Channels of Distribution
CHANNELS OF DISTRIBUTION
The word channel might bring to mind a waterway such as the English Channel, where ships move people and cargo. Or it might bring to mind a passageway such as the Chunnel, the railroad and car tunnel under the English Channel. Either image implies the presence of paths or tracks through which goods, services, or ideas flow. This imagery offers a good starting point for understanding channels of distribution.
The term marketing channel was first used to describe trade channels that connected producers of goods with users of goods. Any movement of products or services requires an exchange. Whenever something tangible (such as a computer) or intangible (such as data) is transferred between individuals or organizations, an exchange has occurred. Marketing channels, therefore, make exchanges possible. How do they facilitate exchanges? Perhaps the key part of any distribution channel is the intermediary. Channel intermediaries are individuals or organizations who create value or utility in exchange relationships. Intermediaries generate form, place, time, and/or ownership values between producers and users of goods or services.
Marketing channels were traditionally viewed as a bridge between producers and users. This traditional view, however, fails to fully explain the intricate network of relationships that underlie marketing flows in the exchanges of goods, services, and information. To illustrate, consider a prescription drug purchase. To get authorization to purchase the drug, one must visit a physician to obtain a prescription. Then, one might acquire the drug from one of several retail sources, including grocery store chains (such as Kroger), mass discounters (such as Wal-Mart), neighborhood pharmacies, and even virtual pharmacies (such as Drugstore.com). Each of these prescription drug outlets is a marketing channel. Pharmaceutical manufacturers, distributors, and their suppliers are all equally important links in these channels of distribution for pharmaceuticals. Sophisticated computer systems track each pill, capsule, and tablet from its point of production at a pharmaceutical manufacturer all the way to its point of sale in retail outlets worldwide.
To appreciate the complexity of marketing channels, exchange should be recognized as a dynamic process. Exchange relationships themselves continually evolve as new markets and technologies redefine the global marketplace. Consider, for example, that the World Wide Web's arrival created a new distribution channel now accounting for trillions in electronic exchanges. It may come as a surprise that the fastest-growing segment of electronic commerce involves not business-to-consumer, (called B2C in today's Web language) but business-to-business (B2B) channels.
Whether these exchange processes occur between manufacturers and their suppliers, retailers and consumers, or in some other buyer-seller relationship, marketing channels offer an important way to build competitive advantages in today's global marketplace. This is so for two major reasons:
- Distribution strategy lies at the core of all successful market entry and expansion strategies. The globalization of manufacturing and marketing requires the development of exchange relationships to govern the movement of goods and services. As one sips one's preferred coffee blend at the neighborhood Star-bucks, consider that consumers in China, Lebanon, and Singapore may be sipping that same blend. Then consider how the finest coffee beans from Costa Rica or Colombia get to thousands of neighborhood coffee shops, airports, and grocery stores around the world.
- New technologies are creating real-time (parallel) information exchange and reducing cycle times and inventories. Take as an example Dell Computer, which produces on-command, customized computers to satisfy individual customer preferences. At the same time, Dell is able to align its need for material inputs (such as chips) with customer demand for its computers. Dell uses just-in-time production capabilities. Internet-based organizations compete vigorously with traditional suppliers, manufacturers, wholesalers, and retailers. Bricks-and-mortars (organizations having only a physical location) and clicks-and-orders (organizations having only a virtual presence) are in a virtual face-off.
DEFINING MARKETING CHANNELS
The Greek philosopher Heraclitus wrote, "Nothing endures but change." Marketing channels are enduring but flexible systems. They have been compared to ecological systems. Thinking about distribution channels in this manner points out the unique, ecological-like connections that exist among the participants within any marketing channel. All marketing channels are connected systems of individuals and organizations that are sufficiently agile to adapt to changing marketplaces.
This concept of a connected system suggests that channel exchange relationships are developed to build lasting bridges between buyers and sellers. Each party then can create value for itself through the exchange process it shares with its fellow channel member. So, a channel of distribution involves an arrangement of exchange relationships that create value for buyers and sellers through the acquisition (procurement), consumption (usage), or elimination (disposal) of goods and services.
