CHAPTER 17 DISTRIBUTION DECISIONS40 percent. Cisco s challenge is to increase its channel partner capacity by adding channel partners, increasing existing partners capabilities, or

C H A P T E R 1 7

D I S T R I B U T I O ND E C I S I O N S

LEARNING OBJECTIVESWhen you have completed this chapter, you will be able to:

• Understand the nature and function of distribution systems.

• Develop and implement effective distribution strategies consistent with the market strategy.

• Trade off alternative forms of direct and indirect distribution.

• Identify challenges and opportunities in ongoing management of distribution.

• Manage power and conflict in distribution systems.

OPENING CASE: CISCO SYSTEMSCisco Systems is the world’s leading supplier of products to power the Internet. Fourteen percent ofits $30 billion revenues goes though direct channels, 86 percent through 28,000 channel partners in160 countries. Originally, Cisco sold direct to end-user customers, but in the late 1990s shifted itsmajor efforts to three types of intermediaries:

• 1-Tier Partners. Systems integrators including global players like EDS and Accenture, but alsowell-established local partners. 1-tier partners integrate Cisco’s products with technology prod-ucts from other firms to provide end-user customers with complete solutions.

• 2-Tier Resellers. Sell to smaller end-user customers than 1-Tier Partners. Resellers’ salesrange from a few thousand to several million dollars; they secure Cisco’s products from dis-tributors. Distributors hold inventory and provide logistics value to Cisco. Cisco may havethousands of resellers in a particular geography, but only a few distributors.

• Service Provider Partners. Mainly telecommunications firms that supply Cisco equipmentto their customers. These channel partners may also make customer-service agreements torelieve their customers of the management burden of operating the equipment.

4 5 1

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Cisco’s sales force works hand-in-hand with channel partners to serve large end-user customers.Salespeople develop end-user customer relationships and make joint sales calls with channel-partnersalespeople. Channel partners are responsible for local relationships, developing business solutions,consultancy assistance, product delivery, after-sales support, and financing their customers’ purchas-es. Cisco develops and monitors joint business plans with its channel partners.

Channel partners provide significant value to Cisco. Most important, they leverage the efforts ofCisco’s salespeople, enabling much greater coverage and customer intimacy for its products. Theydeliver and install Cisco’s products and provide significant after-sales service. Since Cisco insists on30-day payment, channel partners supply their own working capital.

Cisco’s channel-partner relationships have evolved over the years. Its initial concern for partnergrowth evolved into making money for its partners, using measures like return on invested capital.Today, Cisco focuses on partners’ ability to grow and differentiate themselves in their markets.Cisco’s policy places all relevant business through its partners; it will not select the most attractivebusiness to serve directly.

Cisco classifies its channel partners as Premier, Silver, or Gold,1 based on their investment in secur-ing capabilities to provide value to end-user customers. Higher value levels earn greater recognitionfrom customers and greater resources and support from Cisco. Introduced in 2000, this classifica-tion does not consider revenues, so some gold accounts are smaller than other premier accounts. In2002, Cisco introduced an incentive system for three types of performance:

• VIP — Developing advanced technological expertise

• OIP — Seeking out new opportunities and/or new customers

• SIP — Developing new and innovative solutions

Cisco encourages channel partners to earn VIP, OIP, and SIP incentives; an individual partner mayearn incentives in more than one category.

In 2005, Cisco began an emerging-markets initiative. Previously, these countries were in a conven-tional regional geographic organisation. For example, Saudi Arabia belonged to the Europe,Middle-East, and Africa (EMEA) region and competed for resources with advanced western coun-tries like France and Germany. The new emerging-market organisation contains channel partnersfrom 140 countries, including Latin America, the Middle East and Africa, Central and EasternEurope, and Russia. Cisco’s tasks in these markets are:

• Develop enough channel partners to have good coverage. Cisco hired country managers andsalespeople and identified partners in each country.

• Develop replicable channel-partner models for industry verticals fortransfer across countries, like tourism, and oil and gas. Thesepartners may be non-traditional, so Cisco partners withSchlumberger in oil and gas markets.

• Work with country-level policy makers to encourage invest-ment in information technology infrastructure and spur eco-nomic growth.

Ninety-six percent of emerging markets revenues go through channelpartners (100 percent in many countries); annual growth rates exceed40 percent. Cisco’s challenge is to increase its channel partner capacityby adding channel partners, increasing existing partners’ capabilities,or both.

The firm’s products reach customers via distribution channels. Distribution can be direct fromsupplier to customer, but may also be very complex, involving many intermediaries. Inter -mediaries fulfill many different functions and frequently enjoy mutually beneficial relationships

S E C T I O N I I I � M A R K E T I N G I M P E R A T I V E S4 5 2

CASE QUESTION

How do you assess Cisco’s distribution

strategy? Can you think of any drawbacks?


with suppliers. But their goals rarely overlap completely, and distribution systems are riddledwith conflict and power inequalities. FMCG firms like P&G, Colgate, and Gillette all competefor good shelf positions in supermarkets so as to earn higher profits.2 Conversely, chains likeWal-Mart, Albertsons, and Royal Ahold want suppliers to lower prices, pay fees for shelf space,and put store brands in the best positions.

Power inequalities sometimes prevent firms from making distribution innovations. Yet no dis-tribution system lasts forever, and new approaches that add value and reduce costs can unseatmarket leaders. Look at the video-rental market. Traditionally, consumers rented from retailoutlets like Blockbuster or Hollywood Movies. Netflix’s innovation allows consumers to ordermovies online. Blockbuster has countered, but both must now compete with cable and satelliteproviders that bring video-on-demand directly into the home.

THE CHANGING VIEWO L D W AY N E W W AY

Manufacturer as channel captain Retail power increasing

Distribution arrangements fixed Distribution arrangements variable

Conflict models dominate Cooperative models ascendant

Push inventory systems (loading intermediaries Pull inventory (efficient consumer response systems)common)

Direct marketing rare Direct marketing common

Telecommunications infrequent Telecommunications widely used

Overnight distribution unavailable Overnight distribution increasing

Fast delivery rare Delivery speed highly valued

Information technology poorly used Information technology essential

Distribution — local/regional Distribution — regional/national/global

Slow progression: exclusive → selective → intensive Fast progression: exclusive → selective → intensive

Customers patient Customers impatient

(Australia)

Iron Ore, Coal,Limestone(Australia)

Steel ProcessingEquipment(Germany)

Capital(Korea)

SteelManufacturer

(Korea)

PrefabricatedSteel Beams

Argentina

Resource(Location)

Producer(Location)

Product

CustomerLocation

Concentration

Dispersion

D I S T R I B U T I O N D E C I S I O N S � C H A P T E R 1 7 4 5 3

FIGURE 17.1DIFFERING VIEWS OF DISTRIBUTION


DISTRIBUTION SYSTEMS AND THEIR EVOLUTIONTable 17.1 describes intermediaries that facilitate a supplier firm’s goods and services reachingconsumers and/or other end-user customers. A distribution channel or network comprises asubset of these entities; the functions they perform and their interrelationships are continuallyin flux. Table 17.2 shows selected changes as environmental forces, customer needs, and com-petitor actions exert pressure. Leading indicators of impending changes include unhappy con-sumers, end-user customers, and/or suppliers; unexplored channels; new technology; market


Two Views of Distribution — Broad and Narrow

Inputs like raw materials, sub-assemblies, and assemblies undergo changes in state, physical location, and/or timebefore a firm delivers a finished product is delivered to an end-user customer.3 The broad view of distributionincludes all of these changes. Figure 17.1 shows changes that occur for delivery of prefabricated steel beams for anew office tower to an Argentinean builder.

• Raw Materials. Iron ore, coal, and limestone are mined in Australia and shipped to an integrated steel manufacturer in Korea.

• Processing Equipment. Sourced in Germany for use in Korea.

• Capital. Bank loans to finance equipment purchasing and working capital for manufacturing based on bankdeposits made by Korean citizens.

• Steel Beams. Manufactured in Korea

• Completed Steel Beams. Shipped to a distributor in Argentina.

• Finishing. The Argentine distributor does minor finishing operations and delivers beams to the building site.

The major changes that these activities embrace include:

• Change of State. Iron ore, coal, and limestone into prefabricated steel beams.

• Change of Physical Location. Australian raw materials and German processing equipment shipped to Korea.Completed steel beams shipped to Argentina.

• Change in Time. This process takes time to accomplish.4

Along with most marketers, we adopt a narrow view of distribution. We focus on changes in physical location andtime of finished products. Other functions focus on state changes. For steel beams, procurement secures iron ore, coal,limestone, and capital equipment for the steel manufacturer; finance secures capital. Marketing addresses minor statechanges like final processing and repackaging, as well as finishing by the distributor.

Most people understand that firms create value by making state changes. Firms also create value by making physicallocation changes and in the timing of those changes. The Korean manufacturer creates value by forming steel beamsfrom iron ore, limestone, and coal. But the Argentinean builder receives no value if the beams are in Korea or on acargo ship; they have value only at the building site. And unless they arrive on time, the entire construction projectwill stop. Delays may cost millions of euros.

