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MGT301 - Principles of Marketing - Lecture Handout 28

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Lesson overview and learning objectives:

Channel design begins with assessing customer channel-service needs and company channel objectives and constraints. The company then identifies the major channel alternatives in terms of the types of intermediaries, the number of intermediaries, and the channel responsibilities of each. No system, no matter how well it has been planned, is without conflict. Managing distribution conflict is a necessity if quality service and low cost is to be delivered. Since distribution
relationships tend to be long-term in nature, the choice of channel partners is very important and should be taken very seriously these are the all concepts that should be clear after today’s Lesson.

PLACE- THE 3RD P OF MARKETING MIX.

Marketing channel decisions are among the most important facing marketing managers. A company’s channel decisions are linked with every other marketing decision. Companies often pay too little attention to their distribution channels. This can be very damaging. Distribution channel decisions often involve long-term commitments to other firms. There are four major issues or questions that concern distribution channels:

  1. What is the nature of distribution channels?
  2. How do channel firms interact and organize to do the work of the channel?
  3. What problems do companies face in designing and managing their channels?
  4. what role does physical distribution play in attracting and satisfying customers?

A. Marketing Channel

Marketing Channel

A set of interdependent organizations involved in the process of making a product or service available for use or consumption by the consumer or business user. Figure summarizes the simple marketing system that consists of customer, producers that are having some thing valuable for making transactions. These transaction are made in exchange process and creation availability of products for customers. This availability is created by using networks of distribution channels. Every product and service, whether an automobile, a watch, a personal computer, or office furniture, must somehow be made available to billions of people. Products must also be made available to millions of
industrial firms, businesses, government institutions, and other organizations worldwide. Firms try to realize this goal through the creation of distribution channels.
Channel structure has three basic dimensions: the length of the channel, the intensity at various levels, and the types of intermediaries involved. Channel intensity ranges from intensive to selective to exclusive. Intensive means that there are many intermediaries. Selective means that there are a smaller number of intermediaries. Exclusive refers to only one.

B. Why Are Marketing Intermediaries Used?

Why do producers give some of the selling job to intermediaries? After all, doing so means giving up some control over how and to whom the products are sold. The use of intermediaries results from their greater efficiency in making goods available to target markets. Through their contacts, experience, specialization, and scale of operation, intermediaries usually offer the firm more than it can achieve on its own.
Figure shows how using intermediaries can provide economies. Figure A shows three manufacturers, each using direct marketing to reach three customers. This system requires nine different contacts. Figure B shows the three manufacturers working through one distributor, who contacts the three customers. This system requires only six contacts. In this way, intermediaries reduce the amount of work that must be done by both producers and consumers.

Why Are Marketing Intermediaries Used

From the economic system's point of view, the role of marketing intermediaries is to transform the assortments of products made by producers into the assortments wanted by consumers. Producers make narrow assortments of products in large quantities, but consumers want broad assortments of products in small quantities. In the distribution channels, intermediaries buy large quantities from many producers and break them down into the smaller quantities and broader assortments wanted by consumers. Thus, intermediaries play an important role in matching supply and demand.
The concept of distribution channels is not limited to the distribution of tangible products. Producers of services and ideas also face the problem of making their output available to target markets. In the private sector, retail stores, hotels, banks, and other service providers take great care to make their services conveniently available to target customers. In the public sector, service organizations and agencies develop "educational distribution systems" and "health care delivery systems" for reaching sometimes widely dispersed populations. Hospitals must be located to serve various patient populations, and schools must be located close to the children who need to be taught. Communities must locate their fire stations to provide rapid response to fires and polling stations must be placed where people can vote conveniently.

C. Distribution Channel Functions

The distribution channel moves goods and services from producers to consumers. It overcomes the major time, place, and possession gaps that separate goods and services from those who would use them. Members of the marketing channel perform many key functions:

  • Information: gathering and distributing marketing research and intelligence information about actors and forces in the marketing environment needed for planning and aiding exchange.
  • Promotion: developing and spreading persuasive communications about an offer.
  • Contact: finding and communicating with prospective buyers.
  • Matching: shaping and fitting the offer to the buyer's needs, including activities such as manufacturing, grading, assembling, and packaging.
  • Negotiation: reaching an agreement on price and other terms of the offer so that ownership or possession can be transferred.

