NEW! Consumer Psychologist Facebook Forum
Lars Perner, Ph.D.
Assistant Professor of Clinical Marketing
Department of Marketing
Marshall School of Business
University of Southern California
Los Angeles, CA 90089-0443, USA
CHANNELS OF DISTRIBUTION
Firm, Brand, and Product Line
Firm level objectives: It is not enough to simply state a firm’s goal as maximizing the
present value of total profit since this does not differentiate it from other firms and says
nothing about how this objective is to be achieved. Instead, a business and marketing
plan should suggest how the firm can best put its unique resources to use to maximize
stockholder value. A number of resources come into play—e.g.,
• Distinctive competencies—knowledge of how to manufacture, design, or market
certain products or services effectively;
• Financial—possession of cash or the ability to raise it;
• Ability and willingness to take risk;
• The image of the firm’s brand;
• People who can develop new products, services, or other offerings and run the
• Running facilities (no amount of money is going to get a new microchip
manufacturing plant started tomorrow); and
• Contacts with suppliers and distributors and others who influence the success of
Market balance: It is essential that different firms in the same business not attempt to
compete on exactly the same variables. If they do, competition will invariably
degenerate into price—there is nothing else that would differentiate the firms. Thus, for
example, in the retail food market, there are low price supermarkets such as Food 4 Less
that provide few if any services, intermediate level markets like Ralph’s, and high-end
markets such as Vons’ Pavillion that charge high prices and claim to carry superior
merchandise and offer exceptional service
Risk: In general, firms that attempt riskier ventures—and their stockholders—expect a
higher rate of return. Risks can come in many forms, including immediate loss of profit
due to lower sales and long term damage to the brand because of a poor product being
released or because of distribution through a channel perceived to carry low quality
Brand level objectives: Ultimately, brand level profit centers are expected to contribute
to the overall maximization of the firm’s profits. However, when a firm holds several
different brands, different marketing and distribution plans may be required for each.
Several variables come into play in maximizing value. Profits can be maximized in the
short run, or an investment can be made into future earnings. Product profit can be
measured in several ways. If you sell a computer that cost $950 to make for $1,000, you
are making only a 5% gross profit. However, selling a product that cost $5 to make for
$10 will result in a much higher percentage profit, but a much lower absolute margin. A
decision that is essential at the brand level is positioning. Options here may range from a
high quality, premium product to a lower priced value product. Note here that the same
answer will not be appropriate for all firms in the same market since this will result in
market imbalance—there should be some firms perceiving each strategy, with others
Distribution issues come into play heavily in deciding brand level strategy. In order to
secure a more exclusive brand label, for example, it is usually necessary to sacrifice
volume—it would do no good, for Mercedes-Benz to create a large number of low priced
automobiles. Some firms can be very profitable going for quantity where economies of
scale come into play and smaller margins on a large number of units add up—e.g.,
McDonald’s survives on much smaller margins than upscale restaurants, but may make
larger profits because of volume. Some firms choose to engage in a niching strategy
where they forsake most customers to focus on a small segment where less competition
exists (e.g., clothing for very tall people).
In order to maintain one’s brand image, it may be essential that retailers and other
channel members provide certain services, such as warranty repairs, providing
information to customers, and carrying a large assortment of accessories. Since not all
retailers are willing to provide these services, insisting on them will likely reduce the
intensity of distribution given to the product.
Product line objectives: Firms make money on the totality of products and services that
they sell, and sometimes, profit can be maximized by settling for small margins on some,
making up on others. For example, both manufacturers and retailers currently tend to sell
inkjet printers at low prices, hoping to make up by selling high margin replacement
cartridges. Here again, it may be important for the manufacturer that the retailer carry as
much of the product line as possible.
Objectives: A firm’s distribution objectives will ultimately be highly related—some will
enhance each other while others will compete. For example, as we have discussed, more
exclusive and higher service distribution will generally entail less intensity and lesser
reach. Cost has to be traded off against speed of delivery and intensity (it is much more
expensive to have a product available in convenience stores than in supermarkets, for
Narrow vs. wide reach: The extent to which a firm should seek narrow (exclusive) vs.
wide (intense) distribution depends on a number of factors. One issue is the consumer’s
likelihood of switching and willingness to search. For example, most consumers will
switch soft drink brands rather than walking from a vending machine to a convenience
store several blocks away, so intensity of distribution is essential here. However, for
sewing machines, consumers will expect to travel at least to a department or discount
store, and premium brands may have more credibility if they are carried only in full
service specialty stores.
Retailers involved in a more exclusive distribution arrangement are likely to be more
“loyal”—i.e., they will tend to
• Recommend the product to the customer and thus sell large quantities;
• Carry larger inventories and selections;
• Provide more services
Thus, for example, Compaq in its early history instituted a policy that all computers must
be purchased through a dealer. On the surface, Compaq passed up the opportunity to sell
large numbers of computers directly to large firms without sharing the profits with
dealers. On the other hand, dealers were more likely to recommend Compaq since they
knew that consumers would be buying these from dealers. When customers came in
asking for IBMs, the dealers were more likely to indicate that if they really wanted those,
they could have them—“But first, let’s show you how you will get much better value
with a Compaq.”
Distribution opportunities: Distribution provides a number of opportunities for the
marketer that may normally be associated with other elements of the marketing mix. For
example, for a cost, the firm can promote its objective by such activities as in-store
demonstrations/samples and special placement (for which the retailer is often paid).
Placement is also an opportunity for promotion—e.g., airlines know that they, as
“prestige accounts,” can get very good deals from soft drink makers who are eager to
have their products offered on the airlines. Similarly, it may be useful to give away, or
sell at low prices, certain premiums (e.g., T-shirts or cups with the corporate logo.) It
may even be possible to have advertisements printed on the retailer’s bags (e.g., “Got
Other opportunities involve “parallel” distribution (e.g., having products sold both
through conventional channels and through the Internet or factory outlet stores).
Partnerships and joint promotions may involve distribution (e.g., Burger King sells
clearly branded Hershey pies).
