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4.6: Managing Distribution Channels

  • Page ID
    16514
  • What you’ll learn to do: explain how channels affect the marketing of products and services

    By March 2014, most Americans had noticed the Geico gecko; some had fallen in love with him. Regardless of buyers’ feelings about the little lizard, by 2014 enough had purchased auto insurance from Geico through its online sales portal to change the landscape of the insurance industry. Fortune magazine reported on the company’s success:

    It’s official. After decades as the second-largest auto insurer in the U.S., Allstate Corp. now is No. 3.

    Geico, the online auto insurer owned by Warren Buffett’s Berkshire Hathaway Inc., surpassed Allstate in 2013 in auto premiums collected. Berkshire Hathaway released its 2013 results today, finally laying out in black and white the the long-anticipated symbolic passing of that torch.

    State Farm Insurance Cos. remains the largest auto insurer in the U.S. by a large margin. But it’s telling that the No. 2 player now is a company that sells mainly over the Internet rather than through an army of agents. Both State Farm and Allstate still largely depend on thousands of agents around the country to sell their product, but the online channel has grown much faster over the past decade and is expected to continue that trajectory.[1]

    Geico chose to use a channel strategy that eliminates agents as intermediaries and provides a direct channel to consumers. What benefits does this offer consumers? In order to take full advantage of the channel, Geico had to clearly identify and communicate the benefits to its target customers. It did this largely by means of a clever advertising slogan: “Give us 15 minutes and we’ll save you 15 percent on your car insurance.” (Some credit for Geico’s success is probably due to the lizard, too, which helped the company improve its brand visibility.)

    While the message doesn’t say anything overt about Geico’s channel strategy, the message to customers is clear: Geico delivers good value (“save 15 percent”) fast (it only takes 15 minutes). The company’s ability to offer that value (savings and speed) really does come from its choice of channel strategy: direct to consumers (eliminating the intermediary) equals savings of time and money.

    As you’ll learn in this next section, much of marketing’s role in the distribution process is identifying the right channels, creating and managing effective channel partnerships, and ensuring that the channel performance provides value to customers.

    Optimizing Channels

    Close-up view of a gecko.

    Introduction

    Geico didn’t simply find itself owning the online, direct channel. It analyzed its customer needs and competitors’ positions and chose a strategy to accelerate sales growth: Geico defined and managed its channel strategy.

    The Channel Management Process

    The channel management process contains five steps.

    1. Analyze the Consumer

    We begin the process of channel management by answering two questions. First, to whom shall we sell this merchandise immediately? Second, who are our ultimate users and buyers? The immediate and ultimate customers may be identical or they may be quite separate. In both cases, certain basic questions apply: There is a need to know what the customer needs, where they buy, when they buy, why they buy from certain outlets, and how they buy.

    It is best that we first identify the traits of the ultimate user, since the results of that evaluation might determine the other channel institutions we would use to meet those needs. For example, the buying characteristics of the purchaser of a high-quality curved TV might be the following:

    • purchased only from a well-established, reputable dealer
    • purchased only after considerable research to compare prices and merchandise characteristics
    • purchase may be postponed
    • purchased only from a dealer equipped to provide prompt and reasonable product service

    These buying specifications illustrate the kinds of requirements that the manufacturer must discover. In most cases, purchase specifications are fairly obvious and can be determined without great difficulty. In others, though, they can be difficult to determine. For example, some consumers will only dine at restaurants that serve menu items that meet particular dietary needs; others will only patronize supermarkets that demonstrate social responsibility in their sourcing and packaging. Still, through careful and imaginative research, most of the critical factors related to consumer buying specifications can be figured out.

    Once the consumer’s buying specifications are known, the channel planner can decide on the type or types of wholesaler or retailer through which a product should be sold. This means that a manufacturer contemplating distribution through particular types of retailers must become intimately familiar with the precise location and performance characteristics of those he is considering.

    In much the same way that buying specifications of ultimate users are determined, the manufacturers must also discover buying specifications for resellers. Of particular importance is the question “From whom do my retail outlets prefer to buy?” The answer to this question determines the types of wholesalers (if any) that the manufacturer should use. Although many retailers prefer to buy directly from the manufacturers, this is not always the case. Often, the exchange requirements of manufacturers (e.g., infrequent visit, large order requirements, and stringent credit terms) are the opposite of those desired by retailers. Such retailers would rather buy from local distributors who have lenient credit terms and offer a wide assortment of merchandise.