Hong Kong-based Li & Fung supplies garments to U.S. retailers like Abercrombie and Fitch, American Eagle, AnnTaylor, Disney, Guess, Kohl’s, Laura Ashley, Levi Strauss, The Limited, and Reebok. Li & Fung’s Intranet-based, highlycoordinated, and seamless global supply chain comprises hundreds of discrete links. For Guess jeans, yarn may bespun in Korea, fabric woven and dyed in China, and fastenings made in Hong Kong. The jeans are then sewn inGuatemala, and finished goods delivered to the U.S.5


coverage gaps; deteriorating system economics; complacent intermediaries; poor logistics; anddated system interfaces.6

DISTRIBUTION ENTITY DESCRIPTION OF DISTRIBUTION ENTITY

Agents, brokers, Each entity has similar functions. Generally, they sell products but do not takemanufacturers’ title or physically handle goods. They may work for the supplier, the customer,representatives or be impartial between supplier and customer.

Banks and finance firms Provide financing to customers to aid in purchasing products.

Distributors Provide promotional support for suppliers, especially for selective or exclusive distribution (discussed later). Often a synonym for wholesaler.

Retailers Display and sell products to consumers, typically from a fixed location.

Shipping companies Transport products.

Warehouse operators Receive and inventory products, arrange product pickup, often break bulk.

Wholesalers Primarily buy, take title, store, and physically handle goods in large quantities.Usually break bulk — resell to retailers or industrial businesses.

Technology Advances in capturing, transferring, and analysing point-of-sale data drive supply-chain efficiencies. In B2C, purchasing behaviour insights enhance retailer power.

Supplier focus Greater attention to supply-chain management and working capital reduction.

Distributor concentration Powerful intermediaries emerging.

Retailer sophistication In B2C, industry concentration and better management shifts power to retailers.

Customers Increasing expectation of multi-channel access.

Transportation Speedy, reliable, inexpensive ways to transport goods globally increasingly available.

Direct marketing Continuing growth.

Internet purchasing B2C — accelerating as home access to broadband communication increases.B2B — growing popularity of reverse auctions. Spurring disintermediation —direct-to-customer — and re-intermediation — intermediary placed between supplier and customer.

Production Product-build times shortening, permitting widespread mass customisation andinventory throughout the supply chain.

Ultimately, customers’ needs drive distribution arrangements. Early in the life cycle, productsare often unreliable and service needs are high; customers need help to make choices and sup-port to use the new technology. These requirements diminish as customers become more self-sufficient. They may no longer require the benefits that intermediaries provide, and earlymarket leaders’ distribution strategies are increasingly outdated:


TABLE 17.1DEFINITIONS OF SELECTED

DISTRIBUTION ENTITIES* 7

* Developed in part from the American Marketing

Association Glossary of Terms

TABLE 17.2SELECTED CHANGES

AFFECTINGDISTRIBUTION

SYSTEMS

When the PC market was growing fast, effective retail distribution was essential; salespeople explained the features,benefits, and values of various brands and helped customers make intelligent choices. Today, many customers designtheir own PCs and place orders online with firms like Dell. Retail distribution is less important, and successful firmshave evolved more efficient distribution strategies.8

In the 1890s, 70 percent of Americans lived on farms, miles from the nearest general store. Sears Roebuck (SR) revo-lutionised people’s purchasing with a new distribution system — the catalogue. SR offered practical hard goods —Prairie-Breaking plows and Mark-Your-Poultry leg bands — and luxuries like ladies’ kid-opera slippers and ostrich-plume hat trimmings. Buyers no longer drove their horses and carts for hours to reach the store. The store came tothem, and everyone had access to the same goods at the same price. Across the U.S., people kept up with changingfashions and accessed the escalating product variety — the money-back guarantee reassured wary customers. SR’ssales went from $750,000 in 1895 to over $10 million in 1900, as it surpassed then retail leader, Montgomery Ward.9


A distribution system’s effectiveness can change over time, but the supplier firm often has dif-ficulty making distribution changes. It can change prices overnight and, in the short run, devel-op new promotions or even make product and service changes. By contrast, the firm’sdistribution arrangements often stay unchanged, sometimes for decades, in part because ofend-user customer loyalty to distributors. The average tenure of Caterpillar’s 186 dealer rela-tionships worldwide exceeds 50 years!

DEVELOPING A DISTRIBUTION STRATEGYTo develop its distribution strategy, the firm must make several critical decisions10:

• Distribution functions. What exactly must be done in the distribution channel?

• Distribution channel: direct or indirect? Should the firm deal directly with consumersand/or end-user customers? Or should it use intermediaries, and if so, which ones?

• Distribution channel breadth. How many intermediaries should there be at each dis -tribution level? For example, how many wholesalers and/or retailers? Should there beexclusivity?

• Criteria for selecting and evaluating intermediaries. How should the firm decidewhether a particular intermediary is appropriate for handling its products?

We focus largely on physical goods, but distribution is also important for services. Sometimesour concern is the manufacturer; sometimes another entity in the distribution system. Forexample, Whirlpool makes its kitchen appliances, but Nike outsources production to others.

DISTRIBUTION FUNCTIONSDistribution closes gaps in physical location and time between factory-finished products andconsumers and end-user customers by completing many functions. Sometimes the supplierundertakes a particular function; other times intermediaries or end users do so. In a complexdistribution channel, some functions, like physical movement, must be done several times.Table 17.3 shows various functions, classified by product, information, and ownership.

Physical Product Information Ownership

Physical movement12 Order collection Transfer of title

Quality assurance Information-sharing13 Financing

Inventory Selling and promotion Risk-shifting14

Assortment15 Marketing research Impartiality16

Bulk-breaking Service

Physical-state changes17

Increasingly, channel members, especially retailers, try to enhance the customer buying experi-ence. Many large shopping centres in Europe include fast food restaurants, cafes, coffee shops,movie theatres, and entertainment centres including bowling alleys. Some U.S. shopping mallshave indoor amusement parks and walk-through aquariums.

When distribution channel entities perform the required functions, the firm should alignincentives so each is motivated to perform its functions well. Actions that improve the firm’ssales and profits should also benefit channel members. Unfortunately, distribution channelsoften contain inefficiencies and misaligned objectives.


� A distribution channelcomprises many enter-prises, their interrela-tionships, and thefunctions they perform.

� A distribution system’seffectiveness changesover time.

� Distribution arrange-ments are more difficultto change than othermarketing implementa-tion elements.

KEY IDEA

TABLE 17.3DISTRIBUTION CHANNEL FUNCTIONS 11

Market ingQuest ionWhich distribution entitiesdo a good job of providingquality assurance; risk cover-age — insurance, war-ranties, and guarantees;impartiality — identifyingalternatives and the buyingexperience? Why did youselect them?

� Distribution closes gapsin physical location andtime between finishedproducts at the factoryand consumers andend-user customers.

KEY IDEA


DISTRIBUTION CHANNELS: DIRECT OR INDIRECT?Figure 17.2 shows alternative channel designs for carrying out the various distribution functions:

• Direct channels. Suppliers manage most contact with consumers and end users.

• Indirect channels. Intermediaries like distributors, wholesalers, and retailers play a majorrole in transferring products to consumers and end users. Some indirect channels have asingle intermediary; others have multiple intermediaries.

REACHING CONSUMERS THROUGH DIRECT CHANNELS. Direct distribution methods, com-bined with database marketing,18 are alternatives to indirect distribution channels. In B2C,direct distribution has several forms:

• Face-to-face direct sales. As discussed in Chapter 16, some firms’ salespeople sell anddeliver products direct to customers. Direct customer contact can give suppliers intimateinsight into customers’ needs. In advanced economies, the costs of direct selling and dis-tribution are often too high for consumer goods, but Avon, Mary Kay, and Tupperwarehave been successful. In less-developed countries, lower incomes make personal sellingmore viable. When Citibank launched credit cards in India, face-to-face sales were quitesuccessful.19

• Direct sales by telemarketing. The firm contacts customers directly by telephone. Cus -tomers receive purchased products directly by package delivery from remote locations.The high cost of face-to-face selling drives outbound — firm to customer — telemarket-ing, as well as inbound — customer to firm — telemarketing. Centralised telemarketinggives the firm greater message control and cost efficiencies in reaching target customers.

Supplier

Direct Indirect

Direct Sales DirectMarketing

Specialisedretail store The Internet Distributor

Face-to-face Telemarketing Wholesaler Wholesaler

RetailerRetailerRetailerFranchiseWholly owned

Consumers


In the 1990s, Coca-Cola CEO Roberto Goizeuta was widely hailed for improving Coke’s share price by spinning off itsbottlers into an independent firm, Coca-Cola Enterprises Inc. (CCE). CCE controls 80 percent of Coke’s U.S. distribution;Coke has 39 percent ownership. In 2004, CCE switched objectives from revenue growth to improving profit marginsand raised prices sharply. Coke’s volume growth dropped; there was significant conflict between the firms.

