Channels of Distribution and Logistics
Chapter 6 Channels of distribution and logistics LEARNING OBJECTIVES By the end of this chapter you will: n n n n omprehend key elements and decisions in distribution channel design be able to evaluate different configurations of channel structure be familiar with recent trends and developments in channels of distribution appreciate the importance of managing the physical flows of products, services and information into, through, and out of the organization to its customers n grasp the meaning and scope of physical distribution and logistics management n be aware of developments and trends in production and manufacturing, particularly the growth of ‘lean manufacturing’ and implications for logistics n recognize the role of Information Technology and marketing in logistics Channels of distribution and logistics 191 INTRODUCTION
This chapter deals with the ‘place’ element of marketing strategy (i. e. ‘placement’ of goods and services from their respective providers into the hands of customers).
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Before we discuss the structure of marketing channels, followed by logistics, it is useful that we look at their emergence and the functions that channels perform. THE CONSUMER WANTS CYCLE The word ‘channel’ has its origins in the word for canal, which for marketing can be interpreted as a route taken by products as they flow from production to points of intermediate and final use. Marketing is a key factor in a continuous cycle that begins and ends with consumer wants. It is the role of he marketer to interpret consumer wants and combine them with empirical market data such as location of consumers, their numbers and preferences, to establish the starting point for manufacture. On completion of manufacture, the finished product is moved to the consumer and the cycle is complete when he or she obtains satisfaction resulting from product ownership. THE PRODUCER–USER GAP Despite the growth of direct marketing (to be discussed in Chapter 10) in today’s complex economy, most producers still do not sell directly to final users. Between them and consumers lie marketing intermediaries. A distribution channel bridges the gap between user and producer, and so plays an integral role in the operation of the marketing concept. Relationships among channel members are influenced by the structure of the channel.
Marketing channels can be described as sets of interdependent organizations involved in the process of making a product or service available for use or consumption. DEMAND STIMULUS In addition to marketing channels satisfying demand by supplying goods and services in the right location, at the correct quantity and price, they should stimulate demand through promotional activities of retailers, manufacturers and wholesalers. In this way, a marketing channel should be 192 Channels of distribution and logistics viewed not just as a demand satisfier, but as an orchestrated network that creates value for consumers through the generation of form, possession, time and place utilities.
We start by examining ways in which distribution systems are designed and how channel policy is determined, depending on the degree of market exposure sought by a company. DISTRIBUTION SYSTEM DESIGN The starting point for marketing channel design is the end consumer. Although an understanding of consumer purchasing patterns is essential, there are other factors that influence channel organization: n n n n n There may be a restriction in choice of outlets available to suppliers, e. g. retail outlets may already have been secured by established manufacturers. Channel design will be influenced by the number, size and geographic concentration of consumers.
If customers are few in number, but large and geographically concentrated, it may be that direct channels will be suitable. If customers are dispersed, the mechanics of direct channels become increasingly difficult and there will be a need for a large number of intermediaries. Product characteristics affect channel design. Industrial goods manufacturers tend to use direct channels, but there are other factors that influence the decision. Perishable goods, for example, need to be turned over quickly so direct methods are often applied. Non-perishable, non-bulky goods can be handled via indirect channels. Some products are more suited to indirect channels because of environmental characteristics.
For example, in some countries shopping is seen very much as being a leisure activity especially for items like clothing and furniture, so much so that companies such as the Swedish company IKEA have made this a central part of their business model. Some organizations have limited discretion over marketing channel choice owing to economic conditions and legal restrictions. In certain of the Eastern European and Baltic countries such as Estonia, Latvia and Uzbekistan there is still restricted choice in terms of the range and scope of retail outlets for marketers. Any channel decision will have long-term implications for the company, e. g. price will be affected depending on the number of levels between the manufacturer and the end user.
A decision to change channels is likely be long term so it is important that existing channel structures are constantly reviewed to exploit opportunities. STRATEGIC CHANNEL CHOICES An important consideration when formulating channel policy is the degree of market exposure sought by the company. Choices available include: Channels of distribution and logistics 193 n n n Intensive distribution where products are placed in as many outlets as possible. This is most common when customers purchase goods frequently, e. g. household goods such as detergents or toothpaste. Wide exposure gives customers many opportunities to buy and the image of the outlet is not important.
The aim is to achieve maximum coverage. Selective distribution where products are placed in a more limited number of outlets in defined geographic areas. Instead of widespread exposure, selective distribution seeks to show products in the most promising or profitable outlets, e. g. high-end ‘designer’ clothes. Exclusive distribution where products are placed in one outlet in a specific area. This brings about a stronger partnership between seller and re-seller and results in strong bonds of loyalty. Part of the agreement usually requires the dealer not to carry competing lines, and the result is a more aggressive selling effort by the distributor of the company’s products, e.g. n exclusive franchise to sell a vehicle brand in a specific geographical area, in return for which the franchisee agrees to supply an appropriate after sales service back-up. We can see that there are several key decisions to make when determining the company’s distribution system. Its importance is underlined by the fact that the choice of distribution channel has an effect on all elements of the marketing mix and these are long term. TYPES AND CLASSIFICATION OF CHANNELS Marketing channels can be characterized according to the number of channel levels. Each institution that works to bring the product to the point of consumption is included. The number of intermediaries involved in channel operation determines on how many levels it operates.
There are four main types of channel level in consumer markets as shown in Figure 6. 1. The first three levels (zero, one and two) are self explanatory. The three level channel includes a ‘jobber’, or merchant Zero level channel manufacturer Consumer One level channel manufacturer Retailer Consumer Two level channel manufacturer Wholesaler Retailer Consumer Three level channel manufacturer FIGURE 6. 1 Wholesaler Jobber Retailer Consumer Channel relationships 194 Channels of distribution and logistics wholesaler who intervenes between the wholesaler and retailer. It is the jobber’s role to buy from wholesalers and sell to smaller retailers, who are not usually serviced by larger wholesalers.
