Justification for Intermediaries

8/7/2019 Justification for Intermediaries

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Justification for Using Intermediaries

Improve exchange efficiency.

There are certain costs associated with an exchange, therefore need to try to reduce the number of

transactions (exchanges):

*Chicken *Customer1 With 1 intermediary---10 transactions

*Potatoes *Customer2 With no intermediaries---25 transactions

*Carrots * *Customer3

*Plates *Customer4

*Silverware *Customer5

Without an intermediary, each buyer has to negotiate and exchange with each seller. With one

intermediary, each buyer negotiates with one intermediary (as opposed to 5 sellers), and each seller

negotiates with one intermediary (as opposed to 5 buyers).

Number 2 Reason

Intermediaries are specialists in the exchange process, provide access to and control over important

resources for the proper functioning of the marketing channel. Division of labor.

Still need services that intermediaries (wholesalers, retailers etc.) provide; if they were eliminated then

someone else would have to assume the tasks (either producer or customer). Functions can be shifted

and shared among channel members, but cannot be eliminated, unless the buyer assumes them.


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"you can eliminate the middle man, but you can't eliminate their functions"-a well accepted maxim in

marketing.

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Functions of Intermediaries

Primary role of middlemen is to transform the assortment of products made by producers in the

assortments desired by consumers.

Producers make narrow assortments in large quantities, consumers want broad assortments in small

quantities, discrepancy in quantity and assortment.

Match Supply and Demand:

*Chicken *Customer1

*Potatoes *Customer2

*Carrots *Customer3

*Plates *Customer4

*Silverware *Customer5

PRODUCER Specialization in production, economies of scale etc., therefore wants to produce large

quantities but narrow product mixes.

efficiently

CUSTOMER Wants a broad assortment (products produced by many manufacturers) of products made

available conveniently (within easy reach).

Other functions of intermediaries include:

* assuming risk--Provide working capital by paying for goods before they are sold.


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* information Flow

* financing

* payment and title flow.

* negotiation

* contacts

* promotion

A producer will use an intermediary when it believes that the intermediary can perform the function(s)

more economically and efficiently than it can.

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Types of Channels of Distribution

Consumer Channels

Channels for Consumer Products.

Vertical dimensions, determined by the # in the channel.

Channel A:

Producer

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Consumer


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IE door to door purchases, Unsought products IE Encyclopedias. Fruit picking orchards.

Services often use direct channels since the service provider, in most cases, must be there to provide the

service.

Simplest method, not necessarily the most effective.

Technological developments are making the direct channel more common:

* TV Homeshopping

* CDs

* Catalogs, LL Bean etc.

* Internet, WWW

When you can use the media of communication to effect exchange...1-800#s, Credit Cards etc.

Handout...Microsoft's Ali Baba Software-Selling Plan Has Rivals Boiling.

Discusses Microsoft's method of distributing its software directly from its Window's CD.

Channel B:

Producer

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Retailer

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Consumer

Large retailers, JC Penney, KMart, no discrepancy in quantity supplied and demanded. Popular for

shopping products, clothing. Automobiles...cost of transportation and inventory is high.

Channel C:

Producer

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Wholesaler

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Retailer

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Consumer


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Consumer

Mass distribution, IE processed food; also when there are a number of small producers etc. May be the

most efficient distribution channel for consumer products.Convenience products.

Horizontal dimensions, the # of channel members at the same level.IE Chevrolet much wider distribution

than Rolls Royce.

Business to Business Channels

Channel E:

Producer

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Buyer

Very popular, especially for high cost items that need after sale support. Fewer customers clustered

geographically. This is a more common structure than the direct channel in consumer markets.

Channel F:

Producer

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BB distributor

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Buyer

Distributor takes title. Used when there are many customers. IE consumable supplies etc.

Channel G:

Producer

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Agent

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Buyer

When a company does not have a marketing department or sales force, the agent performs those tasks.

Channel H:


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Producer

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Agent

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Distributor

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Buyer

Used as above, with many customers, IE exporting.