    2. Establish the Channel Objectives

    Once customer needs are specified, the marketer can decide what the channel must achieve, which can be captured in the channel objectives. Channel objectives are based on customer requirements, the marketing strategy, and the company strategy and objectives. However, in cases where a company is just getting started, or an older company is trying to carve out a new market niche, the channel objectives may be the dominant objectives. For example, a small manufacturer wants to expand outside the local market. An immediate obstacle is the limited shelf space available to this manufacturer. The addition of a new product to the shelves generally means that space previously assigned to competitive products must be obtained. Without this exposure, the product is doomed.

    As one would expect, there is wide diversity of channel objectives. The following areas encompass the major categories:

    • Growth in sales by reaching new markets and/or increasing sales in existing markets.
    • Maintenance or improvement of market share
    • Achieve a pattern of distribution by a certain time, place, and form
    • Reduce costs or increase profits by creating an efficient channel

    3. Specify Distribution Tasks

    After the distribution objectives are set, it is appropriate to determine the specific distribution tasks (functions) to be performed in that channel system. The channel manager must be very specific in describing the tasks and also detail how these tasks will change depending upon the situation. For example, a manufacturer might delineate the following tasks as necessary to profitably reach the target market:

    • Provide delivery within 48 hours after order placement
    • Offer adequate storage space
    • Provide credit to other intermediaries
    • Facilitate a product return network
    • Provide readily available inventory (quantity and type)

    4. Evaluate and Select Among Channel Alternatives

    Determining the specific channel tasks is a prerequisite of the evaluation and selection process. There are four considerations for channel alternatives: number of levels, intensity at the various levels, types of intermediaries at each level, and application of selection criteria to channel alternatives. In addition, it is important to decide who will be in charge of the selected channels.

    Number of Levels

    Channels can range in levels from two to several (five is typical). The two-level channel (producer to consumer) is a direct channel. The number of levels in a particular industry might be the same for all the companies simply because of tradition. In other industries, this dimension is more flexible and subject to rapid change.

    Intensity at Each Level

    Once the number of levels has been decided, the channel manager needs to determine the actual number of channel components involved at each level. How many retailers in a particular market should be included in the distribution network? How many wholesalers?

    The intensity decision is extremely critical, because it is an important part of the firm’s overall marketing strategy. Companies such as Starbucks and Hershey’s have achieved high levels of success through their intensive distribution strategy.

    Types of Intermediaries and Application of Selection Criteria

    As we discussed, there are several types of intermediaries that operate in a particular channel system. The objective is to identify several possible alternative channel structures, and evaluate these alternatives with respect to some set of criteria such as company factors, environmental trends, reputation of the reseller, and experience of the reseller.

    Who Should Lead?

    Regardless of the channel framework selected, channels usually perform better if someone is in charge, providing some level of leadership. Essentially, the purpose of this leadership is to coordinate the goals and efforts of channel institutions. The level of leadership can range from very passive to quite active—verging on dictatorial. The style may range from very negative, based on fear and punishment, to very positive, based on encouragement and reward. In a given situation, any of these leadership styles may prove effective.

    Under which conditions should the manufacturers lead? The wholesaler? The retailer? While the answer is contingent upon many factors, in general, the manufacturer should lead if control of the product (merchandising, repair) is critical and if the design and redesign of the channel is best done by the manufacturer. The wholesaler should lead where the manufacturers and retailers have remained small in size, large in number, relatively scattered geographically, are financially weak, and lack marketing expertise. The retailer should lead when product development and demand stimulation are relatively unimportant and when personal attention to the customer is important.

    5. Evaluating Channel Member Performance

    The need to evaluate the performance level of the channel members is just as important as the evaluation of the other marketing functions. Clearly, the marketing mix is quite interdependent, and the failure of one component can cause the failure of the whole. There is one important difference, though: the channel member is dealing with independent business firms, rather than employees and activities under its control, these firms may be reluctant to change their practices.

    Sales is the most popular performance criterion used in channel evaluation. Other possible performance criteria are maintenance of adequate inventory, selling capabilities, attitudes of channel intermediaries toward the product, competition from other intermediaries and from other product lines carried by the manufacturer’s own channel members.