Within each channel, intermediaries are connected by three types of flow: 1 Physical flow describes movement of goods from raw material that is processed in various stages of manufacture until it reaches the final consumer. In the case of a towel manufacturer raw material is cotton yarn which flows from the grower via transporters to the manufacturer’s warehouses and plants. Title flow is the passage of ownership from one channel institution to another; when manufacturing towels, title to raw materials passes from the supplier to the manufacturer. Ownership of finished towels passes from manufacturer to the wholesaler or retailer and then to the final consumer. Information flow involves the directed flow of influence from activities such as advertising, personal selling, sales promotion and publicity from one member to other members in the system.
Manufacturers of towels direct promotion, and information flows to retailers or wholesalers, known as trade promotion. This type of activity may also be directed to end consumers, i. e. ‘end user’ promotion. 2 3 Conventional marketing channels comprise autonomous business units, each performing a defined set of marketing functions. Co-ordination among channel members is through the bargaining process. Membership of the channel is relatively easy, loyalty is low and this type of network tends to be unstable. Members rarely co-operate with each member working independently of others. Decision makers are more concerned with cost and investment relationships at a single stage of the marketing process and tend to be committed to established working practices.
Most food grocery products in the European Union are marketed through conventional marketing channels; independent food and grocery producers are responsible for growing, rearing and manufacturing products and brands. These are sold through a series of wholesalers and retailers such as Sainsbury’s, Aldi, Lidl, Tesco or Carrefour each operating as independent businesses in the chain and selling to their own customers. Vertical marketing systems are in contrast to conventional channels where members co-ordinate activities between different levels of the channel to reach a desired target market. The essential feature is that participants acknowledge and desire interdependence, and view it as being in their best longterm interests.
For the channel to function as a vertical marketing system, one of the member firms must be acknowledged as the leader; typically the dominant firm, which can be expected to take a significant risk position and usually has the greatest relative power within the channel. An example of a vertical marketing system is that of franchising. The franchiser, usually on the basis of having a powerful brand or perhaps a patent/copyright, for a fee, allows franchisees to produce or distribute the product or service. The franchiser effectively controls the channel, including aspects such as product ingredients, advertising and marketing, pricing, etc. through formal and legally enforceable agreements. Franchising is an example of what are termed contractual vertical marketing systems which we consider again shortly.
Corporate vertical marketing is when a company owns two or more traditional levels of the channel. In many economies corporate vertical channels have arisen as a result of a desire for growth on the part of companies through vertical integration. Two types of vertical integration are possible with respect Channels of distribution and logistics 195 to the direction within which the vertical integration moves a company in the supply chain: when a manufacturer buys, say, a retail chain, this is referred to as forward integration with respect to the chain. Backward integration is moving upstream in the supply chain, e. g. when a retailer invests in manufacturing or a manufacturer invests in a raw material source.
Although the end result of such movements is a corporate vertical marketing channel, often the stimulus to such movement is less to do with channel economies and efficiencies, and more with control over access to supply or demand, entry into a profitable business or overall scale and operating economies. Much vertical integration activity which took place during the 1990s in many economies resulted in lower overall profitability levels, and in some cases, the demise of companies involved, as companies overextended themselves and/or moved into areas where they had little expertise. Because of this, many companies have now turned their attention towards contractual systems for achieving growth and more control through the vertical marketing system.
Many of the large oil companies are examples of corporate vertical marketing. They prospect for oil, extract it, process it, distribute and retail it through their petrol stations. Other companies operate partial corporate vertical marketing systems in that they integrate only one way. Zara (the clothing retailer) is integrated vertically backward with manufacturing facilities. Firestone (the tyre manufacturer) on the other hand, is vertically integrated forward owning its own tyre retailers. Many companies formalize their obligations within channel networks by employing legitimate power as a means of control achieved by using contractual agreements.
Nearly all transactions between businesses are covered by some form of contract, and as such the contractual agreement determines the marketing roles of each party within the contract. Indeed, the locus of authority usually lies with individual members. The most common form of contractual agreement are franchises and voluntary and co-operative groups. Franchises are where the parent company grants an individual person or relatively small company the right or privilege to do business in a prescribed manner over a certain time period in a specified place. The parent company is referred to as the franchiser (or franchisor) and may occupy any position in the channel network. The franchise retailer is termed the franchisee.
There are four basic types of franchise system: n n n n Manufacturer/retailer franchise, e. g. service stations where most of the garage petrol stations such as Shell and Esso are franchisees of the large oil exploration and refining companies. Manufacturer/wholesaler franchise: e. g. Coca-Cola sell drinks they manufacture to franchised wholesalers, who in turn bottle and distribute soft drinks to retailers. This type of arrangement is common in the food and drinks markets with many of the large companies franchising part of their manufacturing and or wholesaling activities to others. The wholesaler/retailer franchise. Many retail chains are franchisees of large wholesalers.
These wholesalers saw the value of securing a measure of control, and of course a share of the retail profits, from marketing their products and brands. The most notable example is ‘Spar’ which advertises itself as ‘Spar, your 8. 00 till late shop’, and of course all retail members must abide by this promise. The service/sponsor retailer franchise e. g. McDonald’s, Kentucky Fried Chicken, Subway, Car Rental companies like Avis and Hertz and services like DynoRod and Prontaprint. This is the best known and certainly most ubiquitous of franchising arrangements and it has enabled many organizations to rapidly expand their global operations. 196 Channels of distribution and logistics There are different types of franchise arrangement, e. g.