Deciding on a strategy. In view of the need for markets to be balanced, the same
distribution strategy is unlikely to be successful for each firm. The question, then, is
exactly which strategy should one use? It may not be obvious whether higher margins in
a selective distribution setting will compensate for smaller unit sales. Here, various
research tools are useful. In focus groups, it is possible to assess what consumers are
looking for an which attributes are more important. Scanner data, indicating how
frequently various products are purchased and items whose sales correlate with each
other may suggest the best placement strategies. It may also, to the extent ethically
possible, be useful to observe consumers in the field using products and making purchase
decisions. Here, one can observe factors such as (1) how much time is devoted to
selecting a product in a given category, (2) how many products are compared, (3) what
different kinds of products are compared or are substitutes (e.g., frozen yogurt vs. cookies
in a mall), (4) what are “complementing” products that may cue the purchase of others if
placed nearby. Channel members—both wholesalers and retailers—may have valuable
information, but their comments should be viewed with suspicion as they have their own
agendas and may distort information.
We consider direct marketing early in the term as a “contrast” situation against which
later channels can be compared. In general, you cannot save money by “eliminating the
middleman” because intermediaries specialize in performing certain tasks that they can
perform more cheaply than the manufacturer. Most grocery products are most efficiently
sold to the consumer through retail stores that take a modest mark-up—it would not make
sense for manufacturers to ship their grocery products in small quantities directly to
Intermediaries perform tasks such as
• Moving the goods efficiently (e.g., large quantities are moved from factories or
warehouses to retail stores);
• Breaking bulk (manufacturers sell to a modest number of wholesalers in large
quantities—quantities are then gradually broken down as they make their way
toward the consumer);
• Consolidating goods (retail stores carry a wide assortment of goods from different
manufacturers—e.g., supermarkets span from toilet paper to catsup); and
• Adding services (e.g., demonstrations and repairs).
Direct marketers come in a variety of forms, but their categorization is somewhat
arbitrary. The main thing to consider here is each firm’s functions and intentions. Some
firms sell directly to consumers with the express purpose of eliminating retailers that
supposedly add cost (e.g., Dell Computer). Others are in the business not so much to
save on costs, but rather to reach groups of consumes that are not easily reached through
the stores. Others—e.g., online travel agents or check printers—provide heavily
customized services where the user can perform much of the services. Telemarketers
operate by making the promotion in integral part of the process—you are explained the
benefits of the program in an advertisement or infomercial and you then order directly in
response to the promotion. Finally, some firms combine these roles—e.g., Geico is a
customizer, but also claims, in principle, to cut out intermediaries.
There are certain circumstances when direct marketing may be more useful—e.g., when
absolute margins are very large (e.g., computers) or when a large inventory may be
needed (e.g., computer CDs) or when the customer base is widely dispersed (e.g., bee
Direct marketing offers exceptional opportunities for segmentation because marketers
can buy lists of consumer names, addresses, and phone-numbers that indicate their
specific interests. For example, if we want to target auto enthusiasts, we can buy lists of
subscribers to auto magazines and people who have bought auto supplies through the
mail. We can also buy lists of people who have particular auto makes registered.
No one list will contain all the consumers we want, and in recent years technology has
made it possible, through the “merge-purge” process, to combine lists. For example, to
reach the above-mentioned auto-enthusiasts, we buy lists of subscribers to several
different car magazines, lists of buyers from the Hot Wheels and Wiring catalog, and
registrations of Porsche automobiles in several states. We then combine these lists (the
merge part). However, there will obviously be some overlap between the different lists—
some people subscribe to more than one magazine, for example. The purge process, in
turn, identifies and takes out as many duplicates as possible. This is not as simple task as
it may sound up front. For example, the address “123 Main Street, Apartment 45” can be
written several ways—e.g., 123 Main St., #123, or 123-45 Main Str. Similarly, John J.
Jones could also be written as J. J. Jones, or it could be misspelled Jon J. Jonnes.
Software thus “standardizes” addresses (e.g., all street addresses would be converted into
the format “123 Main St #45” and even uses phonetic analysis to identify a likely
alternative spelling of the same name.
Response rates for “good” lists—lists that represent a logical reason why consumer
would be interested in a product—are typically quite low, hovering around 2-3%. Simply
picking a consumer out of the phone-book would yield even lower responses—much less
than one percent. Keep in mind that a relevant comparison here is to conventional
advertising. The response rate to an ad placed in the newspaper or on television is
usually well below one percent (frequently more like one-tenth of one percent). (More
than one percent of people who see an ad for Coca Cola on TV will buy the product, but
most of these people would have bought Coke anyway, so the marginal response is low).
Internet Marketing (Electronic
Online marketing can serve several purposes:
• Actual sales of products—e.g., Amazon.com.
• Promotion/advertising: Customers can be quite effectively targeted in many
situations because of the context that they, themselves, have sought out. For
example, when a consumer searches for a specific term in a search engine, a
“banner” or link to a firm selling products in that area can be displayed. Print and
television advertisements can also feature the firm’s web address, thus
inexpensively drawing in those who would like additional information.
• Customer service: The site may contain information for those who no longer
have their manuals handy and, for electronic products, provide updated drivers
and software patches.
• Market research: Data can be collected relatively inexpensively on the Net.
However, the response rates are likely to be very unrepresentative and recent
research shows that it is very difficult to get consumers to read instructions. This
is one of the reasons why the quality of data collected online is often suspect.
CHALLENGES IN RUNNING WEB SITES
There are a number of problems in running and developing web sites. First of all, the
desired domain name may not be available—e.g., American Airlines could not get
“American.com” and had to settle for “AmericanAir.com.” There is also a question
having your site identified to potential users. Research has found that most search engines
have a great deal of “false hits” (sites irrelevant that are identified in a search—e.g.,
information about computer languages when the user searches for foreign language
instruction) and “misses” (sites that would have been relevant but are not identified). It is
crucial for a firm to have its site indexed favorably in major search engines such as
Yahoo, AOLFind, and Google. However, there is often a constant struggle between web
site operators and the search engines to outguess each other, with the web promoters
trying to “spam” the search engines with repeated usage of terms and “meta tags.” The
fact that many computer users employ different web browsers raises questions about
compatibility. A major problem is that many of the more recent, fancier web sites rely on
“java script” to provide animation and various other impressive features. These
animations have proven very unreliable. Sites may “crash” on the user or prove
unreliable, and many consumers have found themselves unable to complete their
ECONOMICS OF ELECTRONIC COMMERCE:
SELLING ONLINE IS USUALLY MORE EXPENSIVE
Some people have suggested that the Internet may be a less expensive way to
distribute products than traditional “brick-and-mortar” stores. However, in most cases,
selling online will probably be more costly than selling in traditional stores due to the
high costs of processing orders and direct shipping to the customer. Some products may,
however, be economically marketed online. Some factors that are relevant in assessing
the potential for e-commerce to be an effective way to sell a specific products are:
• “Value-to-bulk” ratio. Products that have a lot of value squeezed into a small
volume (e.g., high end jewelry and certain electronic products) are often more
cost-effective to ship to end-customers than are bulkier products with less value
(e.g., low end furniture).