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Multiple Marketing Channels

Dual Distribution

Use several types of channels simultaneously, IE when you have consumer and business to business

markets. Set up 2 or more Marketing channels to attract the same target market or different target

markets. Using two or more channels to attract the same target market can lead to channel conflict.


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Handout...Time Warner to Launch...

This article discusses Time Warner developing additional distribution channels, adopting dual

distribution. The idea is to find efficient ways to make your product available to your customers.

* Record Stores

* TV Shopping

* Catalogs

* Columbia House

It is very important however to avoid Return to Contents

Wholesale Intermediaries

Wholesale transactions are all transactions except the transaction with the ultimate consumer.

Classification of a wholesaler or retailer is determined by the purchaser, not by the price. If over 50% of

sales is with other intermediaries then the intermediary is a wholesaler. If over 50% of sales is with the

consumer, then the intermediary is a retailer.

Firms can engage in wholesaling activities without being wholesalers.

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Nature and Importance of Wholesaling

Approximately a $1.94 trillion industry in the US

300,000 wholesaling establishments in the US

Employ 6.5 million people, down from 6.57 million in 1989

Very competitive. Wholesalers will be eliminated from a channel if they do not perform valuable

functions effectively and efficiently.


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Return to Contents

Types of Wholesale Intermediaries

2 Types of intermediaries:

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Merchant intermediaries

--buy products and resell them.

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Functional intermediaries

--do not take title, they expedite exchanges among producers and resellers, compensated by fees

and/or commission.

Merchant Wholesalers

Take title.

Account for approximately 83% of wholesalers, 50% of wholesale sales. Employ 4.5 million people.

Two types:

* Full Service Wholesalers-offer widest possible range of functions. Categorized as:

o General Merchandise-wide mix (unrelated), limited depth.

o Limited Line-only few products but an extensive assortment.

o Specialty Line-narrowest range of products.

o Rack Jobbers-are specialty line that own and maintain display racks, take back unsold products.

* Limited Service Merchant Wholesalers-only provide some marketing functions.

o Cash and Carry wholesaler-customers pay and furnish their own transportation, No credit.

o Truck Wholesalers-Operate rolling warehouses and sell a limited line of products directly from their

trucks to their customers. Follow regular routes, primarily perishable products.


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o Drop Shippers (desk jobbers)-take title, negotiate sales but do not take possession.

o Mail Order Wholesalers-use catalogues instead of sales force to sell.

Agents and Brokers

Negotiate purchases, expedite sales but do not take title.

Functional middlemen, that bring buyers and sellers together.

Compensated with commission.

Agents represent buyers and sellers on a permanent basis.

Brokers represent buyers and sellers on a temporary basis.

10.4% of wholesalers total sales volume.

* Manufacturers Agent-over half of all agents. Represent two or more sellers and offer customers

complete lines. Handle non- competing (complementary) products. Written agreements.

* Selling Agent-market either all specified line or manufacturers entire output. Perform every

wholesaling activity except taking title of the product. Used in place of a marketing department.

Represent non-competing product lines.

* Commission Merchant-focus primarily on the selling task. Receive goods on consignment from local

sellers and negotiate sales in large central markets.

* Auction Companies-provide storage for inspection. Sales made to the highest bidder.

* Brokers-negotiate exchanges-perform the fewest intermediary functions. Assume no risk.

Manufacturers Sales branches and offices

Resemble merchant wholesalers operations, 9% of wholesale establishments and generate 31% of

wholesale sales. Manufacturer owned.


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* Sales Branches-sell product and provide support services to manufacturers sales forces.

* Sales Office-serves normally associated with agents; like sales branches located away from a

manufacturing plant-carry no inventory.

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Vertical Marketing Systems

The traditional view of channels focuses on buyers and sellers in direct contact. IE don't look beyond the

next level. The systems view focuses on a framework for the whole distribution system.

A Vertical Marketing System (VMS) is a marketing channel that a single channel member coordinates.