McDonald’s insists that franchisees purchase from official suppliers; they provide building and design specifications, help locate finance for franchisees and impose quality standards to which each unit must adhere in order to hold its franchise. Rigorous inspection through ‘secret shoppers’ (explained in Chapter 12) ensures franchise ‘rules’ are being obeyed. Franchises share a set of common features and operating procedures: 1 2 3 4 A franchise essentially sells a nationally, or internationally, recognized trade name, process, or business format to the franchisee. The franchiser normally offers expert advice e. g. location selection, capitalization, operation and marketing. Most franchises operate a central purchasing system at national or international level to enable cost savings to be made at the individual franchise level.
The franchise is subject to a contract binding both parties that normally requires the franchisee to pay a franchise fee and royalty fees to the franchiser, but the franchisee owns the business as opposed to being employed. The franchiser often provides initial and continuous training to the franchisee. 5 Contractual vertical marketing systems like franchising have been one of the fastest growing areas of marketing and distribution. Substantial advantages derive from the franchising system. From a system that essentially involves two independent parties voluntarily agreeing to contract with each other, advantages accrue to both the franchisee and franchiser. Advantages to the franchisee are: n n n n n n The franchisee gains the benefit of being able to sell a well-known product or service which has been market tested and known to work.
The franchisee enjoys access to the knowledge, experience, reputation and image of the franchiser. Because of this the franchisee is able to enter a business much more easily than setting up from scratch. The learning curve is shortened, expensive mistakes can be avoided, and there is less chance of business failure. Although the franchisee has the backing of what is often the large organization of the franchiser, the franchisee is still essentially an independent business with all that this implies for motivation to succeed. The franchisee is often helped by national or international advertising and promotion by the franchiser which would be beyond the means of a small independent business.
The franchisee enjoys the use of the franchiser’s trademark, continuous research and development and market information. The franchiser will normally provide a system of management controls such as accountancy, sales and stock control procedures. Advantages to the franchiser are: n Finding and recruiting a network of franchisees enables rapid growth as wider distribution can be achieved with less capital. Channels of distribution and logistics 197 n n n n The individual franchisee is more motivated than a hired manager might be. The franchiser secures captive outlets for products or services, especially in the case of trade name franchising and private labels. Franchise and royalty fees provide a regular stream of income for the franchiser.
The terms of the franchise contract normally give the franchiser substantial control over how the franchise is operated and normally the franchiser can terminate a contract should the relationship turn out to be unsatisfactory. The costs of such terminations are likely to be less than if the franchiser was operating a corporate owned facility with staff on the payroll. Normally, terms and restrictions on location and sale of the business by the franchisee ensure that the franchiser is able to maintain territorial exclusivity for its franchisees. There are disadvantages, but the franchise relationship combines the strengths of both small and large scale businesses. The franchisee is the small business person who is able to respond to local market conditions and offer personal services to customers.
The franchiser passes on economies of scale in national advertising and bulk purchasing. For a franchise to be successful both parties need to work towards a common goal and avoid conflicts which requires frequent and open communication between partners if the system is to meet changing market conditions while maintaining its integrity. What constitutes the main disadvantages of franchising depends from whose perspective we are looking; the franchisee or the franchiser. The main disadvantages of franchising from each perspective are: Disadvantages to franchiser: n The franchiser loses some control over the provision and marketing of the brand. Poor service on the part of the franchisee can result in problems for brand image. Ideas and techniques can be copied even if seemingly well protected by patents and copyright arrangements. n Some proportion of profit has to be foregone. n There may be less commitment and enthusiasm from the franchisee. n Often franchisees lack business skills or experience. Disadvantages to the franchisee: n lack of support from franchiser; n franchiser may go out of business; n lack of flexibility/scope to use initiative; n close control from franchiser. Franchising is not solely confined to consumer products like fast food. It is used for a wide range of products and services in both consumer and industrial markets. Voluntary and co-operative groups emerged in the 1930s as a response to competition from chain stores.
The scope of co-operative effort has expanded from concentrated buying power to the development of programmes involving centralized consumer advertising and promotion, store location and layout, financing, accounting and a package of support services. 198 Channels of distribution and logistics Generally, wholesale sponsored voluntary groups have been more effective competitors than retail sponsored co-operative groups. Primarily this is because of the difference in channel organization between the two. In the former, a wholesaler can provide strong leadership, because it represents the locus of power within the voluntary system and this is normally supported by a brand name like ‘Spar’.
In the latter, power is diffused throughout the retail membership and role specification and allocation of resources are more difficult to accomplish. The principal purpose here is in bulk purchasing. In voluntary groups, retail members have relinquished some of their autonomy by making themselves highly dependent on specific wholesalers for expertise. In retail co-operative chains, individuals retain more autonomy and this tends to depend much less strongly on the supply unit for assistance and direction. This type of organization is not to be confused with the Co-operative movement that was founded in 1844 by the Rochdale, Lancashire, Society of Equitable Pioneers who were a group of 28 weavers and other workers.
As mechanization of the Industrial Revolution pushed more and more skilled workers into poverty, tradesmen banded together to open their own store selling items they could not otherwise afford. Over four months they pooled together ? 28 of capital. They opened their store with a basic selection of dry goods and foodstuffs and quickly moved into higher quality unadulterated produce. They devised the internationally famous Rochdale Principles: 1 2 3 4 5 6 7 open membership; democratic control (one person, one vote); distribution of surplus in proportion to trade; payment of limited interest on capital; political and religious neutrality; cash trading (no credit); promotion of education.