Market ingQuest ionFingood distributed its prod-ucts to consumers via dis-tributors and retailers. Tospur consumer demand,Fingood cut prices to dis -tributors by 20 percent. Its leading distributor heldprices firm, just increased its margins, and the pricereduction failed. What wereFingood’s mistakes? Howshould it proceed?

FIGURE 17.2REACHING CONSUMERS:

DIRECT AND INDIRECT CHANNELS

In Japan, salespeople visit consumers at home to sell cars. In Britain, Malaysian-based carmaker Proton supplementsshowrooms with salespeople; they visit consumers’ homes with demonstration vehicles. In the U.S., Handtech.comsells PCs via technology consultants who target friends, neighbours, and small businesses.

� Direct distribution methods, combinedwith database market-ing, are powerful alter-natives to indirectdistribution.

KEY IDEA


• Direct marketing. Direct marketing involves sending messages to targeted customer lists,usually by mail or e-mail. Purchasers respond directly and receive products by packagedelivery from remote locations.20

• The Internet. The Internet, combined with package delivery services, is the fastest- growing inbound communications method. Customers initiate the buying process at the supplier firm’s website. Some firms integrate the Internet with telesales. When aLandsend.com visitor clicks on a help icon, a salesperson uses instant messaging to helpnavigate the site. The Internet reduces search costs, and often disintermediates wholesalersand retailers.

• Specialised retail distribution. The supplier firm controls product display and customerexperiences in retail outlets. Retail outlets are either wholly owned by the supplier — likeApple, Gap, Body Shop, and Starbucks — or franchised to a third party — like RosemaryConley Diet & Fitness Clubs and Coffee Republic (coffee shops). Many fast-food brandslike McDonald’s, Kentucky Fried Chicken, and Subway use franchising. Typically, thefranchisor develops the business model and seeks entrepreneurs to invest their own cap-ital. The franchisee agrees to implement the franchisor’s strategy and pays an initiationfee and ongoing fees.21 Franchisors often limit franchisees to a fixed number of outlets soas to retain more control. Sometimes firms use franchising to grow their brands but laterbuy back successful franchises. Luxury-goods supplier LVMH purchased its franchisees togain greater control and cultivate more upscale consumer experiences.22

REACHING CONSUMERS THROUGH INDIRECT CHANNELS. Many B2C firms distribute prod-ucts via indirect channels like wholesalers and retailers that provide physical location and timevalue. By constructing product assortments from many suppliers, these indirect channelsreduce customers’ search costs and provide an entire shopping experience. They may also addbrand value to suppliers’ products, like Harrods (Britain) or Macy’s (U.S.).25

Intermediaries may provide market access that would otherwise be very expensive, or impossi-ble, for the firm to secure. Individuals and organisations in Amazon’s Associates programmesend millions of customers to its website. Market access is particularly important when ventur-ing abroad. Many products fail because firms do not understand local cultures, markets, and


Market ingQuest ionReview the website forLands’ End, Cotton Traders,or a direct marketer of yourchoice. Phone your firm and order a product. In a couple of days, orderanother product. What data did it request on eachoccasion? Did it rememberyou from the first order tothe second order?

Innovative Direct Distribution Methods to Reach Consumers

• Banana Republic. Sets up makeshift stores in corporate offices for several days at a time.• Banco Popular. Serves Hispanic immigrant labourers with check-cashing vans. On Fridays, vans travel to

factories, plants, nurseries, hospitals, and other locations where Hispanic immigrant workers, many illegal, congregate.23

• Starbucks. Starbucks made an agreement with Sainsbury’s, Britain’s third largest food retailer, to set up outletsin its supermarkets. Starbucks would secure direct access to Sainsbury’s customers, and Starbucks’ presencemight bring more customers to its stores.

• Sogebank. Aggressively markets to small, independent business owners in Haiti. Loan officers sell from street-corner offices; they also make home visits to discuss client needs and assess their collateral.24

• P&G. In countries like Mexico and Venezuela, P&G faces serious cultural problems in marketing products liketampons. Religion and beliefs about health risks and loss of virginity from using tampons hamper sales. P&Gfocuses its marketing effort on bonding sessions in women’s homes, much like Tupperware parties. Female hosts educate friends and neighbours about the benefits of tampons and provide free samples. Forty percent ofattendees later become hosts.

� Advantages for whollyowned retail distributionare greater operationalcontrol and earning theentire retail margin; dis-advantages are capitalrequired for growth,and operating risk.

KEY IDEA


customers; local partners can be invaluable. Channel partners also reduce costs for supplierfirms because of cost efficiencies:

• Agents, manufacturers’ representatives, and brokers — selling economies.

• Package delivery and transportation companies — transportation economies.

• Independent warehouses — inventory economies.

• Banks and financial institutions — financing economies.

• Wholesalers and retailers — inventory, selling, and transportation economies.

REACHING ORGANISATIONAL CUSTOMERS. B2B firms use both direct and indirect distribu-tion to reach organisational customers:

• Direct distribution. Firms sell directly to end-user customers using on-the-road salesforces, telemarketing, direct marketing, and/or the Internet. (Few B2B firms operate retailstores.) They use various transportation methods to deliver products to customers.

• Indirect distribution. Some suppliers reach customers, especially small businesses,through retail stores like Office Depot and Staples for office supplies. Plumbing, elec trical,and home building firms use B&Q and Wickes. More generally, many firms reach cus-tomers via wholesalers and distributors.

Table 17.4 shows several factors that help firms choose between direct and indirect distribution.27

Direct distribution Indirect distribution

Small potential customer base Large potential customer base

Custom-tailored products Stockable items, manufactured in large quantities butsold in small quantities

Large quantity sales Small quantity sales

Complex end-user customer purchasing decisions — Simple end-user purchasing decision — often by multiple functions and high-level executives low-level purchasing agents

Delivery speed not critical Rapid delivery and service important

Distribution speed is increasingly important as firms use just-in-time (JIT) inventory systemsto increase operating efficiencies. Industrial distributors must provide customers with complexproduct assortments in a timely manner. Typically, some requirements are predictable butothers are not. Holding sufficient inventory to satisfy both can be very expensive. The OkumaAmerica example is one innovative approach; Volvo is another:


The U.S. Postal Service (USPS) and FedEx are direct competitors in overnight and ground package delivery. Yet USPSallows 10,000 FedEx drop boxes at post offices nationwide — for $232 million. Also, FedEx’s planes ship Express,Priority, and First Class mail — a seven-year agreement for $6.3 billion.

� Direct channels:Supplier firms managethe contact with con-sumers and end users.Indirect channels: intermediaries like dis-tributors, wholesalers,and retailers play amajor role intransferring productsfrom suppliers to con-sumers and end users.

� Intermediaries offervalue-added benefitsthat suppliers cannot.They provide productassortments, shoppingexperience, marketaccess, and oftenreduce the costs ofconducting various distribution functions.

KEY IDEA

Machine tool builder Okuma America requires each of its 46 distributors to stock a minimum numberof machine tools and select repair parts. When customers order an out-of-stock item, the distributorfirst contacts Okumalink — a shared information technology system. Okumalink keeps distributorsinformed about the availability/location of parts in Okuma warehouses. If a part is unavailable, thedistributor contacts other distributors online and arranges delivery direct to the customer.26

TABLE 17.4B2B CUSTOMERS:

FACTORS FAVOURINGDIRECT AND INDIRECT

DISTRIBUTION


DISTRIBUTION CHANNEL BREADTHDistribution channel breadth is the number of channel members the firm uses at a particularlevel — like wholesalers or retailers. The firm can add or subtract distributors as appropriate:

The firm can also add/subtract different types of distributor. Adding a new type is importantwhen customers have preferred outlets for purchasing products and services. In the PacificNorthwest, marine and forest-products distributors each address different types of customersand can relate to their specific problems and issues. Many firms use both types of distributor.

Adding new types of distribution can be both positive and negative. In 2001, Tupperware halteda 15-year slide by placing booths in shopping malls and selling over the Internet. In 2003, itadded distribution in all of Target’s stores, but customers lost a reason to go to Tupperware par-ties; also, salespeople were poorly trained at in-store demonstrations. Sales dropped 17 percent,profits by 47 percent. Tupperware’s sales force shrunk by 25 percent, losing many of its “good,solid performers.” Tupperware stopped distributing at Target, and profits doubled.

When the firm distributes through multiple channels, it must be concerned with channel cross-ing — customers secure product information from one channel, try the product at a secondchannel, and purchase from a third channel. The first two channels provide free service, but onlythe third channel earns revenues.30 As Internet commerce grows, this is an increasing problem fortraditional channels. The firm benefits from making the sale, but other channel partners receiveno revenues for their services. This practice may cause long-run channel breakdown.

Firms have three broad channel breadth options:

• Intensive Distribution. When customers put in little search effort, the firm’s productsshould be easily available. It maximises the number and type of outlets where customersbuy. Intensively distributed consumer products include convenience goods like softdrinks and cigarettes.