The channel member manages channel activities to achieve efficient, low cost distribution aimed atsatisfying the target market customers. There are three types of Vertical Marketing Systems, Corporate,

Administered and Contractual.

Corporate VMS

More than one stage of the distribution channel under one ownership, IE supermarket chains that own

processing plants and large retailers that purchase wholesaling and production facilities.

Examples:

* Sears

* Sherwin Williams

* Giant Foods

* Gallo

* Banana Republic

* Hallmark

* The Gap

* Oil Companies


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Administered VMS

Channel members are independent with a high level of interorganizational management by informal

coordination. Agree to adopt uniform accounting policies etc., and promotional activities.

One Channel member dominates, has a channel leader.

Examples:

* Wal Mart

* Toys R Us

* Kellog

* Pepsi

* Coke

* GE

* P&G

* McKesson Corp

* JC Penney

* Campbell

Channel Leader-Effectiveness of channel hinges on channel leadership. Leader must possess channel

power. Power can come in the following forms:

* Reward--provide financial benefits

* Expert--be the expert compared with other members

* Referent--strongly identify with leader

* Coercive--punish members


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Contractual VMS

Most popular VMS, interorganizational relationships formalized through contracts that spell out each

members rights and obligations. IE McDonald's and KFC. Franchise organizations 1/3 retail sales and

500,000 outlets.

Wholesaler sponsored, IGA stores-independent retailers band together under contractual leadership of

a wholesaler.

Supervalue Stores, largest food wholesaler in the US, offers a broad package of services to 2800

independent food retailers that voluntarily enter into a buying contract.

Retailer sponsored cooperatives which set up, own and operate their own wholesalers.

Handout...Focusing on the Distribution of TV Programming

Moving from an administered VMS to a contractual/corporate VMS system. The networks are losing

their channel power, since there are now six of them competing for the same amount of affiliates as

when it was only ABC, NBC and CBS. Now the networks are contracting (Contractual VMS) with the

affiliates in the hope they will stay loyal to them, or increasing the size of the contracts, or even taking

some form of ownership stake (corporate VMS).

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VMSs try to overcome:

Channel Conflict

Channel members may disagree on the best methods to attain goals. Inevitable when individual short

run goals are not compatible. Can occur between firms at the same level, or between firms at different

levels. Want to maximize profits and autonomy.

Channel members belong to different channel systems, creating potential conflicts. Producers may try to

circumvent intermediaries.

Handout...Whats wrong with selling used CDs.

This article is an excellent example of channel conflict. The retailers are selling used CDs, and the

distributors are not happy, since they receive no revenue from this product, and it competes with their

product. They retaliate by removing advertising monies etc. Other issues include distributors using mail

order wholesale clubs to sell CDs, which is a form of Dual Distribution since they compete directly with


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the traditional retailers, and sell their product very inexpensively...this is also a source for used CDs, as is

the return policies of the retail stores etc.

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Selection of Distribution Channels

Should determine what the final buyer wants and determine the best way to reach them. Marketing

Oriented!!

Determined by:

1. Organizational Goals, Objectives (same day delivery), resources and capabilities. Companies with

wide product mixes can sell more directly to the retailers, have more promotional skills etc. (P&G)

2. Market Characteristics, Geography, greater distance use more intermediaries, market density,clustering, market size etc., industrial vs. consumer, Buyer Behavior, Where?/How?/ May need creativity

, L'Eggs

3. Product Attributes, IE Need to provide a service. Perishability-short channels, storage requirements,

space, fashion, size (reduce handling), complexity, standard.

4. Environmental Forces, IE Competition, Technology

Need to determine the # of Intermediaries

Determine the channel width, intensity of distribution, the products market exposure.

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Intensive Distribution:

All available outlets are chosen for maximum exposure (within reason)....THAT A CONSUMER WOULD

PURCHASE THAT TYPE OF PRODUCT. Timex sells through 45,000 drug stores and thousands of other

stores.

Used for convenience products, especially when sales have a direct relationship to availability.

