Success Strategies in Channel Management

Success Strategies in Channel Management Vertical Integration: Owning the Channel

Vertical Integration: Owning the Channel Make or Buy: A Critical Determinant of organisation Competencies Degrees of Vertical Integration Important forms of organisation-specific capabilities Deciding When to Vertically Integrate Forward Outsourcing as the Starting Point Six Reasons to Outsource Distribution Vertical Integration Forward When Competition Is Low

Vertical Integration: Owning the Channel • Should only one organization do all the channel work, thereby vertically integrating into the distribution stage? In other words, for each flow that the customer is willing to pay to have performed, who should perform it? Should it be a single organization (e.g., producer, agent, distributor, retailer - all rolled into one organisation)? Or should distribution be outsourced (upstream looking down), or should production be outsourced (downstream looking up), thereby keeping separate the identity of producers and downstream channel members?

Make or Buy: A Critical Determinant of organisation Competencies • Vertical integration of distribution involves many complex issues. A structured way is needed to work through the issues; frame a coherent, comprehensive rationale; and reach a decision that can be communicated convincingly. To do so, this section presents a framework for deciding whether the producer should integrate a given flow or a subset of flows in going to market." The premise is that it should own the channel to a market if it has the resources to own and would increase its efficiency in the long run by so doing.

Degrees of Vertical Integration • Under classical market contracts mode, producers and downstream channel members: • Are interchangeable • Deal with each other in a completely independent and impersonal fashion (arm's-length contracting) • Negotiate each transaction as though it were the only one • Begin and end their transactions based solely on the merits of the current set of offerings

The Continuum of Degrees of Vertical Integration

Degrees of Vertical Integration • Relational governance means compromising between the make - buy extremes by creating channels that have some properties of both owned and independent channels. Relational governance can be created in many ways. One of the principal methods of building commitment is selective distribution. Another method, whereby two organizations attempt to coordinate as though they were only one, is franchising, covered in a later section. Franchising and close relationships are channel strategies to simulate vertical integration (this is quasi-vertical integration, another term for relational governance).'' Making these systems work requires power, the subject of the section on power in channels. • Along the continuum of degree of integration, the fundamental issue is how the work of the channel is done. When your employees carry out the flow, you have vertically integrated (the buy option). • In short, vertical integration is not a binary choice but a matter of degree. Degrees of integration form a continuum, anchored by the extremes of classical marketing contracting and vertical integration.

Costs and Benefits • What changes when you choose the make option? If you are a producer, your organization assumes all the costs of distribution, which include all personnel costs. It also bears the risk of the distribution operation and is responsible for all actions. These costs (e.g., warehousing) are substantial and are frequently underestimated, particularly by firms that are accustomed to production but not to distribution.

Deciding When to Vertically Integrate Forward: An Economic Framework • The premise of this section is that the organization's goal is to maximize its overall efficiency in the long run. This is the overall efficiency of the firm. It does not refer to any single flow or product; indeed, the long run may be longer than the life cycle of a given product. In deciding whether to integrate forward into distribution (or, for the down-stream channel member, backward into production), the appropriate question is whether taking on this flow increases efficiency, and does so more than some other use of the resources needed to provide the flow. • Why select this criterion? It is not always appropriate: - But efficiency matters, and matters a very great deal. Why?

Efficiency is the ratio of results obtained (roughly, operating performance) to the resources used to calculate them (roughly, over-head, reflecting the amortization of fixed investments). In the short term, the organisation may be able to sustain losses or tolerate mediocre results (the numerator). • For purposes of channel decision making, this is not necessary. It is enough to focus on factors that drive revenue up and costs or overhead down.

Outsourcing as the Starting Point • One suggestion is that any producer should begin with the premise that the distribution flow should be outsourced. • The fundamental rationale is that, markets for distribution services are efficient .This does not mean that markets for distribution services function perfectly, or even that they function well! It means that given current environmental conditions, technology, and know-how, it is difficult for a given producer to get better operating results than can be delivered by the level of third-party services available to the producer.

Six Reasons to Outsource Distribution • An outside party has six advantages in performing a channel function. Focusing on downstream functions for the moment, these are: • Motivation • Specialization • Survival of the economically fittest • Economies of scale • Heavier market coverage • Independence from any single producer • Let us examine these:.

Motivation. • Outside parties have strong incentives to do their jobs well because they are independent organisations, accepting risk in return for the prospect of rewards. Both positive motivation (profit) and negative motivation (fear of loss) spur the third party to perform. An outsider is attracted by entrepreneurial rewards and driven by fear of losses. • Key to the motivation advantage is that outside parties are replaceable, hence subject to market discipline by their principals. • Distributors are thus under constant pressure to improve operating results, which includes both increasing sales and decreasing costs. In contrast, an organisational distribution network cannot be readily terminated or restructured, and precedent makes it difficult to make substantial changes to incentive systems.

Specialization. • Outsiders have this advantage. For wholesalers, distribution is all they do - they have no distractions. The reverse is true for producers. Specialization engenders and deepens competence. A generalized move to identify and strip down to core competencies - only - is behind many decisions to outsource channel flows.