• Exclusive Distribution. When customers are willing to search and travel, the firm shouldbe very careful in outlet selection. If retailers provide brand equity and a positive shop-ping experience, a B2C firm may choose a few prestigious outlets. Fine china and crystal


Volvo GM (VGM) Heavy Truck Corporation sells replacement parts via commercial truck dealers; it supplies dealersfrom regional warehouses. Parts inventories in Volvo’s warehouses were rising, but, frequently, dealers could notsecure parts they needed because Volvo was out of stock! VGM worked with FedEx Logistics to set up a warehouse in Memphis (FedEx’s hub). When a dealer has an emergency, it calls a toll-free number. FedEx ships the required parts;it delivers to dealer offices, holds for airport pickup, or drops off at the required site. VGM closed three warehouses,reduced total inventory by 15 percent, and regained much business previously lost to stockouts.28

� For B2B suppliers, conditions typicallyfavour either direct orindirect distribution. In each case, there are several options.

KEY IDEA

In France, Norwegian furniture manufacturer J.E. Ekornes distributed via 450 furniture dealers. Ekornes believed thiswas too many. Dealers put in little selling effort, in part because they carried small product selections. Ekornesdropped 300 dealers; the remaining 150 received exclusive territories. These dealers increased local advertising forEkornes’ furniture and dropped competing lines. Ekornes sales increased threefold.29

Staples retail stores linked in-store computer kiosks to Staples.com. An average Staples store carries 8,000 office-supply items; Staples.com offers 200,000 items. An average store shopper spends $600-$700 annually; a store andcatalogue shopper spends $1,200-$1,400. When it added online kiosks, Staples sales jumped to $2,500 per shopper.Each of Staples 1,000 retail outlets has at least four online computer kiosks.


firms distribute their products in high-class department stores like Harrods andSelfridges or specialty stores like Mappin and Webb.

• Selective Distribution. Selective distribution is a sort of compromise between intensiveand exclusive distribution. Too many outlets can lead to excessive competition, but toofew outlets can make the firm’s products difficult to find. Sony and Samsung distributetheir products selectively, making serious outlet decisions. In the U.S., Samsung reposi-tioned its products upmarket and pulled out of Wal-Mart and Kmart.

Distribution breadth is equally important in B2B and B2C marketing. Under competitive pres-sure from Dell, Compaq (now part of HP) shifted its distribution efforts from 40 distributorsto four large wholesalers. Distribution breadth raises three related exclusivity issues:

• Geographic Exclusivity for Distributors. Should the supplier give its distributors geo-graphic exclusivity? (Within limits, most suppliers can enforce such restrictions.)Exclusivity eliminates free riding and intra-brand competition by providing geographicmonopolies. It also motivates distributors to invest in promotion and improved service.But monopoly can breed complacency. When Canon USA’s market share in copiersdeclined, it removed geographic restrictions so its strongest dealers could better competewith Xerox.

• Product Exclusivity for Distributors. To reduce conflict among intermediaries, firmssometimes provide exclusivity to distributors by offering different product designs and/orbrands to different distribution channels. In the U.S., Black & Decker sells the Black &Decker brand at Kmart and similar outlets, Quantum for serious enthusiasts at HomeDepot, and DeWalt for professional contractors and builders through trade dealers. Sony,Panasonic, and Samsung each produce separate models for major retail chains like BestBuy and Circuit City. Through product and/or brand exclusivity, the firm satisfies itschannel partners and better meets end-customer needs.

• Exclusivity for the Supplier. Suppliers sometimes insist that, within a product category,intermediaries distribute only their products. Pepsi and Coke each have exclusive agree-ments with restaurants, airlines, retailers, and school districts to sell and distribute theirbeverages. IBM’s Authorised Assembly Programme commits distributors to use only IBMoriginal parts.

CRITERIA FOR SELECTING AND EVALUATING INTERMEDIARIESBoth parties to a distribution arrangement win when the criteria for selecting channel partnersare clear and unambiguous. The firm should clearly specify the functions and performancestandards that its distributors should meet. Would-be distributors can then fairly assess theircapabilities versus requirements and commit to meet the outcomes desired by both parties. IBMprevailed in a court case because it set and applied clear standards:


Suppliers seeking exclusivity should avoid the appearance of anti-competitive behaviour. In 1999, EuropeanCommission officials seized internal documents in dawn raids on Coca-Cola offices across Europe. Italy’s competitionauthority alleged that Coke designed a complex system of exclusivity bonuses and discounts to “oust . . . Pepsi fromthe market.” Coke was alleged to offer rebates and volume discounts only to retailers that regularly increased shelfspace for its products and made in-store promotions and special offers.31

� Suppliers should selectdistribution channel(s)that are appropriate fortheir target segment(s)and perform therequired functions.

� Providing customerbenefits and values,rather than traditionalindustry practice,should guide the supplier’s distributionchoices.

KEY IDEA

When IBM launched its personal computer, computer retailers who were denied the IBM franchise banded together tosue IBM. The courts ruled that IBM had not discriminated among retailers and that its selection criteria were clearand fairly applied.


Both the firm and its distributors should recognise their obligations before entering into anagreement. To improve the chances of success, the supplier should ask several questions ofpotential distributors32:

• What is the distributor’s credit and financial condition?

• What is the distributor’s selling capability? What is its historic sales performance?

• Will the distributor forgo competitive products? Does it welcome the supplier’s products?

• What is the distributor’s general reputation among suppliers and customers?

• Does the distributor have adequate market coverage?

• How competent is the distributor’s management?

• How does the distributor rate on aggressiveness, enthusiasm, and taking initiative?

• Is the distributor the appropriate size to do business with us?

PUTTING IT ALL TOGETHER: THE DISTRIBUTION STRATEGYFigure 17.3 shows an eight-step method for developing distribution strategy.33 In the boxedinsert, a single supplier develops a distribution strategy for three distinct market segments.

2. Identify & prioritisesegment requirements

regarding channelfunctions

5. Evaluate benefitsand costs of various

channel options

6. Elaboratechannel overlaps–

make seriouschoices

7. Appoint distributors–trade off securing market

coverage and avoidingchannel conflicts

8. Clearly assigndistributor territories

3. Benchmark supplierand competitor channel

capabilities–compare withcustomer requirements

4. Creatively identify channeloptions for each segment–

consider switching costs andpotential conflicts

1.Identify end-customer segments


� Critical distributionstrategy decisionsinclude identifying thefunctions to be per-formed, deciding ondirect versus indirectchannels and distribu-tion channel breadth,and setting criteria forintermediaries.

KEY IDEA

FIGURE 17.3A STEP-BY-STEPAPPROACH TODEVELOPING ANDIMPLEMENTINGDISTRIBUTION STRATEGY


MANAGING DISTRIBUTION CHANNELSEnsuring top performance from distributors day by day can be a significant challenge. We discussintermediary compliance, power inequalities, conflict, and the emerging-partnership model.

INTERMEDIARY COMPLIANCEThe supplier must ensure that channel intermediaries stick to their agreements and implementits market strategies. Table 17.5 lists problems that supplier firms experience with intermedi-aries when objectives become misaligned.


Distribution Strategy For A Small Chocolate Manufacturer

Royale Inc.* is a small Belgian chocolate manufacturer. It targets the European consumer middle market of mid-pricedchocolates for family consumption. Royale distributes its products through supermarkets and other retailers. Theseoutlets add value by offering product assortments. Royale does not sell direct to consumers; it believes that channelintermediaries can more efficiently sell, transport, inventory, and finance its products. Royale evolved its market strategy by targeting two additional segments: European firms for employee consumption, and consumer markets inNorth America. Royale now has several distribution arrangements:

• European consumer middle market. Consumers purchase chocolates from supermarkets and small stores. Majorsupermarkets are regional and national supermarket chains; other retail chains are small regionals and locals.– Major chains. Royale’s strategic account sales force sells direct. Royale delivers to retailers’ warehouses

direct from its factory warehouse via third-party transport. Chains are slow payers, so Royale discounts itsaccounts receivable to a factor.34

– Small regional and local retail chains. Royale uses food brokers. It fills orders from geographically dis-persed, independently owned warehouses. Third-party transport, hired by Royale, supplies these warehousesfrom Royale’s factory warehouse; the independent warehouses make store deliveries.

– Small stores. Royale sells to a European distributor, delivers to the distributor’s main warehouse in its ownlorries, and holds accounts receivable until payment. The distributor makes its own arrangements to ship products to the stores.

• European firms: Royale’s sales force sells direct to corporate purchasing groups. It ships chocolate from independently owned warehouses (see above).

• North American consumer markets: Royale has an export agent with good North American contacts. A distributor identifies retail outlets and makes all local arrangements. The export agent combines orders from dis-tributors and makes all administrative arrangements in Belgium. Royale receives payment by letter of credit;terms are f.o.b. its factory warehouse.35

The Royale illustration shows the complexity of distribution for a small chocolate supplier. For large firms with manyproducts targeting several segments, distribution can be very complex.