Availability more important than the nature of the outlet. Gas station vs convenience store

Convenience products have a high replacement rate and require no servicing.

P&G rely on intensive distribution. Good for consumer package goods. PLACE UTILITY


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Manufacturer promotional support.

Handout....Food Franchisers Expand by Pursuing Customers Into Every Nook and Cranny.

This article focuses on the importance of intensive distribution in the fast-food industry...make the

product (i.e. Taco Bell) available where a customer may want to purchase fast-food, in the gas station,

shopping mall carts etc. Taco Bell have quintrupled its "points of access" to nearly 25,000 from 4,500 the

end of 1992. Issues of Dual Distribution must be covered that may lead to channel conflict...who services

these additional points of access, the franchisor (Taco Bell), or the franchisee.

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Selective Distribution:

Only some available outlets (usually geographic) are chosen. Typically shopping products.

Buyers prefer to spend time searching.

Customer service important.

Selective distribution motivates retail support.

Producers have more control.

Retailer promotional support.

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Exclusive Distribution:

One outlet in a relatively large area. Products purchased infrequently, last a long time and require

service.

Used as an incentive to sellers. No one to undercut them. (Place Utility)

Allows for the highest control.

Easier to get retailers to carry a complete inventory and to provide service and repair facilities.

May be used to introduce new products, then change when market is more competitive (Move from

introduction to the growth stage of the product life cycle.

Horizontal Channel Conflict


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The implication is that the intensity of competition among retailers is a major driver of retailer support

(or lack thereof). Invariably, as a product's distribution base is broadened (more accounts, stores, and

types of stores are added), the likelihood of horizontal channel conflict increases between and among

organizations operating in the same "layer" of the distribution network . As channel conflict increases,

retailers' support for a product typically deceases. While channel conflict can rarely be eliminated

completely, it is critical to contain it.

In most instances, horizontal channel conflict boils down to a question of economics: retailer profits are

pushed below acceptable levels as a result of direct or indirect competitive behavior.

Horizontal channel conflict is increasingly common in real life as companies attempt to reach different

customer segments by utilizing multiple distribution channels (including direct from the manufacturer).

More specifically, when multiple channels are employed and distribution intensity increases, three profit

threats may confront a retailer: sales cannibalization, margin dilution, and customer diversion .

Consider the following cases:


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(a) A mature, commodity-like product is sold through traditional grocery stores that attempt to

maintain margins at roughly 30%. The manufacturer makes a comparable product available through

warehouse club stores that price to operate at 5% margins by maintaining a very bare bones overhead

structure.

(b) A broadly distributed, heavily advertised, branded product becomes a "traffic builder" for some

retailers. That is, they price the product at or below cost to attract customers to their stores, hoping

that the customers will also purchase other higher margin merchandise.

(c) A new, complex product is introduced though a select group of specialized retailers who compete

on service (i.e. front-end consultive selling) not price. As volume builds for the product, similar versions

are offered through "category killer" discounters who offer no in-store service and compete based on

low prices.

(d) A manufacturer that has traditionally sold its products through full-service specialty retailers decides

to have its sales force call directly on particularly large customers, bypassing the retailers, and decides to

hop on the eCommerce bandwagon by selling to price-sensitive customers via the internet at "factory

direct" prices.

In all of the above cases, there is the potential for significant channel conflict that is virtually certain to

deteriorate retail economics (i.e. lower sales, prices, and profits), which may result in a reduction of

aggregate support for the products.


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In case (a), if the grocery stores don't narrow the price spread, they will have some of their sales

cannibalized by the warehouse stores and will likely lose market share since the market is mature (i.e.

slow / no growth).

In case (b), all retailers are likely to suffer margin dilution to the extent that they cut prices (either on an

everyday or promotional basis) in an attempt to maintain their market shares.

In case (c), the full service stores may have some of their customers diverted to the discounters. That is,

customers may take advantage of the pre-sales service, but then buy at the low price outlet. Or the

stores may suffer margin dilution if they accede to customers who benchmark against "low-balling"

competitors and negotiate lower prices This customer practice is commonly referred to as "best-

balling", i.e. negotiating based on the lowest price found in the market. .