Others help to fulfill the completed transactions:

  • Physical distribution: transporting and storing goods.
  • Financing: acquiring and using funds to cover the costs of the channel work.
  • Risk taking: assuming the risks of carrying out the channel work.

The question is not whether these functions need to be performed—they must be—but rather who will perform them. To the extent that the manufacturer performs these functions, its costs go up and its prices have to be higher. At the same time, when some of these functions are shifted to intermediaries, the producer's costs and prices may be lower, but the intermediaries must charge more to cover the costs of their work. In dividing the work of the channel, the various functions should be assigned to the channel members who can perform them most efficiently and effectively
to provide satisfactory assortments of goods to target consumers.

D. Number of Channel Levels

Distribution channels can be described by the number of channel levels involved. Each layer of marketing intermediaries that performs some work in bringing the product and its ownership closer to the final buyer is a channel level. Because

Number of Channel Levels

the producer and the final consumer both perform some work, they are part of every channel. We use the number of intermediary levels to indicate the length of a channel. Figure A shows several consumer distribution channels of different lengths.

Channel 1, called a direct marketing channel, has no intermediary levels. It consists of a company selling directly to consumers. The remaining channels in Figure A are indirect marketing channels. Channel 2 contains one intermediary level. In consumer markets, this level is typically a retailer.

For example, the makers of televisions, cameras, tires, furniture, major appliances, and many other products sell their goods directly to large retailers which then sell the goods to final consumers. Channel 3 contains two intermediary levels, a wholesaler and a retailer. This channel is often used by small manufacturers of food, drugs, hardware, and other products. Channel 4 contains three intermediary levels. In the meatpacking industry, for example, jobbers buy from wholesalers and sell to smaller retailers who generally are not served by larger wholesalers. Distribution channels
with even more levels are sometimes found, but less often. From the producer's point of view, a greater number of levels means less control and greater channel complexity.
Figure B shows some common business distribution channels. The business marketer can use its own sales force to sell directly to business customers. It can also sell to industrial distributors, who in turn sell to business customers. It can sell through manufacturer's representatives or its own sales branches to business customers, or it can use these representatives and branches to sell through industrial distributors. Thus, business markets commonly include multilevel distribution channels.
All of the institutions in the channel are connected by several types of flows. These include the physical flow of products, the flow of ownership, the payment flow, the information flow, and the promotion flow. These flows can make even channels with only one or a few levels very complex.

E. Channel Behavior and Organization

Distribution channels are more than simple collections of firms tied together by various flows. They are complex behavioral systems in which people and companies interact to accomplish individual, company, and channel goals. Some channel systems consist only of informal interactions among loosely organized firms; others consist of formal interactions guided by strong organizational structures. Moreover, channel systems do not stand still—new types of
intermediaries emerge and whole new channel systems evolve. Here we look at channel behavior and at how members organize to do the work of the channel.

Channel Behavior

A distribution channel consists of firms that have banded together for their common good. Each channel member is dependent on the others. Each channel member plays a role in the channel and specializes in performing one or more functions. The channel will be most effective when each member is assigned the tasks it can do best.
Ideally, because the success of individual channel members depends on overall channel success, all channel firms should work together smoothly. They should understand and accept their roles, coordinate their goals and activities, and cooperate to attain overall channel goals. By cooperating, they can more effectively sense, serve, and satisfy the target market.
However, individual channel members rarely take such a broad view. They are usually more concerned with their own short-run goals and their dealings with those firms closest to them in the channel. Cooperating to achieve overall channel goals sometimes means giving up individual company goals. Although channel members are dependent on one another, they often act alone in their own short-run best interests. They often disagree on the roles each should play—on who should do what and for what rewards. Such disagreements over goals and roles generate channel conflict.
Horizontal conflict occurs among firms at the same level of the channel. Vertical conflict, conflicts between different levels of the same channel, is even more common. Some conflict in the channel takes the form of healthy competition. Such competition can be good for the channel—without it, the channel could become passive and non innovative. But sometimes conflict can damage the channel. For the channel as a whole to perform well, each channel member's role must be specified and channel conflict must be managed. Cooperation, role assignment, and conflict management in the channel are attained through strong channel leadership. The channel will perform better if it includes a firm, agency, or mechanism that has the power to assign roles and manage conflict.

