Channel Organization

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conventional distribution channel A channel consisting of one or mure independent producers, wholesale r,s and retailers, each a separate business seeking tit maximize its men profits even at the expense of profit* for the system an a whole.

vertical marketing system (VMS) A distributiim channel structure "i which producers, "wholesalers and retailers act as a unified system. One channel member owns the others, has contracts •wich them, or has so much power that they alt co-operate.

Historically, distribution channels have been loose collections of independent companies, each showing little concern for overall channel performance. These conventional distribution channels have lacked strong leadership and have been troubled by damaging conflict and poor performance. However, over the last decade, new channel organizations have evolved to challenge conventional channels. One of the biggest recent channel developments has been the vertical marketing sysfcms that have emerged to challenge conventional marketing channels.

• Vertical Marketing Systems

Figure 21.3 contrasts the two types of channel arrangement.

A conventional distribution channel consists of one or more independent producers, wholesalers and retailers. Each is a separate business seeking to maximize its own profits, even at the expense of profits for the system as a whole. No channel member has much control over the other members and no formal means exists for assigning roles and resolving channel conflict.

In contrast, a vertical marketing system (VMS) consists of producers, wholesalers and retailers acting as a unified system. One channel member owns the others or has contracts with them, or wields so much power that they all cooperate. The VMS can be dominated by the producer, wholesaler or retailer. Vertical marketing systems came into being to control channel behaviour and

Wholesale Drug Buyers Call the Tune




Sources; Richard Waters, 'Drug industry seeks prescription for growth', Financial 'Ernes (11 May 1994), p. 32; see also Marcel Corstjcns, Marketing Strategy' in the Pharmaceutical Industry (London: Chapman & Hall, 1992), pp. 229-31.

manage channel conflict. They achieve economies through size, bargaining power and elimination of duplicated services. As in the case of drug manufacturers and distribution companies mentioned in Marketing Highlight 21.1, the former sought to increase control over the channel system either through acquiring a distributor (see corporate VMS below) or through co-operative alliance arrangements (see contractual VMS below).

Convention îil marketing channel

Vertical marketing system

Convention îil marketing channel

Vertical marketing system

A conventional marketing channel versus a vertical marketing system corporate VMS A vertical marketing system that combines successive stoats q/ production and distribution under single ownership - channel leadership is established through common ownership contractual VMS

A vertical marketing system in which independent firms at different levels of production and distribution join together through contracts to obtain more economic* or sales impact than they could achieve (dime.


A contractual association between a manufacturer, wholesaler or service organization (a franchiser) and independent businesspeople (franchisees) who buy the right to rrwn ami operate one or more units in the franchise system.

We now look more closely at the three main types of V.VLS .shown in Figure 21.4. Each type uses a different means for setting up leadership and power in the channel.

CORPORATE VMS. In a corporate VMS, co-ordination and conflict management are attained through common ownership at different levels of the channel. Petrol distribution through chains of petrol stations owned by the oil company is an example of delivery and control achieved by such a system. Breweries that sell beer through public houses under their ownership provide another example. In the car rental market, vehicle makers have established dominant positions in most of the world's leading vehicle rental groups. Hertz, the world's largest car rental company, is jointly owned by Ford, Volvo and Hertz management. Ford sees its stake in Hertz as ;i vital means of retaining sales through this outlet alone. Hertz plays a key role for Ford as its biggest single private customer, with nearly 70 per cent of Hertz's vehicle purchases in the United States, and a third of its fleet in Europe, coming from Ford.5

CONTRACTUAL VMS. A contractual VMS consists of independent organizations at different levels of production and distribution, which join together through contracts to obtain more economies or sales impact than each could achieve alone, (Jo-ordination and conflict management are attained through the legal arrangements agreed among channel members. The contracts range from loosely structured agreements about the specification of goods and payment conditions to more detailed agreements about dealer responsibilities or a franchise contract.

A franchise is a contractual association between a franchisor - a manufacturer, wholesaler or service organization - and an independent channel member (the franchisee), which buys the right to sell the franchisor's branded product or service. The franchisee links several stages in the production-distribution system. The franchisor typically provides a brand identity and start-up, marketing and accounting assistance as well as management know-how to the franchisee. In return, the franchisor gets some form of compensation, such as an initial fee and a continuing royalty payment, lease fees for equipment and a share

Figure 21.4

Main types of vertical marketing system of the profits. Franchising has heen a fast-growing retailing form in recent years.