EVOLUTION OF CHANNELS
Marketing channels always emerge from the demands of a marketplace. Nevertheless, markets and their needs are always changing. It is true, then, that marketing channels operate in a state of continuous evolution and transformation. Channels of distribution must constantly adapt in response to changes in the global marketplace. Remember: Nothing endures but change.
At the beginning of the nineteenth century, most goods were still produced on farms. The point of production had to be close to the point of consumption. But soon afterward, the Industrial Revolution prompted a major shift in the American populace from rural communities to emerging cities. These urban centers produced markets that needed larger and more diverse bundles of goods and services. At the same time, burgeoning industrialization required a larger assortment of production resources, ranging from raw materials to machinery parts. The transportation, assembly, and reshipment of these goods emerged as a critical part of production.
During the 1940s, the U.S. gross national product grew at an extraordinary rate. After World War II (1939–1945) ended, inventories of goods began to stockpile as market demand leveled off. The costs of dormant inventories—goods not immediately convertible into cash—rose exponentially. Advancements in production and distribution methods came to focus on cost-containment, inventory control and asset management. Marketers soon shifted from a production to a sales orientation. Such attitudes as "a good product will sell itself" or "we can sell whatever we make" receded. Marketers confronted the need to expand sales and advertising expenditures to persuade individual customers to buy their specific brands. The classic four Ps classification of marketing mix variables (product, price, promotion, and place) emerged as a marketing principle. Distribution issues were relegated to the place domain.
This innovative selling orientation inspired the development of new intermediaries as manufacturers sought fresh ways to expand market coverage to an increasingly mobile population. The selling orientation required that more intimate access be established to a now more diversified marketplace. In response, wholesale and retail intermediaries evolved to reach consumers living in rural areas, newly emerging suburbs, and densely populated urban centers.
Pioneering retailers such as John Wanamaker (1838–1922) in Philadelphia and Marshall Field (1834–1906) in Chicago quickly sprouted as Goliaths in this brave new retail world. Small retailers came of age, as well, offering specialized operations tailored to meet the needs of a changing marketplace. Retailers and their channels evolved in lockstep with the movements and needs of the consumer marketplace. As always, marketing channels were evolving in response to changing marketplace needs.
The impact of two remarkable innovations taken for granted today—the car and the interstate highway system—cannot be ignored. These transforming innovations simultaneously stimulated and satisfied Americans' desire for mobility. Manufacturers suddenly began selling their wares in previously inaccessible locations. Millions of Americans fled from the cities to the suburbs in the 1950s and 1960s. Retailers quickly followed. Yet another channel phenomenon emerged, this one involving groups of stores situated together at one site. The suburban shopping center was born. Its child, the mall, soon followed.
In 1951 the earth moved. That was the year marketers first embraced the marketing concept. The marketing concept decrees that customers should be the focal point of all decisions about marketing mix variables. It was accepted that organizations should make only what they could market instead of trying to market whatever they could make. This new perspective had a phenomenal impact on channels of distribution. Suppliers, manufacturers, wholesalers, and retailers were all forced to adopt a business orientation initiated by the needs and expectations of each channel member's customer.
The marketing concept quickly reinforced the importance of obtaining and then applying customer information when planning production, distribution, and selling strategies. A sensitivity to customer needs became firmly embedded as a guiding principle by which emerging market requirements would be satisfied. The marketing concept remained the cornerstone of marketing channel strategy for some thirty years. It even engendered the popular 1990s business philosophy known as total quality management. Small wonder, then, that in Japan the English word customer has become synonymous with the Japanese phrase for "honored guest."
The customer focus espoused within the marketing concept has a broad, intuitive appeal. Yet the marketing concept implicitly suggests that information should flow unidirectionally from customers to intermediaries and from intermediaries to manufacturers. This unnecessarily restrictive and reactive approach to satisfying customers' needs has been supplanted by the relationship marketing concept. As modern communication and information management technologies emerged, channel members found they could now establish and maintain interactive dialogues with customers. Ideas and information began to be exchanged—bidirectionally—in real time between buyers and sellers. Channel members learned that success comes from anticipating the needs of one's customers before they do. The earth had moved, again, as the relationship marketing philosophy was widely adopted.