• Absolute margins. Some products may have a rather high percentage margin—
e.g., a scarf bought at wholesale at $10 and marked up 100% to be sold at $20.
However, the absolute margin is only $20-$10=$10. In contrast, a laptop
computer may be bought at $1,000 and be marked up by only 15%, or $150, for a
total price of $1,150. Here, however, the absolute margin will be larger--$150.
This allows the merchant to spend money on processing, packaging, and shipping
the order. Ten dollars, in contrast, can only cover a small amount of employee
time and very limited packaging and shipping. Some online merchants do charge
for shipping, but doing so will ultimately make the online merchant less
• Extent of customization needed. Some products need to be customized—e.g.,
checks have to be personalized and airline tickets have to be issued for a specific
departure site, destination time, and travel time. Here, online processing may be
useful because the customer can do much of the work.
• Willingness of customers to pay for convenience. Some consumers may be
willing to pay for the convenience of having products delivered to their door. For
example, delivering high bulk, generally low value groceries is generally not
efficient. However, for some customers, it may be worthwhile to pay to avoid an
inconvenient trip to the grocery store.
• Geographic dispersal of customers. Electronic commerce, when value-to-bulk
ratios and absolute margins are not favorable, is often not viable when customers
are located conveniently close to a retail outlet. However, for some products—
e.g., bee keeping equipment—customers are widely geographically dispersed and
thus, a centralized distribution center may be more economically viable.
Specialty books—e.g., for collectors of vintage automobiles—may not be
worthwhile for bookstores to stock, and these may thus be economically sold
• Vulnerability of inventory to loss of value. Some products—especially high tech
products—have a very high effective carrying costs. It has been estimated that
because of the rapid technological progress made in the computer field, computer
parts may lose as much as 1.5% of their value per week. If shipping directly to
the customer can reduce the channel time by five weeks, this potentially “rescues”
as much as 7.5% of the product value. In such a situation, then, trying to reach
the customer directly may make sense, even if the direct costs of distribution are
higher, because of the inventory value issue.
There are a number of economic realities of online competition:
• As discussed, costs of handling online orders is often higher than that of
distributing through traditional stores.
• Even if online selling is more cost effective in some situations, a firm selling
online will, in the long run, be competing with other online merchants—not just
against traditional “brick-and-mortar” stores. By the forces of supply and
demand, online prices will then be driven down so that the profit from selling
online will be no greater than that from traditional retailing. Any reduced costs
would then be expected to go to customers.
• Competition will be greater for products that have large markets than for those
where markets are smaller and more specialized. Amazon.com, for example, has
found it necessary to discount best selling books deeply. Higher prices—closer to
the list price—can be charged for specialty books, but for a large part of the
market, competition will be intense.
• A new online merchant will face competition from established traditional
merchants. These will often have the cash reserves to stay in business for a long
time even with temporary competition. The online merchant, if it has no cash
reserves other than stockholders’ investment, may run out of cash before it can
ISSUES IN WEB SITE DESIGN
Web site design: The web designer must make various issues into consideration:
• Speed vs. aesthetics: As we saw, some of the fancier sites have serious problems
functioning practically. Consumers may be impressed by a fancy site, or may
lack confidence in a firm that offers a simple one. Yet, fancier sites with
extensive graphics take time to download—particularly for users dialing in with a
modem as opposed to being “hard” wired—and may result in site crashes.
• Keeping users on the site: A large number of “baskets” are abandoned online as
consumers fail to complete the “check-out” process for the products they have
selected. One problem here is that many consumers are drawn away from a site
and then are unlikely to come back. A large number of links may be desirable to
consumers, but they tend to draw people away. Taking banner advertisers on
your site from other sites may be profitable, but it may result in customers lost.
• Information collection: An increasing number of consumers resist collection of
information about them, and a number of consumers have set up their browsers to
disallow “cookies,” files that contain information about their computers and
Cyber-consumer behavior: In principle, it is fairly easy to search and compare online,
and it was feared that this might wipe out all margins online. More recent research
suggests that consumers in fact do not tend to search very intently and that large price
differences between sites persist. We saw above the problem of keeping consumers from
prematurely departing from one’s site.
Site content. The content of a site should generally be based on the purposes of operating
a site. For most sites, however, having a clear purpose be evident is essential. The site
should generally provide some evidence for this position. For example, if the site claims a
large selection, the vast choices offered should be evident. Sites that claim convenience
should make this evident. A main purpose of the Internet is to make information readily
available, and the site should be designed so that finding the needed information among
all the content of the site is as easy as possible. Since it is easy for consumers to move to
other sites, the site should be made interesting. To provide the information and options
desired by customers, two-way interaction capabilities are essential.
WEB SITE TRAFFIC GENERATION
The web is now so large that getting traffic to any one site can be difficult. One method is
search engine optimization, a topic that will be covered below. Other methods include
“viral” campaigns wherein current users are used to spread the word about a site, firm, or
service. For example, Hotmail attaches a message to every e-mail sent from its service
alerting the recipient that a free e-mail account can be had there. Google offers a free e-
mail account with a full gigabyte of storage. This is available only by invitation from
others who have such e-mail accounts. Amazon.com at one point invited people, when
they had completed a purchase, to automatically e-mail friends whose e-mail addresses
they provided with a message about what they had just bought. If the friend bought any
of the same items, both the original customer and the friend would get a discount.
Another method of gaining traffic is through online advertising. Sites like Yahoo! are
mainly sponsored by advertisers, as are many sites for newspapers and magazines.
Individuals who see an ad on these sites can usually click to go to the sponsor’s web site.
Occasionally, a firm may advertise their sites in traditional media. Geico, Dell Computer,
and Progressive Insurance do this. Overstock.com has also advertised a lot on traditional
TV programs. Conventional advertising may also contain a web site address as part of a
larger advertising message.