F. Vertical Marketing Systems

Historically, distribution channels have been loose collections of independent companies, each showing little concern for overall channel performance. These conventional distribution channels have lacked strong leadership and have been troubled by damaging conflict and poor performance. One of the biggest recent channel developments has been the vertical marketing systems that have emerged to challenge conventional marketing channels. Figure contrasts the two types of channel arrangements. A conventional distribution channel consists of one or more independent producers, wholesalers, and retailers. Each is a separate business seeking to maximize its own profits, even at the expense of profits for the system as a whole. No channel member has much control over the other members, and no formal means exists for assigning roles and resolving channel conflict. In contrast, a Vertical Marketing System (VMS)
consists of producers, wholesalers, and retailers acting as a unified system. One channel member owns the others, has contracts with them, or wields so much power that they must all cooperate. The VMS can be dominated by the producer, wholesaler, or retailer. Vertical marketing systems came into being to control channel behavior and manage channel conflict. We look now at three major types of VMSs: corporate, contractual, and administered. Each uses a
different means for setting up leadership and power in the channel. We now take a closer look at each type of VMS.

Vertical Marketing Systems

a. Corporate VMS

A corporate VMS combines successive stages of production and distribution under single ownership. Coordination and conflict management are attained through regular organizational channels.

b. Contractual VMS

A contractual VMS consists of independent firms at different levels of production and distribution who joins together through contracts to obtain more economies or sales impact than each could achieve alone. Coordination and conflict management are attained through contractual agreements among channel members. There are three types of contractual VMSs: wholesaler-sponsored voluntary chains, retailer cooperatives, and franchise organizations.
In wholesaler-sponsored voluntary chains, wholesalers organize voluntary chains of independent retailers to help them compete with large chain organizations. The wholesaler develops a program in which independent retailers standardize their selling practices and achieve buying economies that let the group compete effectively with chain organizations. In retailer cooperatives, retailers organize a new, jointly owned business to carry on wholesaling and possibly production. Members buy most of their goods through the retailer co-op and plan their advertising jointly. Profits are passed back to members in proportion to their purchases. In franchise organizations, a channel member called a franchiser links several stages in the production-distribution process. There are three forms of franchises. The first form is the manufacturer-sponsored retailer franchise system, as found in the automobile industry. The second type of franchise is the manufacturer-sponsored wholesaler franchise system, as found in the soft drink industry.. The third franchise form is the service-firm-sponsored retailer franchise system, in which a service firm licenses a system of retailers to bring its service to consumers. The fact that most consumers cannot tell the difference between contractual and corporate VMSs shows how successfully the contractual organizations compete with corporate chains

c. Administered VMS

An administered VMS coordinates successive stages of production and distribution, not through common ownership or contractual ties but through the size and power of one of the parties. In an administered VMS, leadership is assumed by one or a few dominant channel members.
Manufacturers of a top brand can obtain strong trade cooperation and support from resellers.

G. Horizontal Marketing Systems

Another channel development is the horizontal marketing system, in which two or more companies at one level join together to follow a new marketing opportunity. By working together, companies can combine their capital, production capabilities, or marketing resources to accomplish more than any one company could alone. Companies might join forces with competitors or noncompetitors. They might work with each other on a temporary or permanent basis, or they may create a separate company. Such channel arrangements also work well globally.

H. Hybrid Marketing Systems

In the past, many companies used a single channel to sell to a single market or market segment. Today, with the proliferation of customer segments and channel possibilities, more and more companies have adopted multichannel distribution systems—often called hybrid marketing channels. Such multichannel marketing occurs when a single firm sets up two or more marketing channels to reach one or more customer segments. The use of hybrid channel systems has increased greatly in recent years.
Figure shows a hybrid channel. In the figure, the producer sells directly to consumer segment 1 using direct-mail catalogs and telemarketing and reaches consumer segment 2 through retailers. It sells indirectly to business segment 1 through distributors and dealers and to business segment 2 through its own sales force.

