The document describes the supply chain of a garden hose purchased by a customer at a Walmart store in Amarillo, Texas. It details how the hose was originally sampled in Hong Kong, manufactured in China using parts from Thailand, shipped to a warehouse in Mexico, and then transported through various means to the Walmart distribution center and store where the customer purchased it. The supply chain involved companies in several countries performing different functions like manufacturing, transportation, and storage before the final sale.

1. Consider the following example. The final movement of a retail
item occurred on March 6 at 10:47 A.M. when a customer
brought home a garden hose that she had just purchased at a
Walmart Supercenter in Amarillo, Texas. Thirteen months
earlier, a sample of that hose had been in a Hong Kong
showroom where a Walmart buyer ordered 200,000 hoses for the
next year’s selling season from the showroom’s vendor. The
buyer then hired a Chinese agent to represent Walmart after the
buyer returned to Arkansas. This agent was to make sure that
the factories met Walmart’s regulations regarding working
conditions and that the hoses and parts met the retailer’s quality
standards. Over the next nine months, the hoses were assembled
in mainland China using nozzles made in Thailand. The hoses
were then transported to a warehouse in El Paso’s free-trade
zone. In late January, three truckloads of these hoses were
shipped from El Paso to the Walmart distribution center in
Plainview, Texas, for immediate shipment to the Amarillo
Supercenter. In this example, manufacturing occurred in both
China and Thailand, a Mexican warehouse stored the products
for several months, and a Mexican motor carrier was used to
transport the hoses by truck to the United States, where, after
going through customs, the hoses were shipped to the free-trade
zone. From there, either a U.S. or a Mexican trucking company
took the hoses to Walmart’s Plainview distribution center.
Within an hour of being received at the distribution center,
Walmart’s own trucks were taking the hoses to Amarillo. Thus,
before the final retail transaction could take place, several
physical movements were needed that involved many firms other
than the retailer. As the above example illustrates, retailers
cannot properly. Perform their roles without the assistance of
other firms. Retailers are part of a supply chain—a valuable
component, but not the only one. In contrast to Walmart’s rather
slow-moving supply chain, this chapter’s ‘‘Global Retailing’’
box describes how one Spanish apparel chain, Zara, has

2. revolutionized the fashion world and become the world’s
second-largest clothing retailer (in sales) by keeping a tight grip
on every link in its supply chain. It is important to understand
the retailer’s role in the larger supply chain. Retailers have used
the term supply chain interchangeably with the term channel.
Traditionally, this consisted of a set of institutions that moves
goods from the point of production to the point of consumption.
However, with increased concern about the physical
environment or ecosystem, many retailers are beginning to view
the supply chain as ‘‘dirt to dirt.’’ This broadened view traces
all of the materials that go into manufacturing and then the
institutions that bring the product to the retailer but then also
includes what the consumer does to dispose of or recycle the
product. Over the last decade, retailers became more aware of
the need to expand their view of the supply chain due to
harmful ingredients found in products such as lead used in paint
for children’s toys or foreign substances used in pet food. Using
the more traditional view, the supply chain or channel might
include manufacturers, wholesalers, and retailers. For example,
the manufacturer could sell directly to an individual for
household usage, sell to a retailer for sale to the individual, or
sell to a wholesaler for sale to the retailer, who then sells to the
individual. Thus, supply chains consist of all the institutions
and all the marketing activities (storage, financing, purchasing,
transporting, etc.) that are spread over time and geographical
space throughout the marketing process. If the retailer is a
member of the supply chain that collectively does the best job,
that retailer will have an advantage over other retailers. Why
should the retailer view itself as part of a larger channel or
supply chain? Why can’t it simply seek out the best assortment
of goods for its customers, sell then goods, make a profit, go to
the bank, and forget about the supply chain? In reality, the
world of retailing is not that easy. Profits sufficient for survival
and growth would be difficult, if not impossible, to achieve if
the retailer ignored the supply chain. This does not mean that a
channel should never be altered. Innovative retailers are always

3. seeking to find a new method to change the existing supply
chain and replace it with a better one. For example, discounters
changed their relationships with vendors when they began to
buy directly from manufacturers in large quantities, warehouse
the merchandise in efficiently run distribution centers, and ship
to their own stores as a means of obtaining lower prices. Prior
to this change, discounters purchased smaller quantities from
wholesalers only when the merchandise was needed. Similarly,
as described in Chapter1’s ‘‘Retailing: The Inside Story,’’
airlines
restructured their supply chains to circumvent the need for
travel agents by having customers purchase their own tickets
directly from the airlines using the Internet. Prior to making
changes in the overall channel structure, supply-chain members
must understand that all channels are affected by five external
forces: (1)consumer behavior, (2) competitor behavior, (3) the
socioeconomic environment,(4) the technological environment,
and(5) the legal and ethical environment. These external forces
cannot be completely controlled by the retailer or any other
institution in the supply chain, but they need to be taken into
account when retailers make decisions. For example, a change
in the minimum-wage law will usually increase the retailer’s
cost of doing business. Similarly, a rapid rise or fall in fuel
prices will result in a shift between using rail and motor carriers
to deliver product. The retail strategic planning and operations
management model (Exhibit 2.6) dramatizes the importance of
these external forces in retail decision making. Supply-chain or
channel structure also depends on the number of tasks or
functions each member is willing to perform. Eight marketing
functions must be performed by any supply chain or channel:
buying, selling, storing, transporting, sorting, financing,
information gathering, and risk taking. Most of these functions
are self-explanatory; however, the concept of ‘‘sorting’’
requires some explanation. Sorting involves breaking down
heterogeneous materials or product into more homogenous
groups such as sorting oranges into those that are good for