Viral marketing is more suitable for some products than for others. To get others
involved in spreading the word, the product usually must be interesting and unique. It
must also be simple enough so that it can be explained briefly. It is most useful when
switching or trial costs are low. It is more difficult, for example, getting people to sign up
for a satellite system or cellular phone service where equipment has to be bought up front
and/or a long term contract is required makes viral marketing more difficult. Viral
marketing does raise some problems about control of the campaign. For example, if a
service is aimed at higher income countries and residents there spread the word to
consumers in lower income countries, people attracted may be unprofitable. For Google’s
one gigabyte e-mail account, for example, there are large costs that may be covered by
advertising revenues from ads aimed at people who can afford to buy products and
services. Advertisers, however, may not be willing to pay for targets who cannot afford
their products. It is also difficult to control “word of mouth” (or “word of keyboard”).
Measuring the effectiveness of a campaign may be difficult. When a viral campaign relies
on e-mail, messages received may be considered spam by some recipients, leading to
potential brand damage and loss of goodwill.
Online promotions. One way to generate traffic is promotions. Many sites often offer
new customers discounts or free gifts. This can be expensive, but sometimes, the gifts can
be ones that have a low marginal cost. For example, once the firms pays for the
development of a game, the cost of letting new users download it is modest. The U.S.
army uses this approach in making a game available. To be allowed to use some of the
“cooler” features, the user has to go through various stages of “basic training.”
SEARCH ENGINE OPTIMIZATION
Many Internet users find desired information and sites through search engines such as
Google. Research shows that a large proportion of the traffic goes to the first three sites
listed, and few people go so sites that appear beyond the first “page” or screen. On
Google, the default screen size is ten sites, so being in the top ten is essential.
Because of the importance of search engines, getting a good ranking or coming up early
on the list for important keywords is vitally important. Many consultants offer, for large
fees, to help improve a site’s ranking.
There are several types of sites that are similar to search engines. Directories involve sites
that index information based on human analysis. Yahoo! started out that way, but now
most of the information is accessed through search engine features. The Open Directory
Project at http://www.dmoz.org indexes sites by volunteer human analysts. Some sites
contain link collections as part of their sites—e.g., business magazines may have links to
business information sites.
Several issues in search engines and directories are important. Some search engines, such
as Google, base rankings strictly on merit (although sites are allowed to get preferred
paid listings on the right side of the screen). Other search engines allow sites to “bid” to
get listed first. Some sites may end up paying as much as a dollar for each surfer who
clicks through. If a potential customer is valuable enough, it may be worth paying for
enhanced listings. Often, however, it is better to be listed as number two or three since
only more serious searchers are likely to go beyond the first site. The first listed site may
attract a number of people who click through without much serious inspection of the site.
Some search engines are more specific than others. The goal of Google, Yahoo! and
MSN is to contain as many sites as possible. Others may specialize in sites of a specific
type to reduce the amount of irrelevant information that may come up.
Search engines often have different types of strategies. Google is very much technology
oriented while Yahoo! appears to be more market oriented. Another major goal of Google
is speed. Some sites may contain more content of one type than another. For example,
AltaVista appears to have more images, as opposed to text pages, indexed.
Search engine rankings. The order in which different sites are listed for a given term is
determined by a secret algorithm developed by the search engine. An algorithm is a
collection of rules put together to identify the most relevant sites. The specific algorithms
are highly guarded trade secrets, but most tend to heavily weigh the number of links from
other sites to a site and the keywords involved. More credit is given for a link from a
highly rated site—thus, having a link from CNN.com would count much more than one
from the site of the Imperial Valley Press. On any given page, the weight given from a
link will depend on the total number of links on that page. Having one of one hundred
links will count less than being the only one. One source reports that the weight appears
to be proportional so that one out of one hundred links would carry one percent of the
weight of being the sole link, but that may change and/or vary among search engines.
For Google, some of the main ranking factors appear to be:
• Number and quality of links to the site, as discussed above.
• Relevant keywords. Note that the ranking algorithm tests for “spam.” Reckless
repeating keywords may actually count against the rating of the site.
• The “click-through” share of the site. Since late 2006 or early 2007, Google
reportedly fine-tunes rankings by observing the percentage of the time that a
particular site is chosen for a given set of search terms. Sites that are selected
more frequently may improve in rank and those less frequently selected—despite
their merits presumed from the other factors—may move down.
Types of search engines. Some engines, such as Google, are general purpose search
engines. Some are specialized. Some are hybrids, containing some directory structure in
addition to search engine capabilities. Some “reward” sites such as iwon.com attract
people by allowing them to enter a lottery when doing a search. Some sites are aggregator
sites—they do not have their own databases but instead combine the results from
simultaneous searches on other search engines.
Text optimization. It is important to repeat important words as much as possible subject
to credibility. Search engines today are increasingly sophisticated in identifying
“spamming” through frivolous repetition of the same words or early use of words that are
not relevant to the main content of the site. Words that appear early in the text and on the
index page will tend to be weighted more heavily. For some search engines, it may be
useful to include common misspellings of a word so that the site will come up when that
spelling is used. Some web site owners have attempted to include hidden text so that a
search engine would find the desired words while the visitor would see something else.
Some web designers, for example, would hide text behind a graphic, make the text in a
very small font, and/or make the font color the same, or nearly the same, as the
background. Other web site designers have made a “legitimate” site, only to have a
command to move the visitor to another site when they go to the searched site. Search
engines today are increasingly able to detect this type of abuse, and sites may be
penalized as a result.
Early search engines relied heavily on “meta tags” where the web site creator specified
what he or she believed to be appropriate keywords, content descriptions, and titles.
Because these tags are subject to a lot of abuse, these no longer appear to be significant.
Link optimization. Many web sites engage in “link exchanges”—that is, complementary
sites will agree to feature links to each other. It may be useful for a webmaster to ask
firms whose content does not compete for a link. Sites should register with the Open
Directory Project at http://www.dmoz.org since, if a site is classified favorably, this may
The bottom line on Google. Today, the most significant factor in search engine
rankings appears to be the “value” of the links that reach a site. Links from “low value”
sites (those that are not rated highly, and especially those considered to the “spam”) count
for very little. Links from highly rated sites on the relevant keywords count for literally
thousands—sometimes tens and hundreds of thousands—times as much as less important
site. In the past, the presence of important key terms on a site was the main driver of
rankings, subject to some rudimentary safeguards against obvious “spamming” sites
which used the words as a way to gain rankings without providing relevant information.