Hybrid Marketing Systems

Hybrid Marketing Channel

Hybrid channels offer many advantages to companies facing large and complex markets. With each new channel, the company expands its sales and market coverage and gains opportunities to tailor its products and services to the specific needs of diverse customer segments. But such hybrid channel systems are harder to control, and they generate conflict as more channels compete for customers and sales

I. Channel Design Decisions

We now look at several channel decisions manufacturers face. In designing marketing channels, manufacturers struggle between what is ideal and what is practical. A new firm with limited capital usually starts by selling in a limited market area. Deciding on the best channels might not be a problem: The problem might simply be how to convince one or a few good intermediaries to handle the line.

If successful, the new firm might branch out to new markets through the existing intermediaries. In smaller markets, the firm might sell directly to retailers; in larger markets, it might sell through distributors. In one part of the country, it might grant exclusive franchises; in another, it might sell through all available outlets. In this way, channel systems often evolve to meet market opportunities and conditions. However, for maximum effectiveness, channel analysis and decision making should be more purposeful. Designing a channel system calls for analyzing consumer service needs, setting channel objectives and constraints, identifying major channel alternatives, and evaluating them.

a. Analyzing Consumer Service Needs

As noted previously, marketing channels can be thought of as customer value delivery systems in which each channel member adds value for the customer. Thus, designing the distribution channel starts with finding out what targeted consumers want from the channel. Do consumers want to buy from nearby locations or are they willing to travel to more distant centralized locations? Would they rather buy in person, over the phone, through the mail, or via the Internet? Do they value breadth of assortment or do they prefer specialization? Do consumers want many add-on services (delivery, credit, repairs, installation) or will they obtain these elsewhere? The faster the delivery, the greater the assortment provided, and the more add-on services supplied, the greater the channel's service level.
But providing the fastest delivery, greatest assortment, and most services may not be possible or practical. The company and its channel members may not have the resources or skills needed to provide all the desired services. Also, providing higher levels of service results in higher costs for the channel and higher prices for consumers. The company must balance consumer service needs not only against the feasibility and costs of meeting these needs but also against customer price preferences. The success of off-price and discount retailing shows that consumers are often willing to accept lower service levels if this means lower prices.

b. Setting Channel Objectives and Constraints

Channel objectives should be stated in terms of the desired service level of target consumers. Usually, a company can identify several segments wanting different levels of channel service. The company should decide which segments to serve and the best channels to use in each case. In each segment, the company wants to minimize the total channel cost of meeting customer service requirements.
The company's channel objectives are also influenced by the nature of the company, its products, marketing intermediaries, competitors, and the environment. For example, the company's size and financial situation determine which marketing functions it can handle itself and which it must give to intermediaries. Companies selling perishable products may require more direct marketing to avoid delays and too much handling. In some cases, a company may want to compete in or near the same outlets that carry competitors' products. In other cases, producers may avoid the
channels used by competitors. Finally, environmental factors such as economic conditions and legal constraints may affect channel objectives and design. For example, in a depressed economy, producers want to distribute their goods in the most economical way, using shorter channels and dropping unneeded services that add to the final price of the goods.

c. Identifying Major Alternatives

When the company has defined its channel objectives, it should next identify its major channel alternatives in terms of types of intermediaries, the number of intermediaries, and the responsibilities of each channel member

d. Types of Intermediaries

A firm should identify the types of channel members available to carry out its channel work. For example, suppose a manufacturer of test equipment has developed an audio device that detects poor mechanical connections in machines with moving parts. Company executives think this product would have a market in all industries in which electric, combustion, or steam engines are made or used. The company's current sales force is small, and the problem is how best to reach these different industries. The following channel alternatives might emerge from management discussion:
Company sales force: Expand the company's direct sales force. Assign outside salespeople to territories and have them contact all prospects in the area or develop separate company sales forces for different industries. Or, add an inside telesales operation in which telephone salespeople handles small or midsize companies.

Manufacturer's agency: Hire manufacturer's agents—independent firms whose sales forces handle related products from many companies—in different regions or industries to sell the new test equipment.