* hypothetical firm

Honda had multiple retail dealers in major Pakistani cities — 27 in Lahore and 16 in Karachi. Despite agreements to adhere to Honda’s suggested retail prices, some dealers cut prices. Dealers that invested significantly in their show-rooms were very upset. Honda appointed committees — two dealers and one Honda executive — to monitor pricecompliance in each major city. Non-compliant dealers were fined.36


• Can’t or won’t meet the supplier’s goals

• Carry insufficient inventory

• Are inadequately financed

• Get very close to end-user customers; will not provide the supplier with customer data

• Require fixed payments to carry the supplier’s prod-ucts

• Only sells the supplier’s most attractive products

• Apply insufficient effort to consumers or end-usercustomers the supplier has targeted

• Do not stress the supplier’s brand — in the extreme,push their own private-label or competitors’ brands

• Are overloaded with products from competing andnon-competing suppliers

• Do not allow the firm to contact their sales forces

• Make ineffective use of the supplier’s sales managers

• Do not use the supplier’s promotional materials

• Primarily sell on price, not on value

• Do not follow the supplier’s suggested pricing

• Do not pass on promotional programmes andrebates to consumers and end users

• Do an inadequate job of solving consumer and end-user problems


TABLE 17.5SUPPLIERS’ OPERATINGPROBLEMS WITHRESELLERS

If the firm compensates intermediaries with standardised commissions for all products andcustomers, it may encounter compliance problems. The firm can better direct its distributors ifit varies commissions by product and customer type. It can also tie evaluation and compensa-tion directly to contract requirements like maintaining inventory levels, providing customerservice, and customer satisfaction.37 Table 17.6 shows a partial list of performance measures toevaluate distributors.38

Criterion Frequently Used Operational Performance Measures

Sales performance Gross sales Actual sales/sales quotaSales by product and market segment Market shareSales growth over time Price levels realised

Inventory maintenance Average inventory maintained Inventory turnoverInventory/sales ratio On-time delivery

Selling capabilities Total number of salespeople Salespeople assigned by geographySalespeople assigned to the supplier’s Account managers assigned to strategic

products customers

Information provision Sales data by customer40 Information on inventories and returnsInformation on end-user needs

The firm should continuously evaluate its intermediaries’ performance. But it must rememberthat intermediary relationships are a two-way street. The distributor is also evaluating its supplier’s performance. Are the supplier’s products selling? Are consumers and/or end-usercustomers complaining about the supplier’s products? Are the supplier’s deliveries prompt? Isthe supplier easy to do business with?

POWER IN DISTRIBUTION SYSTEMS 41

Power and conflict are endemic in distribution systems. Power is one channel member’s abili-ty to get another member to act as it wants. Typically, some channel members have more powerthan others; they also have different objectives. When a supplier is more powerful, it can imposedemands. Microsoft sets many conditions for PC manufacturers. Similarly, powerful interme-diaries may exert power based on their market positions. Wal-Mart pressures suppliers for lowprices and demands adherence to its supply-chain guidelines. Over time, power tends to shiftfrom one channel member to another. Table 17.7 identifies conditions for greater or lesserpower upstream or downstream.

TABLE 17.6CHANNEL MEMBERPERFORMANCEEVALUATION 39

� A well-designed com-pensation system canhelp the supplier directits distributors’ efforts.

KEY IDEA

Market ingQuest ionHave you or a friend or colleague ever been involvedin distribution? Which issues in Table 17.5 posedproblems? How did yousolve them?


Upstream — Suppliers Downstream — Distributors or End Users

Demand greater than supply Supply greater than demand

Supplier’s products important to distributor success Supplier’s products unimportant to distributor success

Supplier enjoys monopoly-like position Distributor enjoys monopsony-like position

Proprietary technology Products/services undifferentiated

Few substitute products available Many firms can supply

Few substitute suppliers available Few substitute distributors available

Supplier poses credible threat of forward integration — Distributor poses credible threat of backward to cut out the distributor integration — to make the supplier unnecessary

Distributor has high switching costs Distributor has few switching costs

Individual distributors unimportant to the supplier’s Distributor purchases are a large percentage of the success supplier’s output

Supplier has extensive end-customer contact Supplier has little end-customer data

Figure 17.4 shows entities in a distribution system. We explore the power relationships amongmanufacturers and brand owners, distributors and wholesalers, retailers, and end-user customers.

MANUFACTURERS AND BRAND OWNERS. In the early 20th century, manufacturers grew andincreased their power versus distributors and wholesalers. They researched customer needs,designed good products, and reduced costs and prices via mass production. Firms like Coca-Cola, PepsiCo, Kodak, Kellogg’s, Budweiser, Gillette, Frito-Lay, Levi’s, and Campbell’s all usedconsumer advertising to build powerful brands and become channel captains. Not all brand-owners are manufacturers: Nike, Polo, and Calvin Klein outsource production but carefullymanage distribution. Sometimes raw material/ingredient providers like Nutrasweet (artificialsweetener) and Intel (chip maker) earn significant distribution power.

DISTRIBUTORS AND WHOLESALERS. In the late 19th century, full-line, full-service wholesalerslike Alexander T. Stewart and H.B. Claffin, now long defunct, were channel captains. They dom-inated U.S. consumer goods distribution, linking distant manufacturers with retailers and con-sumers.42 Economic changes and growth in manufacturer and retailer power have diminishedthese once-powerful intermediaries, but they still play a major role in many industries. Asdepicted in the movie Blood Diamond, DeBeers buys nearly all of the world’s raw diamonds andvirtually sets diamond prices worldwide. Value-added resellers (VARs) are a new type of inter-mediary, building additional software modules on other firms’ platforms, and modifying com-puter hardware for niche markets. Systems integrators like Accenture and EDS add value byinstalling and servicing software and hardware (IT integration services) from many vendorsand making them work together.

Intermediaries often provide information value. Insurance brokers dominate business insurance by identifying and analysing business risks and helping firms obtain coverage frominsurers. Intermediaries also provide end-user customers with product choices and reduce thenumber of needed supplier relationships. Consider the time you would spend to buy groceriesfrom individual specialists: milk from a farm, produce from various growers, and meat from a

RetailersRaw Material

ProvidersManufacturers,Brand Owners

Distributors,Wholesalers

End-UserCustomers


TABLE 17.7CONDITIONS THAT

INCREASE OR DECREASEPOWER UP AND DOWN

THE DISTRIBUTIONCHANNEL

FIGURE 17.4POWER IN

DISTRIBUTION SYSTEMS


butcher. Dairies, grocers, and butchers were once valuable intermediaries, but now supermar-kets provide their products in one convenient location.

Using their websites, many suppliers now offer customers greater product variety than traditional retail distribution.43 But intermediaries are also successful. Amazon’s product assort-ment encompasses books, CDs, prescription drugs, and many other products from manufac-turers and retailers. eBay is also a powerful intermediary, using online auctions to link sellersand buyers. Priceline, Orbitz, Expedia, and Travelocity all broker sales of airline tickets and hotelrooms online.44

RETAILERS. In many sectors, strong retail chains have evolved via industry concentration. In theU.S., large specialised retailers like Best Buy, Toys “R” Us, and B&Q virtually dictate industrydirection. Tesco, ASDA, and Sainsbury’s dominate British supermarkets; Wal-Mart, RoyalAhold, Kroger, and Safeway play a similar role in the U.S. But national warehouse clubs likePrice Club, Costco, and Sam’s Club place significant pressure on grocery suppliers. Retailing hastrailed many industries in globalisation, but Carrefour (France), Wal-Mart (U.S.), and Zara(Spain) now have significant global operations.

Major retailers like these are often price leaders. They use buying power and efficient logistics todrive down costs. They study customer needs and use powerful information technology to tailortheir product assortments. They also force suppliers to pay direct payments to secure shelf space,aka slotting fees.46 In 2001, slotting fees for five major U.S. food companies — Campbell’s,Kellogg’s, Coca-Cola, Pepsico, and Kraft — equaled 14 percent of sales at retailers that sold theirproducts. Kraft spent $4.6 billion, Pepsico $3.4 billion, and Coca-Cola $2.6 billion, just to gettheir products well placed on retailers’ shelves. At Christmas, to enhance its own highly profitablebattery sales, Wal-Mart persuades Kodak to stop supplying batteries with its cameras.

END-USER CUSTOMERS. In B2C markets, individual consumers seldom have significant power,but consumer groups can profoundly influence producers. European consumers boycottedgenetically modified products like Round-up Ready corn, and local groups protestingMcDonald’s presence have vandalised its restaurants. In Germany, environmentally mindedconsumers encourage strict recycling laws. In B2B, mergers and acquisitions have left theremaining customers in several industries with significant power. The few global automobilefirms and aircraft manufacturers Boeing and Airbus are good examples.

CONFLICT IN DISTRIBUTION SYSTEMSBecause distribution channel members have multiple organisational relationships, there is highpotential for conflict. Operational conflicts occur daily due to late shipments, invoice errors,unfulfilled promises, unacceptable product quality, a supplier firm’s attempts to load channelsby forcing unwanted inventory on intermediaries, and price and margin disagreements. ESPN’sdistributors, the cable companies, continually complain about price increases but don’t darestop distributing ESPN. These conflicts are frustrating, annoying, and can disrupt the channel,so most channel members try to minimise them. But some firms take actions to create strate-gic conflicts and gain advantage. Consider the simple channel in Figure 17.5.