Now, the effect of keywords is secondary except for searches that involve a very unique
key term. Search engines cannot usually measure the amount of traffic that goes to a site.
 Traditionally, then, the traffic of a site was not directly incorporated into the ranking
system. Today, however, Google is reported to weigh the percentage that a site is chosen
for click-through when the site comes up in a search. That is, if a site is initially highly
ranked, if a small proportion of searchers actually choose to go to that site, this site is
likely to have its rank reduced.
Google now offers a set of “Analytics” tools, including a set of web traffic statistics.
Webmasters can sign up voluntarily to participate in this by placing certain “meta tag”
code in their web pages. (This code is invisible to people viewing the respective web
page in its regular display mode). Therefore, for such sites, Google does, in principle,
have access to traffic information from all sources, including other search engines or
links from other sites. It is not clear whether Google actually uses this information,
As we have discussed earlier, firms have to make tradeoffs between different
considerations such as cost of distribution, intensity vs. exclusivity, and service
provided. Some of the services ultimately desired by consumers include bulk-breaking
(as previously discussed), spatial convenience (being able to buy milk in the supermarket
rather than having to drive out to a farmer to get it), timing of availability (having
someone—the retailer and other channel members—plan to have toothpaste available in
the store when the consumer needs it), and providing a breadth of assortment (the same
store will carry different kinds of food and other merchandise from different suppliers.
Segmentation involves identifying groups of consumers who respond relatively similarly
to different treatments. In general, we want to find segments that contain people who are
as similar as possible to each other while, simultaneously, being as different as possible
from members of other segments. Thus, for example, members of what we might term a
price sensitive food segment are likely to seek out the lowest priced retailers even if they
are not located conveniently, buy larger packages, switch brands depending on what is on
sale, and cut coupons. The “fussy” segment, in contrast, may shop either where the best
quality is found or at the most convenient location, and may be brand loyal and not cut
coupons. Note that not all members of each segment will be completely alike, and there
is some tension between precision of description and cutting the segments into too small
pieces. The idea, here, then, is for different channels to serve different consumers (e.g.,
price sensitive individuals are targeted by Food 4 Less while more upscale stores target
the price insensitives).
Channel Structure and Membership
Paths to the customer. For most products and situations, it is generally more efficient
for a manufacturer to go through a distributor rather than selling directly to the customer.
This is especially the case when consumers need to have variety and assortment (e.g.,
consumer would like to buy not just toothpaste but also other personal hygiene products,
and even other grocery products at the same place), when products are bought in small
volumes or at low value (e.g., a candy bar sells for less than $1.00), or even
intermediaries have skills or resources that the manufacturer does not (a sales force,
warehousing, and financing). Nevertheless, there are situations when these conditions are
not met—most typically in industrial settings. As an extreme case, most airlines are
perfectly happy only being able to buy aircraft and accessories from Boeing and would
prefer not to go through a retailer—particularly since the planes are often highly
customized. More in the "gray" area, it may or may not be appropriate to sell
microcomputers directly to consumers rather than going through a distributor—the costs
of providing those costs may be roughly comparable to the margin that a distributor
Potential channel structures. Channel structures can assume a variety of forms. In the
extreme case of Boeing aircraft or commercial satellites, the product is made by the
manufacturer and sent directly to the customer’s preferred delivery site. The
manufacturer, may, however, involve a broker or agent who handles negotiations but
does not take physical possession of the property. When deals take on a smaller
magnitude, however, it may be appropriate to involve retailer--but no other intermediary.
For example, automobiles, small planes, and yachts are frequently sold by the
manufacturer to a dealer who then sends directly to the customer. It does not make sense
to deliver these bulky products to a wholesaler only to move them again. On the other
hand, it would not make sense for a California customer to fly to Detroit, buy a car there,
and then drive it home. As the need for variety increases, a wholesaler may then be
introduced. For example, an office supply store needs to sell more merchandise than any
one manufacturer can produce. Therefore, a wholesaler will buy a very large quantity of
binders, file folders, staplers, reams of paper, glue sticks, and similar products and sell
this in smaller quantities—say 200 staplers at a time—to the office supply store, which,
in turn, may go to another wholesaler who has acquired telephones, typewriters, and
photocopiers. Note that more than one wholesaler level may be involved—a local
wholesaler serving the Inland Empire may buy from each of the two wholesalers listed
above and then sell all, or most, of the products needed by local office supply stores.
Finally, even in longer channels, agents or brokers may be involved. This, in particular,
will happen when the owner of a small, entrepreneurial company has more experience
with technology than with businesses negotiations. Here, the manufacturer can be freed,
in return for paying the agent, from such tasks, allowing him or her to focus on what he
or she does well.
Criteria in selecting channel members. Typically, the most important consideration
whether to include a potential channel member is the cost at which he or she can perform
the required functions at the needed level of service. For example, it will be much less
expensive for a specialty foods manufacturer to have a wholesaler get its products to the
retailer. On the other hand, it would not be cost effective for Procter & Gamble and Wal-
Mart to involve a third party to move their merchandise—Wal-Mart has been able to
develop, based on its information systems and huge demand volumes, a more efficient
distribution system. Note the important caveat that cost alone is not the only
consideration—premium furniture must arrive in the store on time in perfect condition,
so paying more for a more dependable distributor would be indicated. Further, channels
for perishable products are often inefficiently short, but the additional cost is needed in
order to ensure that the merchandise moves quickly. Note also that image is important—
Wal-Mart could very efficiently carry Rolex watches, but this would destroy value from
"Piggy-backing." A special opportunity to gain distribution that a manufacturer would
otherwise lack involves "piggy-backing." Here, a manufacturer enlists another
manufacturer that already has a channel to a desired customer base, to pick up products
into an existing channel. For example, a manufacturer of rhinoserous and hippopotamus
shampoo might be able to reach zoos by approaching a manufacturer of crocodile teeth
cleaning supplies that already reaches this target. In the case of reciprocal piggy-backing,
the shampoo manufacturer might then, in turn, bring the teeth cleaning supplies through
its existing channel to exotic animal veterinarians.
