Lars Perner, Ph.D.
Assistant Professor of Clinical Marketing
Department of Marketing
Marshall School of Business
University of Southern California
Los Angeles, CA 90089-0443, USA
CHANNELS OF DISTRIBUTION
Firm level objectives: It is not enough to simply state a firm’s goal as maximizing the present value of total profit since this does not differentiate it from other firms and says nothing about how this objective is to be achieved. Instead, a business and marketing plan should suggest how the firm can best put its unique resources to use to maximize stockholder value. A number of resources come into play—e.g.,
- Distinctive competencies—knowledge of how to manufacture, design, or market certain products or services effectively;
- Financial—possession of cash or the ability to raise it;
- Ability and willingness to take risk;
- The image of the firm’s brand;
- People who can develop new products, services, or other offerings and run the needed supports;
- Running facilities (no amount of money is going to get a new microchip manufacturing plant started tomorrow); and
- Contacts with suppliers and distributors and others who influence the success of the firm.
Market balance: It is essential that different firms in the same business not attempt to compete on exactly the same variables. If they do, competition will invariably degenerate into price—there is nothing else that would differentiate the firms. Thus, for example, in the retail food market, there are low price supermarkets such as Food 4 Less that provide few if any services, intermediate level markets like Ralph’s, and high-end markets such as Vons’ Pavillion that charge high prices and claim to carry superior merchandise and offer exceptional service
Risk: In general, firms that attempt riskier ventures—and their stockholders—expect a higher rate of return. Risks can come in many forms, including immediate loss of profit due to lower sales and long term damage to the brand because of a poor product being released or because of distribution through a channel perceived to carry low quality merchandise.
Brand level objectives: Ultimately, brand level profit centers are expected to contribute to the overall maximization of the firm’s profits. However, when a firm holds several different brands, different marketing and distribution plans may be required for each. Several variables come into play in maximizing value. Profits can be maximized in the short run, or an investment can be made into future earnings. Product profit can be measured in several ways. If you sell a computer that cost $950 to make for $1,000, you are making only a 5% gross profit. However, selling a product that cost $5 to make for $10 will result in a much higher percentage profit, but a much lower absolute margin. A decision that is essential at the brand level is positioning. Options here may range from a high quality, premium product to a lower priced value product. Note here that the same answer will not be appropriate for all firms in the same market since this will result in market imbalance—there should be some firms perceiving each strategy, with others being intermediate.
Distribution issues come into play heavily in deciding brand level strategy. In order to secure a more exclusive brand label, for example, it is usually necessary to sacrifice volume—it would do no good, for Mercedes-Benz to create a large number of low priced automobiles. Some firms can be very profitable going for quantity where economies of scale come into play and smaller margins on a large number of units add up—e.g., McDonald’s survives on much smaller margins than upscale restaurants, but may make larger profits because of volume. Some firms choose to engage in a niching strategy where they forsake most customers to focus on a small segment where less competition exists (e.g., clothing for very tall people).
In order to maintain one’s brand image, it may be essential that retailers and other channel members provide certain services, such as warranty repairs, providing information to customers, and carrying a large assortment of accessories. Since not all retailers are willing to provide these services, insisting on them will likely reduce the intensity of distribution given to the product.
Product line objectives: Firms make money on the totality of products and services that they sell, and sometimes, profit can be maximized by settling for small margins on some, making up on others. For example, both manufacturers and retailers currently tend to sell inkjet printers at low prices, hoping to make up by selling high margin replacement cartridges. Here again, it may be important for the manufacturer that the retailer carry as much of the product line as possible.
Objectives: A firm’s distribution objectives will ultimately be highly related—some will enhance each other while others will compete. For example, as we have discussed, more exclusive and higher service distribution will generally entail less intensity and lesser reach. Cost has to be traded off against speed of delivery and intensity (it is much more expensive to have a product available in convenience stores than in supermarkets, for example).
Narrow vs. wide reach: The extent to which a firm should seek narrow (exclusive) vs. wide (intense) distribution depends on a number of factors. One issue is the consumer’s likelihood of switching and willingness to search. For example, most consumers will switch soft drink brands rather than walking from a vending machine to a convenience store several blocks away, so intensity of distribution is essential here. However, for sewing machines, consumers will expect to travel at least to a department or discount store, and premium brands may have more credibility if they are carried only in full service specialty stores.
Retailers involved in a more exclusive distribution arrangement are likely to be more “loyal”—i.e., they will tend to
- Recommend the product to the customer and thus sell large quantities;
- Carry larger inventories and selections;
- Provide more services
Thus, for example, Compaq in its early history instituted a policy that all computers must be purchased through a dealer. On the surface, Compaq passed up the opportunity to sell large numbers of computers directly to large firms without sharing the profits with dealers. On the other hand, dealers were more likely to recommend Compaq since they knew that consumers would be buying these from dealers. When customers came in asking for IBMs, the dealers were more likely to indicate that if they really wanted those, they could have them—“But first, let’s show you how you will get much better value with a Compaq.”
Distribution opportunities: Distribution provides a number of opportunities for the marketer that may normally be associated with other elements of the marketing mix. For example, for a cost, the firm can promote its objective by such activities as in-store demonstrations/samples and special placement (for which the retailer is often paid). Placement is also an opportunity for promotion—e.g., airlines know that they, as “prestige accounts,” can get very good deals from soft drink makers who are eager to have their products offered on the airlines. Similarly, it may be useful to give away, or sell at low prices, certain premiums (e.g., T-shirts or cups with the corporate logo.) It may even be possible to have advertisements printed on the retailer’s bags (e.g., “Got milk?”)
Other opportunities involve “parallel” distribution (e.g., having products sold both through conventional channels and through the Internet or factory outlet stores). Partnerships and joint promotions may involve distribution (e.g., Burger King sells clearly branded Hershey pies).