Case (d) is often the most controversial and emotional of the channel conflict situations since the

manufacturer is involved. The specialty store may be hit by a profitability triple threat: some sales will

cannibalized by the manufacturer's direct sales force; some full-service customers will be diverted to

buy directly from the manufacturer; and margins will be diluted if prices are reduced to match the

factory direct prices.


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In both cases (c) and (d), the full service retailers are likely to become economically demotivated and

shift their sales attention to more profitable products. As a result, the product may lose its primary

sources of market support.

As the above cases illustrate, the dominating distribution objective, broadening market coverage (i.e.

increasing customers' convenience), is somewhat at odds with the other two - enlisting product support

and avoiding channel conflict. While a company may want broad rather than selective distribution, and

may want to attack different market segments though multiple channels of distribution, the stark reality

is that intensive hybrid distribution may, if not very carefully managed, result in horizontal channel

conflict, deteriorating retail economics, and eventual loss of critical retail-level product support.

Mitigating Channel Conflict

While some level of channel conflict is inevitable, especially as products mature, it can be (and should

be) mitigated.

In order to contain the level of conflict, companies need to embrace distribution philosophies that:

(1) Adopt a long-run perspective and refrain from opportunistic initiatives that may jeopardize

established channel relationships for the sake of potentially transient short-term gains.


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(2) Are respectful of system economics, recognizing that channel partners must earn fair financial

returns to stay motivated.

(3) Stay open and flexible by avoiding restrictive long-run agreements (formal or "common law") that

foreclose adaptation to changing markets.

On a more tactical level, companies should:

(1) Avoid premature distribution through margin-crunching channels despite their sometimes alluring

potential to satisfy the "thrill of volume".

(2) Delineate clear rules for territorial coverage and "account ownership" so that competing channels

(including the manufacturer direct channel) avoid fighting over the same set of customers.


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(3) Build and maintain "fences" between competing channels to minimize leakage. For example, many

companies market different brands to different intermediaries, or offer derivative models that are

similar to, but different from their base products, that match the needs of different channels (e.g.

newest full featured models to specialty stores, older "stripped down" models to discounters), and that

"shelter" retailers from head-to-head price competition.

Welcome to a world where an infinite number of distribution channels are chasing a finite number of

customers. The emergence of the Internet has added considerable complexity to distribution channels

by offering a variety of e-market places such as B2B auctions (PEFA.com), reverse auctions

(Freemarkets.com), B2C operations (Amazon), C2B auctions (Priceline.com), and C2C formats

(Ebay.com).

As a result, the various types of distribution channels available in industries such as airlines, financialservices, music industry, publishing, and telecommunication services are exploding. And manufacturers

who took pride in the integrity of their distribution channels with specific channels reaching specific

customer segments are suddenly facing a dizzying array of choices.

The addition of new distribution channels brings with it the potential for additional sales volume at the

cost of greater channel conflict. A new channel, regardless of whether it is the Internet, an emerging low

cost indirect channel, or a new manufacturer sales force will increase channel conflict.

Channel conflict occurs because now there is another type of distribution channel that is perceived by

the existing channels to be chasing after the same customers with the same brand.

The fear of conflict with existing channels can paralyse a company. But on the other hand much of what

channel members call channel conflict is healthy channel competition. Therefore the objective of

conflict management should not be to eliminate channel conflict but rather manage it so that it does not

escalate to destructive levels.

From the manufacturer's perspective, channel conflict becomes destructive when the existing

distribution channels react to channel migration by reducing support or shelf space for the

manufacturer.


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For example, when Este Lauder set up a website to sell its Clinique and Bobbi Brown brands, the

department store Dayton Hudson reduced space on Este Lauder products. In extreme cases, an existing

distributor may drop the brand as happened when Levi's began expanding its distribution. Gap decided

to stop stocking Levis and concentrate on their own Gap brands.

