Going to market
- Distribution channels are value delivery systems
- Innovation in the distribution channel
- The omni-channel revolution
- Omni-channel retailing
The routes that companies use to take their products to market are commonly called distribution channels. These channels usually comprise a number of linked entities that perform specific tasks to enable an efficient and effective connection to be established between a supplier and the end user. Thus, for example, a pharmaceutical company might utilise a variety of channels to reach an end user. Wholesale distributors can be used to sell products to retail chemist shops who then make the product available to the end user. In other cases the pharmaceutical company might sell directly to healthcare organisations such as hospitals. These different channels will have different costs attached to them and will differ in terms of how effective they are in delivering value to the end user. It will be apparent then that the choice of distribution channels and the way in which those channels are managed must be key management concerns.
Traditionally, distribution channels were viewed purely as a means to enable the physical fulfilment of demand. They tended to follow well-established conventions and used structures and institutions that had been little changed in years. Now things are different. In recent years there have been seismic upheavals that have disrupted existing channels and have led to dramatic changes in how companies go to market.
One often quoted example of how a business can become a significant player in its sector through channel innovation is Dell. Dell was able to gain a market leadership position in the PC industry not through the products that they sold but by the way they sold them – direct to end users. By going direct to the end user Dell was able to create a direct connection with the marketplace, building computers and related products to order rather than for stock and offering a level of product customisation. At the same time, the margin that they would have to give to the traditional reseller or dealer was retained by Dell. This was a model that enabled the company to achieve some of the best financial results in the industry for many years. It can be argued that Dell was one of the pioneers of the move towards disintermediation, meaning the elimination of the ‘middleman’ in a distribution channel. This trend towards disintermediation has gathered pace as many other companies such as Amazon, Expedia and Apple have demonstrated in their different ways how channel innovation can change the rules of the game.
Distribution channels are value delivery systems
Distribution channels are not just physical conduits through which products flow, they are primarily a way to connect with customers and to provide a means of delivering the value that customers seek. Distribution channels should work in both directions, i.e. serving the customer on the one hand and providing a means of capturing customer insight and enabling market understanding on the other.
In order to ensure the smooth running of this two-way flow of products and information, there is a requirement for the creation of aligned and seamless connections between all of the entities in the channel. The problem is that often because these players are independent of each other and with low levels of shared information between them, there is little alignment with a consequential impact on the effective and effective working of the channel.
One framework that can be helpful in seeking to develop a distribution channel strategy is presented in Figure 3.1 below. It is based upon an approach originally created by McKinsey1 which they termed the ‘value delivery system’. In a sense it can be argued that distribution channels are actually value delivery systems and hence the appropriateness of this framework.
Figure 3.1 The value delivery system
Source: Lanning, M. J. and Michaels, E. G., ‘A business is a value delivery system’, McKinsey & Co., Inc., June 1998
Let us examine each of these elements in turn:
Choose the value
In Chapter 2 we introduced the concept of customer value and the importance of linking the design of the supply chain to the value proposition. All businesses must choose where they want to compete, i.e. the target market(s). Because markets are not homogenous there needs to be a clear understanding of the segmentation of the market and strong insight into the value preferences of each segment. The decision on which segment(s) the company chooses to compete in should be based on a rigorous and objective analysis of the capabilities that the organisation can access. In other words ‘do we have what it takes to succeed in this market segment?’
Emerging from this analysis of what customers value in the chosen target market segments should be the development of a clearly defined value proposition. The value proposition is an articulation of the compelling reason(s) why customers should do business with us. This is the starting point for the development of a ‘go-to-market’ strategy – the development of the product/service offer and the value delivery system to support that offer. Thus for example Wal-Mart, the world’s biggest retailer, has since the beginning had a very clear value proposition – ‘Everyday Low Price’ – which it has delivered through a low-cost and efficient supply chain. Skype, the Internet-based communication system, has an equally clear value proposition: ‘Wherever you are, wherever they are – Skype keeps you together’
Provide the value
In a sense the reason why customers buy products or services is because they have ‘problems’ that require ‘solutions’. Those companies that have recognised this tend to be very focused around developing solutions to buying problems. Often they will engage the customer in helping develop these solutions – a process sometimes termed ‘co-creation’. They will focus on finding innovative ways to reduce the customer’s total cost of ownership and will seek to tailor solutions to meet customers’ specific needs.
