Dell is seriously thinking about expanding their stores and giving up their strategic competitive advantage of direct e-commerce only distribution. There were so many debates on how the role of intermediaries has changed due to the Internet and social networks. Today many companies still have not resolved these issues while spending millions on world class solutions such as ATG. I came across this note which was a speech I gave to a b-school marketing club some two years ago. I was talking about channel strategy and I thought I should share with you here:
Any company out there with a product/service to sell, how to make that product available to their targeted customers can be as crucial a strategic issue as developing the product and the brand itself, while distribution strategy seems to be a very traditional concern, companies has come under intense scrutiny due to a number of major developments including the Internet and Warehouse Clubs. The expanding market power of retailers has forced many to rethink their channel approaches.
First, let’s talk about the expanding role of the Internet, expanding social connectivity that will result in the coming of “social commerce”. In consumer and business procurement activity has created unprecedented opportunities for easy and vast access to customers and the experience has moved beyond transaction to experiential, the other thing is the economics of materials delivery has been revolutionized by super efficient logistical networks deployed by third-party logistics powerhouses. As a result, many manufacturers are reconsidering whether they should rely on intermediaries or should what extend they should rely on them. Today’s topic of my speech is to give some insight into this issue.
Firms in a variety of industries have recently established avenues for selling direct (e.g., Nike, Banana Republic, Target, Mattel, Kodak, IBM, Sony, Levis, etc.), and still many others are still seriously evaluating such strategies. In general, this decision entails a determination of the number of levels in the distribution network, the number of outlets within each level, and other variables, such as pricing, inventory levels, and service levels, customer expectations and shopping behavior etc. Today I want to talk about the strategy and the management activities.
The basic motivations for this include: (1) resellers carry only limited assortments of a manufacturer’s products, (2) direct control of distribution and pricing can lead to higher profit margins, (3) resellers can use their power to extract various concessions from the manufacturers, (4) manufacturers can provide a broader product selection in a better ambiance with higher service in direct outlets, (5) more flexibility in experimenting with product attributes such as personalization, (6) closer contact with customers with direct feedback mechanism, and (7) protection from crises faced by resellers
Getting rid of intermediaries can also improve supply chain efficiency, by allowing upstream parties better visibility into market demand.
While these arguments have long supported the use of direct sales and company-owned concept stores, they are just as relevant when the markets are created via the Internet. Indeed, the explosion in possibility of e-commerce and the coming of “social commerce” is what has drawn many manufacturers into the realm of direct sales. It is not only about moving products, but engaging with customers.
Elimination of intermediaries is not without disadvantage, though.
The role of intermediaries is to efficiently create and satisfy demand, through activities that include customer education, providing market coverage, providing breadth of assortment, processing orders, customer support, etc. We refer to these collectively as “sales effort.” If a manufacturer cannot otherwise provide these functions efficiently, elimination of intermediaries may cause an erosion of profits, market share, or both. Many instances this establishes the manufacturer as a direct competitor to its reseller partner, potentially leading to tension referred to as “channel conflict.” We hear this all the time and there seems to be a lot of confusion of what is required to deal with this issue. There's a well-publicized story involved letters in May of 1999 by Home Depot to more than 1,000 of its suppliers, stating “Dear Vendor, It is important for you to be aware of Home Depot’s current position on its’ [sic] vendors competing with the company via e-commerce direct to consumer distribution. We think it is short-sighted for vendors to ignore the added value that our retail stores contribute to the sales of their products....We recognize that a vendor has the right to sell through whatever distribution channels it desires. However, we too have the right to be selective in regard to the vendors we select and we trust that you can understand that a company may be hesitant to do business with its competitors”
In general, channel conflict can undermine attempts to develop cooperative relations in the intermediated channel, which may lower the profits of ALL parties. The desire to use both channel types may compel a manufacturer to redefine its relationship with the intermediary, with careful attention to the division of labor and any associated financial terms. For instance, in 1998, the former Compaq unveiled an aggressive effort to sell personal computers directly to end customers, bypassing the dealers who helped make it one of the world’s largest sellers of PCs. To appease its dealers and distributors, Compaq’s plan included maintaining separate brands for small business and corporate markets and paying dealers an estimated 5-6% commission for referring small business customers.
On the other hand, while IBM may take orders for PCs over the Web, it redirects the sales to its distributors and allows some of them to add further value by performing a variety of assembly steps. Although they later on dropped these practices and decided even to close down retail outlets and go fully e-channel.
Most of the times adding a new distribution channel often create channel conflict, whether the new channel is owned by the manufacturer or involves other intermediaries. The use of the term focuses specifically on resellers’ concerns about the installation of a manufacturer-direct channel since this represents a growing trend in industry. There is no end in sight for this trend.
So how do you formulate a channel strategy? You start from an assessment of channel power and levels of cooperation. Manufacturers must evaluate the following factors when determining the right level of cooperation or when assessing their channel power:
1/ Brand Equity: A strong brand (Apple) drives customers to a manufacturer's site while a weak brand (Acer) points customers to a retailer;
2/Margins: Higher margins (Nike or Adidas) let a manufacturer more easily absorb direct e-commerce costs not already part of its core expertise;
3/ Level of Customer Involvement: The larger and less frequent a purchase, the more effort and consideration a customer exerts during the buying process, and where the brand community exists;
4/ Retailer Value-Added: The more a retailer contributes to the customer experience, the higher the value-add (e.g., large product assortment, service wrapper);
5/ Internet Value-Added: The more the Internet enhances the shopping experience, the higher the value-add of selling directly (e.g. relevant content and customization);
6/ Competitive Intensity: The level of competition within both the retail and manufacturing segments will also be a factor in channel strategy since it is a key determinant of market power (e.g., the more retailers there are then the stronger the manufacturer's position);
A number of factors, including e-commerce and the transformation of logistical economics driven by the growth of the third-party logistics industry, have led many companies to consider engaging in direct e-com sales. This may put such companies in competition with their existing reseller partners. The potential channel conflict has huge implications for distribution strategy. Here I have proposed a concept model that captures key attributes of the relationship between a manufacturer / brand owner and a reseller who act independently, including various sources of inefficiency. These include double marginalization within the re-seller channel, and the failure of each channel to fully perceive the positive externality that its sales efforts can have on the other channel. The latter is directly related to the issue of channel conflict. I believe that the addition of a direct e-channel alongside a reseller channel is not necessarily detrimental to the reseller. In fact, the manufacturer will reduce the wholesale price to retain some of the reseller’s selling effort, and in some cases, this can make both parties better off.
Using an industrial economic point-of-view, there actually can be a net system-wide efficiency gain to share because the whole-sale price reduction can counteract double marginalization. With such a multi-channel arrangement, diverting product flow to the direct channel can create efficiency gains if this serves demand at lower overall supply chain cost. Hence, the reseller’s concern may, in reality, be groundless; There are also ways to meet customer service expectations and can dramatically enhance the overall shopping experience and even extend that to the resellers.
There are simply many ways to create win-win situation. Yes channel conflicts can be avoided even in the age of channel proliferations. The answer is a harmonized and flexible channel strategy.
On this note I want to say thank you and I will spend the next 20 minutes taking questions.
Recent Comments