8
PLACEMENT OR DISTRIBUTION: THE SECOND ‘P’ OF TACTICAL MARKETING

Figure 8-1: Marketing Alignment Map

Placement, or distribution, is the way a company ensures its target market or markets have access to its products or services. The goal is to ensure that the customer has access to the products or services a company sells in the location he or she would be most likely to look for that product or service.

The method the company uses to reach the market is called a channel, which forms the basis of the second ‘P’ of marketing. The channel or channels a company selects will depend on the type of product or service, the size and configuration of the market, where the customer will look for the solutions offered by a company, costs and control considerations.

GO WHERE THE MARKET LOOKS FOR SOLUTIONS

Companies should be very familiar with the various places their markets shop for the particular product or service that they offer. For example, service organisations often sell direct to the consumer or business purchaser. In a law firm, the distribution channel is the team of legal professionals who both sell and provide services to customers. If a company tried to set up a professional sales team to sell the services of lawyers the purchaser had not met, it would be less likely to be successful. The market does not expect to shop for legal services through intermediaries.

However, that is how they expect to shop for office supplies. Consumers and business purchasers rarely go directly to a paper clip manufacturer to purchase a box of paperclips. Instead, they look for that product, and others like it, in retail facilities or through commercial office supply distributors. As a result, the paper clip manufacturer will probably sell through wholesalers and retailers rather than attempting to go direct to the purchaser. Wholesalers and retailers are both distribution channels.

Although a company could decide to move away from the classic distribution channels for its industry, it must very carefully consider other places its customers might be receptive to hearing about and purchasing their product. It can be quite expensive to shift customer thinking. On the other hand, it can be—and has been—done at extreme cost savings as well. As mentioned in a previous chapter, the founders of the game Cranium knew they would have difficulty selling through traditional distribution networks because of the significant presence of extremely large competitors. Instead, they sold through other retail environments that didn’t typically sell games but were places their target market spent leisure time. Their efforts, reinforced by promotions and an innovative product, were well rewarded and saved the company large sums of money.

BALANCE COST WITH BENEFITS

For many product manufacturers, the cost of getting the product from the manufacturing facility to the consumer represents a significant portion, or even a majority, of the costs relative to the price. Companies must weigh the costs of promoting, distributing and selling their own products, which can be substantial, against the costs of using third-party intermediaries, like distributors or brokers, to help them reach their markets.

Of course, using an intermediary does not mean that the company is excused of all promotional costs. Even when an intermediary’s role includes promotion, the manufacturer or service provider must be proactive when promoting their products or services. In fact, most manufacturers factor in the need to promote both to their channel, to encourage them to carry their products and place them in premium locations, and to the end user. By promoting to the end user, they help create demand, which increases the channel’s interest in carrying the product.

In some cases, the benefit is related to the company’s core competencies. For example, many manufacturers that are extremely innovative are strong at concepting, and manufacturing may not also be as strong at retailing. Developing another strength within the organisation can be costly. In these cases, using a retailer, or combination of intermediaries, makes sense because they lack the experience required to be successful.

CONSIDER THE IMPACT ON BRAND

Control issues are also significant. Although a company has tighter control over its brand, and often, better opportunities to listen to its market, in direct distribution environments, these arrangements are not always practical. When intermediaries are involved, the company needs to invest more heavily in brand management and oversight to ensure the individuals representing the company at the customer-facing end of the distribution chain do not adversely affect the product or the brand.

AN INTRODUCTION TO CHANNEL MANAGEMENT

The management of this second ‘P’ in the marketing mix, placement (or distribution), is called channel management. Like product management, it is a specialty field within the marketing function. However, most organisations do not have a channel manager on staff. Instead, this function is frequently managed by the person who runs the sales team, by someone on the marketing team or by the executive team itself. As a result, the executive team needs a solid understanding of the common distribution arrangements in order to ensure it is generating the best returns on the company’s distribution investments.

There are two basic categories of distribution approaches: direct distribution and indirect distribution, which is often called channel marketing. When a company uses multiple distribution approaches, it is called multi-channel distribution.

Direct Distribution

Many companies use the direct distribution approach: The company producing the goods or services sells directly to the customer. For example, a CPA firm typically meets with and sells services directly to its clients. A farmer may sell goods at a local farmers’ market or in a retail facility at his or her farm. A restaurant sells a meal and the experience to its diners. An industrial manufacturer might sell its parts to the manufacturers who incorporate them into their products. An insurance company might have its own agents selling to a specific population. In all of these cases, the company is selling directly to the end user.

Direct distribution approaches present several advantages. Common direct distribution approaches are outlined in box 8-1 and the sections that follow. They provide natural opportunities to listen to the market, learn about their needs and improve the company’s ability to serve them. They can also be less expensive because the company does not need to pay intermediaries to sell products on its behalf.

On the other hand, direct distribution means the company’s executive team will need to carefully consider how it ensures its products or services are accessible to the market. There are many common approaches to doing this. Each has its benefits and its drawbacks and will be best suited for one type of product or service over another.

Box 8-1: Common Direct Distribution Approaches

Brick-and-Mortar Facilities

One of the most common approaches to selling goods or services directly is to have a store, office or other customer-facing facility. These are best used in cases when the customer makes his or her purchase decision based on the physical ability to see the product or connect with someone from the company in person; when the market, within an easily accessible geographic radius, is big enough to support sales; or when the goods or services must be delivered in person.