Parallel Distribution. Most manufacturers find it useful to go through at least one
wholesaler in order to reach the retailer, and it is simply not efficient for Colgate to sell
directly to pathetic little "mom and pop" neighborhood stores. However, large retail
chains such as K-Mart and Ralph’s buy toothpaste and other Colgate products in such
large volumes that it may be efficient to sell directly to those chains. Thus, we have a
"parallel" distribution network whereby some retailers buy through a distributor and
others do not. Note that we may also be tempted to add a direct channel—e.g., many
clothing manufacturers have factory outlet stores. However, note that the full service
retailers will likely object to being "undercut" in this manner and may decide to drop or
give less emphasis to the brand. It may be possible to minimize this contract by
precautions such as (1) having outlet stores located in vacation areas not within easy
access of most people, (2) presenting the merchandise as being slightly irregular, and/or
(3) emphasizing discontinued brands and merchandise not sold in regular stores.
Evaluating Channel Performance. The performance of channel members should be
periodically monitored—a channel member may have looked attractive earlier but may
not, in practice be able to live up to promises. (This can be either because of complacency
or because the channel member simply did not realize the skills and resources needed to
perform to standards). Thus, performance level (service outputs) and costs should be
evaluated. Further, changes in technology or in the market place may make it worthwhile
to shift certain functions to another channel member (e.g., a distributor has expanded its
coverage into another region or may have gained or lost access to certain retail chains).
Finally, the extent to which compensation is awarded in proportion to performance
should be reassessed—e.g., a distributor that ends up holding inventory longer or taking
on more returns may need additional compensation.
Market Deficiencies. "Gap" analysis involves analyzing current market offering to
assess the extent to which they meet customer demands. Demand side gaps involve a
market situation where consumers are not satisfied buying what is available—usually
either because the level of service provided is not adequate or because the offering is too
expensive. Supply side gaps, in contrast, involve firms that provide services that are
needed, but ones that can be met elsewhere at lower prices.
Demand Side Gaps. Customer satisfaction abounds, and many consumers would like to
replace their current suppliers. This can happen either generally—there is a widespread
dissatisfaction with banks among consumers, and many would switch if they found one
that they thought to provide better service—or the gap can be with one segment that is
not being well served. As an example of the latter, consider parents who, if they had not
had children, would have been perfectly satisfied with an ordinary Internet service
provider but are now worried that their children can be exposed to inappropriate material
online. Therefore, the PAX Network, which features family-oriented television
programming, stepped in to offer a service that claims to block out most objectionable
sites. Further, one auto parts store owned by a woman ran an advertising campaign aimed
at women, acknowledging that women were often being asked by their husbands and
boyfriends to be "parts runners." The ad then went on to talk about the cleanliness of the
store and non-condescending attitudes of the sales people.
Note that although a gap may exist in the sense that existing firms are not offering what
consumers may ideally want, there is a limit to what buyers would be willing to pay for.
For example, before starting their ice-cream business, Ben and Jerry considered going
into business delivering the New York Times to people’s doors on Sunday mornings along
with fresh baked bagels. A problem here, however, could have been the cost of this
service. Sometimes, a firm may be able to come in and fill a gap, but may need to
compromise on exactly how far to go. There are usually some struggles between what
would be nice to have and what customers are wiling to pay for. For example, many
computer buyers would like to have someone come and set up the computer, the
peripherals, and the Internet connection, but might balk at paying $150 for this service.
Many consumers would like to have their dry cleaning picked up and delivered, but when
push comes to shove, they would not be willing to pay for the extra service.
In the early 1990s, a firm owning several supermarket chains decided start Tiangues, a
chain aimed at Hispanic consumers in Southern California. Employees were screened to
be fluent in both Spanish and English, and foods that would appeal especially to different
Hispanic groups were emphasized. The chain was very popular when it first opened, but
it soon lost market share as it was found that with time, what mattered most to customers
was low prices.
Wheel of Retailing. An interesting phenomenon that has been consistently observed in
the retail world is the tendency of stores to progressively add to their services. Many
stores have started out as discount facilities but have gradually added services that
customers have desired. For example, the main purpose of shopping at establishments
like Costco and Sam’s Club is to get low prices. These stores have, however, added a
tremendous number of services—e.g., eye examinations, eye glass prescription services,
tire installation, insurance services, upscale coffee, and vaccinations. To the extent these
services can be added in a cost effective manner, that is a good thing. Ironically,
however, what frequently happens is that "room" now opens up for a "bare bones" chain
to come in and fill the void that the original store was supposed to have filled! New stores
can now come in and offer lower prices before additional, costly services "creep" in.
Note that upscaling over time may be an appropriate strategy and that the owner of the
"rising" chain may itself want to start another, lower-service division (e.g., Ralph’s may
want to own another chain such as Food 4 Less).
Supply Side Gaps. Supply side gaps come about when a business finds that the services
that it has traditionally offered to customers in the past are now too expensive to justify
the value they provide. For example, in the "old days" (i.e., until the early 1990s), travel
agents provided a valuable service—they would "match" travelers and airlines, finding a
reasonable fare and travel time and issuing the ticket to the customer who, then, did not
have to call all the airlines for a fare and then visit the airport or an airline office.
However, nowadays, it is much more convenient for consumers to carry e-tickets, and it
is frequently easier to go online to compare fares and travel time at one’s convenience.
Therefore, travel agents, to command their commissions, will often need to provide
something extra that the online services cannot. The problem is that, for most consumers,
there just isn’t much that the travel agent can offer other than fancy coffee or donuts,
which you can get more conveniently elsewhere anywhere. Maybe they can take passport
photos or arrange bus transportation to a cruise ship, but is that enough to justify people
coming to them? Online services are starting to offer package deals—air fare, hotel, and
Finding opportunities. Again, it is important to emphasize the need for market balance.
Frequently, there will be room for higher cost services for one segment, and perhaps a
diametrically opposed service for the lower cost service.
Gaps, costs, and performance. Generally, we find that gaps do not exist when cost and
service are "in line" with customer expectations. Thus, for example, Nordstrom serves a
segment that desires high service. Nordstrom incurs a great deal of costs in this, which
are ultimately passed on to the consumer, but Nordstrom’s customers are willing to pay
for this. Similarly, Wal-Mart provides some, but less, service and does so at a very low
cost. Thus, another segment’s preferences are served. Thus, service output demand is
matched with supply. On the other hand, many auto repair facilities provide less service
than is expected and do not adequately make up for this by low prices. Therefore, an
opportunity might exist for someone to offer better service at a not much higher cost. On
the other hand, nowadays people may not be willing to pay the extra cost for going to a
butcher shop and pay significantly more if what they get is only a little better than what is
available in the supermarket meat section.