To this end these companies will seek to develop supply chains and distribution channels that are flexible and that can adapt to customers changing needs. Later in this chapter we will highlight the major changes that are underway in retailing – particularly through the use of multiple channels – and how those companies using conventional and slow-to-change channels have been severely impacted.
A key decision therefore concerns the design and structure of the distribution channel, particularly the role if any to be played by intermediaries. If intermediaries are to be used then they must be seen as partners in the value delivery system. Their role in providing the value that customers seek and in solving the problems that they have must be clearly defined. The more that intermediaries can become ‘value-added resellers’ the better. For example, through providing a customisation capability, through the provision of technical support or by reducing the end users’ search costs.
It is critical that channel partners are seamlessly integrated into the total value delivery system. They should share the same strategic objectives and be committed to the overall value proposition. The importance of a high level of collaborative working across the supply chain is a theme to which we shall return in later chapters but it is clear that without that willingness to work closely together, the value delivery system will not function efficiently.
Communicate the value
A prime requirement is to ensure that the value proposition is enunciated and proclaimed not only in the end market but also within the business and to its channel partners. One powerful way to enable the development of a shared vision across all parties involved in the value delivery system – both within the company and externally – is to think in terms of ‘a chain of customers’. The idea as we briefly outlined in Chapter 2 is that every person, every department, every business unit has a customer. It may be an external customer but more likely it will be an internal customer. In most conventional organisations this might seem like an alien concept. Walk into any department in a large organisation and ask a random sample of employees ‘who is your customer?’ and it may be interesting to hear the answers!
It is not sufficient, though, for employees to know who they are serving, but why. In other words what contribution are they making to the value delivery system and the overall value proposition? The purpose of establishing a chain of customers is to try and escape from the inward-looking ‘silo’ mentality that typifies traditional businesses where the only people with responsibility for customer engagement are the sales force.
The communication process should be two-way. One of the important roles of any distribution channel is to enable customer feedback and sales data to flow swiftly up the supply chain. Zara, the fast-growing fashion retailer highlighted in Chapter 2, has built a large part of its success on its ability to capture customer reactions to it styles, designs and colours in the store through conversations with sales people. These insights are fed back to the design team in Spain who can use this information to modify products and to guide them when designing new products. Scania, the Swedish truck manufacturer, is another good example of a company that stays in close contact with their customers enabling a close linkage between their approach to channel management and their go-to-market strategy.
Scania’s value delivery system
To an extent unmatched by the competition, Scania puts the customer experience at the heart of its strategies, from product design to the aftermarket value chain. It communicates directly with truck drivers, commits to resolving easy-to-fix problems within days and uses the full range of feedback channels from drivers and other end users in its product development processes. On the shop floor, cross-functional collaboration and working groups help employees understand the value of their delivery to the next stage in the workflow, shortening time-to-market for new products and services. Internal rules of conduct, codified in a document entitled ‘How Scania is Managed’ and embraced by managers, line employees and Scania affiliates, describe the decision-making structure and key processes that govern the company.
Source: Kovac, M., Ledingham, D., & Weinger, L., ‘Creating an adaptive go-to-market system’, Bain & co. www.bain.com/publications/articles/creating-an-adaptive-go-to-market-system.aspx. Accessed 5 April 2015.
Capture the value
As companies increasingly utilise multiple channels to go to market, and as their portfolio of customers grows, it is not easy for them to understand the real cost of serving specific customers through a particular channel. There can be considerable differences in the ‘cost-to-serve’ between channels. For example, serving customers through an Internet-based channel will possibly involve home delivery of products in single units. Compare this with the same customer visiting a retail store and buying the product off-the-shelf in the traditional way. The Internet channel will probably have significantly higher ‘last mile’ costs than the retail store. In other words, the relative delivery costs of the two channels will be quite different. Then when we start to include the inventory investment in each of the two channels the picture might change again because of the different requirements for working capital.
In Chapter 4 we will explore in detail the ways in which a clearer view of cost-to-serve might be obtained through using a different approach to logistics cost accounting. The reason why this information is important is that a lot of the potential financial value that could be captured by the channel is being eroded because of the failure to understand the true costs involved.
A further consideration to be taken into account when developing a distribution channel strategy is how should the financial value generated through that channel be shared amongst its members? When a company uses intermediaries, for example a distributor or value-added reseller, then those intermediaries will require a margin on the sales they make.