Administered vertical marketing systems (VMS) do not have the formal arrangements of a contractual system or the clarity of power dependence of a corporate system. It is a co-ordinated system of distribution channel organization in which the flow of products from the producer to the end user is controlled by the power and size of one member of the channel system rather than by common ownership or contractual ties. Member organizations acknowledge the existence of dependence and adhere to the leadership of the dominant firm, which may operate at any level in the channel. Large retail organizations like Marks & Spencer typify this system. In administered systems like Marks & Spencer, units can exist with disparate goals, but there is informal collaboration on inclusive goals.
Decision making occurs by virtue of interaction between channel members in the absence of a formal inclusive structure. However, the locus of authority still remains with individual channel members. As in conventional channels commitment is selforiented and there is a minimum amount of system-wide orientation among the members. As McCammon1 observes: Manufacturing organizations . . . have historically relied on administrative expertise to coordinate reseller marketing efforts. Suppliers with dominant brands have predictably experienced the least difficulty in securing strong trade support, but many manufacturers with Channels of distribution and logistics 199 fringe’ items have been able to elicit reseller co-operation through the use of liberal distribution policies that take the form of attractive discounts, financial assistance, and various types of concessions that protect resellers from one or more of the risks of doing business. An example of a successful administered VMS in is that of the furniture/lifestyle retailer, IKEA who has developed close working relationships with its suppliers. Acting as the channel co-ordinator, IKEA is committed to cost-effective supply and their suppliers benefit from the channel leadership of an effective and marketing-oriented retailer. Administered VMS are one step removed from conventional marketing channels. In an administered system, co-ordination of marketing activities is achieved by the use of programmes developed by one or a limited number of firms.
Successful administered systems are conventional channels in which the principles of effective inter-organizational management have been correctly applied. Before we discuss how such marketing channels are co-ordinated, it is important that we discuss their structure. STRUCTURE OF MARKETING CHANNELS The marketing channel has two basic aspects: 1 2 the placement of intermediary types of channel in relation to each other i. e. the order in which they occur; the number of different intermediary levels or stages in the channel i. e. how many different separate types of intermediary are involved, so types of intermediary and number of levels determine the structure of a marketing channel. There are several types of channel structure, dependent on the type of goods.
An example of a structure for consumer goods such as food and clothing is shown in Figure 6. 2. This figure is based on three assumptions: 1 2 3 The channel consists of complete organizations. Manufacturers’ agents and selling agents are included with the merchants even though they do not take title to the goods. Physical movement follows exactly the movement of ownership. We must understand the underlying reasons for the emergence of channel structures. Four logical steps can be identified: 1 2 3 4 The efficiency of the process can be increased via an intermediary. Channel intermediaries arise to adjust the discrepancy of assortments through the performance of the sorting processes.
Marketing agencies remain together in channel arrangements to provide the routine of transactions. Channels exist to facilitate deliveries and to avoid inventory stock-outs. 200 Channels of distribution and logistics 1 M 2 M 3 M 4 M 5 M 6 M 7 M 8 M 9 M C W R A R W W A C W W C R W W W C C C R C R C R C R C M = Manufacturer W = Wholesaler A = Agent (sells for manufacturers) R = Retailer C = Consumer FIGURE 6. 2 A typical example of structure for consumer goods Rationale for intermediaries As numbers of transactions increase, the need for intermediaries becomes greater. The marketing channel is a ‘canal’ which contains the physical flow of products.
Because of the complex array of intermediaries operating within a channel, which may be involved in one or all aspects of channel function, the channel may also be visualized as a chain-link arrangement where each intermediary unit is effectively a link. Manufacturers are dependent on the effectiveness of their intermediaries if their channels of distribution are to meet their marketing goals. Intermediaries of a channel specialize in more than one function. Their inclusion primarily depends on their superior efficiency in the performance of basic marketing tasks. Such intermediaries, through their experience, specialization, contacts and scale of operation, offer other channel members more than they can achieve on their own. However, this type of specialization leads to some important behavioural concepts. Position and role Each channel member chooses a position or location in the channel. Role’ refers to the functions and degree of performance expected of the firm filling a position. Channel intermediaries perform the distribution function at a lower unit cost than the manufacturer who is the intermediary most distanced from the consumer, and they balance the production efficiencies of the supplier to the purchasing needs of the customer. Another reason is to break down large volumes into smaller quantities, termed ‘breaking bulk’, e. g. a furniture retailer places an order for 100 tables, but the individual buys only one. When we consider the selling process, the number of intermediaries can reduce the number of transactions Channels of distribution and logistics 201 ontained within the selling process. See Figure 6. 3. Figure 6. 3 shows that there are four manufacturers and ten retailers who buy goods from each manufacturer. Here the number of contact lines amounts to 40 (i. e. 4 10). If all four manufacturers sell to 10 retailers through one intermediary, the number of contacts is reduced to 14 (i. e. 4 10). The number of contacts increases as the number of intermediaries increases, e. g. when the number of wholesalers is increased to 2, contacts will increase from 14 to 28 (i. e. [4 2] [10 2]). Thus, greater numbers of intermediaries result in diminishing returns per contact. (a) Selling directly Manufacturers
Retailers 40 contact lines (b) Selling through one wholesaler Manufacturers Wholesaler Retailers 14 contact lines (c) Selling through two wholesalers Manufacturers Wholesalers Retailers 28 contact lines FIGURE 6. 3 The economics of intermediary systems 202 Channels of distribution and logistics Assortment and sorting In addition to increasing the efficiency of transactions, intermediaries smooth the flow of goods and services by creating what economists refer to as ‘possession’, ‘place’ and ‘time’ utilities. This smoothing requires that intermediaries perform a sorting function to overcome the discrepancy that arises between goods produced by manufacturers and goods demanded by the consumer.