    Correcting or Modifying the Channel

    As a result of the evaluation process, or because of other factors such as new competition, technology, or market potential, changes may need to be made in the channel structure. Because channel relationships tend to be long-term, and the channel decision has such a pervasive impact on the business, any change should be carefully evaluated. Later in this module we will discuss service outputs and their role in measuring and modifying channel performance.

    The Human Aspect of Distribution

    By its very nature, a channel of distribution is made up of people. Ideally, a channel member should coordinate his or her efforts with other members in such a way that the performance of the total distribution system to which he or she belongs is enhanced. This is rarely the case, though. Part of this lack of cooperation is due to the organizational structure of many channels, which encourages a channel member to be concerned only with channel members immediately adjacent to them, from whom they buy and to whom they sell. A second reason is the tendency of channel members to exhibit their independence as separate business operations. It is difficult to gain cooperation under this arrangement. Four human dimensions have been incorporated into the study of channel behavior: roles, communication, conflict, and power. It is assumed that an understanding of these behavioral characteristics will increase the effectiveness of the channel.

    Role

    Most channel members participate in several channels. Establishing the role of a channel member means defining what the behavior of the channel member should be. For example, a basic role prescription of the manufacturer may be to maximize the sales of his or her particular brand of product. This suggests that the manufacturer is to actively compete for market share and aggressively promote his or her brand. The role prescriptions of independent wholesalers, however, are likely to be quite different. Since wholesalers may represent several competing manufacturers, their role would be to build sales with whatever brands are most heavily demanded by retailers. Therefore, a major issue in channel management is defining the role prescriptions of the various participants in order to achieve desired results. This is accomplished through a careful appraisal of the tasks to be performed by each channel member and clear communication of these roles to the members.

    Communication

    Channel communication is sending and receiving information that is relevant to the operation of the channel. It is critical for the the channel member to foster an effective flow of information within the channel. Communication will take place only if the channel member is aware of the pitfalls that await. The channel manager should therefore try to detect any behavioral problems that inhibit the effective flow of information through the channel and try to solve these problems before the communication process in the channel becomes seriously distorted.

    Conflict

    Any time individuals or organizations must work together and rely on one another for personal success, conflict is inevitable. In a distribution channel, conflict usually arises in one of two forms: structural or behavioral.

    Structural conflict occurs when the channel partners are expected to cooperate and compete. For example, imagine that you want to buy a new pair of Nike shoes and you have two choices. You can go to a local Foot Locker retailer and buy the shoes for $89, or you can go online to Nike.com and buy the shoes for $69. In effect, Nike is undercutting its retail channel while selling through a direct channel. It is likely that Foot Locker is unhappy about this. While a retailer expects to compete with other retailers who carry the same brands, it doesn’t expect that the manufacturer will sell through the direct channel at deep discounts. This type of structural conflict is often the cause of behavioral conflict.

    All organizations expect to manage some level of behavioral conflict in the channel. They do this by:

    • Establishing a mechanism for detecting conflict
    • Evaluating the effects of the conflict
    • Resolving the conflict

    Given the distributed nature of the channel, it is often difficult to resolve conflict. Strategies such as the formation of a channel committee, joint goal setting, and bringing in arbitrators have all been used. In some cases, conflict becomes part of the ongoing channel dynamic—it’s difficult but manageable. Eric Schmidt, chairman and CEO of Google Inc., notes: “From my experience the most successful companies are the ones where there is enormous conflict. Conflict does not mean killing one another, but instead means there is a process by which there is a disagreement. It is okay to have different points of view and disagree, because tolerance of multiple opinions and people often leads to the right decision through some kind of process.”

    Power

    Power is the capacity to use force in a relationship. It is often the means by which one party is able to control or influence the behavior of another party. In the channel mechanism, power refers to the capacity of a particular channel member to control or influence the behavior of another channel member. For instance, a large retailer may want the manufacturer to modify the design of the product or perhaps be required to carry less inventory. Both parties may attempt to exert their power in an attempt to influence the other’s behavior. The ability of either of the parties to achieve this outcome will depend on the amount of power that each can bring to bear.

    Third-Party Sales

    Chart titled Marketing Channels for Consumer Products, which visualizes the interactions between producers, intermediaries, and consumers concerning the flow of goods between direct channels, retail channels, wholesale channels, and agent channels.

    Throughout the channel structure there are a number of points where sales may occur.