4. eating versus good for juice or other products. It also involves
building up assortments of products that shoppers like to find
together in a store—for example, orange juice with muffins,
eggs, cereal, or bacon. Whether the economic system is
capitalistic, socialistic, or somewhere in between, every supply
chain must perform these eight marketing functions. They
cannot be eliminated. They can, however, be shifted or divided
in differing ways among the different institutions and the
consumer in the supply chain. All forms of retailing were
created by rearranging the marketing functions among
institutions and consumers. For example, department stores
were created specifically to build a larger assortment of goods.
They capitalized on the opportunity to perform one or more
functions better than the current competition. No longer was it
necessary to travel to one store for a shirt and pants, another for
shoes, and yet another for cookware; the necessary assortment
was available in a single store. Supermarkets increased
consumer participation by shifting more of the information
gathering, buying, financing, and transporting functions to
customers. Before supermarkets, consumers could have the
corner grocer select items and deliver them and have them
placed on a store credit account for payment every two weeks
when the household received income, but with the introduction
of super-markets came self-service and cash and carry.
Consumers had to locate goods within the store, select them
from an array of available products, pay for the goods, and
transport them home. The airlines have now shifted the
purchasing of tickets and the printing of boarding passes to the
customer. By performing these marketing functions, the
consumer is compensated with lower prices. It is important to
note that a marketing function does not have to be shifted in its
entirety to another institution or to the consumer; instead, it can
be divided among several entities. For example, manufacturers
that don’t want to perform the entire selling function could have
the retailer perform part of the job through in-store promotions,
local advertising, or promotions on the retailer’s website. At the

5. same time, the manufacturer could assume some of the tasks
using national advertising and by developing its own website to
provide product information such as installation, cleaning
directions, and the manufacturer’s warranty. No member of the
channel would want or be able to perform all eight marketing
functions entirely. For this reason, the retailer must view itself
as being dependent on other supply-chain members. The
institutions involved in performing the eight marketing
functions are usually broken into two categories: primary and
facilitating. Primary marketing institutions are supply-chain
members that take title to the goods. Facilitating marketing
institutions are those that do not actually take title but assist in
the marketing process by specializing in the performance of
certain functions. Exhibit 5.1 classifies the major institutions
participating in the supply chain. Primary Marketing
Institutions There are three types of primary marketing
institutions: manufacturers, wholesalers, and retailers. Because
manufacturers produce goods, we don’t often think of them as
marketing institutions. But manufacturers cannot exist by only
producing goods; they must also sell the goods produced. To
produce those goods, the nation’s 400,000 manufacturers must
purchase many raw materials, semi finish goods, and
components. In addition, manufacturers often need the
assistance of other institutions in performing the eight
marketing functions. A second type of primary marketing
institution is the wholesaler. Wholesalers generally buy
merchandise from manufacturers and resell to retailers, other
merchants, industrial institutions, and commercial users. An
example of a wholesaler is Houston-based Sysco Corporation.
Through its subsidiaries, Sysco engages in the distribution and
marketing of food and related products primarily to the food-
service industry in the United States and Canada. It distributes
frozen foods, fully prepared entrees, fruits, vegetables, and
desserts, as well as various nonfood items, including disposable
napkins, plates, and cups; tableware; cleaning supplies; and
restaurant and kitchen equipment to restaurants, hospitals,

6. nursing homes, schools and colleges, hotels and motels. There
are430,000 wholesalers in the United States, each performing
some of the eight marketing functions.1 Just as it is important
for retailers to continuously evaluate their own strategies, it is
equally important for them to consider the strategies of the
wholesalers in their supply chain. The third type of primary
institution is the retailer. Today there are 1.1 million retail
stores or institutions and more than 1.8 million service
establishments in the United States.2 Retailers can perform
portions of all eight marketing functions. It is possible that
some firms, such as the membership warehouse clubs (Sam’s
and Costco) can act as both a wholesaler selling to small
businesses and a retailer selling to households. However, for
statistical purposes, the Census Bureau con-siders all
membership warehouse clubs to be wholesalers since the
majority of their
business involves wholesale transactions. Facilitating Marketing
Institutions many institutions facilitate the performance of the
marketing functions. Most specialize in one or two functions;
yet none of them takes title to the goods. Institutions that
facilitate the buying and selling functions in the supply chain or
channel include agents and brokers, who are independent
businesspeople who receive a commission
or fee when they are able to bring a buyer and seller together to
negotiate a trans-action. Seldom do agents or brokers take
physical possession of the merchandise. One of the new breed
of e-tailing brokers is Priceline.com, Inc. It pioneered the e-
commerce pricing channel known as a demand collection
channel, which allows it to act without holding any inventory.
Priceline’s channel enables consumers to use the Internet to
make bids on a wide range of products and services while
enabling sellers to generate incremental revenue. Using its
‘‘Name Your Own Price’’ or ‘‘Negotiation’’ proposition,
Priceline collects consumer demand in the form of individual
customer offers, guaranteed by a credit card, for a particular
product or service at a price set by the customer. Priceline then