In addition, intermediaries bring together a range of similar or related items into a large stock, thus facilitating the buying process. A supermarket will buy in thousands of lines to provide shoppers with choice, and a builders’ merchant will provide everything from sand and gravel to light fittings that the builder can use. In this way, intermediaries play an important role in facilitating the flow of products from the manufacturer to the consumer. Routine transactions The cost of distribution can be minimized if transactions are routinized. In effect, through routinization, a sequence of marketing agencies is able to hang together in a channel arrangement or structure.
A good example is automatic ordering, whereby the cost of placing orders is reduced when retail inventory levels reach the necessary re-order point. Searching Buyers and sellers are often engaged in similar activities within the marketplace. There is a degree of uncertainty if manufacturers are unsure of customer wants and needs, and consumers are not always sure what they will find. In this respect, marketing channels facilitate the searching process in two ways: 1 2 Wholesale and retail institutions are organized by different product groups; for example, fashion, hardware, grocery. Many products are widely available from wide ranging locations. FLOWS IN MARKETING CHANNELS
When we discuss marketing flows, there will be times when the word ‘function’ could be used, but here we refer to marketing ‘flows’ in channels as a better method of describing movement. In this way, we can show that various intermediaries that make up a marketing channel are connected by several distinguishable types of flow, summarized in Figure 6. 4, which depicts eight universal flows. The figure shows that physical possession, ownership and promotion are typically forward flows from producer to consumer. Each of these moves is ‘down’ the channel; a manufacturer promotes the product to a wholesaler, who in turn promotes it to a retailer, and so on. Negotiation, financing and risking flows move in both directions, whereas ordering and payment are backward flows.
Financing is the most important of these flows; at any one time, when stocks are being held by one member of the channel, financing is in operation. When a wholesaler takes ownership and physical Channels of distribution and logistics 203 Physical possession Ownership Promotion Producers Retailers Negotiation Financing Rising Ordering Payment Wholesalers Customers: household and industrial FIGURE 6. 4 Marketing flows in channels Woolly Thinking Under the auspices of the Confederation of British Wool Textiles (CBWT), groups of British wool textile manufacturers exchange information and ideas. The Confederation is organized into distinct groups in the industry with each group representing a particular stage in the manufacturing and processing of wool.
For example, there is a group representing ‘Raw Fibre Producers’, another representing ‘Spinners’, another representing ‘Fabric Manufacturers’ and one representing the interests of ‘Dyers and Finishers’. possession of a portion of the output of a manufacturer, the wholesaler is essentially financing the manufacturer. This notion is apparent if the costs of stock are considered. Stock held in stores as dormant stock is ‘dead money’, but if this is freed via a wholesaler, this ‘dead money’ is available for reinvestment. The furniture industry exemplifies the flow. Traditional furniture retailers operating on a sold-order basis do not participate in the backward financing flow.
However, ‘warehouse type’ furniture retailers participate in this flow directly, and receive benefits from manufacturers in the form of lower prices and preferential treatment. This backward flow of financing is not solely associated with stockholding, another example being prepayment for merchandise. The problem is that in the event of any downturn in sales the warehouse type retailer with large sums of money tied up in stock is very vulnerable to cash flow and liquidity problems. To underline this, blaming the downturn in the UK housing market in July 2009, the UK’s second largest carpet retailer, Allied Carpets, called in the receiver. 204
Channels of distribution and logistics Forward flow of financing is more common. All terms of sale, with the exception of cash on delivery and prepayment, may be viewed as elements of the forward flow of financing. In addition to these flows there is information flow. Typically, information regarding product attributes is passed ‘down’ the channel, often with the dominant channel member having greater influence on this function. Marketing information is passed ‘back’ up the channels. In addition, information flows horizontally, i. e. with intermediaries operating at the same level, such as fibre manufacturers, communicating for mutual benefit.
CHANNEL CO-ORDINATION However well designed a marketing channel may be it is important that it is organized and coordinated, otherwise activities and flows will not operate effectively, and the full potential of the system will not be realized. Emphasis should be placed on understanding behavioural dimensions of inter-organizational relationships, because through such understanding, the manager can organize, manipulate and exploit available resources. The long-term objective of channel management is to achieve, at a reasonable cost, the greatest possible impact at the end user level, so that individual members of the channel can obtain satisfactory returns (e. g. rofits, market share) as compensation for their specific contributions. The behaviour of intermediaries within any given structural arrangement should thus be directed towards achieving high yield performance. Once the marketing management of an organization isolates the market targets to attack, and the products and services which it must supply in order to satisfy needs and wants in those various segments, the question of how best to make products and services available for consumption arises. Figure 6. 5 identifies four major steps that represent the co-ordination process. The first step is to determine the level of service outputs demanded by end users of the commercial channel system.
Service outputs that are among the most significant in distribution are, for example, lot size. Some companies insist on a minimum order level. Under this limit they will not accept the order. In contrast, often smaller companies are unable or unwilling to supply orders over a certain size. A second type of service output is delivery or waiting time, or how long it takes from order to delivery. A third service output relates to market decentralization or spatial convenience, namely, to where the provider will deliver. For example, some suppliers will only deliver locally whereas at the other extreme some will undertake to deliver anywhere in the world. Finally, there is breadth and depth of product or service assortment.
This refers to whether or not the provider is able to supply a full range of products and services or only a selected range, i. e. a ‘one -stop shopping’ facility. The second step involves identifying the marketing tasks that need to be carried out in order to achieve the service outputs, and which channel members have the capability to perform the tasks. Management must then determine whether, through the use of channel control strategies, they will be able to control the behaviour of existing channel members or be compelled to integrate channel flow vertically so the required service outputs are provided to end users. Channels of distribution and logistics 205 Step 1 Determine service output levels required by customers
Step 2 Analyse the roles which channel members must perform to assure delivery of the required service outputs Step 3 Use economic and other power bases to motivate channel members to carry out their assigned roles Step 4 Devise mechanisms for dealing with conflicts that occur within the channel FIGURE 6. 5 Stages in the channel co-ordination process For example, if a desired level of service output is that orders must be fulfilled within five working days then the channel and logistics system must be designed to reach this service level. If intermediaries in the channel are unwilling or unable to meet this service output then alternative channel arrangements must be found.
