Representative List of Distribution Costs by Function (continued)
11. Customer Service 13. Returned
Salaries: administrative; customer service representatives; clerical Stationery and supplies
Salaries: administrative; clerical; returned-goods clerical Returned-goods processing: material labor Forms and supplies
12. Printing and Recording of Accounts Receivable Sales invoice forms
Salaries: clerical; administrative; accounts receivable clerks; sales invoicing equipment operators Depreciation: sales invoicing equipment company has pertinent information to undertake distribution cost analysis by customer segment and product line. This sort of data allows the analyzer to find out how cost under each head varies with sales volume; for example, how warehousing expenses vary with sales volume, how packaging and delivery expenses are related to sales, and so on. In other words, the purpose here is to establish a relationship between annual sales and different types of cost. These relationships are useful in predicting the future cost behavior for established dollar-sales objectives, assuming present channel arrangements are continued.
To find out the cost of distribution for alternative channels, estimates should be made of all relevant costs under various sales estimates. Cost information can be obtained from published sources and interviews with selected informants. For example, assume that a company has been selling through wholesalers for a number of years and is now considering distribution through its own branches. To follow the latter course, the company needs to rent a number of offices in important markets. Estimates of the cost of renting or purchasing an office can be furnished by real estate agents. Similarly, the cost of recruiting and hiring additional help to staff the offices should be available through the personnel office. With the relevant information gathered, simple break-even analysis can be used to compute the attractiveness of the alternative channel.
Assume that a company has 20,000 potential customers and, on an average, that each of them must be contacted every two weeks. A salesperson who makes 10 calls a day and who works five days a week can contact 100 customers every two weeks. Thus, the company needs 20,000 ^ 100 = 200 salespeople. If each salesperson receives $30,000 in salary and $20,000 in expenses, the annual cost of its salespeople is $10,000,000. Further, assume that 10 sales managers are required for control and supervision and that each one is paid, say, $50,000 a year. The cost of supervision would then be $500,000. Let $9,500,000 be the cost of other overhead, such as office and warehouse expenses. The total cost of direct distribution will then be $10,000,000 + $500,000 + $9,500,000, or $20 million.
Assume that distribution through wholesalers (the arrangement currently being pursued) costs the company 25 percent of sales. Assuming sales to be $x, we can set up an equation, 0.25x + $20 million, and solve for x (x + $80 million). If the company decides to go to direct distribution, it must generate a sales volume of $80 million before it can break even on costs. Thus, if sales potential is well above the $80 million mark, direct distribution is worth considering.
One problem with break-even analysis is that distribution alternatives that are considered equally effective may not always be so. It is a pervasive belief that the choice of a distribution channel affects total sales revenue just as the selection of an advertising strategy does. For example, a retailer may receive the same number of calls under either of two channel alternatives: from the company's salesperson or from a wholesaler's salesperson. The question, however, is whether the effect of these calls is the same. The best way to handle this problem is to calculate the changes that would be necessary in order to make channel alternatives equally effective. To an extent, this can be achieved either intuitively or by using one of the mathematical models reported in the marketing literature.
Coverage of the Market. An important aspect of predicting future sales response is the penetration that will eventually be achieved in the market. For example, in the case of a drug company, customers can be divided into three groups: (a) drugstores, (b) doctors, and (c) hospitals.
One measure of the coverage of the market (or penetration of the market) is the number of customers in a group contacted or sold, divided by the total number of customers in that group. Another measure may be penetration in terms of geographical coverage of territory. But these measures are too general. Using just the ratio of customers contacted to the total number of customers does not give a proper indication of coverage because not all types of customers are equally important. Therefore, customers may be further classified, as shown in the accompanying display:
Then the desired level of penetration for each subgroup should be specified (e.g., penetrate 90 percent of the large, 75 percent of the medium, and 50 percent of the small drugstores). These percentages can be used for examining the effectiveness of an alternative channel.
An advanced analysis is possible, however, by building a penetration model. The basis of the model is that increments in penetration for equal periods are proportional to the remaining distance to the aimed penetration. The increments in penetration in a period t will be: t = rp(1 - r)t - 1, where p = targeted or aimed penetration and r = penetration ratio. This ratio signifies how rapidly the cumulative penetration approaches aimed penetration. For example, if aimed penetration is
Classification Large, medium, and small Large, medium, and small Large, medium, and small
Basis of Classification Annual turnover Number of beds Number of patients attended
80 percent and if r = 0.3, then first-year penetration is 80 x 0.3 = 24 percent. Next year, the increment in penetration will be 80 x 0.3 x 0.7 = 16.8 percent. Hence, cumulative penetration at the end of the second year will be 24 + 16.8 = 40.8. The value of p for each subgroup is a matter of policy decision on the part of the company. The value of r depends on the period during which aimed penetration is to be achieved and on sales efforts in terms of the number of medical representatives/salespeople and their call pattern for each subgroup. For the existing channel (selling through the wholesalers), the value of r can be determined from past records. For the alternate channel (direct distribution), the approximate value of r can be computed in one of two ways:
1. Company executives should know how many salespeople would be kept on the rolls if the alternate channel were used. The executives can also estimate the average number of calls a day a salesperson can make and hence the average number of customers in a subgroup he or she can contact. With this information, the value of r can be determined as follows:
Number of customers in a subgroup contacted Value of r for under existing channel _ existing channel Number of customers in Value of r for a subgroup that would alternate channel be contacted in alternate channel
2. A second approach may be to find out (or estimate) the penetration that would be possible after one year if the alternate channel is used, then to substitute this in the penetration equation to find r when p and t are known.