In the U.S., a diversified investor with several mutual funds has many interactions — multiple calls to purchase/sellindividual funds and check fund balances, deposit/receive multiple checks, and receive multiple statements. By combining multiple funds, Schwab’s OneSource decreases the hassle and keeps funds continuously invested.45

� Intermediaries addvalue by reducing thenumber of relationshipsa supplier and end-usercustomer must have.

� Intermediaries occupythe critical regionbetween suppliers andend-user customers.

KEY IDEA


STRATEGIC CONFLICTS INITIATED BY DOWNSTREAM CUSTOMERS. We discuss four conflicts:

• End-user customers grow and desire direct-to-supplier relationships. Many suppliersstart out using distributors to reach end-user (especially small business) customers. Asthese end users grow, they often want direct supplier relationships. They believe that distributors provide insufficient value for their margins, and the end-users want lowerprices.

If the supplier firm agrees to these requests, it risks its distributor relationships. After all,the distributor played a major role in growing the supplier’s business. But if the supplierremains loyal to its distributor, it risks losing valuable end-user customers.

• Distributors become large and change the power balance: In the U.S., small single-loca-tion retailers once characterised automobile retailing, and manufacturers like GM, Ford,and Chrysler were very powerful. But mega-dealers like Potemkin, Auto Nation, andCarMax have emerged, with multiple locations selling huge volumes from several producers. Their growth has shifted the power balance from car manufacturers to carretailers.48

• Distributors commence production: Sometimes innovative distributors disrupt channelrelationships via backward integration — making products they formerly distributed.Nucor began as a steel distributor; dissatisfaction with suppliers led it to manufacturesteel. It is now the U.S.’s most profitable steel producer.

• New buying influences enter the distribution channel: In some industries, independentbuying groups amass buying power for their members. Spar and Nisa have long servedsmall grocery and hardware stores respectively. In the U.S., Novation and Premier pur-chase hospital supplies for many small and large hospitals.

Supplier firm

Distributor

End-user customer

Upstream

Downstream


FIGURE 17.5A SIMPLE

DISTRIBUTION CHANNEL

� Distribution channelmembers have highconflict potential.

KEY IDEA

Jco supplies disposable tableware for parties. It reaches retailers like Playstore through Disco, a major national distributor. Founded as one store in the early 1980s, Playstore now has more than 500 outlets. In the early 2000s,Playstore’s new management team told Jco that it wanted to cut out Disco and buy direct from Jco.

Norton was a large-scale producer of grinding wheels; it became market leader by forging strong relationships withindustrial distributors. This led to strong market share with small business customers, like local machine shops. Butmarket share dropped precipitously at large customers, like auto manufacturers, who decided to bypass distributorsand form direct relationships with grinding wheel suppliers.47


STRATEGIC CONFLICTS INITIATED UPSTREAM BY SUPPLIERS. We consider two conflicts:

• To reach end-user customers more efficiently, the supplier goes direct: Sometimes sup-pliers believe they can be more effective than distributors. They bypass distributors andsell directly to end-user customers; distributors resent these initiatives:

Growth of the Internet for direct-to-end-user customer sales increases the likelihood ofconflict with intermediaries. Schwab and E*Trade successfully provide on-line trading toindividual investors. moneysupermarket and Best Deal Insurance allow insurancecustomers to compare prices and connect directly to their preferred suppliers. But poten-tial distribution conflicts hampered the early efforts of Merrill Lynch and many insurancefirms from doing likewise.

Sometimes suppliers go direct in a limited way that minimises conflict. Firms like Appleand Nike — NikeTown — have their own retail stores. Wholesalers and retailers believeNikeTown and Apple stores enhance these brands, so there is little conflict. Mattel sells awide range of toys and apparel over the Internet, but avoids conflict by never undercut-ting its distributors’ retail prices and not offering some popular items.

• To better penetrate the market, the supplier adds new types of distributors. Supplierssometimes add new types of distributors to address new segments; current distributorsare often unhappy with these initiatives. Hill’s Science Diet pet food experimented with astore-within-a-store pet-shop concept in grocery channels, but lost support from petshops and feed stores.50 By contrast, when Goodyear distributed through mass merchan-disers like Wal-Mart, it kept independent Goodyear dealers happy by working to increasemarket demand for replacement tyres.51

PLANNING FOR POWER CHANGESIn general, the firm is better off improving its power position. If it initiates strategic conflict, itmust assess the likely impact on other channel members. A supplier should predict the impacton distributors and other downstream customers, and anticipate how they may respond. Onechannel member may initiate strategic conflict but nonetheless maintain relationships with theothers. To continue the Norton example: Norton eventually addressed its market share loss atlarge customers by going direct. Distributors were upset, but they remained loyal; they had noviable alternative suppliers. Similarly, major U.S. airlines eliminated travel-agent commissionsand encouraged passengers to purchase on the web. But travel agents have few options and socontinue to sell airline seats. Tables 17.8 and 17.9 show possible actions for upstream suppliersand downstream customers, respectively, to improve their power positions.


British brewer Bass Ale piloted a home-delivery service. Cash-and-carry warehouses and convenience stores that carried Bass Ale’s products feared they would lose business. A leading cash-and-carry firm, Nurdin and Peacock,stopped carrying several Bass beers and encouraged customers to avoid Bass products. Bass abandoned the pilot.49


Type of Action Examples

Improve bargaining • Integrate disparate product lines.52

power

Become central to • Strongly support current products, especially in market downturns where such the distributor’s success support may differentiate the supplier from competitors.

• Hire a sales and marketing group to research end users’ needs, then pass salesopportunities to distributors.

• Develop value-added services such as sales training, field technical support, fieldselling support, inventory control systems and product manuals, both directly andnon-directly related to its own products.53

• Develop joint marketing strategies with distributors.

• Innovate new products and, perhaps more importantly, develop expectations ofcontinuous innovation. Strong supplier relationships assure the distributor of earlyaccess to these innovations.

Raise the distributor’s • Offer benefits to concentrate purchases with the supplier.54

switching costs • Develop customised products needing customised equipment and specialised training.

• Develop dedicated online access for simplified order placing and information.

• Increase the number of contact points within the distributor.

• Work to improve the supplier’s reputation by enhancing the quality of its relationships.

• Work to secure end-user/testing agency qualification by brand, rather than by thegeneric product.

Broaden the scope of the • Develop an information base on end users. Initiate direct communication, for supplier’s options example, by a technical support force or via e-mail.

• Broaden the distribution base by adding distributors.

• Explore limited forward integration by adding a few wholly owned distributors.55

• Demonstrate the folly of backward integration by distributors.

Type of Action Examples

Improve bargaining • Centralise purchasing operations.power

Action at end-user • Add value to end-user customers.customers • Build loyalty with end-user customers.

• Introduce additional services.

• Consider branding service packages.

Action with suppliers • Persuade the supplier to outsource activities to the distributor.

• Work to minimise the supplier’s costs.

• Increase contact points with the supplier.

Broaden the scope of • Secure additional suppliers.distributor options • Explore limited backward integration.

• Show the disadvantages of forward integration by the supplier.


TABLE 17.8ILLUSTRATIVE

ACTIONS TO IMPROVESUPPLIER POWER

TABLE 17.9ILLUSTRATIVE

ACTIONS TO IMPROVEDISTRIBUTOR POWER

� When suppliers attemptto improve their powerpositions, they shouldtry to anticipate theactions of other distribution channelmembers.

KEY IDEA


THE PARTNERSHIP MODELWhen firms exercise power and generate strategic conflict, they assume a zero-sum game; if thefirm wins, another channel member loses, and vice versa. But the partnership model can be apositive-sum game. By developing trust and working together, several channel members win;there are no losers.56

P&G and Wal-Mart have a highly effective distribution partnership. Wal-Mart captures point-of-sale data for P&G products at its stores and transmits these to P&G in real time using state-of-the-art information systems. By combining these data with seasonal purchasing trends, P&Gimproves its forecasts and gains manufacturing, purchasing, and packaging efficiencies; reducesinventory; and cuts costs. For example, P&G codes its products by store destinations and placesthem directly onto Wal-Mart trucks at warehouse interchange points. Full trucks leave fre-quently for store-to-store deliveries.57 The firms also use paperless systems for receiving goodsand managing receivables and payables.58 JC Penney has a similar relationship with Hong Kongshirt maker, TAL Apparel. It sends TAL point-of-sale data from all 1,040 North American stores.TAL forecasts Penney’s requirements and replenishes each Penney’s store, sometimes by air.Penney previously held up to nine months’ inventory.59

By developing partnerships, channel members can establish joint strategic goals like cuttingcosts and reducing supply-chain inventory while limiting stockouts.60 Better forecasting allowsretailers to offer more efficient product sets, do more effective promotions, and eliminate heavydiscounts on unwanted merchandise. By working with retailers, suppliers can achieve lowerproduction and distribution costs and better use promotional funds. Federated DepartmentStores (FDS) used a re-engineering approach to cost-cutting61:

LEGAL ISSUES IN DISTRIBUTIONOther than pricing, distribution issues are more subject to legal concerns than other marketing-mix variables. The legality of various distribution practices varies by industry and geography.What is illegal in one country may be normal business practice elsewhere.62 We provide anintroduction to these issues to provide a general sense for all readers.63 Distribution is the focusof many antitrust lawsuits; violations occur when a firm with market power takes actions thatreduce competition. Offended competitors often file these suits but sometimes the EU and localgovernments initiate legal action — typically the EU Commission and member states’ Officesof Fair Trading.64 Critical issues vary by country but include:

• Price discrimination. Some countries have laws that prohibit suppliers from setting dif-ferent prices for different buyers, where this would reduce competition.