For example, many retailers, such as grocery stores, have physical facilities because many consumers either prefer, or are accustomed to, making grocery purchases in person. Similarly, it is common for many service organisations to have physical facilities. Health clubs, restaurants and hotels need specially designed facilities in order to deliver their services to their markets. Hair salons, hospitals and not-for-profit human services organisations may need the physical facilities in order to provide their product. In some cases, the facility is also a key part of the product they deliver. A zoo, for example, sells the experience of learning about the animals it houses. Without animals, the value of the product would be significantly lower.

Brick-and-mortar facilities offer many advantages: providing ease of access to local customers, serving in a promotional capacity as customers see signage when passing their facilities, housing company operations and providing many opportunities to converse with customers. Owned properties can also be good corporate assets, providing some income to the company in terms of appreciation upon sale.

However, there are also significant disadvantages. Brick-and-mortar facilities are expensive to construct and maintain, which may not be among the core competencies of the company itself. Leased facilities may include restrictions, are typically more expensive than ownership and leave the company vulnerable in renegotiation processes.

Sales Teams

Most organisations have some type of sales team, regardless of whether they are viewed this way. A sales team, or a sales person, is responsible for helping customers understand the benefits of the solution provided by the company they represent and giving them an opportunity to place an order with the company. The most successful sales personnel understand the careful balance between the promotions end of their job, when they are educating and persuading, and the order-taking aspects of their job, when they are closing the sale.

In a retail environment, the entire customer-facing team is the sales team. If you walk into Tesco, for example, the person who answers your questions and helps you find the solution is also helping the company make the sale. In a restaurant, the server is the sales person, taking your order and offering you an opportunity to add soup, salad, a beverage or dessert to your order. This is called upselling or cross-selling.

Some product manufacturers have their own sales teams, which may include employees who work in brick-and-mortar facilities like show rooms, sales people who call on customers by phone or in person and team members who respond to inquiries and take orders over the phone. For example, computer component manufacturer Hewlett Packard has a sales team that is dedicated to selling directly to its larger business customers. The Boeing Company’s sales team sells its airplanes directly to airlines, the military, corporations and other end users.

In a professional service environment, and in many consumer service environments, the person providing the service or the person who interacts with the customer on behalf of that person or team also acts as the sales professional. In the same respect, doctors, hair dressers, architects and others whose customers buy services delivered by an expert are also serving as sales people.

In the not-for-profit environment, sales people who sell trust in the organisation’s ability to accomplish its mission in return for the funding required to accomplish it are called development officers. In bigger not-for-profits, as with bigger for-profit organisations, these sales professionals may specialise, focusing on major gifts (large donations), corporate contributions or grants. In all cases, they are the sales team.

There are different types of sales professionals and different skill sets that suit each one. Some sales professionals are proactive, aggressively looking for new customers in a market. These individuals tend to be better at persuading customers to try a new product or solution.

Other sales professionals are better at retaining and nurturing existing customers. This is an extremely important function because it is typically less expensive to sell another unit of product or service to an existing customer than to attract and sell to a new customer.

Some sales professionals are primarily responsive in nature. For example, when I call the apparel manufacturer LL Bean to order clothing, the customer service representative, a sales person, answers my call and takes my order. However, a good order-taker should still understand the value of a cross-sell and try to persuade the customer to purchase a complementary service or product.

There are many advantages to a strong sales force. If they are well-trained and understand your customers’ needs, they can customise information and requests to the customer’s situations and needs, respond to questions, explain benefits and build loyalty more effectively than automated solutions, all of which can lead to greater sales. In many cases, there is no substitute for sales professionals in the sales process.

However, there are also some drawbacks. First, many companies spend large amounts of money hiring sales people or putting people into sales roles when the people selected are not good at sales. This happens most frequently in professional services, when managers are promoted to senior managers or partners and suddenly discover they must sell business, a skill they have never developed. However, it also happens in other environments.

The second drawback is that unlike the physical facility, or an automated purchasing process like a website, humans are not completely predictable. Even with extensive training, brand indoctrination and great selection processes, sales people can make mistakes. They can misunderstand customers, fail to make an order or fail to represent the brand in the way the executive team would like. They can also simply fail to effectively connect with a customer, client or donor, leading to a lost sale.

To mitigate the risks associated with the human nature of a sales force, companies with strong sales teams often invest both in strong selection systems, to help them identify the right candidates for sales roles, and in extensive training. For example, Starbucks provides baristas with extensive training, educating them about the products they offer, how to make the perfect cup of coffee and how to interface with their customers. See box 8-2 for other ways to fully capitalise on your sales team.

Box 8-2: Ways to Maximise Returns on Investments in a Sales Team

The third drawback to using sales professionals is cost. Sales professionals rely more heavily than other direct distribution mechanisms on strong promotional efforts. Consider a single sales person selling a new or unknown product or service. He or she would need to establish contact with the customer, explain the benefits, persuade the customer to give the solution a try and make the sale. Depending on the amount of time and cost required, this process could require hours or days, translating to expensive compensation, benefits, tax and operational expenses. If the margin on the sale is small, the return on the investment might be negative. The return on a customer service person or order-taker might be higher, but only if the phone is ringing. If it isn’t, and the sales person sits idle, the investment is lost.

In order to drive a strong return on sales professionals as a distribution tactic, it is important to invest in strong promotional efforts. Promotions drive down the cost per sale by informing the customer about the benefits of the solution a company offers, predisposing them to try or purchase the product or service, and sometimes even prompting a call to the otherwise idle order-taker. Because promotions are generally designed to reach large portions of a market simultaneously, they can be extremely effective at driving up the return on the company’s investment in its sales force.

Many of the other direct distribution approaches require at least some investment in sales professionals. However, if the margins on products are small and the markets are broad, some form of automated sales approach, such as a website or a combination of automated and human distribution approaches, might deliver better returns.