Deciding on a strategy. In view of the need for markets to be balanced, the same distribution strategy is unlikely to be successful for each firm. The question, then, is exactly which strategy should one use? It may not be obvious whether higher margins in a selective distribution setting will compensate for smaller unit sales. Here, various research tools are useful. In focus groups, it is possible to assess what consumers are looking for an which attributes are more important. Scanner data, indicating how frequently various products are purchased and items whose sales correlate with each other may suggest the best placement strategies. It may also, to the extent ethically possible, be useful to observe consumers in the field using products and making purchase decisions. Here, one can observe factors such as (1) how much time is devoted to selecting a product in a given category, (2) how many products are compared, (3) what different kinds of products are compared or are substitutes (e.g., frozen yogurt vs. cookies in a mall), (4) what are “complementing” products that may cue the purchase of others if placed nearby. Channel members—both wholesalers and retailers—may have valuable information, but their comments should be viewed with suspicion as they have their own agendas and may distort information.
We consider direct marketing early in the term as a “contrast” situation against which later channels can be compared. In general, you cannot save money by “eliminating the middleman” because intermediaries specialize in performing certain tasks that they can perform more cheaply than the manufacturer. Most grocery products are most efficiently sold to the consumer through retail stores that take a modest mark-up—it would not make sense for manufacturers to ship their grocery products in small quantities directly to consumers.
Intermediaries perform tasks such as
- Moving the goods efficiently (e.g., large quantities are moved from factories or warehouses to retail stores);
- Breaking bulk (manufacturers sell to a modest number of wholesalers in large quantities—quantities are then gradually broken down as they make their way toward the consumer);
- Consolidating goods (retail stores carry a wide assortment of goods from different manufacturers—e.g., supermarkets span from toilet paper to catsup); and
- Adding services (e.g., demonstrations and repairs).
Direct marketers come in a variety of forms, but their categorization is somewhat arbitrary. The main thing to consider here is each firm’s functions and intentions. Some firms sell directly to consumers with the express purpose of eliminating retailers that supposedly add cost (e.g., Dell Computer). Others are in the business not so much to save on costs, but rather to reach groups of consumes that are not easily reached through the stores. Others—e.g., online travel agents or check printers—provide heavily customized services where the user can perform much of the services. Telemarketers operate by making the promotion in integral part of the process—you are explained the benefits of the program in an advertisement or infomercial and you then order directly in response to the promotion. Finally, some firms combine these roles—e.g., Geico is a customizer, but also claims, in principle, to cut out intermediaries.
There are certain circumstances when direct marketing may be more useful—e.g., when absolute margins are very large (e.g., computers) or when a large inventory may be needed (e.g., computer CDs) or when the customer base is widely dispersed (e.g., bee keepers).
Direct marketing offers exceptional opportunities for segmentation because marketers can buy lists of consumer names, addresses, and phone-numbers that indicate their specific interests. For example, if we want to target auto enthusiasts, we can buy lists of subscribers to auto magazines and people who have bought auto supplies through the mail. We can also buy lists of people who have particular auto makes registered.
No one list will contain all the consumers we want, and in recent years technology has made it possible, through the “merge-purge” process, to combine lists. For example, to reach the above-mentioned auto-enthusiasts, we buy lists of subscribers to several different car magazines, lists of buyers from the Hot Wheels and Wiring catalog, and registrations of Porsche automobiles in several states. We then combine these lists (the merge part). However, there will obviously be some overlap between the different lists—some people subscribe to more than one magazine, for example. The purge process, in turn, identifies and takes out as many duplicates as possible. This is not as simple task as it may sound up front. For example, the address “123 Main Street, Apartment 45” can be written several ways—e.g., 123 Main St., #123, or 123-45 Main Str. Similarly, John J. Jones could also be written as J. J. Jones, or it could be misspelled Jon J. Jonnes. Software thus “standardizes” addresses (e.g., all street addresses would be converted into the format “123 Main St #45” and even uses phonetic analysis to identify a likely alternative spelling of the same name.
Response rates for “good” lists—lists that represent a logical reason why consumer would be interested in a product—are typically quite low, hovering around 2-3%. Simply picking a consumer out of the phone-book would yield even lower responses—much less than one percent. Keep in mind that a relevant comparison here is to conventional advertising. The response rate to an ad placed in the newspaper or on television is usually well below one percent (frequently more like one-tenth of one percent). (More than one percent of people who see an ad for Coca Cola on TV will buy the product, but most of these people would have bought Coke anyway, so the marginal response is low).
Online marketing can serve several purposes:
- Actual sales of products—e.g., Amazon.com.
- Promotion/advertising: Customers can be quite effectively targeted in many situations because of the context that they, themselves, have sought out. For example, when a consumer searches for a specific term in a search engine, a “banner” or link to a firm selling products in that area can be displayed. Print and television advertisements can also feature the firm’s web address, thus inexpensively drawing in those who would like additional information.
- Customer service: The site may contain information for those who no longer have their manuals handy and, for electronic products, provide updated drivers and software patches.
- Market research: Data can be collected relatively inexpensively on the Net. However, the response rates are likely to be very unrepresentative and recent research shows that it is very difficult to get consumers to read instructions. This is one of the reasons why the quality of data collected online is often suspect.
CHALLENGES IN RUNNING WEB SITES
There are a number of problems in running and developing web sites. First of all, the desired domain name may not be available—e.g., American Airlines could not get “American.com” and had to settle for “AmericanAir.com.” There is also a question having your site identified to potential users. Research has found that most search engines have a great deal of “false hits” (sites irrelevant that are identified in a search—e.g., information about computer languages when the user searches for foreign language instruction) and “misses” (sites that would have been relevant but are not identified). It is crucial for a firm to have its site indexed favorably in major search engines such as Yahoo, AOLFind, and Google. However, there is often a constant struggle between web site operators and the search engines to outguess each other, with the web promoters trying to “spam” the search engines with repeated usage of terms and “meta tags.” The fact that many computer users employ different web browsers raises questions about compatibility. A major problem is that many of the more recent, fancier web sites rely on “java script” to provide animation and various other impressive features. These animations have proven very unreliable. Sites may “crash” on the user or prove unreliable, and many consumers have found themselves unable to complete their transactions.