How important is a customer dialogue? Sophisticated database and interactive technologies enable channel members to quickly identify changes in customers' preferences. This, in turn, allows manufacturers to modify product designs nimbly. Relationship marketing allows manufacturers to mass-customize offerings and to reduce fixed costs associated with production and distribution. Retailers and wholesalers make better-informed merchandising decisions. This is yet another lesson in the costs of carrying unwanted products. Relationship marketing yields greater customer satisfaction with the products and services they acquire and consume. And why not? The customer's voice was heard when the offering was being produced and distributed.
Relationship marketing is driven by two principles having particular relevance to marketing channel strategy:
- Long-term, ongoing relationships between channel members are cost-effective. (Attracting new customers costs over ten times more than retaining existing customers.)
- The interactive dialogue between providers and users of goods and services is based on mutual trust. (The absence of trust imperils all relationships. Its presence preserves them.)
THE ROLE OF INTERMEDIARIES
This progression from a production to a relationship orientation allowed many new channel intermediaries to emerge because they created new customer values. Intermediaries provide many utilities to customers. The provision of contractual efficiency, routinization, assortment, or customer confidence all create value in channels of distribution.
One of the most basic values provided by intermediaries is the optimization of the number of exchange relationships needed to complete transactions. Contractual efficiency describes an aspiration shared among channel members to move toward the point where the quantity and quality of exchange relationships is optimized. Without channel intermediaries, each buyer would have to interact directly with each seller. This interaction would be extremely inefficient. Imagine its impact on the total costs of each exchange.
When only two parties participate in an exchange, the relationship is a simple dyad. Exchange processes become far more complicated as the number of channel members increases. The number of exchange relationships that can potentially develop within any channel equals:
where n is the number of organizations in a channel. When n is 2, only one relationship is possible. When n doubles to 4, up to 25 relationships can unfold. Increase n to 6, and the number of potential relationships leaps to 301. The number of relationships unfolding within a channel quickly becomes too large to efficiently manage when each channel member deals with all other members. Channel intermediaries are thus necessary to facilitate contractual efficiency. But as the number of intermediaries approaches the number of organizations in the channel, the law of diminishing returns kicks in. At that point, additional intermediaries add little new value within the channel.
McKesson Drug Company, the nation's largest drug wholesaler, acts as an intermediary between drug manufacturers and retail pharmacies. About 600 million transactions would be necessary to satisfy the needs of the nation's 50,000 pharmacies if these pharmacies had to order on a monthly basis from each of the 1,000 U.S. pharmaceutical drug manufacturers. When this example is extended to the unreasonable possibility of daily orders from these pharmacies, the number of transactions required rises to more than 13 billion. The number of transactions is nearly impossible to consummate. Nevertheless, introducing 250 wholesale distributors into the pharmaceutical channel reduces the number of annual transactions to about 26 million. This reduction in transactions is contractual efficiency.
The costs associated with generating purchase orders, handling invoices, and maintaining inventory are considerable. Imagine the amount of order processing that would be necessary to complete millions upon millions of pharmaceutical transactions. McKesson offers a computer-networked ordering system for pharmacies that provides fast, reliable, and cost-effective order processing. The system processes each order within one hour and routes the order to the closest distribution system. Retailers are relieved of many of the administrative costs associated with routine orders. Not coincidentally, the system makes it more likely that McKesson will get their business as a result of the savings.
Routinization refers to the means by which transaction processes are standardized to improve the flow of goods and services through marketing channels. Routinization has several advantages for all channel participants. To begin with, as transaction processes become routine, the expectations of exchange partners become institutionalized. The need to negotiate on a transaction by-transaction basis disappears. Routinization permits channel partners to concentrate more attention on their own core businesses. Routinization clearly allows channel participants to strengthen their relationships.
Organizations strive to ensure that all market offerings they produce are eventually converted into goods and services consumed by members of their target market. The process by which this market conversion occurs is called sorting. In marketing channels, assortment is often described as the smoothing function. The smoothing function relates to how raw materials are converted to increasingly more refined forms until the goods are acceptable for use by final consumers. The next time you purchase a soda, consider the role intermediaries played in converting the original syrup to a conveniently consumed form. Coca-Cola ships syrup and other materials to bottlers throughout the world. Independent bottlers carbonate and add purified water to the syrup. The product is then packaged and distributed to retailers, and consumers buy it. That is assortment. That is what channels of distribution do. Two principal tasks are associated with the sorting function:
- Categorizing. At some point in every channel, large amounts of heterogeneous supplies have to be converted into smaller homogeneous categories. Returning to pharmaceutical channels, the number of drugs available through retail outlets is huge. More than 10,000 legal drugs exist. In performing the categorization task, intermediaries first arrange this vast product portfolio into manageable therapeutic categories. The items within these categories are then categorized further to satisfy the specific needs of individual consumers.