It should be emphasised that any margin that an intermediary might take should not be seen as a sharing of the supplier’s profit. Rather the margin should be regarded as a recompense for the transfer of cost – and possibly also risk – from the supplier to the intermediary. Thus, for example, if a wholesaler carries inventory on behalf of a manufacturer, then the wholesaler will incur a holding cost on that inventory. As this relieves the manufacturer of the need to carry that inventory, the wholesaler can be recompensed to the extent of the cost saved by the supplier.
A useful analysis for the supplier to undertake is to examine in detail the ‘channel margin’ associated with different channels. The channel margin is defined as the difference between the price paid by the end user in the final market (the ‘street’ price) and the price that the supplier achieves when they sell it (the ‘factory gate’ price).
The channel margin reflects the value that is going to intermediaries rather than to the supplier. Sometimes this can be considerable and it might raise questions as to whether the channel should be re-configured to enable a greater share of the value to be retained by the supplier.
Innovation in the distribution channel
Until recently, channels of distribution changed very little. The same institutions and structures that had existed for centuries were still in place. The role of the wholesaler, distributor, stockist or retailer remained more or less the same. However a combination of competitive pressure and technology development has, in the last few decades, brought about dramatic changes in those distribution channels. One of the biggest drivers of these changes has been the rapid rise in the use of the Internet both for on-line shopping and for business-to-business transactions. The Internet has enabled a greater connectivity between sellers and buyers and in the process has disrupted existing channels – particularly impacting the role of intermediaries. In many cases, as we have observed, the need for intermediaries has been removed – what some have termed ‘disintermediation’. In other cases it has created new opportunities for those intermediaries to take advantage of the changed needs of customers and suppliers, particularly by acting as ‘info-mediaries’ i.e. using information and knowledge to create new value for their customers. Thus a company like the Hong Kong based global company Li and Fung, originally a traditional import/export business, can now act as an aggregator on behalf of its clients to seek out suppliers and then use the combined purchasing power of these clients to buy much more cost-effectively.
Innovation in the logistics service sector has also been a key enabler of change. The growth of worldwide express delivery providers such as DHL, FedEx and UPS, have made direct-to-customer distribution channels commercially viable for many industries. The growing demand from the marketplace for faster replenishment and higher levels of availability provide a further impetus for the development of new routes to market which can combine speed of response with a lower cost of ownership to the customer.
One impressive example of the way in which distribution channels have been transformed is provided by the stellar growth of the Chinese company Alibaba, highlighted in the box below.
Alibaba: changing the distribution channel
In September 2014, a Chinese company that relatively few in the West had heard of, achieved the world’s biggest IPO (Initial Public Offer) to date, which valued the business at US$ 230 billion. That company was Alibaba, only founded in 1999 by Chinese entrepreneur Jack Ma, now China’s biggest Internet retailer.
Originally Alibaba was a business-to-business portal to enable overseas customers to buy from Chinese suppliers. Alibaba rapidly grew to become a platform to enable a number of other distribution channels to be developed. One of these spin-offs is Taobao – a consumer-to-consumer portal like e-Bay – which features over 700 million products and is one of the world’s most visited websites. A fourth spin-off, TMall, is China’s biggest business-to-customer Internet channel with over half the Chinese b2c market. Other businesses include Alipay which is an on-line payment service that facilitates transactions across the web.
The distinguishing feature of Alibaba is that it is primarily a platform to enable companies, consumers and buyers and sellers generally to connect and to do business with each other. It is rapidly expanding outside of China, for example in 2014 it launched its US shopping site, 11Main. This is an on-line shopping mall where customers can browse and shop at over 1,000 stores for a whole host of products.
Alibaba’s business model is not to buy and sell products itself or to own and hold inventory. Their aim is to provide an e-commerce platform for others to use, making its money through commissions on sales and on-line advertising.
Figure 3.2 Key issues for channel strategy
It is probably true to say that the rate of change in distribution channels has been greater in recent decades than in the whole of the last century. We have probably not yet fully understood the impact that these changes will have on how companies will go to market in the years ahead. Certainly it will be wise for businesses to keep their current distribution channel strategies under constant review. Figure 3.2, based on a framework developed by McKinsey, suggests that an ongoing evaluation of the organisation’s channel strategy should focus on the three critical dimensions of effectiveness, efficiency and changes in the business environment.