ECONOMICS OF ELECTRONIC COMMERCE:
SELLING ONLINE IS USUALLY MORE EXPENSIVE
Some people have suggested that the Internet may be a less expensive way to distribute products than traditional “brick-and-mortar” stores. However, in most cases, selling online will probably be more costly than selling in traditional stores due to the high costs of processing orders and direct shipping to the customer. Some products may, however, be economically marketed online. Some factors that are relevant in assessing the potential for e-commerce to be an effective way to sell a specific products are:
- “Value-to-bulk” ratio. Products that have a lot of value squeezed into a small volume (e.g., high end jewelry and certain electronic products) are often more cost-effective to ship to end-customers than are bulkier products with less value (e.g., low end furniture).
- Absolute margins. Some products may have a rather high percentage margin—e.g., a scarf bought at wholesale at $10 and marked up 100% to be sold at $20. However, the absolute margin is only $20-$10=$10. In contrast, a laptop computer may be bought at $1,000 and be marked up by only 15%, or $150, for a total price of $1,150. Here, however, the absolute margin will be larger--$150. This allows the merchant to spend money on processing, packaging, and shipping the order. Ten dollars, in contrast, can only cover a small amount of employee time and very limited packaging and shipping. Some online merchants do charge for shipping, but doing so will ultimately make the online merchant less competitive.
- Extent of customization needed. Some products need to be customized—e.g., checks have to be personalized and airline tickets have to be issued for a specific departure site, destination time, and travel time. Here, online processing may be useful because the customer can do much of the work.
- Willingness of customers to pay for convenience. Some consumers may be willing to pay for the convenience of having products delivered to their door. For example, delivering high bulk, generally low value groceries is generally not efficient. However, for some customers, it may be worthwhile to pay to avoid an inconvenient trip to the grocery store.
- Geographic dispersal of customers. Electronic commerce, when value-to-bulk ratios and absolute margins are not favorable, is often not viable when customers are located conveniently close to a retail outlet. However, for some products—e.g., bee keeping equipment—customers are widely geographically dispersed and thus, a centralized distribution center may be more economically viable. Specialty books—e.g., for collectors of vintage automobiles—may not be worthwhile for bookstores to stock, and these may thus be economically sold online.
- Vulnerability of inventory to loss of value. Some products—especially high tech products—have a very high effective carrying costs. It has been estimated that because of the rapid technological progress made in the computer field, computer parts may lose as much as 1.5% of their value per week. If shipping directly to the customer can reduce the channel time by five weeks, this potentially “rescues” as much as 7.5% of the product value. In such a situation, then, trying to reach the customer directly may make sense, even if the direct costs of distribution are higher, because of the inventory value issue.
There are a number of economic realities of online competition:
- As discussed, costs of handling online orders is often higher than that of distributing through traditional stores.
- Even if online selling is more cost effective in some situations, a firm selling online will, in the long run, be competing with other online merchants—not just against traditional “brick-and-mortar” stores. By the forces of supply and demand, online prices will then be driven down so that the profit from selling online will be no greater than that from traditional retailing. Any reduced costs would then be expected to go to customers.
- Competition will be greater for products that have large markets than for those where markets are smaller and more specialized. Amazon.com, for example, has found it necessary to discount best selling books deeply. Higher prices—closer to the list price—can be charged for specialty books, but for a large part of the market, competition will be intense.
- A new online merchant will face competition from established traditional merchants. These will often have the cash reserves to stay in business for a long time even with temporary competition. The online merchant, if it has no cash reserves other than stockholders’ investment, may run out of cash before it can become profitable.
ISSUES IN WEB SITE DESIGN
Web site design: The web designer must make various issues into consideration:
- Speed vs. aesthetics: As we saw, some of the fancier sites have serious problems functioning practically. Consumers may be impressed by a fancy site, or may lack confidence in a firm that offers a simple one. Yet, fancier sites with extensive graphics take time to download—particularly for users dialing in with a modem as opposed to being “hard” wired—and may result in site crashes.
- Keeping users on the site: A large number of “baskets” are abandoned online as consumers fail to complete the “check-out” process for the products they have selected. One problem here is that many consumers are drawn away from a site and then are unlikely to come back. A large number of links may be desirable to consumers, but they tend to draw people away. Taking banner advertisers on your site from other sites may be profitable, but it may result in customers lost.
- Information collection: An increasing number of consumers resist collection of information about them, and a number of consumers have set up their browsers to disallow “cookies,” files that contain information about their computers and shopping habits.
Cyber-consumer behavior: In principle, it is fairly easy to search and compare online, and it was feared that this might wipe out all margins online. More recent research suggests that consumers in fact do not tend to search very intently and that large price differences between sites persist. We saw above the problem of keeping consumers from prematurely departing from one’s site.
Site content. The content of a site should generally be based on the purposes of operating a site. For most sites, however, having a clear purpose be evident is essential. The site should generally provide some evidence for this position. For example, if the site claims a large selection, the vast choices offered should be evident. Sites that claim convenience should make this evident. A main purpose of the Internet is to make information readily available, and the site should be designed so that finding the needed information among all the content of the site is as easy as possible. Since it is easy for consumers to move to other sites, the site should be made interesting. To provide the information and options desired by customers, two-way interaction capabilities are essential.
WEB SITE TRAFFIC GENERATION
The web is now so large that getting traffic to any one site can be difficult. One method is search engine optimization, a topic that will be covered below. Other methods include “viral” campaigns wherein current users are used to spread the word about a site, firm, or service. For example, Hotmail attaches a message to every e-mail sent from its service alerting the recipient that a free e-mail account can be had there. Google offers a free e-mail account with a full gigabyte of storage. This is available only by invitation from others who have such e-mail accounts. Amazon.com at one point invited people, when they had completed a purchase, to automatically e-mail friends whose e-mail addresses they provided with a message about what they had just bought. If the friend bought any of the same items, both the original customer and the friend would get a discount.
Another method of gaining traffic is through online advertising. Sites like Yahoo! are mainly sponsored by advertisers, as are many sites for newspapers and magazines. Individuals who see an ad on these sites can usually click to go to the sponsor’s web site. Occasionally, a firm may advertise their sites in traditional media. Geico, Dell Computer, and Progressive Insurance do this. Overstock.com has also advertised a lot on traditional TV programs. Conventional advertising may also contain a web site address as part of a larger advertising message.