Almost every kind of business has heen franchisee! - from hotels and fast-food restaurants to dental and garden maintenance services, from wedding consultants and domestic services to funeral homes and fitness centres.

Franchising offers a number of benefits to both the franchisor and franchisee.

The main advantages for the franchisor are as follows:

• The franchisor secures fast distribution for its products and services, but does not incur the full costs of setting up and running its own operations. Franchising also enables the franchisor to expand a successful business more rapidly than by using its own capital.

• The franchisor gets very highly motivated management as die franchisees are working for themselves rather than a salary.

• The contractual relationship ensures that franchisees operate to and maintain franchisors' standards.

The main advantages for franchisees are as follows;

• They are buying into a proven system if selling an established brand name (e.g. McDonald's, Shell, Interflora).

• They can start a business with limited capital and benefit from the experience of the franchisor. This way they reduce the costs and risks of starting a new business.

• Franchisees also get the benefits of centralized purchasing power - since the franchisors will buy in bulk for the franchisees.

• They get instant expertise in operational issues such as advertising, promotions, accounts and legal matters, and can rely on franchisors' help should things go wrong.

Franchise systems have several disadvantages:

• Franchisors invariably have to forfeit some control when operating through franchisees.

• The franchisees may not all perform exactly to franchisors' operating standards, and inconsistencies in service levels can tarnish the brand name.

• Franchisees may not always have a good deal, in that they have to work extremely hard to meet sales and financial targets to make the business pay, and although they have already paid their initial fee, they have to meet continuing management services or royalty payments.

There are three forms of franchise. The first form is the manufacturer-sponsored retailer franchise system, as found in the car industry. BMW, for example, licenses dealers to sell its cars; the dealers are independent Imsinesspeople who agree to meet various conditions of sales and service. Shell, the oil company, adopts a franchising system on many of its forecourts in the United Kingdom, French designer garden furniture company. Jardin en Plus, has relied greatly on franchising to expand into other European markets. The second type of franchise is the manufacturer-sponsored wholesaler franchise system, as found in the soft-drinks industry. Gooa-Gola, for example, licenses bottlers (wholesalers) in various markets, which buy Coca-Cola syrup concentrate and then carbonate, bottle and sell the finished product to retailers in local markets. The third franchise form is the service-firm-sponsored retailer .franchise system, in which a service firm licenses a system of retailers to bring its service to consumers. Examples are found in: the fashion business (Benetton, Stefanel, The Body Shop); the car rental business (Hertz, Avis, Europcar); the fast-food service business (McDonald's, Burger Ring); the home furnishing business (IKEA and Marks & Spencer used franchising to expand into foreign markets); and the hotel business (Holiday Inn, Ramada Inn. Balladins).

The fact that most consumers cannot tell the difference between contractual and corporate VMSs shows how successfully the contractual organizations compete with corporate chains.

administered VMS

A vertical marketing system that co-ordinates successive stages of production and distribution, not through common ownership or contractual tics, but through the .sise and power of one of the partics.

ADMINISTERED VMS. An administered VMS co-ordinates successive stages of production and distribution, not through common ownership or contractual ties, but through the size and power of one of the parties. Manufacturers of a top brand can obtain strong trade co-operation and support from resellers. For example, in the fast-moving consumer-goods market, companies like Unilever and Procter & Gamble can command unusual co-operation from resellers regarding displays, shelf space, promotions and price policies. In the consumer electronics sector, Sony can obtain a great deal of trade support from retail stores for its top-selling brands, Similarly, large retailers like IKEA, Marks & Spencer and Toys '#' Us can exert strong influence on the manufacturers that supply the products thcv sell. Consider IKEA.