Industrial distributors: Find distributors in the different regions or industries who will buy and carry the new line. Give them exclusive distribution, good margins, product training, and promotional support.

e. Number of Marketing Intermediaries

Companies must also determine the number of channel members to use at each level. Three strategies are available: intensive distribution, exclusive distribution, and selective distribution. Producers of convenience products and common raw materials typically seek intensive distribution—a strategy in which they stock their products in as many outlets as possible. These goods must be available where and when consumers want them. For example, toothpaste, candy, and other similar items are sold in millions of outlets to provide maximum brand exposure and consumer convenience. By contrast, some producers purposely limit the number of intermediaries handling their products. The extreme form of this practice is exclusive distribution, in which the producer gives only a limited number of dealers the exclusive right to distribute its products in their territories. Exclusive distribution is often found in the distribution of new automobiles and prestige women's clothing. Exclusive distribution also enhances the car's image and allows for higher markups.
Between intensive and exclusive distribution lies selective distribution—the use of more than one, but fewer than all, of the intermediaries who are willing to carry a company's products. Most television, furniture, and small-appliance brands are distributed in this manner. They can develop good working relationships with selected channel members and expect a better-than-average selling effort. Selective distribution gives producers good market coverage with more control and less cost than does intensive distribution.

J. Channel Management Decisions

Once the company has reviewed its channel alternatives and decided on the best channel design, it must implement and manage the chosen channel. Channel management calls for selecting and motivating individual channel members and evaluating their performance over time.

a. Selecting Channel Members

Producers vary in their ability to attract qualified marketing intermediaries. Some producers have no trouble signing up channel members. In some cases, the promise of exclusive or selective distribution for a desirable product will draw plenty of applicants. At the other extreme are producers who have to work hard to line up enough qualified intermediaries..
When selecting intermediaries, the company should determine what characteristics distinguish the better ones. It will want to evaluate each channel member's years in business, other lines carried, growth and profit record, cooperativeness, and reputation. If the intermediaries are sales agents, the company will want to evaluate the number and character of other lines carried and the size and quality of the sales force. If the intermediary is a retail store that wants exclusive or selective distribution, the company will want to evaluate the store's customers, location, and future growth potential.

b. Motivating Channel Members

Once selected, channel members must be motivated continuously to do their best. The company must sell not only through the intermediaries but to them. Most companies see their intermediaries as first-line customers. Some use the carrot-and-stick approach: At times they offer positive motivators such as higher margins, special deals, premiums, cooperative advertising allowances, display allowances, and sales contests. At other times they use negative motivators, such as threatening to reduce margins, to slow down delivery, or to end the relationship altogether. A
producer using this approach usually has not done a good job of studying the needs, problems, strengths, and weaknesses of its distributors.
More advanced companies try to forge long-term partnerships with their distributors to create a marketing system that meets the needs of both the manufacturer and the distributors. In managing its channels, a company must convince distributors that they can make their money by being part of an advanced marketing system.

c. Evaluating Channel Members

The producer must regularly check the channel member's performance against standards such as sales quotas, average inventory levels, customer delivery time, and treatment of damaged and lost goods, cooperation in company promotion and training programs, and services to the customer. The company should recognize and reward intermediaries who are performing well. Those who are performing poorly should be assisted or, as a last resort, replaced. A company may periodically "requalify" its intermediaries and prune the weaker ones.
Finally, manufacturers need to be sensitive to their dealers. Those who treat their dealers lightly risk not only losing their support but also causing some legal problems.

Changing Channel Organization

Changes in technology and the explosive growth of direct and online marketing are having a profound impact on the nature and design of marketing channels. One major trend is toward disintermediation—a big term with a clear message and important consequences. Disintermediation means that more and more, product and service producers are bypassing intermediaries and going directly to final buyers, or that radically new types of channel intermediaries are emerging to displace traditional ones.
Thus, in many industries, traditional intermediaries are dropping by the wayside. Disintermediation presents problems and opportunities for both producers and intermediaries. To avoid being swept aside, traditional intermediaries must find new ways to add value in the supply chain. To remain competitive, product and service producers must develop new channel opportunities, such as Internet and other direct channels. However, developing these new channels often brings them into direct competition with their established channels, resulting in conflict. To ease this problem, companies often look for ways to make going direct a plus for both the company and its channel partners:
However, although this compromise system reduces conflicts, it also creates inefficiencies.

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