Viral marketing is more suitable for some products than for others. To get others involved in spreading the word, the product usually must be interesting and unique. It must also be simple enough so that it can be explained briefly. It is most useful when switching or trial costs are low. It is more difficult, for example, getting people to sign up for a satellite system or cellular phone service where equipment has to be bought up front and/or a long term contract is required makes viral marketing more difficult. Viral marketing does raise some problems about control of the campaign. For example, if a service is aimed at higher income countries and residents there spread the word to consumers in lower income countries, people attracted may be unprofitable. For Google’s one gigabyte e-mail account, for example, there are large costs that may be covered by advertising revenues from ads aimed at people who can afford to buy products and services. Advertisers, however, may not be willing to pay for targets who cannot afford their products. It is also difficult to control “word of mouth” (or “word of keyboard”). Measuring the effectiveness of a campaign may be difficult. When a viral campaign relies on e-mail, messages received may be considered spam by some recipients, leading to potential brand damage and loss of goodwill.
Online promotions. One way to generate traffic is promotions. Many sites often offer new customers discounts or free gifts. This can be expensive, but sometimes, the gifts can be ones that have a low marginal cost. For example, once the firms pays for the development of a game, the cost of letting new users download it is modest. The U.S. army uses this approach in making a game available. To be allowed to use some of the “cooler” features, the user has to go through various stages of “basic training.”
SEARCH ENGINE OPTIMIZATION
Many Internet users find desired information and sites through search engines such as Google. Research shows that a large proportion of the traffic goes to the first three sites listed, and few people go so sites that appear beyond the first “page” or screen. On Google, the default screen size is ten sites, so being in the top ten is essential.
Because of the importance of search engines, getting a good ranking or coming up early on the list for important keywords is vitally important. Many consultants offer, for large fees, to help improve a site’s ranking.
There are several types of sites that are similar to search engines. Directories involve sites that index information based on human analysis. Yahoo! started out that way, but now most of the information is accessed through search engine features. The Open Directory Project at http://www.dmoz.org indexes sites by volunteer human analysts. Some sites contain link collections as part of their sites—e.g., business magazines may have links to business information sites.
Several issues in search engines and directories are important. Some search engines, such as Google, base rankings strictly on merit (although sites are allowed to get preferred paid listings on the right side of the screen). Other search engines allow sites to “bid” to get listed first. Some sites may end up paying as much as a dollar for each surfer who clicks through. If a potential customer is valuable enough, it may be worth paying for enhanced listings. Often, however, it is better to be listed as number two or three since only more serious searchers are likely to go beyond the first site. The first listed site may attract a number of people who click through without much serious inspection of the site.
Some search engines are more specific than others. The goal of Google, Yahoo! and MSN is to contain as many sites as possible. Others may specialize in sites of a specific type to reduce the amount of irrelevant information that may come up.
Search engines often have different types of strategies. Google is very much technology oriented while Yahoo! appears to be more market oriented. Another major goal of Google is speed. Some sites may contain more content of one type than another. For example, AltaVista appears to have more images, as opposed to text pages, indexed.
Search engine rankings. The order in which different sites are listed for a given term is determined by a secret algorithm developed by the search engine. An algorithm is a collection of rules put together to identify the most relevant sites. The specific algorithms are highly guarded trade secrets, but most tend to heavily weigh the number of links from other sites to a site and the keywords involved. More credit is given for a link from a highly rated site—thus, having a link from CNN.com would count much more than one from the site of the Imperial Valley Press. On any given page, the weight given from a link will depend on the total number of links on that page. Having one of one hundred links will count less than being the only one. One source reports that the weight appears to be proportional so that one out of one hundred links would carry one percent of the weight of being the sole link, but that may change and/or vary among search engines.
For Google, some of the main ranking factors appear to be:
- Number and quality of links to the site, as discussed above.
- Relevant keywords. Note that the ranking algorithm tests for “spam.” Reckless repeating keywords may actually count against the rating of the site.
- The “click-through” share of the site. Since late 2006 or early 2007, Google reportedly fine-tunes rankings by observing the percentage of the time that a particular site is chosen for a given set of search terms. Sites that are selected more frequently may improve in rank and those less frequently selected—despite their merits presumed from the other factors—may move down.
Types of search engines. Some engines, such as Google, are general purpose search engines. Some are specialized. Some are hybrids, containing some directory structure in addition to search engine capabilities. Some “reward” sites such as iwon.com attract people by allowing them to enter a lottery when doing a search. Some sites are aggregator sites—they do not have their own databases but instead combine the results from simultaneous searches on other search engines.
Text optimization. It is important to repeat important words as much as possible subject to credibility. Search engines today are increasingly sophisticated in identifying “spamming” through frivolous repetition of the same words or early use of words that are not relevant to the main content of the site. Words that appear early in the text and on the index page will tend to be weighted more heavily. For some search engines, it may be useful to include common misspellings of a word so that the site will come up when that spelling is used. Some web site owners have attempted to include hidden text so that a search engine would find the desired words while the visitor would see something else. Some web designers, for example, would hide text behind a graphic, make the text in a very small font, and/or make the font color the same, or nearly the same, as the background. Other web site designers have made a “legitimate” site, only to have a command to move the visitor to another site when they go to the searched site. Search engines today are increasingly able to detect this type of abuse, and sites may be penalized as a result.
Early search engines relied heavily on “meta tags” where the web site creator specified what he or she believed to be appropriate keywords, content descriptions, and titles. Because these tags are subject to a lot of abuse, these no longer appear to be significant.
Link optimization. Many web sites engage in “link exchanges”—that is, complementary sites will agree to feature links to each other. It may be useful for a webmaster to ask firms whose content does not compete for a link. Sites should register with the Open Directory Project at http://www.dmoz.org since, if a site is classified favorably, this may help rankings.