7. either communicates that demand directly to participating
sellers or accesses participating sellers’ private databases to
determine whether Priceline can fulfill the customer’s offer and
earn its brokerage commission. Priceline’s business model can
be applied to a broad range of products and services and is
already being copied. Marketing communications agencies, or
advertising agencies, also facilitate the selling process by
designing effective advertisements and advising management o
where and when to place these advertisements. Institutions that
facilitate the transportation function are motor, rail, and air
carriers and pipeline and shipping companies. Transporters can
have a significant effect on how efficiently goods move through
the supply chain. These firms offer differing advantages in
terms of delivery, service, and cost. Generally, the quicker the
delivery, the more costly it is. However, there is usually a
trade-off because faster delivery enables the supply chain to
have lower warehousing costs. The major facilitating institution
involved in storage is the public warehouse, which stores goods
for safekeeping in return for a fee. Fees are usually based on
cubic feet used per time period (month or day). Frequently,
retailers take advantage of special promotional buys from
manufacturers but have no space for the goods in their stores or
storage facilities. As a result, they find it necessary to use
public warehouse. A variety of facilitating institutions also help
provide information throughout the supply chain. For example,
the role of computer specialists, referred to as channel
integrators, in setting up computer channels for transmitting
information is evident throughout the business world. Retailers
can now order many types of merchandise online. In fact, many
retail analysts believe that Walmart’s leap into the number-one
spot in worldwide retail sales stems directly from Retail Link, a
sophisticated electronics system used to manage its huge supply
and distribution network. Retail Link (described in this
chapter’s ‘‘What’s New?’’) enables the suppliers to work in
tandem with Walmart as the retail environment shifts. Due to
the success of Retail Link, most of today’s major retailers

8. require that all their vendors be linked electronically to their
computers, thereby permitting the vendors to automatically ship
replacements without purchase orders and receive payment
electronically. By saving on distribution costs, these retailers
have been able to hold their selling prices constant despite a
slight increase in merchandise costs. Other facilitating
institutions aid in financing, such as commercial banks,
merchant banks, factors, stock and commodity exchanges, and
venture-capital firms. These institutions can provide, or help the
retailer obtain, funds to finance marketing functions. For
example, retailers frequently use factors for short-term loans to
fund working-capital requirements (e.g., to finance the
increased level of inventory needed for the Christmas selling
season) while relying on banks for long-term loans to continue
growth and expansion (adding new stores or remodeling).
Venture-capital firms are primarily used by retailers starting a
new operation or format. Finally, insurance firms can assume
some of the risks in the channel, insuring inventories, buildings,
trucks, equipment and fixtures, and other assets for the retailer
and other primary marketing institutions. They can also insure
against a variety of events such as employee and customer
injuries, changes in interest rates, and the impact of terrorist
activity. Having reviewed the various functions and institutions
in the supply chain, we are now ready to examine how the
primary marketing institutions are arranged into a supply chain.
A direct supply chain or channel occurs when manufacturers
sell their goods directly to the final consumer or end user. In
these rare cases, the lack of involvement by other middle men
pushes the manufacturer to perform most of the marketing
functions (e.g., transporting is often performed by facilitating
institutions or even the consumer). An example of such a supply
chain is Firestone, which sells some of its tires through
company-owned retail outlets to the consumer. The supply chain
becomes indirect once independent members (or retailers.
retailers) are added between the manufacturer and the consumer.
Indirect supply chains, as shown in Exhibit 5.3, may include

