manufacturer has substantial resources to devote to the new product’s marketing program, is perceived to have a great deal of marketing expertise, and has an extensive track record of past new product successes. Thus, pull strategies are commonly employed by large consumer goods marketers such as Procter & Gamble, Unilever, Frito-Lay, and Diageo PLC. Such companies have the deep pockets necessary to implement pull strategies, and their products typically have sufficiently broad appeal to make an aggressive consumer promotion and advertising program worthwhile.

Push Strategy  Smaller firms with limited resources, those without established reputations as savvy marketers, and those attempting to gain better channel support for existing products with relatively small shares and volumes often have difficulty achieving cooperation solely on the promise of future sales and profits. In such situations firms usually adopt a push strategy in which much of the product’s marketing budget is devoted to direct inducements to gain the cooperation of wholesalers and/or retailers. Typically, a manufacturer offers channel members a number of rewards, each aimed at motivating them to perform a specific function or activity on the product’s behalf. The rationale is that by motivating more wholesalers or retailers to carry and aggressively sell the product, more customers are exposed and persuaded to buy it.

Most small and medium-sized marketers of consumer goods employ push strategies because they lack the necessary resources for, or sell products whose relatively narrow appeal cannot justify, the expense involved in a pull strategy. The growing number of energy bars—Clif bars, Luna bars, Balance bars, and others—are examples of products marketed largely through push strategies, even though some limited consumer promotion does appear for these products.

CHANNEL CONFLICTS AND RESOLUTION STRATEGIES

Regardless of how well a manufacturer administers its channel system, some amount of channel conflict is inevitable. Some conflict is essential if members are to adapt to change. Conflict should result in more effective and efficient channel performance, provided it does not become destructive. Disagreements among channel members can occur for several reasons, including incompatible goals, unclear rights and responsibilities, and misperceptions and poor communication.

Because channel conflict is inevitable, the challenge is not to eliminate it but to manage it better. Firms can pursue several approaches aimed at recognizing and resolving potential conflicts early before they cause a breakdown of cooperation in the system. These include involving channel members in policy decisions (use of dealer advisory boards), increasing interaction among personnel at all levels (a manufacturer’s salespersons making sales calls with each of its distributors), focusing on common goals, and the use of mediation and arbitration.

A manufacturer might also proactively adjust policy to defuse the source of conflict or increase the incentives and rewards available to channel members to lessen the economic consequences of contentious issues. For example, Hallmark created a separate line of greetings cards for sales through mass merchandisers to reduce the amount of direct competition with its traditional retailers, and it created a Web site that helped those retailers attain discounts from other, noncompeting suppliers and thereby improve their profits.

There are legal constraints on how much and what kinds of power can be used to resolve conflicts or control channel members’ actions. This is most apt to be the case when the firm uses an exclusive or selective distribution strategy and/or attempts to dictate how the channel intermediary will perform in marketing the product. In recent years, the U.S. courts have begun to use more of a rule-of-reason approach to potential offenses rather than finding specific practices inherently illegal. Even so, vertical relationships are covered by the major antitrust acts—Sherman, Clayton, and FTC. See Exhibit 12.12 for a brief discussion of the major nonprice legal constraints imposed by the federal government.

Exhibit 12.12  Summary of Nonprice Legal Constraints in the United States

1. Exclusive dealing. The requirement that a channel member sell or lease only the seller’s products is illegal if the requirement substantially lessens competition.

2. Tying contracts. This requires a buyer to take products other than the one wanted and, with some exceptions, is illegal per se. Reciprocity, wherein a buyer refuses to do business with a supplier unless that firm buys its products, is similar to tying contracts and is illegal when coercion is involved and substantial commerce is affected.

3. Territorial restrictions. This involves the granting of a geographical monopoly to a buyer for a given product. The decision here rests on the effect of intrabrand restrictions on interbrand competition. Resale restrictions on the type of customer the buyer can sell to are handled on much the same basis.

4. Refusal to deal . The right of a seller to select its customers—or to stop selling to one—is legal as long as it does not substantially lessen competition or foster a restraint of trade.

5. Promotional allowances and services. These must be offered to all resellers on proportionally equal terms and must be used for the purposes intended (e.g., advertising allowances must be used to pay for advertising).

6. Incentives for resellers’ employees. Such incentives (e.g., push money) are generally acceptable, provided they do not injure competition substantially.