The bottom line on Google. Today, the most significant factor in search engine rankings appears to be the “value” of the links that reach a site. Links from “low value” sites (those that are not rated highly, and especially those considered to the “spam”) count for very little. Links from highly rated sites on the relevant keywords count for literally thousands—sometimes tens and hundreds of thousands—times as much as less important site. In the past, the presence of important key terms on a site was the main driver of rankings, subject to some rudimentary safeguards against obvious “spamming” sites which used the words as a way to gain rankings without providing relevant information. Now, the effect of keywords is secondary except for searches that involve a very unique key term. Search engines cannot usually measure the amount of traffic that goes to a site. Traditionally, then, the traffic of a site was not directly incorporated into the ranking system. Today, however, Google is reported to weigh the percentage that a site is chosen for click-through when the site comes up in a search. That is, if a site is initially highly ranked, if a small proportion of searchers actually choose to go to that site, this site is likely to have its rank reduced.
Google now offers a set of “Analytics” tools, including a set of web traffic statistics. Webmasters can sign up voluntarily to participate in this by placing certain “meta tag” code in their web pages. (This code is invisible to people viewing the respective web page in its regular display mode). Therefore, for such sites, Google does, in principle, have access to traffic information from all sources, including other search engines or links from other sites. It is not clear whether Google actually uses this information, however.
As we have discussed earlier, firms have to make tradeoffs between different considerations such as cost of distribution, intensity vs. exclusivity, and service provided. Some of the services ultimately desired by consumers include bulk-breaking (as previously discussed), spatial convenience (being able to buy milk in the supermarket rather than having to drive out to a farmer to get it), timing of availability (having someone—the retailer and other channel members—plan to have toothpaste available in the store when the consumer needs it), and providing a breadth of assortment (the same store will carry different kinds of food and other merchandise from different suppliers.
Segmentation involves identifying groups of consumers who respond relatively similarly to different treatments. In general, we want to find segments that contain people who are as similar as possible to each other while, simultaneously, being as different as possible from members of other segments. Thus, for example, members of what we might term a price sensitive food segment are likely to seek out the lowest priced retailers even if they are not located conveniently, buy larger packages, switch brands depending on what is on sale, and cut coupons. The “fussy” segment, in contrast, may shop either where the best quality is found or at the most convenient location, and may be brand loyal and not cut coupons. Note that not all members of each segment will be completely alike, and there is some tension between precision of description and cutting the segments into too small pieces. The idea, here, then, is for different channels to serve different consumers (e.g., price sensitive individuals are targeted by Food 4 Less while more upscale stores target the price insensitives).
Paths to the customer. For most products and situations, it is generally more efficient for a manufacturer to go through a distributor rather than selling directly to the customer. This is especially the case when consumers need to have variety and assortment (e.g., consumer would like to buy not just toothpaste but also other personal hygiene products, and even other grocery products at the same place), when products are bought in small volumes or at low value (e.g., a candy bar sells for less than $1.00), or even intermediaries have skills or resources that the manufacturer does not (a sales force, warehousing, and financing). Nevertheless, there are situations when these conditions are not met—most typically in industrial settings. As an extreme case, most airlines are perfectly happy only being able to buy aircraft and accessories from Boeing and would prefer not to go through a retailer—particularly since the planes are often highly customized. More in the "gray" area, it may or may not be appropriate to sell microcomputers directly to consumers rather than going through a distributor—the costs of providing those costs may be roughly comparable to the margin that a distributor would take.
Potential channel structures. Channel structures can assume a variety of forms. In the extreme case of Boeing aircraft or commercial satellites, the product is made by the manufacturer and sent directly to the customer’s preferred delivery site. The manufacturer, may, however, involve a broker or agent who handles negotiations but does not take physical possession of the property. When deals take on a smaller magnitude, however, it may be appropriate to involve retailer--but no other intermediary. For example, automobiles, small planes, and yachts are frequently sold by the manufacturer to a dealer who then sends directly to the customer. It does not make sense to deliver these bulky products to a wholesaler only to move them again. On the other hand, it would not make sense for a California customer to fly to Detroit, buy a car there, and then drive it home. As the need for variety increases, a wholesaler may then be introduced. For example, an office supply store needs to sell more merchandise than any one manufacturer can produce. Therefore, a wholesaler will buy a very large quantity of binders, file folders, staplers, reams of paper, glue sticks, and similar products and sell this in smaller quantities—say 200 staplers at a time—to the office supply store, which, in turn, may go to another wholesaler who has acquired telephones, typewriters, and photocopiers. Note that more than one wholesaler level may be involved—a local wholesaler serving the Inland Empire may buy from each of the two wholesalers listed above and then sell all, or most, of the products needed by local office supply stores. Finally, even in longer channels, agents or brokers may be involved. This, in particular, will happen when the owner of a small, entrepreneurial company has more experience with technology than with businesses negotiations. Here, the manufacturer can be freed, in return for paying the agent, from such tasks, allowing him or her to focus on what he or she does well.
Criteria in selecting channel members. Typically, the most important consideration whether to include a potential channel member is the cost at which he or she can perform the required functions at the needed level of service. For example, it will be much less expensive for a specialty foods manufacturer to have a wholesaler get its products to the retailer. On the other hand, it would not be cost effective for Procter & Gamble and Wal-Mart to involve a third party to move their merchandise—Wal-Mart has been able to develop, based on its information systems and huge demand volumes, a more efficient distribution system. Note the important caveat that cost alone is not the only consideration—premium furniture must arrive in the store on time in perfect condition, so paying more for a more dependable distributor would be indicated. Further, channels for perishable products are often inefficiently short, but the additional cost is needed in order to ensure that the merchandise moves quickly. Note also that image is important—Wal-Mart could very efficiently carry Rolex watches, but this would destroy value from the brand.
"Piggy-backing." A special opportunity to gain distribution that a manufacturer would otherwise lack involves "piggy-backing." Here, a manufacturer enlists another manufacturer that already has a channel to a desired customer base, to pick up products into an existing channel. For example, a manufacturer of rhinoserous and hippopotamus shampoo might be able to reach zoos by approaching a manufacturer of crocodile teeth cleaning supplies that already reaches this target. In the case of reciprocal piggy-backing, the shampoo manufacturer might then, in turn, bring the teeth cleaning supplies through its existing channel to exotic animal veterinarians.