• Resale Price Maintenance (RPM). Suppliers set retail prices for their products. RPM isillegal in most countries, but a 2007 Supreme Court decision allowed for its reestablish-ment in many situations in the U.S.65


FDS’ traditional garment-distribution practice involved several steps:

• At the manufacturer. Make the garment, add a hang tag, press the garment, place it on a wire hanger andcover with polyethylene, put several garments in a box, ship the box to a Federated facility.

• At Federated. Remove the garment from the box, remove the polyethylene, throw out the wire hanger, put thegarment on a floor-ready hanger, put the garment in new polyethylene, add a price tag, place the garment in ashipping container, ship to a Federated store. This activity averaged 20 minutes per box.

FDS improved the process by giving garment producers floor-ready hangers and barcodes for each item. It cut theaverage time to process new inventory from 4.5 days to 2.5 days and significantly reduced working capital.

� The partnership modelis an increasingly popular alternative tothe power/strategicconflict approach.Channel members jointly set goals andwork together forgreater efficiency and effectiveness.

KEY IDEA


• Tying Agreements. Strong suppliers try to force resellers to sell their entire product line.Full-line forcing is illegal if it reduces competition. Overstating the firm’s revenues byoverloading distributors — channel stuffing — can also lead to legal problems.

• Exclusive Territories. In general, the courts look unfavourably on arrangements that givedistributors exclusive territories when this reduces competition.

• Selecting and Terminating Distributors. Generally, suppliers are free to select and termi-nate distributors. See the previous IBM example on page 463.

• National and Local Laws. Many local laws focus on distribution. Some countries andlocal governments tightly regulate alcohol sales — especially type of outlet and openinghours. In some localities, laws prohibit certain types of store from opening on Sundays.In Britain, large supermarkets can only open for six hours on Sundays.


� Distribution laws varyby industry and geogra-phy. What is illegal inone country may benormal business prac-tice in other countries.

� In the U.S., manyantitrust lawsuitsinvolve distributionissues.

KEY IDEA

KEY MESSAGES• A broad view of distribution embraces changes in state, physical location, and time. Marketing

generally takes a narrow view — distribution includes changes in physical location and time.

• Distribution channels continuously evolve; the firm can gain competitive advantage by innovat-ing its distribution arrangements.

• In developing distribution strategy, the supplier firm must make crucial decisions in four areas:• Distribution functions. What exactly must be done in the distribution channel?• Distribution channel: direct or indirect? Should the firm deal directly with consumers

and/or end-user customers? Or should it use intermediaries? If so, which?• Distribution channel breadth. How many intermediaries at each distribution level? For

example, how many wholesalers and/or retailers? Should there be exclusivity?• Criteria for selecting and evaluating intermediaries. How should the firm decide

whether a particular intermediary is appropriate for handling its products?

• Implementing strategy through distributors can be very challenging. The supplier must clarifyeach channel member’s responsibilities, understand potential distributor problems, and takesteps to gain compliance.

• Typically some channel members have more power than others, but each has options toimprove its position. Distributors/wholesalers, manufacturers/brand owners, retailers, and consumers or end-user customers may each be channel captains.

• Operating conflict is endemic, but sometimes firms initiate strategic conflict to improve theirpositions. Many firms are moving to partnership models where each member gains.


ENDNOTES


1 This system replaced an earlier classification based on revenues. Ciscohas a level below Premier called Registered Partner; these firms accountfor a smaller portion of Cisco’s revenues. Developed from interviewswith Cisco executives and data from V.K. Rangan, Transforming YourGo-To-Market Strategy, Boston, MA: Harvard Business School Press,2006.

2 Some observers believe that P&G acquired Gillette to improve its powerposition versus supermarkets.

3 In this chapter, an end-user customer is where the product loses itsidentity; consumers and firms can be end-user customers. Consumeradvertising may push end-user customers down the channel. Previously,end-user customers for microprocessors were PC manufacturers. Theintel inside campaign turned consumers into end-user customers.Sometimes we use the term end user instead of end-user customer.

4 The broad view includes concentration and dispersion. The inputs areconcentrated in Korea, and prefabricated steel beams are dispersed toArgentina (and other customers). Relatedly, natural resources are ran-

domly distributed — meaningless heterogeneity; customers require dis-parate resource bundles — meaningful heterogeneity. All distributionsystems transform meaningless heterogeneity into meaningful hetero-geneity. For example, a New York restaurant serves patrons a delicioussalad of California lettuce, Mexican tomatoes, and Arizona carrots.

5 Many supply chains are now global, in part due to technologicaladvances and reduced trade barriers. Hides from Argentinean cows aretanned in China, sewn into flight jackets in Korea, then sold in Japan.

6 C.B. Bucklin, S.P. DeFalco, J.R. DeVincentis, and J.P. Levis III, “Are YouTough Enough to Manage Your Channels,” The McKinsey Quarterly,(1996), pp. 105–114.

7 The term distribution encompasses all of these functions — the logisticsfunction is about getting the product from A to B.

8 Counteracting this general trend, Apple’s retail stores showcase theMacIntosh, iPod, iTunes, and other products.

QUESTIONS FOR STUDY AND DISCUSSIONCan you answer the questions implied by this chapter’s learning objectives? Check!

1. Your friend operates a highly successful restaurant — focusing on regional specialties — inhis hometown in the Czech Republic. He wants to expand nationally. What are his options and the pros and cons? How would you advise him to proceed? Why? What pitfalls should helook out for?

2. Alasdair MacLean wanted a high-speed bicycle. He gathered information about several bicycles from a department store. He test-rode several models at a local bicycle store. Hebought his favourite model from the manufacturer’s website. Several major department storesand a trade association of local bicycle stores have complained about this behaviour to BikeCo,a leading bicycle manufacturer. How would you advise BikeCo?

3. Germany-based SchmittCo produces a wire harness to protect electric wires in automobiles.SchmittCo sells to a distributor; the distributor sells to CarSup, a Tier-One supplier to globalauto firms. Last year, SchmittCo’s sales to the distributor dropped by 20 percent. SchmittCo dis-covered that the auto firms were demanding local supply in various geographies. CarSup wasdriving compliance; 40 percent of its requirements were now sourced in Asia, hence the drop inSchmittCo’s business. Hansat, one of SchmittCo’s sister business units sold significant quanti-ties of electric wire to CarSup. How should SchmittCo proceed?

4. Refer to the Jco, Playstore, and Disco example on page 469. The retailer, Playstore, told Jco itwould no longer purchase Jco products from the distributor, Disco. Playstore would purchasedirect from Jco or find a new supplier. Disco also distributes products for several of Jco’s sister business units. Playstore owns roughly half its 500 outlets; the others are franchisees.Some franchisees are unhappy with Playstore’s new management, and half have formed anindependent federation. Jco expects the federation to assume greater control of shelf selectionand purchasing. What should Jco do?

5. Select a product in which you are interested, or this book — Managing Marketing in the 21st

Century. What are the key distribution decisions? What actions would you take?


9 Sears eventually dropped its catalogue after 100 years, in the 1990s,when increasing numbers of consumers began shopping online, D.V.Fites, “Make Your Dealers Your Partners,” Harvard Business Review, 74(March-April 1996), pp. 84–95.

10 Going to Market, 9-599-078, Harvard Business School.

11 Many physical distribution functions are irrelevant for distributingservices and/or information products.

12 Aka outbound logistics. In the U.S., drop shipping, where the manufac-turer ships products direct to customers, often in retailers’ packaging,has grown along with direct marketing and the Internet. Sometimesproducts needing repair must be returned — inbound or reverse logis-tics. Annually, suppliers spend $40 billion, handling over $60 billionworth of returned goods like mobile phones; personal communicationto author Capon from John Beystehner, senior VP of Worldwide Salesand Marketing, UPS.

13 Includes data on sales, product availability, product location, invento-ry levels, ownership changes, and financing.

14 Channel members often shift risks associated from the flow of title andfinancing via insurance, warranties, and guarantees.