Channel conflict becomes particularly destructive when parties take actions that hurt themselves in

order to hurt the other party. For example, in 2002, Albert Heijn, the largest Dutch supermarket chain,

boycotted some Unilever brands for sometime in order to retaliate against the manufacturer.

While this was resolved quickly, it was an action that could have potentially hurt both parties. Albert

Heijn would have lost some brands such as Bertoli mayonnaise and Cif cleaning products that have very

high brand loyalty amongst Dutch consumers.

As described below, several channel conflict management strategies exist, none of which is a panacea,

but the judicious use of them can help avoid destructive conflict. These are part of the arsenal of any

multi-channel marketer.

Clear segmentation: The rationale for having multiple types of channels should always be built on a clear

end user segmentation strategy. When the convenience store complains to the manufacturer about the

prices at which Wal-Mart is selling their products, it has to be explained that there is no way that a

convenience store can compete with Wal-Mart on prices for the price seeking customer.

Instead the convenience store has to compete on saving the consumer time vis--vis travel, shopping

and transaction processing, all at a reasonable price premium.

They serve two different segments and each should be encouraged to specialise on its target segment.

Of course, the brand owner should ensure that the number of distribution points that they have within a

particular type of distribution channel is balanced against the size of the segment that the channel

reaches.

Dedicated products: Many designers who have pushed for sales through outlet stores have managed the

conflict with their existing retailers by developing special products for these outlet stores.


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Similarly, many luxury brand companies, like Camus Cognac and Guylian chocolates, offer special pack

sizes and products that are attractive to travellers at duty-free airports in order to minimise the conflict

with their regular high street retailers.

On the Internet, manufacturers can offer those SKUs which retailers are usually not willing to carry. At

the extreme, some manufacturers dedicate different brands to different channels, sometimes referred

to as channel brands.

Expanding sales: Having a new 'hit' product helps facilitate channel migration. Goodyear managed the

migration to the mass merchandisers with only a reasonable amount of conflict by simultaneously

restricting the distribution of its new Aquatredtyre to the independent dealers.

This allowed the independent dealer to protect their profit-ability and sales volume through the higher

margin, higher value, Aquatredtyre. It is easier to expand channels when revenues are growing as

existing dealers are less likely to see absolute declines in sales and profits.

Dual compensation and role differentiation: Some manufacturers agree to compensate the existing

channels for sales through the new channel. While it may be perceived as just buying off the support of

the existing channels for the channel migration, it can be useful if the existing distribution is given a role

to perform in support of the new channel.

For example, when Allstate started selling insurance directly off the Web, they agreed to pay agents 2%

commission if they provided face-to-face service to customers who get their quotes off the web.

However, since this was lower than the 10% commission that agents typically received for offline

transactions, many agents did not like it.

Yet, it does help lower the negative backlash. Using the existing channel partner can be a useful

complement.


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Equitable treatment: Some retailers will be upset that the prices at which they purchase from the

manufacturer are higher than those charged to other retailers or the direct sales force. There is often

the feeling that the manufacturer is favoring other channels at their expense.

While one may never fully be able to overcome these concerns, the best antidote is to treat channels

equitably and in a transparent manner. If the manufacturer's prices differ across channels, it should be

based on the functions that the particular channel member performs.

So, yes, Tesco and Wal-Mart receive lower prices, but it is because they engage in practices (buying large

quantities, not demanding in-store help and promotions) that lower the manufacturer's cost to serve

them.

Final thoughts

The temptation for manufacturers is always to expand the number of distribution points as it usually

results in an immediate increase in sales. However, having too many channels chase too few consumers

results in channels dropping the level of support to the brand.

In the long run, this can have a deleterious impact on sales as well as brand image. On the other handchanging customer preferences modify industry structures. Traditional industry leaders have frequently

neglected the fastest growing new distribution channels.

A delicate balance must be maintained between moving too quickly and unleashing destructive channel

conflict versus clinging too long to declining distribution networks.

Justification for Intermediaries

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