Parallel Distribution. Most manufacturers find it useful to go through at least one wholesaler in order to reach the retailer, and it is simply not efficient for Colgate to sell directly to pathetic little "mom and pop" neighborhood stores. However, large retail chains such as K-Mart and Ralph’s buy toothpaste and other Colgate products in such large volumes that it may be efficient to sell directly to those chains. Thus, we have a "parallel" distribution network whereby some retailers buy through a distributor and others do not. Note that we may also be tempted to add a direct channel—e.g., many clothing manufacturers have factory outlet stores. However, note that the full service retailers will likely object to being "undercut" in this manner and may decide to drop or give less emphasis to the brand. It may be possible to minimize this contract by precautions such as (1) having outlet stores located in vacation areas not within easy access of most people, (2) presenting the merchandise as being slightly irregular, and/or (3) emphasizing discontinued brands and merchandise not sold in regular stores.
Evaluating Channel Performance. The performance of channel members should be periodically monitored—a channel member may have looked attractive earlier but may not, in practice be able to live up to promises. (This can be either because of complacency or because the channel member simply did not realize the skills and resources needed to perform to standards). Thus, performance level (service outputs) and costs should be evaluated. Further, changes in technology or in the market place may make it worthwhile to shift certain functions to another channel member (e.g., a distributor has expanded its coverage into another region or may have gained or lost access to certain retail chains). Finally, the extent to which compensation is awarded in proportion to performance should be reassessed—e.g., a distributor that ends up holding inventory longer or taking on more returns may need additional compensation.
Market Deficiencies. "Gap" analysis involves analyzing current market offering to assess the extent to which they meet customer demands. Demand side gaps involve a market situation where consumers are not satisfied buying what is available—usually either because the level of service provided is not adequate or because the offering is too expensive. Supply side gaps, in contrast, involve firms that provide services that are needed, but ones that can be met elsewhere at lower prices.
Demand Side Gaps. Customer satisfaction abounds, and many consumers would like to replace their current suppliers. This can happen either generally—there is a widespread dissatisfaction with banks among consumers, and many would switch if they found one that they thought to provide better service—or the gap can be with one segment that is not being well served. As an example of the latter, consider parents who, if they had not had children, would have been perfectly satisfied with an ordinary Internet service provider but are now worried that their children can be exposed to inappropriate material online. Therefore, the PAX Network, which features family-oriented television programming, stepped in to offer a service that claims to block out most objectionable sites. Further, one auto parts store owned by a woman ran an advertising campaign aimed at women, acknowledging that women were often being asked by their husbands and boyfriends to be "parts runners." The ad then went on to talk about the cleanliness of the store and non-condescending attitudes of the sales people.
Note that although a gap may exist in the sense that existing firms are not offering what consumers may ideally want, there is a limit to what buyers would be willing to pay for. For example, before starting their ice-cream business, Ben and Jerry considered going into business delivering the New York Times to people’s doors on Sunday mornings along with fresh baked bagels. A problem here, however, could have been the cost of this service. Sometimes, a firm may be able to come in and fill a gap, but may need to compromise on exactly how far to go. There are usually some struggles between what would be nice to have and what customers are wiling to pay for. For example, many computer buyers would like to have someone come and set up the computer, the peripherals, and the Internet connection, but might balk at paying $150 for this service. Many consumers would like to have their dry cleaning picked up and delivered, but when push comes to shove, they would not be willing to pay for the extra service.
In the early 1990s, a firm owning several supermarket chains decided start Tiangues, a chain aimed at Hispanic consumers in Southern California. Employees were screened to be fluent in both Spanish and English, and foods that would appeal especially to different Hispanic groups were emphasized. The chain was very popular when it first opened, but it soon lost market share as it was found that with time, what mattered most to customers was low prices.
Wheel of Retailing. An interesting phenomenon that has been consistently observed in the retail world is the tendency of stores to progressively add to their services. Many stores have started out as discount facilities but have gradually added services that customers have desired. For example, the main purpose of shopping at establishments like Costco and Sam’s Club is to get low prices. These stores have, however, added a tremendous number of services—e.g., eye examinations, eye glass prescription services, tire installation, insurance services, upscale coffee, and vaccinations. To the extent these services can be added in a cost effective manner, that is a good thing. Ironically, however, what frequently happens is that "room" now opens up for a "bare bones" chain to come in and fill the void that the original store was supposed to have filled! New stores can now come in and offer lower prices before additional, costly services "creep" in. Note that upscaling over time may be an appropriate strategy and that the owner of the "rising" chain may itself want to start another, lower-service division (e.g., Ralph’s may want to own another chain such as Food 4 Less).
Supply Side Gaps. Supply side gaps come about when a business finds that the services that it has traditionally offered to customers in the past are now too expensive to justify the value they provide. For example, in the "old days" (i.e., until the early 1990s), travel agents provided a valuable service—they would "match" travelers and airlines, finding a reasonable fare and travel time and issuing the ticket to the customer who, then, did not have to call all the airlines for a fare and then visit the airport or an airline office. However, nowadays, it is much more convenient for consumers to carry e-tickets, and it is frequently easier to go online to compare fares and travel time at one’s convenience. Therefore, travel agents, to command their commissions, will often need to provide something extra that the online services cannot. The problem is that, for most consumers, there just isn’t much that the travel agent can offer other than fancy coffee or donuts, which you can get more conveniently elsewhere anywhere. Maybe they can take passport photos or arrange bus transportation to a cruise ship, but is that enough to justify people coming to them? Online services are starting to offer package deals—air fare, hotel, and car rental—anyway.
Finding opportunities. Again, it is important to emphasize the need for market balance. Frequently, there will be room for higher cost services for one segment, and perhaps a diametrically opposed service for the lower cost service.
Gaps, costs, and performance. Generally, we find that gaps do not exist when cost and service are "in line" with customer expectations. Thus, for example, Nordstrom serves a segment that desires high service. Nordstrom incurs a great deal of costs in this, which are ultimately passed on to the consumer, but Nordstrom’s customers are willing to pay for this. Similarly, Wal-Mart provides some, but less, service and does so at a very low cost. Thus, another segment’s preferences are served. Thus, service output demand is matched with supply. On the other hand, many auto repair facilities provide less service than is expected and do not adequately make up for this by low prices. Therefore, an opportunity might exist for someone to offer better service at a not much higher cost. On the other hand, nowadays people may not be willing to pay the extra cost for going to a butcher shop and pay significantly more if what they get is only a little better than what is available in the supermarket meat section.