Without effective channel management and control there is no guarantee that the desired service outcomes will be achieved, so a major issue in channel management relates to where, and to what extent, marketing flow participation should be assumed to generate the desired service outputs; e. g. if a car buyer needs finance, the manufacturer, the retailer or an outside intermediary should provide it, but lending services must be readily available if the consumer is going to feel comfortable in considering a specific purchase that requires finance. In a situation where no channel intermediary is willing to accept the risk of financing, the initial supplier may have to assume this, i. e. it would prefer to specialize in those flows that it can perform at a comparative advantage.
The third step in the co-ordinative process is to determine which strategies should be used to achieve the desired results, irrespective of whether management decides to invest in integrating functions or whether it deals with independent companies. Essentially this is an issue of where and how ‘power’ is applied in the channel. Power is the ability to get somebody to do a task. In the context of a marketing channel it can be defined in terms of how one channel member can exert influence on another channel member. For example, due to their size and purchasing power, many retail multiples in the UK like Marks & Spencer are able to exercise substantial power over their suppliers.
Power is the mechanism by which congruent and effective roles become specified, roles become realigned when necessary, and appropriate role performance is enforced. There are several bases of power, which include reward, coercion and expertise. 206 Channels of distribution and logistics The fourth step involves setting up mechanisms to deal with conflict issues that may arise so that the channel will continue to provide the desired service outputs even if channel members disagree. Very often channel members perform unique roles. Thus, manufacturers specialize in production and national promotions, while retailers specialize in merchandising, distribution and promotion at a local level. This specialization means that channel members become reliant on each other to achieve objectives.
There has to be co-operation between channel members, as without it, the task will not be completed. Such co-operation does not always come easy and needs to be cultivated. CHANNEL CONFLICT There is a danger that there will be conflicts of interest and distribution channels will exhibit levels of conflict. For example, suppliers may want to deliver weekly to a retailer, but the retailer wants to hold less stock, so may want daily deliveries. Ideally, channel members should attempt to coordinate their objectives, plans and activities with other intermediaries such that performance of the total distribution system to which they belong is enhanced.
Evidence supports the view that such integrated activity throughout the length of the marketing channel is rare and channel participants are not too concerned with transactions that occur between each of the various channel links. Channel intermediaries are more concerned about dealings between channel members immediately adjacent to themselves, from whom they buy, and to whom they sell. Channel intermediaries do not function as component members of a distribution system, but operate independently, making decisions concerning their own methods of operation, functions performed and clients served as well as deciding their own objectives, policies and programmes.
Therefore, a marketing channel should be a set of interlocking and mutually dependent elements and it is in the interests of all channel members for there to be a substantial degree of co-operation, but an almost inevitable feature is potential conflict between members which should be taken into account when making channel arrangements. It is possible that healthy competition can lead to conflict and management should seek ways to reduce this conflict. Conflict in distribution channels can occur in different forms as follows: 1 2 Horizontal conflict – is related to competition among similar types of intermediaries at the same level in the channel – e. g. two household textile stores in competition with each another.
Intertype conflict – refers to competition among different types of intermediaries at the same level in the channel. This kind of competition has intensified since the advent of ‘scrambled merchandising’ by retailers (where retailers add new product lines that are unrelated to their normal lines of business) e. g. supermarkets have added homewares and clothing to their product lines, offering consumers a wider product range and attaining higher margins. Intertype conflict is significant as it reflects a way in which industries remain efficient and respond to changing market conditions. Vertical conflict – refers to competition among different levels in a channel.
Such problems can be damaging to existing co-operative relationships e. g. in recent years some of the major car producers have been in conflict with their distributors over matters like pricing and discount policies, stockholding levels and exclusivity agreements. 3 Channels of distribution and logistics 207 Stress and conflict can be in a dormant state; times of change cause existing stress to peak, leading to hostility among channel members. Some conflict is inevitable in channels and may even be positive in that it can prompt needed changes. The earlier example regarding retailers selling manufacturers’ brands at lower prices than manufacturers wish is an example of vertical conflict.
Selling of brands like Levis and Calvin Klein at prices lower than those recommended by manufacturers has given rise to vertical conflict in the channel. Other examples of this type of conflict in the UK recently have been the selling of discounted books and discounted pharmaceutical products by the large retail supermarket groups. Goal incompatibility Channel members appear to share a common goal – maximizing the efficiency and effectiveness of the total system. However, each firm exists as a separate legal entity, each with its own employees, owners and other interested parties who help shape its goals and strategies. Some firms’ goals may be incompatible with the aims and objectives of other channel members.
This incompatibility can be a primary cause of stress which will ultimately result in conflict. The distribution of channel profits is a typical example. Each institution will desire the highest possible profit for the whole channel and the natural tendency will be towards co-operation to achieve maximum profit levels. However, each individual firm can be expected to desire the largest obtainable share of total channel profits. The predictable result is conflict over the allocation process. Even if goals are compatible, there may be disagreements about methods employed: all channel members may agree that increases in volume of a product are desirable, but may disagree on the means employed to accomplish it.
Wholesalers may desire more shelf space for better positioning of products in retail stores; retailers may feel that more advertising and promotional effort by the manufacturer would accomplish the objective of an increase in sales. The result is conflict over which method to use. Position, role and domain incongruence In a channel consisting of a manufacturer using only wholesalers who sell to retailers, there will be a realignment of the roles and domains of each party. By serving large retailers direct, positions will be re-specified. Changes in position specification, or poorly defined positions, can precipitate conflict among channel members, so the manufacturer must anticipate and understand the expected behaviour of such members. In situations where consensus does not exist, conflict can be expected.