In just over four decades, IKEA, the privately owned Swedish furniture retailer, grew from a single store in Sweden's backwoods to become one of the most successful international retailers in the world. It now has more than 100 outlets in 28 countries across the glohe, taking over Skr39 billion a year in sales. Smart targeting, careful attention to customer needs and rock-bottom prices have made IKEA the world's largest home furnishings company. Its success formula was based on reinventing die furniture-retailing business. Traditionally, selling furniture was a fragmented affair, shared between department stores and small family-owned shops. All sold expensive products and delivered up to two or three months after a customer's order. IKEA trims costs to a minimum while still offering service. It does this by using a global sourcing network stretching to about 2,300 suppliers in 67 countries. IKEA relies on long-term relationships with key suppliers that can supply high quality at low prices. In return these suppliers get technical advice and leased equipment from the eompany. IKEA's designers also work closely with suppliers to reduce product eosts from the outset. Other savings come from IKEA displaying its vast product range in cheap out-of-town stores. It sells most of its furniture as knocked-down kits for customers to take home and assemble themselves. The firm enjoys huge economies of scale from operating such huge stores, and from enormous production runs made possible by selling the same furniture all around the world. This enables IKEA to compete on quality while undercutting rival manufacturers by up to 30 per cent on price. IKEA's success also means success for its suppliers. But they rmist operate to IKEA's terms and enable the global firm to fulfil its promise of quality merchandise at low eost to customers worldwide.0

Horizontal Marketing Systems

Another channel development is the horizon till marketing system, in which two or more companies at one level join together to follow a new marketing opportunity. By combining their capital, production capabilities or marketing resources, companies can accomplish more than any one company working alone. Companies might join forces with competitors or non-competitors.7 They might work with each other on a temporary or permanent basis, or they may even create a separate company:

Nestle and Coca-Cola formed a joint venture to market ready-to-drink coffee and tea worldwide. Coke provided worldwide experience in marketing and distributing beverages, and Nestle contributed two established brand names - Nescafe and Nestea. Such channel arrangements work well globally. Because of its excellent coverage of international markets, Nestle sells General Mills' Cheerios brand in markets outside North America. Seiko Watch's distribution partner in Japan, K. Hattori, markets Schiek's razors and, as a result, Schick has the leading market share in Japan, despite Gillette's overall strength in many other markets.8

Other examples include relailer co-operatives, which are made up of independent retailers that band together to own wholesale operations jointly, or to conduct joint merchandising and promotions. The Swiss Migros, with its dozen or so co-operatives, and the UK's Co-operative Societies have tried to exploit group buying and promotion economies through setting up such horizontal marketing arrangements.

horizontal marketing systems

A channel arrangement in which two or more companies at one level join together to follow a new marketing opportunity.

retailer co-operatives Contractual vertical marketing systems in which retailers organize a new, jointly-owned business to carry on wholesaling and possibly production.

The number of horizontal marketing systems has increased dramatically in recent years, so businesses must develop flexibility and management capabilities to enable them to capitalize on the growing opportunities presented by such marketing channel systems.

hybrid marketing than n els

Multichannel distribution, an when a single firms -sets up two or more marketing channels to reach one or more customer segments. A variety of direct and indirect approaches are used to deliver the finn's goods to its customers.

Hybrid Marketing Systems

In the past, many companies used a single channel to sell to a single market or market segment. Today, with the proliferation of customer segments and channel possibilities, more and more companies have adopted multichannel distribution systems - often called hybrid marketing channels. Such multichannel marketing occurs when a single firm sets up two or more marketing channels to reach one or more customer segments.

Figure 21.5 shows a hybrid channel system. In the figure, the producer sells directly to consumer segment 1 using direct-mail catalogues and telemarketing, and reaches consumer segment 2 through retailers. It sells indirectly to business segment 1 through distributors and dealers, and to business segment 2 through its own sales force.

Sony maintains 3 wide distribution coverage by adopting a hybrid marketing system. In the UK, Sony sells its consumer products through exclusive retail outlets such as the Sony Centres, through mass merchandisers like electrical chains and catalogue shops (e.g. Comet, Dixons and Argos), and by using direct marketing channels, such as mail-order catalogues operated by direct marketers Grattan, Preemans and Kays.

Hybrid channels offer many advantages to companies facing large and complex markets. With each new channel, the company expands its sales and market coverage, and gains opportunities to tailor its products and services to the specific needs of diverse customer segments. But such hybrid channel systems are harder to control, and they generate conflict as more channels compete for customers and sales. For example, when IBM began selling personal computers directly to customers at low prices through catalogues and telemarketing, many of its dealers cried "unfair competition' and threatened to drop the IBM line or give it less emphasis. The key to managing hybrid channel systems successfully is mini-

nrizing interchanncl member conflict, while maximizing consumer demand through superior product quality and design and extensive communications to reinforce brand values and identity. In some cases, the multichannel marketer brings all of its channels under its own ownership and control to minimize external channel conflict, although the marketer might face greater internal conflict over how much financial support each channel deserves.

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