Closing gaps. Firms may be able to close, or reduce, their gaps by reconsidering their
offerings. A gasoline station that offers an "average" level of service at prices higher than
those of self-service stations might either target the low cost segment, lowering prices
and cutting costs, or targeting a premium service and "beefing up" service. Similarly, a
firm that faces a segmented market might "branch off" into different units that offer
different levels of service to different customers. For example, Toyota started the Lexus
division for consumers who demanded more service than would have been cost effective
to offer to its traditional customers. On the supply side, closing gaps mostly involves
improving efficiency and/or reducing costs in other ways. Alternatively, existing
channels may be reassessed—e.g., airlines have deemphasized travel agents.
Channel Management and Conflict
Vertical integration. Generically speaking, products may come and reach consumers
through a chain somewhat like this:
Raw materials ---> component parts ---> product manufacturing
---> product/brand marketing ---> wholesaler ---> retailer
Money can be made at each stage in the chain and it may be tempting for firms to try to
get into all aspects. For example, Henry Ford wanted to make all the components for his
own cars, so Ford tried to run its own rubber plantation with limited success. The
temptation to try to expand vertically can be especially strong when an industry faces
limited growth and thus presents limited opportunities for reinvestment into traditional
operations (e.g., if the auto industry is not growing as much as desired, one way to
reinvest profits, rather than having to pay them back to stockholders who would then
have to pay taxes on the dividends, might be to buy steel mills. The problems, however,
is that the management is not used to running such businesses and that managerial time
will be spread among more areas.
Business structures. A business can be squarely focused in just one area—e.g.,
Kentucky Friend Chicken is only in the fast food business and prides itself on this. On the
other hand, certain businesses are part of an assortment of businesses that all have
common, or at least overlapping, membership. Sometimes, these businesses can be
related in some way—for example, Pepsico used to own several restaurant fast food
chains, and Microsoft, in addition to being in the software business, used to own Expedia,
the online travel service. Here, expertise and brand equity might be transferred from
businesses to business. In other situations, however, these "empires" may consist of
unrelated businesses that were bought not so much because they "fit" into management
expertise, but rather because they were for sale when the conglomerate had money to
invest. With the tobacco industry currently being relatively profitable but having a
questionable future, a tobacco firm might invest in a software maker. Generally, such
investments are risky because of problems with management oversight. In Japan, many
firms are part of a keiretsu, or a conglomerate that ties together businesses that can aid
each other. For example, a keiretsu might contain an auto division that buys from a steel
division. Both of these might then buy from a iron mining division, which in turns buys
from a chemical division that also sells to an agricultural division. The agricultural
division then sells to the restaurant division, and an electronics division sells to all others,
including the auto division. Since the steel division may not have opportunities for
reinvestment, it puts its profits in a bank in the center, which in turns lends it out to the
electronics division that is experiencing rapid growth. This practice insulates the
businesses to some extent against the business cycle, guaranteeing an outlet for at least
some product in bad times, but this structure has caused problems in Japan as it has failed
to "root out" inefficient keiretsu members which have not had to "shape up" to the rigors
of the market.
Motivations for outsourcing. While firms, as discussed above, often have certain
motivations for trying to "gobble" up as many business opportunities as possible, there
are also reasons for "outsourcing" or contracting out certain functions to others. Auto
makers, for example, have often found it profitable to buy a number of components from
non-union manufacturers. Often small vendors, run by entrepreneurs, are better
motivated to perform certain services—e.g., insurance agents can have an incentive to
build up and service a client base more effectively than an internal staff could. It is also
possible for outsiders to specialize—chemical firms, for example, may be better able to
research and develop paints than auto manufacturers. Smaller independent firms may also
operate more leanly, facing market competition better than large, centralized firms. A
firm specializing in just making nuts and bolts may have greater economies of scale than
Rolls Royce, which makes only a limited number of cars.
Channel Power. Some channel members need others more than others need them. For
example, Wal-Mart has a lot more power, given its large volume purchases, than many of
its suppliers. There are several sources of power. Reward power involves a channel
member being able to positively reinforce another’s performance—e.g., Coca Cola may
be able to give a price break or pay a fee for additional shelf space. A retailer that meets a
certain goal—e.g., the sale of 50,000 cases per month—may receive a bonus. In contrast,
coercive power involves the threat of a punishment. A large retailer, for example, may
tell a small manufacturer that no further orders will be forthcoming unless a price
discount is offered. Expert power includes knowledge. Wal-Mart, for example, because
of its heavy investment in information technology, can persuasively argue about likely
sales volumes at different price levels. "Legitimate" power involves government or other
regulations—e.g., auto dealers have a great deal of power over auto makers because only
they are allowed to sell to end customers in the continental U.S. under most
circumstances. Finally, referent power involves the desire of the other side to be
associated—most manufacturers of upscale merchandise are highly motivated to ensure
their availability at Nordstrom’s.
Channel conflict. We have seen throughout the term that conflict exists between channel
members. For example, Coca Cola would like to increase its sales by offering a discount
on its cans. However, the retailer knows that overall soda sales will not go up much when
Coke is put on sale—consumers who bought other brands will just switch, for the most
part. Therefore, the retailer might like to "pocket" any discount that Coke offers.
Similarly, Bass might like to increase its sales by selling to Costco, but its full service
retailers will object to this competition. A number of approaches to resolution are
available, but none are perfect. Sharing of information may help build trust, but this can
be expensive, cumbersome, and may result in this information being available to
competitors. The two sides might seek outside mediation, with a supposedly neutral party
suggesting a fair solution, or the two sides may try to compromise on their own. One side
may accommodate the other, but may not be motivated to continue to do so in the future,
or the other may try to coerce its way through threats of punishment.
Distribution Intensity Decisions
We have seen distribution intensity issues throughout the course, so here we will mostly
consider overall strategic issues related to these decisions.
Distribution opportunities. First of all, we must consider what is realistically available
to each firm. A small manufacturer of potato chips would like to be available in grocery
stores nationally, but this may not be realistic. We need to consider, then, both who will
be willing to carry our products and whom we would actually like to carry them. In
general, for convenience products, intense distribution is desirable, but only brands that
have a certain amount of power—e.g., an established brand name—can hope to gain
national intense distribution. Note that for convenience goods, intense distribution is less
likely to harm the brand image—it is not a problem, for example, for Haagen Dazs to be
available in a convenience store along with bargain brands—it is expected that people
will not travel much for these products, so they should be available anywhere the
consumer demands them. However, in the category of shopping goods, having Rolex
watches sold in discount stores would be undesirable—here, consumers do travel, and
goods are evaluated by customers to some extent based on the surrounding merchandise.