9. just a retailer or both a retailer and a wholesaler. Consider, for
example, your neighborhood Avon or Mary Kay representative.
This representative is an independent retailer who purchases
cosmetic products from Avon or Mary Kay and then sells them
to a consumer. This channel is described as being indirect
because it goes from manufacturer to retailer to consumer.
Similarly, when a local independent grocer purchases some
Hunt’s ketchup from Super Value, a large food wholesaler that
had already purchased the ketchup from its manufacturer, Con-
Agra, the channel is also indirect, going from manufacturer to
wholesaler to retailer to consumer. Sometimes the length of a
supply chain is hard to determine. For example, when a
consumer purchases cosmetics from a manufacturer’s website
and that manufacturer mails the merchandise directly to the
consumer, the chain is said to be a direct manufacturer-to-
consumer channel. However, if the consumer makes a purchase
from a different manufacturer’s website, such as Avon, and an
Avon sales representative delivers the merchandise to the
consumer from her own inventory, then the channel would
actually be indirect—manufacturer to retailer (remember that
the Avon lady is an independent businessperson) to consumer.
The desired length is determined by many customer-based
factors such as the size of the customer base, geographical
dispersion, behavior patterns like purchase frequency and
average purchase size, and the particular needs of customers.
For example, if the consumer was concerned only about the
price paid for merchandise, then he or she would probably drive
to a farmer’s roadside stand to purchase a dozen eggs. However,
as we pointed out in Chapter 4, factors other than price
influence demand. In this case, the consumer might be willing to
pay 20 percent to 30 percent more for the convenience of
purchasing the eggs at the neighborhood grocer—saving the
time and the cost of gas for an hour’s drive into the country.
Therefore, it is important to remember that, in many cases,
indirect channels are actually cheaper in terms of total costs
involved. In addition, the nature of the product—such as its

10. bulk and weight, perish-ability, value, and technical
complexity—is important in determining supply-chain length.
For example, expensive, highly technological items such as
home entertainment systems will generally use short channels
because of the high degree of technical support and liaison
needed, which may only be available directly from the
manufacturer. Length can also be affected by the size of the
manufacturer, its financial capacity, and its desire for control.
In general, larger and better-financed manufacturers have a
greater capability to bypass intermediaries and use shorter
channels. Manufacturers desiring to exercise a high degree of
control over the distribution of their products are also more
likely to use a shorter chain (e.g., Zara from this chapter’s
‘‘Global Retailing’’ box). Retailers, on the other hand, do not
always have a lot of control over their channel length. For
example, retailers entering Japan will find that their channel’s
long length is to a great extent predetermined. Japan’s channel
structure (often referred to as a multitier distribution channel)
was formed in feudal times and is the accepted method of doing
business in that country. Sometimes the retailer must learn to
operate as efficiently as possible within an inefficient channel.
Supply-Chain Width Supply-chain width or channel width,
shown in Exhibit 5.4, is usually described in terms of intensive
distribution, selective distribution, or exclusive distribution.
Intensive distribution means that all possible retailers are used
to reach the target market. Selective distribution means that a
smaller number of retailers are used, while exclusive
distribution means only one retailer is used in the trading area.
Although there are many exceptions, as a rule, intensive
distribution is associated with the distribution of convenience
goods, which are products that are frequently purchased; those
for which the consumer is not willing to expend a great deal of
effort to purchase. Selective distribution is associated with
shopping goods, items for which the consumer will make a price
or value comparison before purchasing. Exclusive distribution
is identified with specialty goods—usually high-prestige

11. branded products that the consumer expressly seeks out. Thus,
soft drinks, milk, and greeting cards (convenience goods) tend
to be carried by a very large number of retailers; home
appliances and apparel (shopping goods) are handled by
relatively fewer retailers; and specialty goods, such as Rolex
watches, are featured by only one dealer in a trading area. Some
of these specialty goods are so exclusive, Rolls-Royce
automobiles for example, that many trade areas may not have a
retailer handling them.
Control of the Supply Chain
The previous discussion was concerned with the length and
width of a supply chain. However, a more pressing issue is who
should control the supply chain. Many chains consist of
independent business firms who, without the proper leadership,
may look out solely for themselves, to the detriment of the other
members. For this reason, experts agree that no supply chain
will ever operate at a 100-percent efficiency level. Supply-chain
members must have as their goal ‘‘to minimize the sub-
optimization’’ of the supply chain. Supply chains follow one of
two basic patterns: the conventional marketing channel and the
vertical marketing channel. Exhibit 5.5 provides an illustration
of these major channel patterns.
Conventional Marketing Channel
A conventional marketing channel is one in which each member
of the supply chain is loosely aligned with the others and takes
a short-term orientation. Predictably, each member’s orientation
is toward the subsequent institution in the channel. The
prevailing attitude is ‘‘what is happening today’’ as opposed to
‘‘what will happen in the future.’’ The manufacturer interacts
with and focuses efforts on the wholesaler, the wholesaler is
primarily concerned with the retailer, and the retailer focuses
efforts on the final consumer. In short, all of the members focus
on their immediate desire to close the sale or create a
transaction. Thus, the conventional marketing channel consists
of a series of pairs in which the members of each pair recognize
each other but not necessarily the other components of the