Online Stores

One of the most rapidly growing distribution channels is online stores. For a relatively small investment, almost any organisation whose products or services have a fixed price, and even some that do not, can establish an e-commerce site that allows customers to make purchases on a website. The growth in this area has transformed many industries that once relied on intermediaries to make sales and provided national, and sometimes global, market exposure to small companies offering even just one product. In some cases, direct access to customers has nearly eliminated entire intermediary industries. When airline tickets, hotel reservations and other travel arrangements could be easily made online, travel agencies, an important set of intermediaries for the travel industry, were virtually eliminated.

Many retailers have an online presence to complement their brick-and-mortar facilities. Customers of the clothing retailer Nordstrom can, for example, purchase clothing online or in the store and return or exchange purchases through either channel. Others exist exclusively online, like Amazon.com, which has become the world’s largest online department store, selling everything from books to household goods to business supplies.

With overnight shipping, even perishables like flowers and food can be ordered online, opening new possibilities for agribusiness and other companies that previously relied on a complex distribution network. Even online grocery shopping is expanding in many areas, with customers supplementing as needed from their local market. In these cases, companies combine online ordering with delivery from local facilities. Although personal services are offered less frequently, many companies offer gift certificates or gift cards for purchase online, extending their market to gift givers whose friends or family enjoy a particular company’s goods or services.

Online stores are relatively inexpensive to set up and manage and dramatically reduce the cost of a sales force. However, they are not an option for every business. Online stores are best suited for companies whose products and services can easily be shipped without being damaged, have little to no customisation, have relatively standardised pricing and can be shipped cost-effectively. Online stores are less effective for professional services and personal services, including health care, hair salons, repair services and other sales that require personal interaction.

Catalogues

Like online stores, catalogues offer customers the opportunity to browse a selection and then place an order either online or by telephone. Catalogues are commonly used by retailers and wholesalers representing a broad selection of items and whose customers might be in the market for one or more of those items. Like online stores, this approach is best for products with fixed prices that are purchased relatively frequently within a market. If a product is not purchased frequently, catalogues can become outdated before the product is needed.

The key advantage to catalogues is that they arrive on the customer’s desk or in his or her mailbox without invitation, giving the company an opportunity to introduce itself to a customer it might not otherwise have been successful in reaching.

There are, however, a number of disadvantages. The costs involved in laying out a catalogue, printing and mailing it can be extremely high. In addition, the company must have another channel (Internet and/or customer service personnel, such as a sales team) in order to complete the sale. As with online stores, the company must also have a logistical infrastructure to efficiently ship and return goods.

Event-Based Distribution

Some organisations distribute products to customers through events of various types. For example, smaller farms, artists and other small businesses may use farmers’ markets to reach customers. In these cases, the company or individual rents a space, erects a temporary retail facility (typically a booth) and sells products directly to consumers. Not-for-profits frequently use events to generate contributions, either by selling a ticket that includes a contributed amount or asking for a contribution from individuals attending the event.

Auctions are also used as distribution events. Some auctions offer the products of numerous vendors, such as commodity, fish or livestock auctions. In other cases, a business may be auctioning off its own products alone, like collectibles.

Promotions-Based Distribution

Most promotional efforts are designed to drive buyers to a purchase but not to serve as the distribution channel. However, some organisations promote and solicit sales at the same time. Many not-for-profits use direct mail solicitation as a means of collecting donations. More recently, social media campaigns, e-mail campaigns and text message campaigns have all been used to generate donations for not-for-profits, political campaigns and other similar organisations. Other companies, including music, food, wine and book clubs, and more recently, clothing clubs such as Trunk Club, send a box of goods to the consumer who must return them within a finite period of time or be charged for the purchase. Magazine publishers often include an envelope or postcard that the would-be subscriber could complete and mail in, sometimes in a direct mail promotional piece and almost always within the publication itself, as a tear-out card. In each of these cases, the promotional piece is designed to both persuade and collect orders and/or payment.

Advantages and Disadvantages to Direct Distribution

As mentioned earlier in this chapter, direct distribution only works if the company is able to appear in the places where customers are most likely to look for and purchase the company’s product. Sometimes, a direct distribution system is simply not an option because building the infrastructure to deliver goods or services to the entire market would be prohibitively expensive. In other cases, the structure of the industry discourages or prohibits direct sales.

For example, prescription drug companies do not typically sell their products directly to patients. Government regulations discourage that behaviour. Instead, they sell indirectly through pharmacies and physicians. A candy manufacturer might prefer to sell its sweets directly to the consumer, but most customers purchase candy in grocery stores or other retail environments. If the candy seller were to limit its sales exclusively to direct channels, like a company website, it would not be as likely to achieve widespread sales. If it constructed physical stores to sell its products, the infrastructure costs would be extremely high. Instead, companies in this situation use a variety of indirect distribution channels to ensure their products reach the market.

When a company could use either a direct or an indirect channel approach, the management team should carefully consider which approach will be best for the company. Although direct distribution allows a company to take its product directly to the customer, the executive team should weigh the benefits of the increased margin with the costs and expertise required to do so.

Successfully owning a distribution system requires several of the following conditions:

• The company promotes its own product.

• The company ensures its distribution will reach potential customers in locations where they look for solutions to the need the product or service is designed to address.

• The company invests in customer relationship development if customers generally make repeat purchases from the same vendor.

• The company is in a position to manage financing or the risk of bad debt.

• The company handles customer service, returns and related issues.