Because each role represents a code of conduct defining the channel member’s expected contribution, adequate performance is critical to maintaining harmony within the channel system. Inadequate performance, or failure to behave in the prescribed manner, frustrates attempts by one firm to predict what the other will do and such frustration is a major cause of channel conflict. Conflict may also arise when there is lack of agreement concerning who is the channel leader (termed the ‘channel captain’). If channel members disagree on the domain of firms in the system, there will be conflict and an inability to achieve goals. If domains overlap, and two or more firms lay claim to the same functions, products or customers, disagreement might lead to hostility.
The conflict between car producers and their distributors just described, in part stems from the issue of 208 Channels of distribution and logistics who controls the channel. In the past it has been the car companies who have been channel captains but market and legislative changes have shifted the balance more towards distributors, giving rise to conflict. Communication breakdown Communication breakdowns may cause conflict in two ways: 1 The failure of one firm to pass on vital information to other channel members. A manufacturer wishing to maintain a competitive advantage may decide not to announce a new product until a national distribution programme has been developed.
Retailers, on the other hand, need information about new products as soon as possible to prepare their own strategy for the introductory period. Distortion within the message process is called ‘noise’ that often arises from confused language nuances. When channel members attach different meanings to language and terminology (e. g. if their roles are unclear and confused) stress results and there is potential for conflict. Speculation surrounding the health of Apple boss Steve Jobs caused problems for the company and its distributors. In January 2009 the annual MacWorld conference normally used to announce new products and developments was cancelled.
This caused speculation in the trade about whether or not Jobs would continue. The problem was not so much Jobs’ illness bur rather the rumours about it. In July 2009 it was announced that Jobs was making a good recovery from a liver transplant. 2 Communication breakdowns are common in specialist business areas. Noise arises when functional specialists develop terminology that means little to those outside that business environment. Unclear communication with non-specialists can play a part in developing conflict so the specialist should ensure that communications have been understood. Differing perceptions of reality Different solutions to mutual problems can lead to confliction behaviour.
Even when channel members have a strong desire to co-operate and goal agreement exists, conflict can occur when perceptions of the real facts differ. Bare Bellies Update Dear all, further to my e-mail yesterday, I’ve had clarification that a new system for producing bare belly information will be in place. Please note there will no longer be blank bare belly sheets available in departments. Confused? So was this organization’s staff who received this e-mail. The e-mail was from the organization’s publicity department and was sent to all staff. ‘Bare bellies’ is a term used by printers to denote blank sheets to be printed on. The e-mail related to the production of company promotional material. Channels of distribution and logistics 209
Each channel member brings to the relationship different backgrounds and prejudices; facts are likely to be interpreted according to prior experience. All members may agree that the channel is not functioning as effectively as desired; each channel member may perceive a different reason for this lack of effectiveness. Manufacturers may feel that a retailer’s lack of stock is due to failure to maintain adequate safety stock levels and realistic reorder points. The retailer may feel that inventory policies are realistic and that the problem is caused by the manufacturer’s inability to meet scheduled delivery times. Each party is interpreting the situation based upon experience and natural prejudices associated with its own position and role. Ideological differences
Sometimes there may be a fundamental ideological conflict in channels which stems from big business and small business perceptions of management, particularly concerning the appropriate level of sales effort. For example, a manufacturer may be so satisfied with the performance of a wholesaler in a given territory that pressure is exerted on the wholesaler to expand the line of products on offer, whereas the wholesaler may be satisfied with allowing the business to continue to run in its present form. In this way, pressures exerted by the manufacturer will lead to stress and conflict in the relationship. If this is an established channel, it is in the interests of everybody to settle the dispute or misunderstanding quickly.
There are several methods of resolving conflict, and it is a task of management to seek ways in which to manage it to avoid it becoming dysfunctional and to harness the energies in conflict situations to produce solutions. Depending on which underlying cause is identified, different strategies can be employed in isolation. Another important factor in the resolution of the conflict will be the weight of power of the channel member seeking to resolve the conflict. Problem solving Adopting superordinate goals is a method that refers to goals that are desired by all members caught up in the conflict. Often such goals cannot be achieved by individual channel members, as concerted efforts of all parties are required.
Such disputes become more pronounced when the channel is confronted by an external threat, and conflict only dissipates when alternative channel systems emerge. The threat to existing channel members of new channel arrangements for car retailing in the UK has brought about a reduction in conflict between traditional channel members. Car manufacturers and dealers were challenged by the fact that consumers were increasingly purchasing new cars through a variety of new channels including sourcing them from countries where prices might be lower, the growth of ‘car hypermarkets’ where cars are sourced on the ‘grey market’ and through the Internet.
The result has been for existing traditional channel members to adopt superordinate goals and this has resulted in a reduction of conflict between them in an effort to survive. Permanent conflict resolution requires an integration of the needs of both sides to the dispute so they find a common goal without sacrificing their basic economic and ethical principles. The problem is developing a common goal on which all parties agree. 210 Channels of distribution and logistics A solution exists to alleviate communications noise in distribution channels. A more efficient flow of information and communications in channels permits members to find solutions to their conflict based on common objectives. Channel communication efforts should be designed to decrease or avoid conflict, e. g. sing sales representatives to convey information from wholesalers or retailers implies that the manufacturer is trying to encourage the attainment of both individual and common goals; the function of the sales representative in such cases is that of ‘problem solver’. Persuasion This implies that institutions involved draw on their leadership potential. If effective channel management is to be achieved, it is often the case that there will be a need to locate an institution or an agency within the system that is willing to assume this role. Channel leadership is the intentional use of power to affect the behaviour of other channel members and cause them to act in a manner that contributes to the maintenance or achievement of a desired level of performance.