Whilst most business sectors have been, or will be soon, disrupted by the Internet and related information and communication technology (ICT) innovation, perhaps the greatest impact of these developments has been on retailers. This has been termed by some commentators ‘The Omni-channel Revolution’.
The omni-channel revolution
A headline in the business section of a national UK newspaper The Sunday Telegraph on 5 April 2015 read ‘7,500 jobs at risk as retailers shut stores’. The article went on to say that ‘more than 200 shops and 7,500 jobs are at risk at Britain’s biggest out-of-town retailers as the dramatic change in shopping habits leads to widespread store closures’.
After 50 or so years of more or less continuous expansion, major retailers around the globe are having to re-evaluate their strategies. For many years, major retailers such as Wal-Mart, Tesco and Carrefour had ridden a global wave of growing consumer demand for their style of retailing and the products that they offered. These companies had invested massive sums in so-called ‘big box’ trading formats, usually in the form of out-of-town or edge-of-town developments. However a combination of economic, social and technological disruptions have seemingly combined to bring this expansion to a halt.
The jury is still out as to whether this is a permanent change in the retail landscape, but some of the underlying causes of this step-change in the industry are apparent. One of the main triggers causing this upheaval was the global financial crisis of 2008, which led to a recession across many economies both in the West and in emerging markets. One effect of that recession was to give a boost to those retailers who were able to capitalise on the new consumer focus on value. In particular this ‘drift to thrift’ benefitted the discounters with limited product ranges selling staple lines at very keen prices. European retailers such as Aldi, Lidl and Netto were well positioned to exploit this fast-growing segment of the market.
At the same, time consumers’ shopping habits have been changing. There is clear evidence that the pattern of the past whereby shoppers would tend to do a ‘big shop’ just once a week or even once a fortnight has changed. Customers now are tending to buy smaller quantities more frequently and to do this at a time and a place that suits them. Hence the rise of convenience stores – smaller formats with limited ranges – catering for time-sensitive shoppers.
But perhaps the biggest game-changer of all has been the astronomic rise of on-line shopping through the Internet. In consumer markets there is growing evidence that the Internet is revolutionising both marketing and supply chain management. Every year the volume and value of transactions conducted via the Internet continues to grown in most markets around the world.
It is not only the sheer scale of this new channel that brings challenges to logistics management, it is also the prospect that the Internet is likely to speed up the shift from a sellers’ market to a buyers’ market. In a way, the Internet ‘democratises’ the supply chain by placing the customer or consumer at the centre of the network. The customer can rapidly access information on alternative suppliers, they can make price comparisons, they can access delivery lead-times and they can ask to have their own specific requirements catered for.
Equally the supplier can learn more about the customer and can tailor marketing strategies accordingly. One of the best examples is provided by Amazon, which has developed powerful tools to enable it to target existing customers with product suggestions that match the profile of their previous purchases. At the same time, suppliers can use the Internet to better manage demand by steering customers towards products that are currently available from stock or even towards ones that have higher margins.
Associated with the rapid rise of Internet channels has been the growth of ‘mobile commerce’, i.e. the use of mobile phones to enable a two-way communication channel to be established between suppliers and customers. Suppliers can use this channel to alert customers to promotional offers, for example. Consumers increasingly are using their mobile phones for Internet access to place orders and to make price comparisons whilst on shopping expeditions.
An example of how mobile commerce is impacting sales is given in the example below from Domino’s Pizza in the UK.
Domino’s Pizza sales boosted by smart phone app
Domino’s Pizza sales in the UK have been given a significant boost through orders placed via mobile phones and tablets. Announcing a 14% increase in revenue for the half-year ending in June 2015, Chief Executive David Wild said that 77% of sales came via the Internet and that of this, app-based sales accounted for over one-half. The Domino’s Pizza app has been downloaded an astonishing ten million times.
The company expects to see this trend continue and has announced a partnership with Microsoft to install the Domino’s Pizza app on its XBox console. Orders can be placed whilst playing games or watching a film!
Sources: The Times, 29 July 2015 and The Sunday Times, 26 October 2014
One of the advantages of having direct contact with the customer through on-line ordering is the dramatic improvement in visibility of real demand that it provides. For example, Tesco, one of the world’s biggest on-line grocery retailers (as well as one of the world’s biggest bricks and mortar retailers), can see what its real product availability is because it is able to capture actual demand as it happens and is therefore able to measure on-the-shelf availability accurately. In the bricks and mortar business, even with sophisticated electronic point-of-sale (EPOS) data, the company cannot get the same level of accurate information.