    The most straightforward of these is the direct channel, in which the producer sells directly to the consumer. In every other structure, multiple sales occur—from producer to wholesaler, from wholesaler to retailer, from retailer to buyer. In cases involving an intermediary, there is a third-party sale. Third-party sales are sales conducted by anyone other than the producer. Even when there are four or five parties involved, we refer to all of them as third parties.

    Third-party sales are often vexing for marketers. When a company uses a direct sales approach, the marketer can devise a sales compensation structure that creates the right incentives for the sales team to sell the right products to the right customers at the right price. In a third-party sales situation, it is much more difficult to understand and influence the sales process. Let’s look at a direct sales situation and a third-party sales situation to understand the differences.

    Direct Sales Incentives

    Three models walking down a runway wearing stylish floral dresses.

    Nanette Lepore is a high-end clothing designer who has created a personal brand. Nanette sells direct to consumers both online and through her boutique stores across the U.S. Through the direct channel, Nanette’s marketing team owns every aspect of the sales experience. When customers enter a store or land on her Web page, they see a complete outfit that is designed to sell the look that Nanette most wants them to buy. This includes clothing, shoes, and accessories all designed and sold by Nanette Lepore.

    Nanette Lepore’s blog and social media presence drive interest in the products that are available in stores and online, with an emphasis on those that are targeted for immediate sale.

    When she completes drawings for next season’s looks, Nanette provides digital copies of her drawings to her sales associates, who have been cultivating a list of their most fashion-forward customers. These customers can review drawings and preorder clothing before it is available to the public. These customers pay top dollar for Nanette Lepore’s most current creations.

    In the store, sales associates are not equally compensated for all sales. Once a line of clothing goes on sale, the price is reduced. From the perspective of a sales associate, instead of earning a 5 percent commission ($40) on an $800 dress, the associate will earn a 5 percent commission ($10) on a discounted $200 dress. The associate may earn no commission or a reduced commission on clearance items.

    The sales staff is preparing customers in advance and in the moment to pay top dollar for Nanette Lepore’s hottest fashions. They do this because there is an entire sales system and compensation structure that centers on Nanette Lepore. They also do this because they have become part of the Nanette Lepore brand and feel a commitment to Nanette Lepore and to the women for whom she is designing.

    Third-Party Sales Incentives

    Many retailers sell the Nanette Lepore line, including Neiman Marcus, Saks Fifth Avenue, Nordstrom, Zappos, Gilt, Shopbop, and 6pm.com.

    The Neiman Marcus sales associate in the dress department is paid a flat commission regardless of the brand she sells. A strong sales associate will identify shoppers with an affinity for Nanette’s designs and present them in the changing room or call to let them know that new Nanette Lepore designs have arrived. If a dress from Diane von Furstenberg or Kate Spade is more likely to make the sale, the dress by Nanette Lepore will not be suggested. The sales associate has incentives to make the largest possible sale—regardless of brand.

    If the customer buys a Nanette Lepore dress and heads to the shoe department or accessory department to complete her outfit, she won’t have Nanette Lepore brands as an option. Each department carries the most popular brands, and Nanette Lepore bags and shoes are a new, unproven brand.

    In a more extreme example, 6pm.com is the online bargain outlet for Zappos. There is no sales associate, and little effort is made to feature or present any particular brand or clothing. Customers come searching for rock-bottom pricing. Nanette Lepore’s fashions sell at a discount of 60 percent to 70 percent off the manufacturers’ suggested retail price.

    If this example doesn’t seem like something that you have experienced, walk into BestBuy and look for a phone, camera, or computer. Ask a sales associate to help you. You will quickly find that the store’s sales compensation structure is driving what is available to you—and what is recommended.

    What about something as simple as breakfast cereal in a grocery store? Which products are at eye level? Which are difficult to find? Which are not available? Sales incentives are determining the answers to each of these questions.