Closing gaps. Firms may be able to close, or reduce, their gaps by reconsidering their offerings. A gasoline station that offers an "average" level of service at prices higher than those of self-service stations might either target the low cost segment, lowering prices and cutting costs, or targeting a premium service and "beefing up" service. Similarly, a firm that faces a segmented market might "branch off" into different units that offer different levels of service to different customers. For example, Toyota started the Lexus division for consumers who demanded more service than would have been cost effective to offer to its traditional customers. On the supply side, closing gaps mostly involves improving efficiency and/or reducing costs in other ways. Alternatively, existing channels may be reassessed—e.g., airlines have deemphasized travel agents.
Vertical integration. Generically speaking, products may come and reach consumers through a chain somewhat like this:
Raw materials ---> component parts ---> product manufacturing
---> product/brand marketing ---> wholesaler ---> retailer
Money can be made at each stage in the chain and it may be tempting for firms to try to get into all aspects. For example, Henry Ford wanted to make all the components for his own cars, so Ford tried to run its own rubber plantation with limited success. The temptation to try to expand vertically can be especially strong when an industry faces limited growth and thus presents limited opportunities for reinvestment into traditional operations (e.g., if the auto industry is not growing as much as desired, one way to reinvest profits, rather than having to pay them back to stockholders who would then have to pay taxes on the dividends, might be to buy steel mills. The problems, however, is that the management is not used to running such businesses and that managerial time will be spread among more areas.
Business structures. A business can be squarely focused in just one area—e.g., Kentucky Friend Chicken is only in the fast food business and prides itself on this. On the other hand, certain businesses are part of an assortment of businesses that all have common, or at least overlapping, membership. Sometimes, these businesses can be related in some way—for example, Pepsico used to own several restaurant fast food chains, and Microsoft, in addition to being in the software business, used to own Expedia, the online travel service. Here, expertise and brand equity might be transferred from businesses to business. In other situations, however, these "empires" may consist of unrelated businesses that were bought not so much because they "fit" into management expertise, but rather because they were for sale when the conglomerate had money to invest. With the tobacco industry currently being relatively profitable but having a questionable future, a tobacco firm might invest in a software maker. Generally, such investments are risky because of problems with management oversight. In Japan, many firms are part of a keiretsu, or a conglomerate that ties together businesses that can aid each other. For example, a keiretsu might contain an auto division that buys from a steel division. Both of these might then buy from a iron mining division, which in turns buys from a chemical division that also sells to an agricultural division. The agricultural division then sells to the restaurant division, and an electronics division sells to all others, including the auto division. Since the steel division may not have opportunities for reinvestment, it puts its profits in a bank in the center, which in turns lends it out to the electronics division that is experiencing rapid growth. This practice insulates the businesses to some extent against the business cycle, guaranteeing an outlet for at least some product in bad times, but this structure has caused problems in Japan as it has failed to "root out" inefficient keiretsu members which have not had to "shape up" to the rigors of the market.
Motivations for outsourcing. While firms, as discussed above, often have certain motivations for trying to "gobble" up as many business opportunities as possible, there are also reasons for "outsourcing" or contracting out certain functions to others. Auto makers, for example, have often found it profitable to buy a number of components from non-union manufacturers. Often small vendors, run by entrepreneurs, are better motivated to perform certain services—e.g., insurance agents can have an incentive to build up and service a client base more effectively than an internal staff could. It is also possible for outsiders to specialize—chemical firms, for example, may be better able to research and develop paints than auto manufacturers. Smaller independent firms may also operate more leanly, facing market competition better than large, centralized firms. A firm specializing in just making nuts and bolts may have greater economies of scale than Rolls Royce, which makes only a limited number of cars.
Channel Power. Some channel members need others more than others need them. For example, Wal-Mart has a lot more power, given its large volume purchases, than many of its suppliers. There are several sources of power. Reward power involves a channel member being able to positively reinforce another’s performance—e.g., Coca Cola may be able to give a price break or pay a fee for additional shelf space. A retailer that meets a certain goal—e.g., the sale of 50,000 cases per month—may receive a bonus. In contrast, coercive power involves the threat of a punishment. A large retailer, for example, may tell a small manufacturer that no further orders will be forthcoming unless a price discount is offered. Expert power includes knowledge. Wal-Mart, for example, because of its heavy investment in information technology, can persuasively argue about likely sales volumes at different price levels. "Legitimate" power involves government or other regulations—e.g., auto dealers have a great deal of power over auto makers because only they are allowed to sell to end customers in the continental U.S. under most circumstances. Finally, referent power involves the desire of the other side to be associated—most manufacturers of upscale merchandise are highly motivated to ensure their availability at Nordstrom’s.
Channel conflict. We have seen throughout the term that conflict exists between channel members. For example, Coca Cola would like to increase its sales by offering a discount on its cans. However, the retailer knows that overall soda sales will not go up much when Coke is put on sale—consumers who bought other brands will just switch, for the most part. Therefore, the retailer might like to "pocket" any discount that Coke offers. Similarly, Bass might like to increase its sales by selling to Costco, but its full service retailers will object to this competition. A number of approaches to resolution are available, but none are perfect. Sharing of information may help build trust, but this can be expensive, cumbersome, and may result in this information being available to competitors. The two sides might seek outside mediation, with a supposedly neutral party suggesting a fair solution, or the two sides may try to compromise on their own. One side may accommodate the other, but may not be motivated to continue to do so in the future, or the other may try to coerce its way through threats of punishment.
We have seen distribution intensity issues throughout the course, so here we will mostly consider overall strategic issues related to these decisions.
Distribution opportunities. First of all, we must consider what is realistically available to each firm. A small manufacturer of potato chips would like to be available in grocery stores nationally, but this may not be realistic. We need to consider, then, both who will be willing to carry our products and whom we would actually like to carry them. In general, for convenience products, intense distribution is desirable, but only brands that have a certain amount of power—e.g., an established brand name—can hope to gain national intense distribution. Note that for convenience goods, intense distribution is less likely to harm the brand image—it is not a problem, for example, for Haagen Dazs to be available in a convenience store along with bargain brands—it is expected that people will not travel much for these products, so they should be available anywhere the consumer demands them. However, in the category of shopping goods, having Rolex watches sold in discount stores would be undesirable—here, consumers do travel, and goods are evaluated by customers to some extent based on the surrounding merchandise. (Please see the chart in the PowerPoint notes).