12. supply chain. The conventional marketing channel, which is
historically predominant in the United States, is a sloppy and
inefficient method of conducting business. It fosters intense
negotiations with in each pair of institutions in the supply
chain. In addition, members are unable to see the possibility of
shifting or dividing the marketing functions among all the
participants. Obviously, it is an unproductive method for
marketing goods and has been on the decline in the United
States since the early 1950s.
Vertical Marketing Channels
Vertical marketing channels are capital-intensive networks of
several levels that are professionally managed and rely on
centrally programmed systems to realize the technological,
managerial, and promotional economies of long-term
relationships. The basic premise of working as a system is to
operate as close as possible to that elusive 100-percent
efficiency level. This is achieved by eliminating the sub-
optimization that exists in conventional channels and improving
the channel’s performance by working together.3 Formerly
adversarial relationships between retailers and their suppliers
are now giving way to new vertical channel partnerships that
minimize such inefficiencies.4 Because vertical channel
members realize that it is impossible to offer consumers value
without being a low-cost, high-efficiency supply chain, they
have developed either quick response (QR) systems or efficient
consumer response (ECR) systems. These systems, which are
identical despite the differing names adopted by various retail
industries, are designed to obtain real-time information on
consumers’ actions by capturing stock-keeping unit (SKU) data
at point-of-purchase terminals and then transmitting that
information through the entire supply chain. This information is
used to develop new or modified products, manage channel wide
inventory levels, and lower total channel costs. The final section
of this chapter discusses category management, which is
accomplished when all the members (who would have acted
independently in a conventional channel) work as team to apply

13. the ECR concept to an entire category of merchandise. There
are three types of vertical marketing channels: corporate,
contractual, and administered. Each has grown significantly in
the last half-century.
Corporate Channels
Corporate vertical marketing channels typically consist of either
a manufacturer that has integrated vertically forward to reach
the consumer or a retailer that has integrated vertically
backward to create a self-supply network. The first type
includes manufacturers such as Dell, Sherwin Williams, Polo
Ralph Lauren, and Coach, which have created their own
warehousing and retail outlets or Internet selling sites. An
example of the second type includes Holiday Inns, which for
years was vertically integrated to control a carpet mill, furniture
manufacturer, and numerous other suppliers needed to build and
operate its motels. To illustrate this point, consider that Holiday
Inn had to conduct extensive research to overcome
manufacturing problems encountered with the production of
cinnamon rolls, the trademark of its Holiday Inn Express units.
Incorporate channels, it is not difficult to program the channel
for productivity and profit goals since a well-established
authority structure already exists. Independent retailers that
have aligned themselves in a conventional marketing channel
are at a significant disadvantage when competing against a
corporate vertical marketing channel. Contractual Channels
Contractual vertical marketing channels, which include
wholesaler-sponsored voluntary groups, retailer-owned
cooperatives, and franchised retail programs, are supply chains
that use a contract to govern the working relationship between
the members. Each of these variations allows for a more
coordinated, system wide perspective than conventional
marketing channels. However, they are more difficult to manage
than corporate vertical marketing channels because the authority
and power structures are not as well defined. Supply-chain
members must give up some autonomy to gain economies of
scale and greater market impact. Wholesaler-Sponsored

14. Voluntary Groups. Wholesaler-sponsored voluntary groups are
created when a wholesaler brings together a group of
independently owned retailers (independent retailers is a term
embracing anything from a single mom-and-pop store to a small
local chain)—grocers, for example—and offers them a
coordinated merchandising program (store design and layout,
store site and location analysis, inventory management
channels, accounting and bookkeeping channels, insurance
services, pension plans, trade area studies, advertising and
promotion assistance, employee-training programs) as well as a
buying program that will provide these smaller retailers with
economies similar to those obtained by their chain store rivals.
In return, the independent retailers agree to concentrate their
purchases with that wholesaler. It is a voluntary relationship;
that is, there are no membership or franchise fees. The
independent retailer may terminate the relationship whenever it
desires, so it is to the wholesaler’s advantage to build
competitive merchandise assortments and offer services that
will keep the voluntary group satisfied. In the past, local food
wholesalers got practically all of their business from
independent grocers. Recently, however, as transportation costs
have risen, major chains operating over a wide geographic area
have also started using local or regional wholesalers. While
welcoming this new business, wholesalers have attempted to
keep their independents happy (since they still account for more
than 40 percent of their business) by offering them additional
services. Wholesaler-sponsored voluntary groups have been a
major force in marketing channels since the mid-1960s. They
are now prevalent in many lines of trade. Independent Grocers’
Alliance (IGA) and National Auto Parts Association (NAPA)
are both examples of wholesaler-sponsored voluntary groups.
Retailer-Owned Cooperatives. Another common type of
contractual vertical marketing channel is retailer-owned
cooperatives, which are wholesale operations organized and
owned by retailers; these are most common in hardware
retailing. They include such familiar names as True Value