In some cases, it can make more sense for a company to outsource their distribution functions. This is especially true when retail or other direct distribution approaches are the organisation’s core competency. Running a retail operation requires specialised expertise that is quite different than, for example, software development or furniture manufacturing. In many cases, it is more economical and practical to use external resources than to develop new internal capacity.

Although working with intermediaries does mean that the company sacrifices some of its profit margin, it can dramatically reduce the company’s investments in distribution and promotions, and, in many cases, improve the returns a company generates.

Indirect, or Channel, Distribution

Companies that help deliver and sell the product to the market are called channel intermediaries or distribution intermediaries. They provide a range of services that may include distribution, sales, promotion and/or financing.

Distribution Channel Configurations

Channels can be relatively short, moving products and services directly to the customer as is true of direct distribution, or relatively long. The longest distribution channel configurations involve multiple steps in which the producer of the product or service sells through several intermediaries before the product or service reaches the actual market. Each has common characteristics, benefits and challenges. In all cases, as noted previously, a company using intermediaries should carefully consider both how it can improve its products appeal to the channel and how it can create and sustain demand in the market to which the channel distributes.

Retailers

Who Uses This: Many companies sell products directly to retailers, who then sell them directly to the consumer or business purchaser. Hewlett Packard, for example, sells its printers and printer products to Sam’s Club, Staples and other retailers, who then sell them to the customer. In this process, title for the products typically changes hands, and retailers simply resell what they have purchased.

Cost Considerations: Because the retailer is also taking a cut of the price the consumer will pay, the revenues to the product manufacturer will be less than they would have been had the manufacturer decided to go direct to the consumer. However, the manufacturer will typically have much lower promotional expenses and no retail infrastructure to sustain and continue to focus on what they do best: innovate and manufacture.

Brand and Other Control Considerations: Larger companies who sell through retailers typically collaborate on promotional initiatives and have more leverage relative to the product placement within the store and the shelf space they are given. They may also provide point-of-purchase and other promotional materials that can help ensure consistent brand messaging and positioning. However, smaller companies who sell direct to retailers generally have considerably less leverage. Because the size and placement of products in a retail environment is closely linked to sales, this loss of control can negatively affect sales. The smaller manufacturer often has more limited opportunity to define the brand outside of the product’s packaging, as well.

Wholesalers

Who Uses This: Most product manufacturers, particularly smaller ones, sell through wholesalers or distributors, who then sell the goods to retailers or business purchasers. For example, Fair Oaks Farms sells its milk in bulk to the Select Milk Producers cooperative, which packages it and sells it to grocery stores, institutions and restaurants. The Japanese seafood wholesaler Daito Gyorui provides a similar service to fishing companies, finding purchasers around the world for fish caught in any particular market.

Full-service merchant wholesalers provide a range of services, including packaging products for specific markets. Other wholesalers, such as drop-shippers, never actually handle the product. Instead, they play a sales function, identifying markets, selling the products and arranging for delivery direct from the manufacturer. Jobbers, or rack jobbers, are wholesalers who manage the inventory in the retail environment, freeing the retailer from that responsibility and collecting payment only when something sells. In some respect, jobbers work with retailers in the same way that an individual works with a consignment shop. Some distribution companies are primarily transportation companies, providing shipping, storing and sales services on behalf of manufacturers. In all cases, the wholesaler takes the title of the goods. In other words, they purchase the goods from the manufacturer, and, thereby, assume some level of financial risk if the products do not sell in a timely manner.

Cost Considerations: Like all indirect channel configurations, the wholesaler marks up the product it sells. So, if the company wants the product to be sold to the customer at a specific price point, it will need to sell to the wholesaler at a lesser point. If the wholesaler is, in turn, selling the product to a retailer, the price must reflect the retailer’s need to make a profit. These discounts reflect the services the wholesaler and retailer are providing, plus their own profit margin. Because the profit margin is now shared between the manufacturer, the wholesaler and, if applicable, the retailer, the manufacturer has less profit than it would if it owned the distribution process and could manage it with the same financial and operational efficiency. Of course, that isn’t generally the case. That is why this approach appeals to many companies.

Because the wholesaler or distributor typically represents many products and cultivates relationships with customers or retailers, a distributor provides the manufacturer with far greater access to customers than the company might otherwise have accessed and often assumes much of the promotional expense the company might otherwise have. The wholesaler might also provide shipping, warehousing or other storage services, assume financing and collections costs relative to product sales and improve cash flows or revenue timing for manufacturers.

Brand and Other Control Considerations: Depending on the wholesale arrangement, a company may lose considerable control using wholesalers to facilitate the distribution process. If the wholesaler handles a broad array of products, the company may or may not aggressively promote the manufacturer’s products, may combine them with other inferior sources or may change the pricing structure or packaging in ways that diminish the value of the brand. Strong contractual agreements with wholesalers can help mitigate these risks, but because the wholesaler is purchasing the products, the manufacturer may have little real clout in negotiations.

Manufacturer Agents/Brokers

Who Uses This: Some manufacturers use agents or brokers to facilitate the distribution process. Unlike wholesalers, brokers and agents, also called reps or manufacturers’ reps, do not assume title to the products. They focus on selling and take a commission or a fee when they are successful, acting as an outsourced sales team. The Indian company, Tata Global Beverages, owner of the Tetley Tea label, for example, uses JL International, a food broker based in Ontario, Canada to help extend its reach into North American markets.

Companies use brokers who are experienced in a market to ensure they are well represented. They typically have strong relationships with the companies through which the manufacturer is trying to sell, giving them an advantage in the negotiating process. Also, they know what to expect when an offer is a good one and what additional terms should be negotiated. Unlike the wholesaler or retailer with whom they are negotiating, they represent the manufacturer and help to ensure the company is getting the best possible terms on its channel arrangements.