The penetration model makes it easier to predict the exact coverage in each subgroup of customers over a planning period (say, five years hence). The marketing strategist should determine the ultimate desired penetration p and the time period in which it is to be achieved. Then the model would be able to predict which channel would take the penetration closer to the objective.
Customer Service. The level of customer service differs from customer to customer for each business. Generally speaking, the sales department, with feedback from the field force, should be able to designate the various services that the company should offer to different consumer segments. If this is not feasible, a sample survey may be planned to find out which services customers expect and which services are currently being offered by competitors. This information can be used to develop a viable service package. Then the capability and willingness of each channel alternative to provide these services may be matched to single out the most desirable channel. This can be done intuitively. A more scientific approach would be to list and assign weights to each type of service, then rate different channels according to their ability to handle these services. Cumulative scores can be used for the service ranking of channel alternatives. Conjoint measurement can be used to determine which services are most important to a particular segment of customers.
Communication and Control. Control may be defined as the process of taking steps to bring actual results and desired results closer together. Communication refers to the information flow between the company and its customers. To evaluate alternate channels on these two criteria, communication and control objectives should be defined. With reference to communication, for example, information may be desired on the activities of competitors, new products from competitors, the special promotional efforts of competitors, the attitudes of customers toward the company's and toward competitors' services, and the reasons for success of a particular product line of the company. Each channel alternative may then be evaluated in terms of its willingness, capabilities, and interest in providing the required information. In the case of wholesalers, the communication perspective may also depend on the terms of the contract. But the mere fact that they are legally bound by a contract may not motivate wholesalers to cooperate willingly. Finally, the information should be judged for accuracy, timeliness, and relevance.
Environmental shifts, internal or external, may require a company to modify existing channel arrangements. A shift in trade practice, for instance, may render distribution through a manufacturer's representative obsolete. Similarly, technological changes in product design may require frequent service calls on customers that wholesalers may not be able to make, thus leading the company to opt for direct distribution.
To illustrate the point, consider jewelry distribution. For centuries, jewelry was distributed through jewelry shops that relied on uniqueness, craftsmanship, and mystique to reap fat margins on very small volumes. Traditionally, big retailers shunned jewelry as a highly specialized, slow-moving business that tied up too much money in inventory. But this attitude has changed in the last few years. For example, between 1978 and 1982, jewelry stores' share of the jewelry market declined from 65 percent to less than 50 percent. On the other hand, relying on hefty advertising and deep discounting, mass merchandisers (e.g., J.C. Penney, Sears, Montgomery Ward, Target, and others) have been making fast inroads into the jewelry business. For example, in 1983 J.C. Penney became the fourth-largest retail jewelry merchant in the United States behind Zale, Gordon Jewelry, and Best Products, the catalog showroom chain. Such a shift in trade practice requires that jewelry manufacturers modify their distribution arrangements.23
Similarly, as computer makers try to reach ever-broadening audiences with lower-priced machines, they need new distribution channels. Many of them, IBM and Apple, for example, have turned to retail stores. In the 1970s, people would have laughed at the idea of selling computers over the counter; now it is a preferred way of doing business. The tantalizing opportunity to sell computers to consumers has also given birth to specialty chains specializing in computer and related items.
Ben & Jerry's Homemade Inc. had to change their distribution arrangements for a different reason. Dreyer's Grand Ice Cream controlled 70 percent of its distribution, and the relationship was regarded as a cornerstone of Ben & Jerry's success.
Then, Dreyer made an unwanted takeover offer which Ben & Jerry's resented. The company decided to end the relationship with Dreyer and forged a new alliance with Diage PLC's Haagen-Dazs, until now regarded as an arch competitor, to deliver its products.24
Generally speaking, a new company in the market starts distribution through intermediaries. This is necessary because, during the initial period, technical and manufacturing problems are big enough to keep management busy. Besides, at this stage, the company has neither the insight nor the capabilities needed to deal successfully with the vagaries of the market. Therefore, intermediaries are used. With their knowledge of the market, they play an important role in establishing a demand for a company's product. But once the company establishes a foothold in the market, it may discover that it does not have the control of distribution it needs to make further headway. At this time, channel modification becomes necessary.
Managerial astuteness requires that the company do a thorough study before deciding to change existing channel arrangements. Taking a few halfhearted measures could create insurmountable problems resulting in loose control and poor communication. Further, the intermediaries affected should be duly taken into confidence about a company's plans and compensated for any breach of terms. Any modification of channels should match the perspectives of the total marketing strategy. This means that the effect of a modified plan on other ingredients of the marketing mix (such as product, price, and promotion) should be considered. The managers of different departments (as well as the customers) should be informed so that the change does not come as a surprise. In other words, care needs to be taken to ensure that a modification in channel arrangements does not cause any distortion in the overall distribution system.
The point may be illustrated with reference to Caterpillar.25 A decade ago, many observers predicted Caterpillar's demise. Yet today the company's overall share of the world market for construction and mining equipment is the highest in its history. And the biggest reason for the turnaround, has been the company's system of distribution and product support and the close customer relationships it fosters. The backbone of that system is Caterpillar's 186 independent dealers around the world. They have played a central role in helping the company build close relationships with customers and gain insights into how it can improve products and services. The company's success may be attributed to several factors. For one thing, the company stands by its dealers in goods times and in bad. In addition, it gives them extraordinary support, helps ensure that the dealerships are well run, and emphasizes full and honest two-way communication. Finally, it stresses the emotional ties that have developed between the company and its dealers over time.
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