A company has to consider factors related to the market and customers, its own situation, the product and the competitive environment.
All these factors have a strong bearing on the type of distribution channel selected.
A company should be very deliberate in deciding upon a distribution channel as it is expensive, cumbersome and can invite litigations to dismantle a distribution channel once it is established because interests of independent intermediaries are involved.
- Buyers may mandate that products be sold to them only in a certain way. They may prefer to buy from a particular type of outlet, and only at a particular time, and a supplier needs to match customer expectations if it wants their business.
A supplier also needs to be mindful of customer needs regarding product information, installation and technical assistance. Buyers’ level of need regarding such services has to researched.
The company has to decide whether the channel intermediary can meet these needs in terms of expertise, commitment and cost, or it has to set up its own infrastructure to serve customers’ needs effectively.
For instance, car service can be provided by dealers or independent authorized service providers, or by service centers run by the company. The company has to decide as to who will provide the service.
- The willingness of channel intermediaries to sell and distribute a company’s product strongly influences its decision to use one channel arrangement over another. A company has to resort to direct distribution if distributors refuse to distribute its product.
For an industrial product company, this will mean recruitment of salespeople, and for a consumer product company, this will mean selling through direct mail, telephone, or internet. This situation may arise if the brand or the product is not well established, the intermediaries feel that there would not be enough buyers, selling the product is difficult and complicated, and there is not enough margin.
For such products the manufacturer will have to increase margins for the intermediaries and provide them more support.
Alternatively, the manufacturer has to create demand among final consumers for the product, so that intermediaries get interested in keeping it. Investment in branding is a good option for marketers of consumer products and even the marketers of industrial products should not rule out the option of branding their products.
When customers will demand products, it will be in the self-interest of retailers to keep such products. In fact, manufacturers should look at branding as their weapon for the long term, against powerful intermediaries.
Once they have made the initial investment in building a strong brand, they can reduce the margins of the intermediaries and plough back the money in more branding efforts.
iii. The profit margins demanded by wholesalers and retailers and the commission rates demanded by sales agents also affect their viability and attractiveness as a channel intermediary. These costs need to be assessed in comparison with those that will be incurred if the company decides to sell directly to customers.
As the power of retailers has increased, they are demanding higher margins from manufacturers. While most manufacturers are complying due to retailers’ command over a huge base of customers and lack of alternate means of reaching customers, some companies are trying to bypass retailers by opening their own stores.
If retailers’ dominance continues, some radical response to bypass the powerful retailers should be expected from manufacturers in the near future.
- The location and geographic concentration of customers strongly affects channel selection. Direct distribution is feasible if the customer base is clustered, and is local. Direct distribution is also feasible when customers are few in number and buy in large quantities, as in the case of industrial customers.
When a company has large number of customers who buy in small lots, and are widely dispersed, it has to use channel intermediaries to reach them-direct distribution would be prohibitively expensive, and can be justified only if unit price is high and the company is able to customize the product in the time between the customer placing an order and the company delivering the product, as Dell does.
- Most manufacturers are good at designing and producing products, and hence want to delegate the task of selling and distributing to channel intermediaries. Some manufacturers lack the financial and managerial resources to take on the tasks of selling and distributing.
Therefore, the company does not open its own stores or hires its own salespeople, and uses distributors or agents to sell and distribute its product. A manufacturer of consumer products will need huge investment in setting up infrastructure for distribution because the number of customers is large and are geographically dispersed.
The distribution channels of consumer products are long, and managing such a wholly- owned distribution infrastructure will be an arduous task even for the mightiest manufacturers. Also, most manufacturers do not have customer-based skills to sell and distribute their products, and hence have to rely on intermediaries.
- A wide mix of products makes direct distribution feasible, as the cost of setting up and operating a common distribution infrastructure is distributed over a larger number of products.
Narrow or single product companies find the cost of direct distribution prohibitive unless the product is expensive and its customers buy in bulk. Therefore, they have to use channel intermediaries to sell and distribute their products.
iii. When a company uses independent channel intermediaries, it loses control over the way the product is sold to customers. The company loses control of the price charged to customers and the way the product is stocked and presented to customers.
There is no guarantee that the channel intermediary will stock its new products or its full range of products. It may just be interested in stocking products which sell more or on which it earns higher margins. Manufacturers of electronic products are opening wholly-owned megastores to showcase their full range of products.