Cost Considerations: Agents sometimes work on a fixed fee basis. More often, manufacturers pay a percentage of the total value of goods sold. For example, a manufacturer may pay a broker who sells private label orange juice 3% of the total sales and 5% of anything sold under the manufacturer’s brand label.¹ In some cases, the agent will sell direct to the end user. However, if the agent sells through other wholesalers or into retail environments, the product price will be reduced accordingly. On the other hand, because the agent’s compensation is based on their success rates, this approach can be significantly less risky, and less costly, than hiring a sales force.

Brand and Other Control Considerations: Some agents provide a full range of promotional services on behalf of their client, whereas others simply handle the sales process. Because the agent works directly for the manufacturer, the company may be able to retain more control over brand reputation. On the other hand, using an agent adds one more layer of complexity to a multi-level supply chain, increasing the number of opportunities for brand to be distorted.

Many agents also represent multiple manufacturers, sometimes specialising in a specific type of product offering, like tools. When this happens, an agent might favour one product line over another either because of personal preference or because the commission for that product line is more favourable. Most companies carefully negotiate commissions to be competitive with competing products being sold by the same agent, perhaps offering incentive compensation for sales growth. Other companies negotiate exclusive representation for their product class, limiting the number of competitors who can be represented by a given agent. This is particularly common with products from luxury manufacturers, such as Gucci.

Service Provider Agents/Brokers

Who Uses This: Many service-based companies, such as insurance, employ agents. For example, the Blue Cross and Blue Shield companies generally sell health insurance policies through independent brokers who present their clients with a variety of options.

Cost Considerations: The cost considerations are similar to those listed previously for product manufacturers.

Brand and Other Control Considerations: Although some independent agents serve exclusively one service provider, many serve multiple organisations. In many cases, these individuals act as agents for the customer not the service provider. As a result, any particular service provider’s product may not generate the visibility it might otherwise have if a dedicated agent or sales force were representing it. Many companies offer agents incentive commission structures that provide greater rewards for higher levels of sales to help motivate agents to show their products.

Incentivising Sales Through Indirect Channels

In order to encourage agents, wholesalers and retailers to more aggressively promote their products, manufacturers commonly offer a variety of incentives. The most common incentives for agents are temporary incentives, including badges, free products or even vacation travel. Temporary margin increases are sometimes used for wholesalers and retailers.

Many manufacturers also provide some level of promotional assistance, developing point-of-purchase displays or other promotional tools for retailer use. Others negotiate a specific dollar amount in market development funds or demand generation funds that are used by the wholesaler or retailer to promote the product.

Manufacturers can also use the stick, rather than the carrot, to drive the behaviour they want. Some manufacturers will threaten to change agents or wholesalers, withdraw their products or delay or limit product availability. Of course, these approaches are only effective if the manufacturer has a product that is lucrative for the channel and has strong customer demand.

CUTTING OUT THE MIDDLEMAN

In order to avoid the cost associated with indirect distribution channels, many companies look for ways to reduce the costs of middlemen, increase the control they exercise over their brand, or both. There are many ways these objectives can be accomplished, including vertical integration, exclusive licensing, franchising and disintermediation.

Vertical Integration

Many companies look for ways to vertically integrate their distribution channels in order to reduce costs and increase control. This means that they create their own, wholly-owned intermediaries to represent their products, either under their existing company name or as separate companies. In some cases, they may also represent the products of other manufacturers or service providers. This allows them to sell their products directly to the consumer, rather than engaging with agents, wholesalers and/or retailers.

Some companies construct their own retail environments. For example, Apple, Inc. sells its products both through its own retail stores and traditional big box retailers, like Best Buy. The retail stores are owned by Apple, so the company eliminates the loss in revenues it has when it sells to a third-party retailer. On the other hand, it has the added cost of building, maintaining, staffing and managing a retail chain. Oil companies, like BP, often own their own distribution channels as well, selling fuel to consumers in company-owned gas stations.

Other companies own one component of the distribution channel, like the wholesaler. Fair Oaks Farms’ CEO Mike McClosky was a co-founder of a wholesaler for milk products, the Select Milk Producers cooperative, which purchases the milk from the dairy farmers who own the cooperative and delivers it to their business customers, such as cheese manufacturers.

Anheuser-Busch, the U.S.-based beer manufacturer, works with a range of independent wholesalers, and it also owns its own distributors in major U.S. markets. Although retailers still take a cut of Anheuser-Busch’s profits, it is able to retain some portion of what it would otherwise have paid the wholesaler. Because the company has selected only certain markets for this form of integration, there are clearly cost benefits to using other distributors in other markets.

Some companies construct or acquire a distribution network primarily for their own benefit but also provide services to other manufacturers or service providers. For example, Hood Industries, based in Mississippi, was founded in 1983 as a plywood manufacturing facility. The company grew, acquiring additional plywood and lumber manufacturing companies to expand its product offerings. In the mid-1990s, the company saw the opportunity to improve distribution efficiencies and profitability by acquiring distributors that represented both their products and those of other companies targeting the same market. In 1995, the company acquired its first distribution company, McEwen Company. In 1998, it acquired a second distributor. Both distributors, now operating under the Hood Distribution name, serve a variety of wood and related product manufacturers in addition to Hood Industries’ own plywood and lumber companies.²

The advantage of vertical integration is that the manufacturer, rather than the intermediary, can keep the profit the intermediary would otherwise have made. However, vertical integration can be costly and distracting for smaller organisations.