15. (which was highlighted in Exhibit 2.3), Ace, and Handy Hard-
ware, and they offer scale economies and services to member
retailers, allowing their members to compete with larger chain-
buying organizations. It should be pointed out that, in theory,
whole- sale-sponsored groups should be easier to manage since
they have only one leader, the wholesaler, versus the many
owners of the retailer-owned group. One would assume that in
retailer-owned cooperatives, individual members would desire
to keep their autonomy and be less dependent on their supplier
partner for support and direction. In reality, however, Just the
opposite has been true. A possible explanation is that retailers
belonging to a wholesale co-op may make greater transaction-
specific investments in the form of stock ownership, vested
supplier-based store identity, and end-of-year rebates on
purchases that combine to erect significant exit barriers from the
cooperative. Franchises. The third type of contractual vertical
marketing channel is the franchise. A franchise is a form of
licensing by which the owner of a trademark, service mark,
trade name, advertising symbol, or method (the franchisor)
obtains distribution through affiliated dealers (franchisees).
Each franchisee is authorized by the franchisor to sell its goods
or services in either a retail space or a designated geographical
area. The franchise governs the method of conducting business
between the two parties. Generally, a franchisee sells goods or
services supplied by the franchisor or that meet the franchisor’s
quality standards. This relationship is regulated by Federal
Trade Commission laws. In many cases, the franchise operation
resembles a large chain store. It operates with standardized
logos, uniforms, signage, equipment, storefronts, services,
products, and practices—all as outlined in the franchise
agreement. The consumer might never know that each location
is independently owned. Franchising is a convenient and
economic means of fulfilling an individual’s desire for
independence with a minimum amount of risk and investment
but maximum opportunities for success. This is possible through
the utilization of a proven product or service and marketing

16. method. Consider that one of the benefits of franchising is that
it permits a franchisee to select a location in a somewhat
sophisticated manner based on the various professional
forecasting models that use data from earlier units. Another
advantage is in the purchasing of key items. Holiday Inn, for
example, knows more about how to buy mattresses and furniture
than most of its franchisees. However, a franchisee–franchisor
relationship requires an ongoing commitment, with each party
expected to uphold its end of the contract though active
communication, solidarity, and mutual trust. In those cases
where a franchisee–franchisor relationship does not work, it is
usually the result of a franchisee misunderstanding the
franchising model and the franchisor failing to set expectations
or the franchisee not understanding them at the outset.
Remember that a franchisee gives up some freedom in business
decisions that the owner of a non-franchised business would
retain. The most common franchise mistakes result from a
franchisee’s incorrect perception of him- or herself as a
traditional entrepreneur. In order to maintain uniformity of
service and to ensure that the operations of each outlet will
reflect favorably on the organization as a whole, the franchisor
must exercise some degree of control over the operations of
franchisees, requiring them to meet stipulated standards of
product and service quality and operating procedures. There are
some 1,200 franchisors in the United States today, and they can
be found at any position in the marketing channel; about 60
percent of them have startup costs of less than $300,000. The
franchisor could be a manufacturer such as Chevrolet or Midas
Mufflers; a service specialist such as Sylvan Learning, Stanley
Steemer, AAMCO Transmissions, H&R Block, Lawn Doctor,
Merry Maids, Mr. Handyman, Supercuts, or Century 21 Real
Estate; a retailer such as Gingiss Formalwear; or a fast-food
retailer such as McDonald’s, Dunkin’ Donuts, Subway,
Domino’s Pizza, or KFC. It should be noted that franchising
isn’t all about food anymore. Consumer service providers such
as fitness centers, lawn-care specialists, dance studios, and pet

17. hotels have not opened the most outlets recently, but they have
been the best performing.6 A more complete list can be found at
the Inter-national Franchise Association website
(www.franchise.org).7 Another advantage of being a franchisee
was illustrated during the recent economic crisis when many
financial institutions cut or reduced their loans to the
franchisees. Such actions, for example, made it harder for fast-
food franchises to remodel existing locations and buy or open
new restaurants.8 However, while most franchisors normally
don’t provide financial assistance to existing franchisees, they
made an exception during the recent recession. This was
because the franchisors were able to get the financing partly
because of their historically low default rate on previous loans
as well as their current balance sheets. By securing these loans,
a franchisor provided capital to be used by the franchisee for
expansions, acquisitions, debt consolidation, and refinancing for
new and current obligations.9 Finally, although only a third of
U.S. franchisors are currently operating in foreign countries,
another third are looking to expand internationally within the
next five years. After all, why compete in overcrowded U.S.
markets when many foreign markets are available? Although
franchising is seen as an economic-development tool for poor
countries, the most widely considered foreign markets are the
most prosperous markets of Canada, Japan, Mexico, Germany,
the United Kingdom, and, more recently, Southeast Asia—
Philippines, Thailand, Taiwan, Singapore, and Indonesia.
Administered Channels
The final type of vertical marketing channel is the
administered channel. Administered vertical marketing
channels are similar to conventional marketing channels, yet
one of the members stakes the initiative to lead the channel by
applying the principles of effective inter-organizational
management, which is the management of relationships between
the various organizations in the supply chain. Administered
channels, although not new in concept, have grown substantially
in recent years. Frequently, administered channels are initiated