Channel intermediaries are obliged to perform certain tasks like in-store promotion in retail stores, promotion in the local media by retailers, or appointing a minimum number of salespersons in a region by a wholesaler. It is very important for manufacturers to constantly monitor whether channel members are performing the agreed functions.
- Design and production of large and complex products need personal contact between the manufacturer and customer. These products are also expensive, and hence direct selling and distribution of such products is economically viable.
The manufacturer and customer remain in active contact during the lifetime of the equipment, as both need to collaborate during its installation, operation and service.
- Perishable products require short channels to supply the customer with fresh stock. Bulky or difficult to handle products may require direct distribution because distributors may refuse to carry them in their stores due to space constraint or because expensive provisions will have to be made to handle and store them. Intermediaries may have difficulty in displaying such bulky products.
If competitors control traditional channels of distribution, for instance, through exclusive dealership arrangements, a company has to decide to sell directly or set up its own distribution network. It recruits salespeople to sell directly or builds its own distribution infrastructure in terms of setting up distribution centers and opening retail outlets, to reach customers.
Players of an industry sell and distribute in a particular way, but a manufacturer should not assume that channels of distribution used by competitors are the only way to reach their customers. It should explore alternate means of reaching customers i.e., use distributors and retailers not used by competitors to reach customers.
It should also explore the possibility of using direct marketing and distribution. Alternate distribution channels may be used as a means of attaining competitive advantage. For instance, Dell uses direct marketing to gain a substantial competitive advantage by customizing personal computers to suit customer requirements.
Deciding the number of outlets in a region or for a population, i.e., the intensity of outlets is a critical decision. If the number of outlets is more than required, the cost of serving a customer goes up.
If the number of outlets are less than required, customers will face difficulty in accessing the outlets and they may buy an alternate brand or product or forgo purchase altogether. There are three options for a company:
The product is inexpensive and customers can choose from large number of equally good brands. Intensive distribution is required for such products, which provides maximum coverage of the market by using all available outlets.
Sales are a direct function of the number of outlets penetrated in case of mass market products such as cigarettes, food and confectionaries. This happens because customers have a range of acceptable brands from which they choose. If a brand is not available in an outlet, an alternative is bought.
The convenience aspect of purchase is paramount in such products, and the customer will buy an alternate brand if his preferred brand is not stocked in the store he is shopping. Some such purchases are also unplanned a fid impulsive in nature. They are bought because the products happen to be in sight. If the product or the brand not spotted by the customer, sales are lost.
New outlets should be sought which have not stocked the product or brand so far. The retailers who have been stocking the product do not mind when the manufacturer signs up more retailers to carry the product because the revenue generated from each customer for such products are low.
Wider availability and display of such products across many outlets act to make them popular, which increases the sale of the product in every outlet.
Also, most of these purchases happen in grocery stores for which customers show high amount of loyalty. Therefore it is important that the store has all the products that its customers may want and expect the store to stock. It is not very worrying if the next store has them, too.
For products like electronics goods and home appliances, a manufacturer uses a limited number of outlets in a geographical area. It selects the best outlets in the area in terms of their location, space, decor and the owners’ enthusiasm to carry its products.
It develops close relationships with the outlets and trains their salespeople. It ensures that the salespeople are motivated to sell its products and that they are well compensated. Retail outlets and industrial distributors prefer such an arrangement as it reduces competition amongst them.
Selective distribution works well when the product’s characteristics are such that the customers are willing to spend time to learn about the product and evaluate alternatives. The company cannot make its products available in all possible outlets because customers expect a minimum amount of assistance in making the purchase.
They may also expect the product to be delivered and installed at their homes. They may also expect the retailer to arrange loans and insurance for the product that they plan to buy. Therefore only the retailers who can provide such services can be signed up to carry the product. And when these retailers have made such investments, they do not expect the next shop to be selling the same product.
They expect some territory to themselves. Retailers would be aggrieved if the manufacturer tried to add more outlets in their region as the new outlets would eat into their sales.
The customer makes such purchases after deliberation and is purposeful about buying a brand from a set of brands. He will be willing to travel some distance to find his preferred brand or brands, and therefore, storing the brand in stores which are very close to each other is really not required.
The product is important to the customer and he is willing to travel to buy his preferred brand. The product is expensive and hence the company will incur high inventory holding costs if it is stocked at too many locations.
Only one wholesaler, retailer or industrial distributor is used in a geographical area. Car dealers are an example. Customers cannot negotiate prices between dealers since to buy in a neighboring town or from a dealer in a distant location, may be inconvenient when repairing and servicing are required It allows close co-operation between the manufacturer and the retailer over servicing, pricing and promotion.