    Approaches to Support Third-Party Sales Success

    If the marketer works for the producer—in our example, Nanette Lepore—he will lose significant control and influence in the third-party sale, while the Neiman Marcus marketing team will gain control or power. How can a marketer approach third-party sales most effectively? The following approaches can be used:

    1. Understand and align incentives. A good marketer must understand why each channel partner buys and sells, how they are compensated, and what objectives they are hoping to achieve. In third-party sales, the marketer must optimize an existing structure rather than creating the structure.
    2. Provide exceptional sales support. While the Nanette Lepore sales associates only needs to learn about her line, the Neiman Marcus sales associates must learn thirty or more. Make it very easy for the third-party sales team to become expert in your product.
    3. Create demand for your product. Often marketers blame channel partners for a marketing mix that doesn’t deliver value to the customer. While it is trite to say that a good product sells itself, it is true that the right product is easier to sell. When the distribution channel—”place,” in the marketing mix—creates a lot of complexity, it is even more important to get the other three elements of the marketing mix just right.

    Service Outputs

    As with each element of the marketing mix, different segments of customers have different needs with regard to place, or distribution. Service outputs offer a way to focus on the unique needs of a target buyer and plan for those in the distribution strategy. Service outputs are the productive outputs of the marketing channel that consumers value and desire.

    By identifying the service outputs for each segment of target buyers, the marketer can optimize the distribution strategy for each major segment. It is important to note that there are always trade-offs in the distribution strategy. A channel that provides a high level of customized service, such as a boutique store, will also usually add additional cost. A channel that provides goods in very large quantities with a lower level of service, such as Costco, will generally offer them at a lower cost. Either might be the “right” solution depending on the customer segment.

    Common Service Outputs

    When considering the goals of channel management in meeting customer needs, there are a few broad service outputs that channels can address. The service outputs are explained from the perspective of the target customer, by identifying needs or preferences that a target customer might have:

    1. Spacial convenience: Can I get the product at or near the location where I want it?
    2. Timing of availability: Do I need the product immediately or am I willing to wait?
    3. Quantity: Am I willing to buy in bulk or buy multiple items?
    4. Assortment and variety: Do I have a very particular need or a flexible need? Am I looking for one or many options?
    5. Service: Do I require assistance or support through the purchase process?
    6. Information: Do I need information to make a purchase, or do I enter the buying process having already made a decision?

    Again, service outputs generally involve trade-offs. For example, few customers would ever say, “Timing of availability has no impact on my purchase decision,” but the timing of availability may be less important than the quantity or service needs. Customers generally have strong preferences in some areas and are more flexible in others.

    Service Outputs in Practice

    Imagine that a farmer is selling eggs and wants to meet the needs of her final consumers. Eggs are a fairly uniform product, a commodity, so most consumers are going to make decisions about which eggs they purchase based more on the distribution strategy than on a product or promotional strategy. Price is likely to be a factor, too.

    A carton of a dozen eggs in various shades of white and brown.

    Let’s consider how two different customers might weight the service outputs in two very different but simple egg-buying decisions.

    Service Outputs in two simple egg-buying decisions
    Service Output Experience 1: I’m looking for a nice restaurant for brunch. Service Output Level: Experience 1 Experience 2: I need eggs that I can cook for my family’s breakfast. Service Output Level: Experience 2
    Spatial Convenience I’m willing to drive a little bit, especially to an interesting location with strong reviews. Low I want the most convenient location on my route where I can get in and out quickly. High
    Timing of Availability I’m seeking an experience and am willing to spend some time to get it. Low I want the quickest purchase possible. High
    Quantity I would like a nicely sized portion that seems like good value for the money. Medium I don’t use eggs in bulk but need enough to feed my family. Medium
    Assortment and Variety I would like to have a nice selection of preparations, and I prefer organic farm-fresh eggs. High I just need a dozen eggs of any brand. Low
    Service I want a full-service experience from the wait staff and chef. High I want a quick, efficient check-out, but I don’t require help selecting. Low
    Information I would like to have information about my options, and to understand the opinions of others who have eaten at this restaurant. High I already know everything I need to make a purchase. Low

    For the farmer, these different scenarios can inform the distribution strategy. If she is looking to command a higher price, then she may want to focus on a strategy of selling through restaurant suppliers or directly to restaurants as a retail channel. If she is looking to sell a larger quantity of eggs, then she likely needs to sell to a wholesaler who can get as many of her eggs as possible into the right supermarkets that are located in neighborhoods of many, many consumers seeking spatial convenience in the purchase process. Or, she might want to pursue both strategies but do this with an awareness that she is serving two different target buyers with very different needs.

    By understanding the service outputs of buyer segments, marketers can better match distribution options to buyer needs and provide the right trade-offs to each buyer.


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