18. by manufacturers because channel members have historically
relied on manufacturers’ administrative expertise to coordinate
the retailers’ marketing efforts. Suppliers with dominant brands
have predictably experienced the least difficulty in securing
strong support from retailers and wholesalers. However, many
manufacturers with ‘‘fringe’’ items have been able to elicit such
cooperation only through the use of liberal distribution policies
that take the form of attractive discounts (or discount
substitutes), financial assistance, and various types of
concessions that protect resellers from one or more of the risks
of doing business.10 Some of the concessions manufacturers
offer retailers are liberal return policies, display materials for
in-store use, advertising allowances, extra time for merchandise
payment, employee-training programs, assistance with store
layout and design, inventory maintenance, computer support,
and even free merchandise. Manufacturers that use their
administrative powers to lead channels include Coca-Cola,
Sealy (with its Posture pedic line of mattresses), Villager (with
its dresses and sportswear lines), Scott (with its lawn-care
products), Norwalk (with its upholstered furniture), Keepsake
(with diamonds), and Stanley (with hand tools). Retailers can
also dominate the channel relationship. For example, Walmart,
besides using its Retail Link, was one of the earliest adopters of
ECR systems and today administers the relationship with almost
all of its suppliers by asking that all money designated for
advertising allowances, end-display fees, and so forth be taken
off the price of goods instead. By doing this, the giant retailer
believes that its supply chains are managed in the most efficient
and effective way possible. Retailers that are not part of a
contractual channel or corporate channel will probably
participate in different channels since they will need to acquire
merchandise from many suppliers. Predictably, these channels
will be either conventional or administered. If retailers want to
improve their performance in these channels, then they must
understand the principal concepts of inter-organizational
management. In this case, retailers must strategically manage

19. their relations with or retailers manufacturers. What are the
basic concepts of inter-organizational management that a
retailer needs to understand? They are dependency, power, and
conflict.
Dependency
As we mentioned earlier, every supply chain needs to perform
eight marketing functions. None of the respective institutions
can isolate itself; each depends on the others to do an effective
job in order for the channel to be successful. Retailer A is
dependency on suppliers X, Y, and Z to make sure that goods
are delivered on time and in the right quantities. Conversely,
suppliers X, Y, and Z depend on retailer A to put a strong
selling effort behind their goods, displaying them properly, and
maybe even helping to finance consumer purchases. If retailer A
does a poor job, then each supplier can be adversely affected; if
even one supplier does a poor job, then retailer A can be
adversely affected. In all these alignments, each party depends
on the others to do a good job. This concept was recently
illustrated when several giant retailers worked with detergent
manufactures to develop a concentrated product that would
shrink the package size in half. In return, the retailers would
help convince the consumer to pay the same price for a package
that was half the size because it provided the same cleaning
power. This was a win–win (collaboration) situation for both
parties because retailers were able to use less shelf space and
manufacturers saved on production costs. However, each party
was dependent on the other to achieve these goals. When each
party is dependent on the others, we say that they are
interdependent. While this interdependency is at the root of the
collaboration found in today’s supply chains, it is also the
major cause of the conflict found in supply chains. To better
comprehend this interdependency, an understanding of power is
necessary.
Power
We can use the concept of dependency to explain power, but
first we must define power. Power is the ability of one member

20. to influence the behavior of the other supply chain members.
The more dependent the supplier is on the retailer, the more
power the retailer has over the supplier and vice versa. For
example, a small manufacturer of grocery products would be
very dependent on a large supermarket chain if it wanted to
reach the most consumers. In this instance, the supermarket has
power over the small manufacturer. Likewise, many suppliers
are very dependent on Walmart because it is their biggest
customer. For example, today Walmart accounts for 15 percent
of Procter & Gamble’s (P&G’s) total revenue, more than the
total of many foreign countries.11 Yet this dependence is not
specific to domestic manufacturers. In fact, the Wall Street
Journal recently ran the following headline across the top of its
Marketplace section: ‘‘Walmart Sneezes, China Catches Cold’’
to illustrate the significant dependence so many have on
Walmart.12 Thus, the power one member has over another
supply-chain member is a function of how dependent the second
member is on the first member to achieve its own goals.
There are six types of power:
1. Reward power is based on the ability of A to provide rewards
to B. For instance, a retailer may offer a manufacturer a
prominent end cap display in exchange for additional
advertising monies and promotional support. Yet liquidity
problems due to the recent economic slowdown resulted in the
use of a different form of reward power: merchandise. Because
of the sharp falloff in consumer spending, manufacturers were
forced to unload excess inventory to anyone with the means to
pay. This resulted in off-price retailers such as T.J. Maxx, Stein
Mart, Ross Stores, and Overstock.com receiving some of the
best selections of apparel, accessories, and electronic goods,
items they would normally not get, at great prices.13
2. Expertise power is based on B’s perception that A has some
special knowledge or superior ability. For example, Midas
Muffler (a franchisor) has developed an excellent training
program for store managers. As a result, franchisees view Midas
as an expert in training effective store managers. Seeking the