Franchising and Licensing

Although owning the intermediaries is one approach to improving control while reducing costs, some companies use exclusive licensing agreements or franchising arrangements to more effectively manage their brand. In these cases, the owners of the franchises and licences are independent individuals or corporations. Their contractual arrangement with the franchisor or licensor limits their ability to represent competitors and provides significant marketing, training and other operational support.

For example, the insurance company State Farm sells its products exclusively through licensed agents who train through its programmes and sell exclusively State Farm products. Although they are independent companies, their contract restricts them from selling products other than State Farm insurance. Their offices and operations all bear the State Farm logo, and they have some geographic exclusivity in their representation of State Farm products.

McDonald’s owns most of its own restaurants and much of the land on which those restaurants sit. However, in most cases, it doesn’t operate the restaurants themselves. It franchises that aspect of the business to individual operator-owners, who have an exclusive contract to operate a McDonald’s restaurant in a specific geographic area. This provides the company with substantial control over the location and design of their physical facilities, an important aspect of their brand, while minimising risk surrounding the operations of a food service business.³

The Coca-Cola Company licenses many of the beverages it sells from other companies, including Core Power, the power drink owned by Fair Oak Farms brands. Coca-Cola’s distribution system, the largest such system in the world, includes wholly-owned wholesalers, distributors in which the company has a substantial or controlling financial interest and independent bottlers to whom it grants a licence. With licensed bottlers, Coca-Cola requires exclusive licensing agreements, allowing it to more effectively manage its own brand image and ensure priority service for its products.⁴

Disintermediation

The most rapidly changing aspect of distribution channel management is the disintermediation, which is the ability to remove intermediaries facilitated by the Internet. Companies whose products would not have reached the markets without wholesalers or agents can now be sold directly through online retailers, such as Amazon.com. An author, for example, can take the traditional path, selling his or her work through an agent to a publisher, who manufactures the book and sells it to, or through, national distributors or jobbers, who then sell to bookstores, who then sell to the reader. This process is time consuming, and the author receives only a small portion of the price paid by the consumer. Now, emerging authors can self-publish, taking their books directly to the biggest bookseller in the world and pocketing significantly more revenue as a result. Similarly, small manufacturers of specialty products can reach mass markets without the assistance of an agent or wholesaler.

However, for many businesses, cutting out the intermediary can mean the business assumes unexpected costs. Many small businesses believe that customer access and a good product are sufficient to promote sales and fail to understand the value of the promotional investments made by conventional intermediaries and the credibility they provide. The Internet’s capacity to provide direct access to retailers has significantly reduced the costs associated with intermediaries but has not eliminated costs altogether. Companies who bypass intermediaries should anticipate spending most of their cost savings on the promoting, financing and other services the intermediary previously fulfilled.

CREATIVE PARTNERSHIPS

Non-marketing managers considering their distribution channel options can also look at business partnerships, alliances and other relationships formed between non-traditional intermediaries for mutual benefit. Although these types of relationships are common for promotional benefit, they can be developed to address distribution needs as well.

There are some general categories of relationships, but there are no limits to the possibilities. Some of the more common creative partnerships are described in the text that follows.

Strategic Partnerships

Often, two companies can partner to collaborate on distribution in ways that benefit both organisations.

For example, the American Red Cross sells products on its website that help individuals become better prepared for emergencies, which is a part of their mission, and help generate revenues for the organisation, a fund development requirement. Eton Corporation produces a radio that can be operated on batteries, using solar power or using electricity, and includes a flashlight and other capabilities. Eton produces a red and white version, in the colours of the American Red Cross, for sale on the American Red Cross website, giving the not-for-profit a good way to generate revenue. It also sells the same item on its own website in a specially marked ‘American Red Cross’ section.

Through this strategic partnership, Eton gains access to another channel (the American Red Cross website) and generates goodwill among consumers who appreciate the support of a well-recognised not-for-profit. The American Red Cross also benefits, generating revenues from both its own site and another channel (Eton’s website) and helping the public become more prepared for emergencies.

Unlikely partners, the competitors Kraft Foods, Inc. and Starbucks, Inc., both of which sell coffee through retail channels, created a strategic partnership for the distribution of Starbucks’ coffee products through Kraft’s extensive retail distribution network. Starbucks gained access to retail shelf space it would otherwise have had difficulty securing, and Kraft generated revenue from sales of the popular coffee brand. Unfortunately, 12 years into their distribution agreement, escalating competition caused bitterness between the two coffee vendors, leading to a much-publicised breakup of the partnership.⁵

Value Added Resellers

This type of arrangement is common in many industries when a manufacturer of a product sells it to another company who then takes the product, adds customer value and sells it to the consumer. For example, the software developer Microsoft Corporation sells its Windows software directly to consumers. However, it accesses another channel through its partnership with computer manufacturer Dell Corporation. The Dell Corporation preloads the software onto its computers, which saves the customer time and effort, thus, providing added value. As a result, Dell hopes its computers will be more appealing to consumers, and Microsoft gains another sale.

Joint Ventures

Joint ventures are more formalised agreements to collaborate for mutual benefit. One organisation might benefit from access to distribution channels, whereas the other derives other benefits, such as access to manufacturing facilities. Both organisations typically have an equity stake in the joint venture itself.