The right to exclusive distribution may be demanded by a distributor as a condition for stocking a manufacturer’s full product line. The manufacturer may agree for exclusive dealing where the distributor agrees not to stock competing lines.
But before granting exclusive dealership to a retailer in a region, the manufacturer should deliberate if his brand has strength enough to be able to make the customers face the inconvenience of traveling some distance to buy the brand. In categories like automobiles where the manufacturers have strong brands and customers have strong preferences, exclusive dealership should be granted.
Since establishing such dealerships involves big investments, it is wise not to fritter away resources in having too many dealers. Not many customers buy a particular brand of car because its dealer happens to be next door.
The purchase is too expensive for customers to engage in such whims. But the same arguments do not hold in categories like apparel where exclusive dealerships are provided Customers’ choice criteria are not crystallized in such categories and customers do not have strong preferences.
It is unrealistic to expect a customer to travel to the other end of the city to buy his favorite shirt. But super premium brands, even in such categories command high brand loyalty and exclusive dealership can be granted for such high-end brands.
Exclusive dealing can reduce competition and make the dealer lackadaisical. This may be against the customer’s interest as he has no alternate recourse.
There is another danger in an exclusive channel arrangement. Since the level of commitment of both the channel member and the manufacturer are higher, in case of estrangement, both are likely to fight bitterly.
Degree of channel integration varies widely. The manufacturer or any particular intermediary has minimal control when independent wholesalers, dealers and agents are part of the distribution channels.
At the other extreme, in the wholly-owned distribution infrastructure, the channel members are owned by the manufacturer who exercises complete control over them. Somewhere in between are arrangements like franchise operation where both franchiser and franchisee exercise power and discretion in their areas of jurisdiction.
Conventional marketing channels:
Channel intermediaries are independent businesses with their individual profit goals. The channel intermediaries are independent business entities, and they would look after their own interests. Therefore, manufactures cannot unilaterally force them to do their bidding.
Independence of channel intermediaries makes it imperative that relationship between the manufacturer and its channel intermediaries be based on fairness and equitable distribution of rewards. Manufacturers have to put money-value on the tasks that the channel intermediaries perform for them, and then compensate them adequately.
It is also important that they jointly decide as to what tasks will be performed by whom—one party may be in a better position to perform an activity, and hence that party should be assigned to perform that activity. For example, retailers are expected to hold inventory for most durable products, resulting in large amount of safety inventory being held at multiple locations.
A manufacturer can hold inventory for all its retailers of a particular region, and the product can be sent to customers directly from manufacturer’s storage area—retailers can concentrate on selling.
A manufacturer who dominates a market through its size and strong brands may exercise considerable power over intermediaries though they are independent. Traditionally, manufacturers exercised control over intermediaries because their brands drove business in retail stores and retailers felt dependent on them.
The manufacturer rationed the supply of hot brands, forced the retailers to carry their full range, and made them participate and contribute in their promotional programmes. But with consolidation and emergence of retail chains, the balance of power has shifted dramatically. They know the preference of customers, and know which brands are selling and how much.
The retail chains enjoy enormous clout with customers and they have huge buying power. The retail chains also have strong brands of their own in most categories. The manufacturers now are dependent on the retailers and the latter are extracting their pound of flesh.
The retailers demand slotting fees for new products, carry only the hot selling brands, require frequent replenishment from manufacturers, and expect the manufacturer to participate and contribute in the store’s promotion programmes.
The relationship between the manufacturer and the intermediaries is governed by balance of power between the two parties. Both manufacturers and retailers have been guilty of exploiting the vulnerable party whenever they have been strong. Manufacturers did it earlier, retailers are doing now. But this is not a good ploy.
The economics of a supply chain dictates that an activity should be done at a point in the chain where it can be done most efficiently and effectively, so that the cost structure of the supply chain is improved and there is more profit for every player. The extra profit should be divided among the partners depending on the efforts expended by the players.
A supply chain operated by dictum of the more powerful party will be inherently inefficient compared to the one based on co-operation between the parties. The powerful player will shift activities to the more vulnerable player even when the powerful player could do that particular activity more efficiently and effectively.
The result is an inefficient supply chain with less profit for all the players. And a large part of the smaller profit is appropriated by the powerful player, leaving the weaker players disgruntled and less willing to co-operate. And more dangerously, the vulnerable players are always looking at ways to get back at their tormentors.