The product life cycle. In general, a brand can expect lesser distribution in its early stages—fewer retailers are motivated to carry it. Similarly, when a product category is new, it will be available in fewer stores—e.g., in the early days, computer disks were available only in specialty stores, but now they can be found in supermarkets and convenience stores as well. Certain products that are not well established may have to get their start on "infomercials," only slowly getting entry into other types out outlets. (Please see PowerPoint chart).
Brief review of distribution intensity issues:
- Full service retailers tend dislike intensive distribution.
- Low service channel members can "free ride" on full service sellers.
- Manufacturers may be tempted toward intensive distribution—appropriate only for some; may be profitable in the short run.
- Market balance suggests a need for diversity in product categories where intensive distribution is appropriate.
- Service requirements differ by product category.
Termination of brands. A retailer may terminate a brand when carrying it under existing terms no longer seems attractive. This can be done overtly—the channel member explicitly announces that the brand will no longer be carried—or more indirectly in the sense that inventory holdings are reduced and customers are recommended substitute brand and/or products.
Maintaining channel member performance. One way to motivate channel members to carry one’s product is through a pull strategy. This involves establishing consumer demand, usually through advertising and/or a strong brand image. For example, most pharmacies need to carry the brand name Bayer aspirin to satisfy their customers. Note, however, that Bayer has invested a great deal of money in this. Alternatively, a firm may offer contract provisions making it attractive to be carried—e.g., prices may be guaranteed for some period of time. Geographical or target market exclusivity may also be offered—a retailer who knows that no one else in the area carries the Vengeful Visions gun line will be more motivated to aggressively push the brand. Stopping short of exclusivity, a firm may attempt to stop supplying channels that sell below a certain retail price "maintenance" level—e.g., Levi’s may decide that they will sell to anyone who wants to carry their jeans so long at such retailers do not sell them below a certain price. Then, retailers can be assured that a certain margin can be achieved, and can invest in services.
"Simulating" exclusivity. When truly exclusive distribution proves undesirable, intra-brand competition can be reduced by offering slightly different, and thus, non-comparable versions to different retailers.
Making exclusivity attractive. Manufacturers can motivate channel members to emphasize their brands by creating mutual dependence. For example, Sony might agree to make a new line of high definition televisions for sale exclusively at Best Buy if Best Buy in return will invest heavily in repair facilities for this new product. If one retailer forsakes other brands in return for a large discount on high quantity orders, both sides may also save money through economies of scale. Finally, the retailer and manufacturer may develop a certain joint brand identity. For example, the high end department stores need to carry high end cosmetics to be credible, and in order to maintain their credibility, high end cosmetics must be available in high end stores.
Retail positioning. There are several ways in which retail stores can position themselves. One strategy involves low-cost, low-service. On the opposite side of the spectrum, others may offer high-cost-high-service. Generally, having a clear strategy and position tends to be more effective since "average" stores tend to face a greater scope of competition—e.g., Sears competes both "below" with K-Mart and "above" with Macy’s. K-Mart, in contrast, competes mostly laterally, facing Wal-Mart and Target.
Margins. Stores need to maximize their profits and must consider their margins to do so. Gross margins generally reflect the difference between what a store pays the retailer and what it charges the customer. On the average, this difference in supermarkets is about 25%. (Although there are large differences between product categories, as an illustration, a can that sold for $1.00 might have been bought on wholesale for $0.75). Net margins, in contrast, take into account the allocated costs of running the store—wages, rent, utilities, insurance, and "shrinkage." In grocery stores, these margins are usually less than 5%. Margins can be considered at the unit level—you make $0.35 on a package of salt—or as a percentage of sales—35% if the salt sold for $1.00. Sometimes, it may also be useful to consider margins per unit of space to best allocate retail space to different categories.
There are two theoretical forms of retailing. The "High-Low" method involves selling products at high prices most of the time but occasionally having significant sales. In contrast, the "everyday low price" (EDLP) strategy involves lower prices all the time but no sales. In practice, there are few if any EDLP stores—most stores put a large amount of merchandise on sale much of the time. It has been found that offering lower everyday prices requires a very large increase in sales volume to be profitable.
Increasing power of retailers. As more and more products compete for space in supermarkets, retailers have gained an increasing power to determine what is "in" and what is "out." This means that they can often "hold out" for better prices and other "concessions" such as advertising support and fixtures. A significant trend in recent years has been toward manufacturers’ "private label" brands—that is, the retailers' own brands competing against the national ones. For example, Del Monte peas may now have to compete against Ralph’s brand of peas in those stores. Although private label brands sell for lower prices than national brands, margins are greater for retailers because costs are lower. For example, it is more profitable to sell a can of peas $1.00 when it cost $0.60 to supply than it is to sell a name brand can at $1.25 when that cost $1.05 at wholesale.
"Power" and "category killer" retailers. A number of retailers have become a great deal more efficient in recent years than has been traditional in the industry. Firms like Wal-Mart have invested greatly in information technology and logistics and have committed to taking a risk on placing large orders placed well in advance of the need. These stores have frequently attracted a large customer base by charging consistent low prices. The philosophy here is to make a little bit of profit on each thing sold and then selling a great deal. A special case is the "category killer" which focuses on a specific product category—e.g., Circuit City buys up very large volumes of electronics and thus can bargain for low prices from manufacturers. Manufacturers get the benefit of large, consistent orders, but must in turn offer exceptionally low prices or risk having business shifted to other brands. Note that in practice, the category killer tends to carry a large variety of brands, buying a large volume of each. Thus, the mere threat of switching to other brands is enough to get a concession from each brand.
Retailing polarity. A number of retailers have tended to go to one extreme or the other—either toward a great emphasis on price or a move toward higher service. Rapid economic growth has made high service retailers more attractive to a growing number of affluent consumers, and less affluent consumers have become more accustomed to intense price competition between different retailers.