15 Developing a product range to satisfy customers; especially importantfor wholesalers and retailers.

16 When purchases are difficult and complex, brokers, agents, and advi-sors often provide impartiality.

17 Includes fitting, sizing, shaping, and finishing — also, paint-mixingand product assembly.

18 Discussed in Chapter 18 under the rubric of customer relationshipmanagement.

19 Sometimes direct sales approaches involve pyramid schemes. Sales -people earn commissions on their own sales; they also earn commis-sions on the sales of salespeople they recruit, sometimes ad infinitum.Handtech.com reps earn 10 percent commissions on their sales, halfthe $145 fee of salespeople they recruit, and 2–5 percent of recruits’sales. In the late 1990s, concerns about potential pyramid-schemeabuse led China to ban direct face-to-face consumer sales temporarily.

20 For factors driving the growth of direct marketing, and its pros andcons, see Chapter 15.

21 Franchising does not imply that there is a physical retail outlet.

22 Ford traditionally distributed products through franchised dealershipsbut purchased its Salt Lake City franchises. It developed the first FordSuperstore offering all brands — Ford, Lincoln, Mercury, Mazda, andJaguar.

23 Banco Popular is the largest U.S. Hispanic bank.

24 These customers account for 80 percent of Haiti’s economy. Sogebankis Haiti’s leading commercial bank.

25 Some department stores emphasise the store brand — Kohl’s (U.S.) andMarks & Spencer (Britain). Showcase stores mainly focus on manufac-turers’ brands — vendors are responsible for inventory, staff, and sell-ing space.

26 J.A. Narus and J.C. Anderson, “Rethinking Distribution,” HarvardBusiness Review, 74 (July-August 1996), pp. 112–120.

27 J.D. Hlavacek and T.J. McCuistion, “Industrial Distributors — When,Who and How? Harvard Business Review, 61 (March-April 1983), pp.96–101.

28 Narus and Anderson, op. cit.

29 Ekornes also changed salesperson pay from commission, to salary plusbonus — based on retailer-service, N. Kumar, “The Power of Trust in

Manufacturer-Retailer Relationships,” Harvard Business Review, 74(November-December 1996), pp. 92–106.

30 P.F. Nunes and F.V. Cespedes, “The Customer Has Escaped,” HarvardBusiness Review, 81 (November 2003), pp. 96-105.

31 Coke rejected allegations of abusive practices.

32 From Pegram, Selecting and Evaluating Distributors, reproduced in B.Rosenbloom, Marketing Channels: A Managerial View, 6th ed., FortWorth, TX: Dryden, 1999, pp. 243-247.

33 L.W. Stern and F.D. Sturdivant, “Customer-Driven DistributionSystems,” Harvard Business Review, 65 (July-August 1987), pp. 34–41;V.K. Rangan, A.J. Menzes, and E. Maier, “Channel Selection for NewIndustrial Products: A Framework, Method and Application,” Journalof Marketing, 56 (July 1992), pp. 69–82; V.K. Rangan, DesigningChannels of Distribution, Boston, MA: Harvard Business School, 1994,9-594-116; J.M. Hulbert, Marketing: A Strategic Perspective, Katonah,NY: Impact Publishing, 1985; E. Anderson, G.S. Day, and V.K. Rangan,“Strategic Channel Design,” Sloan Management Review, (Summer1997), pp. 59-69.

34 Factoring firms buy accounts receivable at a discount.

35 F.O.B. (free on board) is the price for goods at the factory/warehouse.C.I.F (carriage, insurance and freight) is the price for goods deliveredto the customer.

36 Atlas Honda Ltd.: Communication Plan 1993; N. Capon and W. VanHonacker, The Asian Marketing Casebook, Singapore: Prentice Hall,1998. Such anti-competitive practices are illegal in many countries.

37 In the U.S., functional-discount structures must be objectively measur-able to ensure they are fair and non-discriminatory. The SupremeCourt condemned discounts that create exclusivity, or promote anti-competitive behaviour. D. A. Balto “Networks and Exclusivity:Antitrust Analysis to Promote Network Competition,” George MasonLaw Review, 7 (Spring 1999), pp. 523–576.

38 For more detail, see B. Rosenbloom, Marketing Channels: AManagement View, 6th ed., Fort Worth, TX: Dryden 1999 and A.Coughlan, E. Anderson, L.W. Stern, and El-Ansary Adel, MarketingChannels, 6th ed., Prentice Hall, 2001.

39 Reproduced with permission from Rosenbloom, op. cit., p. 439.

40 Some suppliers require extensive information on each sale — by prod-uct item, customer, and delivery and billing location.

41 This section benefited from D. Ford, L.E. Gadde, H. Hakansson, A.Lundgren, I. Snehota, P. Turnbull, and D. Wilson, Managing BusinessRelationships, Chichester, UK: Wiley, 1988.

42 A.P. Chandler, Jr., The Visible Hand: The Managerial Revolution inAmerican Business, Cambridge, MA: Harvard University Press, 1977.

43 P. Berthon and J-P. Berthon, “Changing Channels: The Impact of theInternet on Distribution Strategy,” Business Horizons, (March-April1999), pp. 19–28.

44 Amazon.com works with tens of thousands of commissioned affiliatesthat direct traffic to its website.

45 Of course, in this system, mutual fund suppliers no longer have directcontact with investors. A. J. Slywotzky and D. J. Morrison, The ProfitZone, New York: Times Business, 1997.

46 A 2002 Financial Accounting Standards Board (FASB) rule requiredthat manufacturers restate 2001 revenues by subtracting incentive pay-ments from reported sales. This one-time event revealed the size ofthese payments.

47 Norton Company (A) and (B), 9-570-001/2, Harvard Business School.



48 A few years ago, the U.S. had more than 15,000 car dealerships. Today,the top 250 firms sell over 50 percent of industry volume.

49 C.B. Bucklin, P.A. Thomas-Graham, and E.A. Webster, “ChannelConflict: When Is It Dangerous,” The McKinsey Quarterly, (1997), pp.36–43.

50 Bucklin, Thomas-Graham, and Webster, op. cit.

51 Bucklin, Thomas-Graham, and Webster, op. cit.

52 In the U.S., Heinz placed food, pet food, and food service into a singleunit — it improved distribution and secured greater bargaining powerwith retail chains.

53 The Merck Manual comprises 3,000 pages on disorders and suggestedtherapies. Parker Hannifin’s “O-Ring Handbook” helps design engi-neers specify solutions for preventing oil/air system leakage/ Hlavacekand McCuistion, op. cit.

54 Armstrong World Industries offers educational benefits to distributorsthat place 100 percent of their business with Armstrong.

55 This action can give suppliers good data about distributors and theirchallenges and opportunities — hence, the firm can better serve them.It also sends distributors a message about the supplier’s options. Dealerconcentration led Ford and GM to acquire equity positions in someautomobile dealers. Power equipment manufacturer Cummins hasacquired many of its distributors. Global leading producer Claas sellscombine harvesters to farmers through local distributors. In eachmajor country, Claas owns at least one retail outlet to gain first-handexperience of farmers’ problems/needs. H. Simon, Hidden Champions:Lessons from 500 of the World’s Best Unknown Companies, Boston, MA:Harvard Business School Press, 1996.

56 For trust in partnership relationships, see J.C. Anderson and J.A. Narus,“A Model of Distributor Firm and Manufacturing Firm WorkingPartnerships,” Journal of Marketing, 54 (January 1990), pp. 42–58; andKumar, op. cit. See also J. Lewis, Trusted Partners: How Companies BuildMutual Trust and Win Together, New York: Free Press, 1999.

57 This cross-docking system removes the need for Wal-Mart to haveregional warehouses.

58 G. Stalk, P. Evans, and L.E. Shulman, “Competing on Capabilities: TheNew Rules of Corporate Strategy,” Harvard Business Review, 70(March-April 1992), pp. 57–69.

59 See M.L. Fisher, A. Ramam, and A.S. McClelland, “Rocket ScienceRetailing Is Almost Here — Are You Ready?” Harvard Business Review,78 (July-August 2000), pp. 115–124 for a thoughtful article on gettingthe right product in the right place at the right time at the right pricebased on research at Japan-based World Company and Spain-basedZara fashion retailers.

60 The trade-offs in addressing these issues have repeatedly been demon-strated in “beer game” simulations — J.D. Sterman, “ModelingManagerial Behavior: Misperceptions of Feedback in a DynamicDecision Making Experiment,” Management Science, 35 (March 1989),pp. 321–339.

61 M. Hammer and J. Champy, Re-engineering the Corporation: AManifesto for Business Revolution, New York: Harper Business, 1994. Anarrow view of supply-chain management focuses on product flow. Abroad view includes customer relationship management, customerservice management, demand management, order fulfillment, manu-facturing flow management, procurement, product development, com-mercialisation, and returns, M.C. Cooper, D.M. Lambert, J.D. Pagh,“Supply Chain Management: More than a New Name for Logistics,”The International Journal of Logistics Management, 8 (1997), pp. 1–13.

62 This also applies to other areas. The U.S. has strong patent laws thatprotect firms against counterfeiting. Despite WTO agreements, knock-offs and counterfeit products are commonplace in China.

63 For a more in-depth presentation, see Rosenbloom, op. cit. orCoughlin, Stern, and El-Ansary, op. cit.

64 In the U.S., the FTC and DOJ-ATD play these roles.

65 Some firms get around RPM restrictions by using exclusive distributorterritories.



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