Survival of the Economically Fittest. • If specialists fail to do their functions better than their competitors do, they do not survive. Distribution in most sectors has low mobility barriers: The business is easy to enter and easy to exit. Such businesses attract many entrants and readily eliminate the lesser performers among them, because they can exit swiftly.

Economies of Scale. • Outside parties pool the demands of multiple producers for marketing channel flows. This allows them to achieve economies of scale by doing a great deal of one thing (a set of distribution flows) for multiple parties. In turn, these economies of scale enable the outsider to perform flows that would otherwise be uneconomical to do at all. By offering many brands in a product category, a distributor can do enough business to amortize the fixed costs of distribution facilities, logistical software, and the like.

Heavier Market Coverage. • Heavy coverage of a market stems from the independent's ability to call on many customers, including small customers, to call on them often, and to call on them concerning a broad range of their needs. • Key here is that the independent can realize potential synergies that a vertically integrated producer cannot reproduce. Why? Because the vertically integrated producer may offer to carry the lines of its competitors, in order to duplicate the independent's assortment.

Independence from Any Single Producer. • For their customers, diversified outside providers of channel flows can serve as a sort of independent counsel, an impartial source of advice that does not come from a single producer. They have the opportunity to know their customers well, and strong customer loyalties often result. • Many producers consider independence ("obstinacy" or "conflict of interest") as one of the biggest drawbacks of outsourcing. They desire vertical integration so that they can resolve their differences of opinion by giving orders to sub-ordinates.

Vertical Integration Forward When Competition Is Low • The manager must make the case that a vertically integrated firm would do the job better. It would contribute enough to revenue or reduce direct cost enough to offset any other increases in direct cost, and to justify the necessary increase in overhead. This goes back to a foundation of marketing channels: You can eliminate the channel partner, but you cannot eliminate the functions it performs.

organisation-Specific Capabilities • In distribution, most of the important organisation-specific capabilities are intangible. (In contrast, vertical integration upstream from production turns on physical assets, such as customized parts and assemblies.) Below is a description of the six major forms of organisation-specific capabilities that accrue in the distribution arena.

Important forms of organisation-specific capabilities • Idiosyncratic knowledge, is the specialist knowledge of the producer, its value offers, its operating methods, and the applications its customers make of these value offers. It is that part of this knowledge base that cannot be readily redeployed to another principal. • Downstream channel members make investments to acquire this knowledge, which is indeed an asset. But it is not an idiosyncratic asset.

Organisation-specific Capabilities • Relationships, , are connections between distributor personnel and the personnel of the producer or the producer's customers. The existence of a relationship implies the ability to get things done quickly and correctly and to make oneself understood swiftly. • Brand equity, is a critical idiosyncratic investment in the producer's brand name. Here we can distinguish two cases. In one case, the brand name enjoys substantial brand equity with consumers independent of the downstream channel member's actions. In this case, vertical downstream is not only unnecessary but wasteful. The producer can use brand equity as a source of power over channel members. Here, the producer does not need to integrate forward in order to exert considerable influence over the channel.

Organisation-specific Capabilities • The brand's strategy demands it be stocked, displayed, and presented in a particular manner, but to permit too low a downstream margin to invite the channel member to provide the support itself. This is why perfume makers sometimes rent dedicated space from department stores and pay the salespeople. • A support service, before or after sales, is required to make sure the branded product is properly installed and used, so that the customer is satisfied and positive word of mouth is created.

Organisation-specific Capabilities • Dedicated capacity,, is distribution capability (warehousing, transportation, selling, billing, and so forth) that has been created for a producer and which, by itself represents overcapacity. Thus, if the producer terminates the business, the downstream channel member has excess capacity, which it cannot redeploy without sacrifice of productive value (i.e., losses). • Site specificity,, is when a producer may need marketing channel flows performed in a location that is well suited to the producer but ill suited to other producers. A channel member that creates a facility (e.g., a warehouse) near the producer has created a general-purpose asset if it is near other producers, whom the warehouse could serve. But if the producer is in a location remote from other suppliers, the warehouse will be difficult to redeploy. Its value is specific to the producer; it is worth little or nothing to other ones.

Organisation-specific Capabilities • Customized physical facilities,, is when the actual physical facilities them-selves can be another important transaction-specific asset. For example, a distributor may, for a particular producer, stack the merchandise onto non-standard pallets, which in turn require non-standard forklifts to lift them, and non-standard shelf sizes to hold them.

Vertical Integration To Cope With Environmental Uncertainty • An uncertain environment is one that is difficult to forecast. This may be because the environment is very dynamic (fast changing) or very complex (therefore, difficult to grasp). Such volatile environments pose special challenges. Should the producer integrate forward in order to meet them? • One school of thought holds that a producer needs to take control in order to cope with this environment. It can then learn more about the context and carry out a coherent strategy for dealing with it. Accordingly, it is argued that uncertainty demands integration.

Vertical Integration to Reduce Performance Ambiguity • Another scenario favouring vertical integration is not a failure of the market to provide bidders. It is a failure of information. • Herein lies a fundamental problem with market contracting. When there is performance ambiguity, the producer cannot discern what level of performance it is getting. • In general, measures are poor when they are untimely or inaccurate. Late or inaccurate information, or no information, creates performance ambiguity.

Success Strategies in Channel Management