- Breaking bulk. Producers want to produce in bulk quantities. Thus, it is necessary for intermediaries to break homogeneous lots into smaller units. Over 60 percent of the typical retail pharmacy's capital is tied to the purchase and resale of inventory. The opportunity to acquire smaller lots means smaller capital outflows are necessary at a single time. Consequently, pharmaceutical distributors continuously break bulk to satisfy retailers' lot-size requirements.
The role intermediaries play in building customer confidence is their most overlooked function. Several types of risks are associated with exchanges in channels of distribution, including need uncertainty, market uncertainty, and transaction uncertainty. Intermediaries create value by reducing these risks.
The term need uncertainty refers to the doubts that sellers have regarding whether they actually understand their customers' needs. Usually neither sellers nor buyers understand exactly what is required to reach optimal levels of productivity. Since intermediaries act like bridges linking sellers to buyers, they are much closer to both producers and users than producers and users are to each other. Since they understand buyers' and sellers' needs, intermediaries are well positioned to reduce the uncertainty of each. They do this by adjusting what is available with what is needed.
Few organizations within any channel of distribution are able to accurately state and rank their needs. Instead, most channel members have needs they perceive only dimly, while still other firms and persons have needs of which they are not yet aware. In channels where there is a lot of need uncertainty, intermediaries generally evolve into specialists. The number of intermediaries then increases, while the roles they play become more complex and focused. The number of intermediaries declines as need uncertainty decreases.
Market uncertainty depends on the number of sources available for a product or service. Market uncertainty is difficult to manage because it often results from uncontrollable environment factors. One means by which organizations can reduce their market uncertainty is by broadening their view of what marketing channels can and perhaps should do for them. Channels must be part of the strategic decision framework.
Transaction uncertainty relates to imperfect channel flows between buyers and sellers. When considering product flows, one typically thinks of the delivery or distribution function. Intermediaries play a key role in ensuring that goods flow smoothly through the channel. The delivery of materials must frequently be timed to coincide precisely with the use of those goods in the production processes of other products or services. Problems arising at any point during these channel flows can lead to higher transaction uncertainty. Such difficulties could arise from legal, cultural, or technological sources. When transaction uncertainty is high, buyers attempt to secure multiple suppliers, although this option is not always available.
Uncertainty within marketing channels can often be minimized only through careful actions taken over a prolonged period of exchange. The frequency, timing, and quantities of deliveries typify the processes involved in matching channel functions to the need for efficient resource management within marketing channels. Channel members are often unaware of their precise delivery and handling requirement needs. By minimizing transaction uncertainty, channel intermediaries help clarify these processes. Naturally, as exchange processes become standardized, need, market, and transaction uncertainty is lessened. As exchange relationships develop, uncertainty decreases because exchange partners know one another better.
WHERE MISSIONS MEET THE MARKET
The functions performed by marketing intermediaries concurrently satisfy the needs of all channel members in several ways. The most basic way that market needs can be assessed and then satisfied centers on the role channel intermediaries can perform in helping channel members reach the goals mapped out in their strategic plans. Because they link manufacturers to their final customers, channel intermediaries are instrumental in aligning all organizations' missions with the market(s) they serve. Channel intermediaries foster relationship-building activities and are indispensable proponents of the relationship marketing concept in the marketing channel.
Channels of distribution are not all there is to marketing, but without them all the behaviors and activities known as marketing become impossible. Channels of distribution represent the final frontier within which most sustainable strategic marketing advantages can be achieved. Channels of distribution are the instruments through which organizational missions meet—come face to face with—the marketplace. Strategic success or failure will take place there.
see also Marketing; Retailers; Wholesalers
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Allen D. Truell
Lou E. Pelton