It is time the manufacturer and the independent channel intermediaries shifted the basis of relationship from power to rational distribution of activities in the supply chain and equitable distribution of profit amongst themselves.
A franchise is a legal contract in which the manufacturer or the producer and the intermediary agree to each member’s rights and obligations. The intermediary receives marketing, managerial, technical and financial services from the producer in return for a fee. For instance, McDonald’s combines strengths of a large sophisticated marketing oriented organization with energy and motivation of a locally owned outlet.
Franchise operations give the manufacturer a certain degree of control over its intermediaries. A franchise agreement is a vertical marketing system in which there is a formal co-ordination and integration of marketing and distribution activities between the manufacturer and its intermediaries. Roles and functions of each party are clearly defined, and each is expected to look after the interest of the other.
Franchising occurs at four levels:
- Manufacturer and retailer:
The retailer sets up outlets in which manufacturer’s cars are sold, and it also sets up repair and service facilities for the car. The retailer is motivated. The manufacturer gets retail outlets for its car and repair facilities without the capital outlay required with ownership.
- Manufacturer and wholesaler:
The wholesaler gets the right to produce, bottle and distribute Coke’s product in a defined geographical area.
- Wholesaler and retailer:
The wholesaler acquires the right to distribute manufacturer’s products or purchases its product, and then signs up retailers to sell the product to final consumers. This arrangement is common in hardware stores.
- Retailer and retailer:
A retailer expands geographically by means of franchise operations. For instance, Benetton and McDonald’s have used this approach to expand their operations geographically.
In all franchising arrangements, it is imperative that profits are distributed equitably among both parties. The structure of the agreement between the two parties should be such that profits are divided equitably.
When intermediaries are required to pay a fat upfront fee and the manufacturer takes only a small or no share of the profit generated at the intermediaries’ end, the manufacturer has no major financial motivation to ensure that the intermediaries earn profits.
But when the intermediaries pay small or no upfront fees and the manufacturer shares the profit generated at the intermediaries’ end, the manufacturer becomes interested in the profitability of the intermediaries. McDonald’s follows this practice and ensures that its franchisees earn profits and takes a share in the profits.
Total control over distributor activities comes with channel ownership by the manufacturer or an intermediary. Channel ownership results in creation of a corporate vertical marketing system. When a manufacturer purchases a chain of retail outlets, it begins to control the purchasing, production and marketing activities of these outlets.
In particular, the manufacturer’s control over purchasing means a captive outlet for its product. For example, Purchase of Pizza Hut by Pepsi has tied these outlets to Pepsi’s soft drink brands. Retailing, is a specialized business, and most manufacturers may find it difficult to manage retail operations.
Relationship between Manufacturer and Channel Partners:
It is important that the manufacturer and his channel partners understand and appreciate each other’s requirements.
Most manufacturers believe that if they get more help and support from their distribution channels, they could substantially increase volumes and have even greater impact on profits. But manufacturers too must understand the needs of the channel members and must respond to them.
The prime objective of each member of the channel is to generate profits through a combination of turnover i.e., sales per time period, and gross margin as a percent of sales. Supermarkets operate on a low gross margin but high turnover. Specialty stores and industrial distributors work on high margins and low turnover.
Each channel member must be compensated by the manufacturer for his efforts in selling the manufacturer’s products. The manufacturer will expect to receive greater sales and greater channel motivation. It will be useful for the manufacturer to determine what he should do for the channel members and what he should receive from them.
The manufacturer should take care on two counts. The manufacturer should not ask the channel members to do things that they cannot do. A retailer can try to push the manufacturer’s products but he cannot generate demand for his products.
The manufacturer should accept that it is primarily his responsibility to generate consumer demand for his products. Secondly, the manufacturer should perform those tasks which are important to the channel members but is difficult for them to do on their own.
For example, the manufacturer can develop literature for his products, to be used by all his distributors, much more cheaply than his distributors could do it individually.
It is important that the manufacturer differentiates between selling to the channels and selling through the channels. A manufacturer can fill the distribution pipeline for a limited amount of time. Then the products must flow through the channel, not just into it.
It is wrong and fatal to assume that the sale is consummated when the product moves from the manufacturer to the wholesaler.
The manufacturer must exert leadership throughout the chain of the product moving from its stores to wholesalers to retailers to customers. Not many products have been successful without strong support from channel members.