For example, U.S.-based Kaman Aerospace Group, Inc., an aerospace manufacturer, wanted to extend manufacturing and distribution into India. Rather than build independent facilities, they formed a joint venture with Indian composite manufacturer Kineco Private Ltd. The jointly owned company, Kineco Kaman Composites-India Pvt. Ltd., manufactures advanced composite structures for aerospace and other industries. The joint venture gave Kaman rapid access to a growing market while leveraging excess capacity in Kineco’s existing facilities.⁶

MULTI-CHANNEL DISTRIBUTION

Many companies use a combination of several types of indirect distribution channels, or a combination of both direct and indirect channels to reach their market. For example, Starbucks sells hot beverages, food and products directly to customers in their retail stores. They also sell products through grocery stores and other retailers. Fair Oaks Farms sells milk, butter and cheese directly to customers through its retail facility at the farm and through its website. It also sells its products through a cooperative distributor and through grocery stores and other retailers.

Although almost all professional service firms sell services directly to clients, many join alliances of similar firms in other geographic locations. These firms sell their colleagues’ services when local representation is needed in an area they don’t already serve. This partnership represents another type of multi-channel distribution approach. In another example, not-for-profit organisations conduct much of their fundraising directly and may also work through third-party organisations, like community chests such as United Way or retailers who solicit donations on their behalf.

When a non-marketing manager or executive is reviewing distribution channels proposed by the company’s channel manager or executive team, he or she should consider where their target market or markets look for products, the types of channels that could be used, the advantages and disadvantage each proposed channel presents relative to cost, control, brand consistency and other issues, and whether any of the channels conflict with one another.⁷

CHANNEL CONFLICT

Channel conflict happens when two different channels compete with one another. Because Internet technologies have made it easy for many consumer product manufacturers to sell directly to their customers while maintaining more traditional channels, multi-channel approaches have become more common. Because establishing a website is relatively inexpensive, the online retail approach is appealing. It allows the manufacturer to generate better per-unit profits while benefiting from the promotional efforts of its third-party retail channels.

Similarly, many companies that sell common consumer goods through retailers prefer to sell through as many retailers as possible. By using multiple retailers, all of whom promote their stores and products independently, the manufacturer is effectively increasing its promotional spend. Because the customer will be exposed to the product more frequently, his or her chances of remembering the product name and brand attributes will be greater, and the likelihood of sales will increase.

Although some degree of channel conflict is natural when multiple channels are used, channel conflict can become problematic when one channel receives preferential treatment. For example, consider a cheese manufacturer that has traditionally sold through retail environments and chooses to launch its own website. From the cheese manufacturer’s perspective, launching this new channel provides several advantages. The cost is relatively low, and it benefits from the promotional efforts made by the retailers while pocketing the difference between the retail price and the wholesale price it gets from their retail channels. From the retailer’s perspective, the manufacturer’s website may continue to promote sampling and purchasing behaviours, which subsequently lead to a customer choosing the more convenient local retail solution. However, if the cheese manufacturer offered the cheese for sale online at a price that is lower than the retail price offered in traditional brick-and-mortar environments, the retailers representing the manufacturer might become angry enough to discontinue selling the manufacturer’s products.

Differentiated pricing between various retailers can also lead to channel conflict. For example, in 1982, Jockey International launched its incredibly successful women’s undergarment line, Jockey for Her. When it was first offered to the public, Jockey for Her was available in traditional retail venues like Nordstrom, with a retail price point reflective of the Nordstrom’s premium positioning in the market. Imagine what might have happened had Jockey International, after its first successful year, decided to push the product through a higher volume channel like Costco. As a mass retailer, Costco routinely negotiates low prices with manufacturers and passes along some of those savings to their members in the form of substantially lower prices.

Because Nordstrom would be offering a product that is available at a significant discount through a competitive channel, this would likely represent a significant channel conflict. Nordstrom, in response, might decide to discontinue carrying Jockey for Her products because of significantly reduced sales.

For this reason, manufacturers who offer products direct to the consumer through their own websites or who offer products through multiple channels often carefully negotiate pricing and discount programmes in advance. A manufacturer’s own website often carries products at the same price a customer would pay if they chose to make the purchase through the most expensive alternative channel.

To avoid this form of channel conflict, many companies create separate product lines or separate brand names in order to differentiate products. For example, Maidenform Brands, Inc. sells undergarments using different brand names and target price points in order to minimise channel conflict and preserve strong relationships with retailers. It produces the Bodymates collection of bras and panties, which are sold through Costco stores at discounted prices, while offering Maidenform through U.S. department store Macy’s at more traditional department store price points.⁸

HOW CHANNEL DECISIONS IMPACT PRODUCT AND SERVICE INNOVATION

An established company’s distribution system has an important influence over other aspects of the marketing mix and particularly on product and service innovation. For example, when a company is considering new product or service offerings, it should consider whether the target customers will be likely to turn to the existing distribution channels for the new product or service or whether an entirely new distribution infrastructure will be required. The cost of a product or service requiring a new channel approach will be significantly higher than one that can leverage existing channels.

Similarly, the existing channels might suggest potential product strategies. In the Maidenform example, the company was able to appeal to some channels by offering product lines exclusively through their retail environment. For example, Maidenform’s Luleh product line is sold exclusively through Macy’s, while Sweet Nothings are sold exclusively by Wal-Mart.

QUESTIONS FOR NON-MARKETING MANAGERS TO ASK ABOUT PLACE OR DISTRIBUTION

Many larger companies have channel managers who specialise in managing distribution approaches for their organisations. Other companies use their product marketing team or their sales teams to manage distribution channels. However, in middle market and smaller companies, non-marketing managers and executives may find themselves very involved in the decision-making process.

Whenever a non-marketing manager is asked to provide input on channel selection decisions, it may be helpful to ask some or all of the following questions:

• Where do our customers look for products like ours? Are we missing any channels we should be considering? Likewise, are there channels from which we should consider withdrawing?