The growth of Internet shopping has been accompanied by an increase in home delivery, as many of these emerging channels are primarily aimed at end users who require delivery to a specific address rather than collecting it themselves. Whereas a bricks and mortar retailer has the ‘last 50 metres challenge’, i.e. how to manage the significant cost of getting the product from the delivery vehicle onto the shelf in the most cost-effective way, the on-line retailer is concerned with the ‘last mile’ costs. Because most home deliveries are for a single case equivalent or less, the problem is how to ensure that the cost of delivery does not erode profitability. With the advent of agreed delivery times and the use of dynamic vehicle routing and scheduling tools this problem should reduce.
Whilst may of the new generation of on-line retailers are what are termed ‘pure play’ retailers i.e. selling only on-line, many long-established ‘bricks and mortar’ companies have developed on-line businesses alongside their traditional challen. Moving in effect from ‘single channel’ to ‘multi-channel’ retailing.
Omni-channel retailing
Multi-channel retailing is essentially a logistics and distribution arrangement whereby each channel is more or less independent of the other. Thus a multi-channel retailer might have separate channels for bricks and mortar outlets, for its catalogue business and for its on-line business. Whilst the products sold through those channels might be the same, the logistics and distribution arrangements could be quite separate.
Many companies are now seeking to make the transition from multi-channel to omni-channel retailing. In the omni-channel model all routes to market are served through the same supply chain wherever possible, making use of shared facilities and inventory. Potentially the omni-channel model can not only create high levels of customer satisfaction but also can bring down costs. Figure 3.3 shows the difference between the different channel arrangements. Part of the challenge in moving to an omni-channel model is to ensure that each channel complements the other to provide a consistent customer experience and enable a seamless transition from one channel to another. The rapid rise of ‘mobile’ sales through smart phones and tablets is leading to a situation where consumers can search, make comparisons, place orders anytime, anywhere. Likewise they can opt for home delivery, click and collect or simply shop in store. Integrating all these ‘touch points’ with the physical fulfilment of demand with the highest level of reliability has become a priority for those retailers who want to survive and thrive in the omni-channel world.
One company that has faced this challenge and developed an extremely profitable omni-channel business model is John Lewis, the UK department store retailer. Their story is summarised in the case below.
John Lewis: A leader in omni-channel distribution
John Lewis, one of Britain’s longest-established retailers, was a relatively early entrant into on-line retailing. John Lewis was a traditional – and successful – ‘bricks and mortar’ department store, focusing in recent years on clothing, home goods and consumer electronics. Its department stores continue to attract customers but the real growth in the business has come from Internet-based sales.
Launching its johnlewis.com website in 2001, it rapidly grew sales through that channel. In its first year of operation it generated £24m in sales from 5,000 SKUs, ten years later it generated £600m in revenue from 219,000 SKUs.
A number of factors have led to the success of the John Lewis on-line business, one of which has been its commitment to creating a truly omni-channel retail operation underpinned by an omni-channel supply chain. The decision was taken to move towards an integrated hybrid supply chain that could serve both stores and home delivery. The fundamental transformation was to change from delivering multiple quantities of a particular item to delivering in single units both to stores and to individual customer at home. A further channel to be served was the John Lewis ‘click and collect’ option whereby customers could choose to visit stores to collect their order. A whole new logistics infrastructure had to be developed capable of delivering smaller units more frequently. The benefits have been significant, firstly the ability to efficiently serve their rapidly growing on-line business, secondly the reduction in stockroom space in stores enabling more space to be released for selling and an impressive reduction in overall operating cost with improved stock-turns.
Figure 3.3 From single channel to omni-channel
Whilst we have focused specifically on retailing to show how channel strategies and management have become critical competitive dimensions, it should be emphasised that how a business in any industry goes to market can make the difference between success and failure. In particular the ability to support the chosen channel strategy with cost-effective logistics and supply chain support is vital. Peter Drucker, one of the great management thinkers, once wrote2:
Physical distribution is today’s frontier in business. It is one area where managerial results of great magnitude can be achieved. And it is still largely unexplored.
Drucker wrote the article in Fortune magazine from which the quotation above is taken in 1962 – over 60 years ago. Whilst much progress has undoubtedly been made since then in our thinking and practice of logistics generally, it is probably the case though that distribution channel management is “still largely unexplored territory”.