Often channel control results from channel leadership and like channel power, the level of control achieved by one firm over others in a channel may be issue specific, e. g. while the manufacturer may have control over pricing, retailers may have control over stock levels. Whether or not control can be exerted depends on the power base of each channel member. By its nature, persuasion involves communication between conflicting parties. Emphasis is on influencing behaviour to resolve conflict; the primary intention is to avoid or reduce conflict concerned with domain or sphere of influence. Persuasion allows members to reach a consensus resulting in agreement without formal bargaining. Some years ago a well-known company launched its own brand of cola. The new brand was eagerly tocked by many leading grocery supermarkets who were persuaded to make space for the new brand on their shelves. Inevitably this meant less shelf space for existing brands including some of the best known cola brands in the world. As if this loss of shelf space was not bad enough, the world’s leading cola brand claimed bitterly that at first glace the new Virgin cola looked remarkably like their own cola brand. They subsequently asked Virgin to withdraw the new brand in its present form and at the same time asked their supermarket customers not to stock it. Needless to say, there were protracted discussions, but after a little time all parties were persuaded to come to a compromise which avoided costly litigation and loss of face.
The new cola was altered slightly in appearance, some of the lost shelf space was restored and the new brand gradually made inroads into the market. Bargaining/negotiations The difference between bargaining and persuasion is that in the bargaining process stress continues to exist in the system long after agreement is reached. In negotiation, no attempt is made to fully satisfy a channel member. Instead, the objective is to reach an ‘accommodation’ to stop conflict among members. Such a compromise may resolve the episode, but not necessarily the fundamental stress over which the conflict erupted. If stress continues, it is likely that some issue will cause conflict again at some later date. Compromise is a means by which bargains can be reached in the channel.
Each party gives up something it desires to prevent or end conflict. Often compromise is necessary to reach domain consensus where persuasion and negotiation draw on abilities of parties involved to communicate. Channels of distribution and logistics 211 Politics Politics refers to resolution of conflict involving new organizations in the agreement-reaching process. Mediation involves a third party, usually to secure settlement of a dispute by persuading the parties to continue negotiation or consider recommendations made by the mediator. Mediation involves understanding the conflicting views of parties in such a way that opportunities are perceived that otherwise may have been missed.
The fact that solutions are being offered by a mediator, i. e. somebody external to the dispute, can often lead to a settlement if both parties deem the solutions acceptable. Effective mediation keeps the parties together and clarifies facts so the communication process does not break down. While mediation offers solutions to disputes, channel members are not obliged to accept the solutions. In arbitration, however, the solution suggested by the third party is binding upon the conflicting parties. Arbitration can be compulsory or voluntary, and when it is the former, parties are required by law to submit their dispute to the third party and be bound by the decision.
Voluntary arbitration is a similar process whereby parties are bound by the decision, but the dispute is settled voluntarily. The question of relying on law enforcement to settle disputes in distribution is imprecise as it is doubtful whether solutions enforced by law can be applicable to future channel disputes in different circumstances. In purely domestic channel management, these mechanisms are not greatly used because of the inability to find a neutral third party whose decision will be accepted by everybody involved in the dispute. However, arbitration is a normal and accepted part of international channel management and is part of the contractual agreement between the parties in channel activities.
For example, if an exporter feels that an overseas agent has not fulfilled the terms of an agreement between him or herself and the principal, but the two parties cannot agree as to the remedies for this, then normally the terms and conditions for instituting an arbitration process are written into the original contract and will be instituted to resolve the problem. Diplomacy Channel diplomacy is the normal method by which inter-organizational relations are conducted, adjusted and managed by ‘ambassadors’, envoys or other persons operating at the boundaries of member organizations. Normally channel members rely on diplomatic procedures, especially in nonintegrated systems. Channel diplomats should be the ‘eyes and ears’ of the firms they work for, and should report anything that may be of interest. Such ‘diplomats’ are commonplace in distribution channels at executive level.
In this way, the diplomat’s power base is such that it is obvious to the parties with whom the diplomat will interact. Effective channel management strategies provide for more rational decision making within the channel. THE DYNAMIC NATURE OF CHANNELS Marketing is characterized by constant change, and there is a need for the marketer to adapt to these changes, making marketing channels subject to change and innovation. Channels represent a 212 Channels of distribution and logistics dynamic area of marketing as they are constantly evolving to meet changing customer and market needs which reflect underpinning wider changes and trends in demography and lifestyles. Marketers must be aware of the changing nature of channels and respond to them.
An example of recent developments that are indicative of the innovation and changing nature of this area is the growth of multi-channel systems of direct marketing and Internet marketing which are dealt with in Chapter 10. The growth of multi-channels Companies now use a variety of channel arrangements to reach their target customers. Once, companies tended to use only one type of channel configuration in their marketing; now they use several. The use of multi-channel systems can be for a number of reasons: n n n to increase market coverage by reaching new customers; to reduce costs of selling to certain customers where for example such customers require less service than that provided through the company’s normal channels; to achieve a more customized service to particular customers than would be available through the company’s normal channels.
In multi-channel marketing, a company might sell to one group of customers using telephone selling and no intermediaries, while another target group may be marketed to through a network of dealers, since these customers require after-sales service and technical advice. Although there are advantages to be gained through using several different channel configurations to different target customers, multi-channels can give rise to increased costs if not controlled. They can also give rise to problems of conflict between different channel members where several channels are used, particularly where one type of channel member feels that their contractual rights are being infringed. An example is where the marketer uses a system of ‘appointed’ distributors for the company’s products.
In return for being granted ‘exclusive’ distribution rights in a particular g