(Please see the chart in the PowerPoint notes).
The product life cycle. In general, a brand can expect lesser distribution in its early
stages—fewer retailers are motivated to carry it. Similarly, when a product category is
new, it will be available in fewer stores—e.g., in the early days, computer disks were
available only in specialty stores, but now they can be found in supermarkets and
convenience stores as well. Certain products that are not well established may have to get
their start on "infomercials," only slowly getting entry into other types out outlets. (Please
see PowerPoint chart).
Brief review of distribution intensity issues:
• Full service retailers tend dislike intensive distribution.
• Low service channel members can "free ride" on full service sellers.
• Manufacturers may be tempted toward intensive distribution—appropriate only
for some; may be profitable in the short run.
• Market balance suggests a need for diversity in product categories where
intensive distribution is appropriate.
• Service requirements differ by product category.
Termination of brands. A retailer may terminate a brand when carrying it under existing
terms no longer seems attractive. This can be done overtly—the channel member
explicitly announces that the brand will no longer be carried—or more indirectly in the
sense that inventory holdings are reduced and customers are recommended substitute
brand and/or products.
Maintaining channel member performance. One way to motivate channel members to
carry one’s product is through a pull strategy. This involves establishing consumer
demand, usually through advertising and/or a strong brand image. For example, most
pharmacies need to carry the brand name Bayer aspirin to satisfy their customers. Note,
however, that Bayer has invested a great deal of money in this. Alternatively, a firm may
offer contract provisions making it attractive to be carried—e.g., prices may be
guaranteed for some period of time. Geographical or target market exclusivity may also
be offered—a retailer who knows that no one else in the area carries the Vengeful
Visions gun line will be more motivated to aggressively push the brand. Stopping short of
exclusivity, a firm may attempt to stop supplying channels that sell below a certain retail
price "maintenance" level—e.g., Levi’s may decide that they will sell to anyone who
wants to carry their jeans so long at such retailers do not sell them below a certain price.
Then, retailers can be assured that a certain margin can be achieved, and can invest in
"Simulating" exclusivity. When truly exclusive distribution proves undesirable, intra-
brand competition can be reduced by offering slightly different, and thus, non-
comparable versions to different retailers.
Making exclusivity attractive. Manufacturers can motivate channel members to
emphasize their brands by creating mutual dependence. For example, Sony might agree
to make a new line of high definition televisions for sale exclusively at Best Buy if Best
Buy in return will invest heavily in repair facilities for this new product. If one retailer
forsakes other brands in return for a large discount on high quantity orders, both sides
may also save money through economies of scale. Finally, the retailer and manufacturer
may develop a certain joint brand identity. For example, the high end department stores
need to carry high end cosmetics to be credible, and in order to maintain their credibility,
high end cosmetics must be available in high end stores.
Retail positioning. There are several ways in which retail stores can position themselves.
One strategy involves low-cost, low-service. On the opposite side of the spectrum, others
may offer high-cost-high-service. Generally, having a clear strategy and position tends to
be more effective since "average" stores tend to face a greater scope of competition—
e.g., Sears competes both "below" with K-Mart and "above" with Macy’s. K-Mart, in
contrast, competes mostly laterally, facing Wal-Mart and Target.
Margins. Stores need to maximize their profits and must consider their margins to do so.
Gross margins generally reflect the difference between what a store pays the retailer and
what it charges the customer. On the average, this difference in supermarkets is about
25%. (Although there are large differences between product categories, as an illustration,
a can that sold for $1.00 might have been bought on wholesale for $0.75). Net margins, in
contrast, take into account the allocated costs of running the store—wages, rent, utilities,
insurance, and "shrinkage." In grocery stores, these margins are usually less than 5%.
Margins can be considered at the unit level—you make $0.35 on a package of salt—or as
a percentage of sales—35% if the salt sold for $1.00. Sometimes, it may also be useful to
consider margins per unit of space to best allocate retail space to different categories.
There are two theoretical forms of retailing. The "High-Low" method involves selling
products at high prices most of the time but occasionally having significant sales. In
contrast, the "everyday low price" (EDLP) strategy involves lower prices all the time but
no sales. In practice, there are few if any EDLP stores—most stores put a large amount of
merchandise on sale much of the time. It has been found that offering lower everyday
prices requires a very large increase in sales volume to be profitable.
Increasing power of retailers. As more and more products compete for space in
supermarkets, retailers have gained an increasing power to determine what is "in" and
what is "out." This means that they can often "hold out" for better prices and other
"concessions" such as advertising support and fixtures. A significant trend in recent years
has been toward manufacturers’ "private label" brands—that is, the retailers' own brands
competing against the national ones. For example, Del Monte peas may now have to
compete against Ralph’s brand of peas in those stores. Although private label brands sell
for lower prices than national brands, margins are greater for retailers because costs are
lower. For example, it is more profitable to sell a can of peas $1.00 when it cost $0.60 to
supply than it is to sell a name brand can at $1.25 when that cost $1.05 at wholesale.
"Power" and "category killer" retailers. A number of retailers have become a great
deal more efficient in recent years than has been traditional in the industry. Firms like
Wal-Mart have invested greatly in information technology and logistics and have
committed to taking a risk on placing large orders placed well in advance of the need.
These stores have frequently attracted a large customer base by charging consistent low
prices. The philosophy here is to make a little bit of profit on each thing sold and then
selling a great deal. A special case is the "category killer" which focuses on a specific
product category—e.g., Circuit City buys up very large volumes of electronics and thus
can bargain for low prices from manufacturers. Manufacturers get the benefit of large,
consistent orders, but must in turn offer exceptionally low prices or risk having business
shifted to other brands. Note that in practice, the category killer tends to carry a large
variety of brands, buying a large volume of each. Thus, the mere threat of switching to
other brands is enough to get a concession from each brand.
Retailing polarity. A number of retailers have tended to go to one extreme or the other—
either toward a great emphasis on price or a move toward higher service. Rapid economic
growth has made high service retailers more attractive to a growing number of affluent
consumers, and less affluent consumers have become more accustomed to intense price
competition between different retailers.
Copyright (c) Lars Perner 1999-2008.