• What other places might our customers be receptive to seeing and purchasing our product or service? Are there places our competitors don’t sell that might present new opportunities as channels or distribution partners?

• When considering a new channel: What are the advantages and disadvantages to this channel? Will it conflict with any of our existing channels? Does it require product modifications, special pricing structures or promotional investments or other expenses that hasn’t been included in our analysis?

• What incentives do we provide for our sales force and/or our channels to excel at selling our products or services?

• What are the common barriers our sales force and/or channels are encountering in selling our product or service? How can we address them?

• What feedback are we receiving from our customers about the channels through which they acquire our products or services? Should we be making any changes as a result of that feedback?

• How can we ensure that our brand reputation is not tarnished or distorted through our indirect distribution channel partners? How do we ensure that our channel personnel’s behaviour is consistent with our company’s desired brand reputation? Are we contractually protected against misbehaviour? Do we have a plan in place regarding how misconduct will be handled?

• What sales volume, and over what time frame, do we expect from each channel? How confident are we about these figures? What additional investments must be made in order to ensure we achieve them?

CHAPTER 8 SUMMARY

Placement or distribution is the way a company ensures that the market has access to its products or services. The routes the product takes to get to market are called channels, and this area of marketing is often referred to as channel marketing.

Placement choice is a factor of

• the type of product or service being offered;

• where the consumer looks when buying that type of product or service;

• the size and configuration of the market; and

• the degree of control the company wants to have over the customer experience.

There are two basic types of channels: direct and indirect.

Direct distribution approaches sell directly to the consumer. These include traditional brick-and-mortar stores, online stores, sales teams, catalogues, event- and promotion-based distribution and other methods in which the manufacturer or service provider has direct contact with the customer. Direct distribution has both pros and cons, as follows:

Pros and Cons of Direct Distribution

PROS	CONS
Easier to listen to needs. Greater control over customer experience. No middleman costs.	Greater costs related to promotions facilities and other channel costs distribution costs financing costs customer service expense

Indirect distribution approaches sell through one or more other companies. With the addition of each additional channel component, the product manufacturer pays a portion of the revenues from the consumer’s price and also passes along some of the responsibilities and related expenses for getting the product to the purchaser. Although it is not uncommon for many channels to assume the responsibility for promotions, most companies will still need to consider how they make their own products and services appealing relative to others that the channel might carry. This is particularly true of indirect channels that represent competitors in the same product or service category. In addition to appealing to the channel, the company should also consider how it will create and sustain demand within the broader market because this will improve both the appeal of the products or services and the company’s negotiating power relative to prices and other terms.

When a company uses multiple distribution channels, their approach is called multi-channel distribution. Multichannel approaches provide manufacturers or service providers with great opportunities, as long as they avoid channel conflict.

Channel conflict can happen when a company uses multiple channels or competitors within a channel to sell its products or services. Channel conflicts happen when a company’s channel approaches favour one channel over another or cannibalise too much of one channel’s market. This can cause disruption in market access to products as retailers, wholesalers or other middlemen discontinue or limit sales of the company’s product.

A company’s channel approach plays an important role in the company’s consideration about product line expansion. Because of the costs associated with developing a completely new distribution infrastructure, many companies favour product or service extensions that leverage existing channel relationships.

Endnotes

1 This particular example was taken from the FAQ section of the Food Brokers USA website. Food Brokers USA is an online directory of food brokers in the USA. Their website can be found here: www.foodbrokersusa.com/

2 Source: Hood Industries’ websites: www.hooddistribution.com/index.html and www.hoodindustries.com/about/.

3 Source: McDonald’s Corporation Annual Report 2011. www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/Investors%202012/2011%20Annual%20Report%20Final.pdf

4 From the Coca Cola Company’s website and its 2011 Form 10K filing: www.thecoca-colacompany.com/investors/pdfs/form_10K_2011.pdf

5 Neuman, William. ‘Starbucks and Kraft Escalate Battle Over Marketing Pact,’ The New York Times, December 6, 2010. www.nytimes.com/2010/12/07/business/07coffee.html?pagewanted=all&_r=0

6 MDM Staff. ‘Kaman and Kineco Agree to Form Joint Venture in India,’ Modern Distribution Management, October 9, 2012. www.mdm.com/kaman-and-kineco-agree-to-form-joint-venture-in-india/PARAMS/irticle/29307

7 Distribution channels and channel management are topics that are complex and interesting. This book only touches the surface of this important topic. However, as I researched this topic, I ran across several articles and other resources I found to be helpful. Here are the ones readily available on the Internet:

Dalao, Bernadette. ‘The Ten Types of Wholesalers: Understanding Their Functions, Strategies and the Role They Play,’ from Ground Report blog: www.groundreport.com/Business/The-Ten-Types-of-Wholesalers-Understanding-Their-F/2868350
Kilter, Philip. ‘Distribution and channels: Kilter on marketing,’ an article on the MaRS website, published with permission from John Wiley & Sons, Hoboken, New Jersey. www.marsdd.com/articles/distribution-and-channels-kotler-on-marketing/
Lecture notes prepared by David Gerth, from a variety of sources, for his marketing class: http://ww2.nscc.edu/gerth_d/MKT2220000/Lecture_Notes/unit13.htm

8 Source: Maidenform’s 10K filing on March 9, 2012: http://ir.maidenform.com/phoenix.zhtml?c=190009&p=IROL-secToc&TOC=aHR0cDovL2lyLmludC53ZXN0bGF3YnVzaW5lc3MuY29tL2RvY3VtZW50L3YxLzAwMDEwNDc0NjktMTItMDAyMzgwL3RvYy9wYWdl&ListAll=1&sXBRL=1