21. best managers possible, franchisees give up some of their
control in order to gain access to this training program.
3. Referent power is based on B’s desire to be identified or
associated with A. Examples of this are auto dealers that want
to handle BMWs or Mercedes because of the cars’ status, or a
manufacturer that wants to have its product sold in Neiman
Marcus because of the image that retailer projects. Yet referent
power is not always positive. In 2007, tainted pet food led to
the deaths of more than a dozen dogs and cats and the illnesses
of a thousand more. The food was produced by one
manufacturer and sold using 101 different brand names. As a
result, the differences in the selling price between the various
brands were reflective of the company associated with the brand
name used.14
4. Coercive power is based on B’s belief that A has the capacity
to punish or harm B if B does not do what A wants. For
example, franchisors like Burger King have the right to cancel a
franchisee’s contract if it fails to maintain franchise standards
such as restaurant cleanliness, food menu, hours of operation,
and employee dress or uniforms. 5. Legitimate power is based
on A’s right to influence B or on B’s belief that B should accept
A’s influence. The presence of legitimate power is most easily
seen in contractual marketing channels. A manufacturer may,
for example, threaten to cut off a retailer’s supply if the retailer
fails to meet certain standards. For example, Deere & Company
recently terminated some if its smaller dealerships after years of
selling the company’s equipment. Deere and Co. stated that
many of these smaller dealers simply neglected to run their
businesses as needed by the manufacturer; they neglected to
develop new revenue streams (customers) while failing to assist
the manufacturer in managing inventory costs. Now the
company says that dealers must meet established profit and
customer-loyalty targets or fear being merged with other
dealers.15 This chapter’s ‘‘Service Retailing’’ box describes a
similar fate for the retailers that sell and service America’s
automobiles. Also, if the retailer accepts co-op advertising

22. dollars, the manufacturer may control the minimum retail price,
since this subject is usually covered in the agreement. Absent
such an agreement, the retailer is free to set the selling price.
To do otherwise would be a violation of certain federal antitrust
laws, which we discuss in the next chapter.
6. Informational power is based on A’s ability to provide B with
factual data. Not to be confused with expertise power,
informational power occurs when the factual data is provided
independently of the relationship between A and B. An example
of this power would be a small retail store sharing scanner data
with a vendor. Retailers and suppliers that use reward,
expertise, referent, and informational power can foster a healthy
working relationship. On the other hand, the use of coercive and
legitimate power tends to elicit conflict and destroy cooperation
in the supply chain.
Conflict
Conflict is inevitable in every supply-chain relationship because
retailers and suppliers are interdependent. In other words, every
channel member is dependent on every other member to perform
some specific task. Interdependency has been identified as the
root cause of all conflict in marketing channels. There are three
major sources of conflict between retailers and their suppliers:
perceptual incongruity, goal incompatibility, and domain
disagreement. Perceptual incongruity occurs when the retailer
and supplier have different perceptions of reality. A retailer
may perceive that the economy isn’t coming out of recession
and therefore may want to continue to keep a low level of
inventory investments, while the supplier may believe that the
economy is recovering and, therefore, that inventory
investments should be maintained or possibly increased. Other
areas where the retailer and supplier might perceive things
differently include the quality of the supplier’s merchandise, the
potential demand for the supplier’s merchandise, the consumer
appeal of the supplier’s advertising, and the best shelf position
for the supplier’s merchandise. A second source of conflict is
goal incompatibility, a situation in which achieving the goals of

23. either the supplier or the retailer would hamper the performance
of the other. For example, Nike and Foot Locker have fought
over the retailer’s goal of gaining sales with its liberal use of
‘‘BOGOs’’—industry jargon for ‘‘buy one, get one at half-off’’
sales. Such sales encourage consumers to buy two pairs on a
single shopping trip, thereby reducing the chance the consumer
would buy the second pair elsewhere.16 similarly, and some
manufacturers don’t want their products sold at big-box stores
or discounters for fear of cheapening the brand image. That is
why Stihl advertises that its power tools ‘‘are not sold at
Lowe’s or Home Depot.’’ Another example of incompatibility
between retailer and supplier goals is a situation known as dual
distribution. Dual distribution occurs when a manufacturer sells
to independent retailers while simultaneously selling directly to
the final consumer through its own retail outlets or through an
Internet site. (This chapter’s
‘‘Retailing: The Inside Story’’ points out some of the problems
that a manufacturer must consider when setting up an Internet
site.) Thus, the manufacturer manages a corporately owned,
vertical marketing channel that competes directly with
independent retailers that it supplies through a conventional,
administered, or contractual marketing channel. Retailers tend
to become upset about dual distribution when the two channels
compete at the retail level in the same geographic area.
Remember the case at the end of Chapter 4 where it was pointed
out that Trek Bicycles not only sold its bikes through a local
independent retailer, but also through its own stores nearby?
However, as consolidation continues among department stores,
some manufacturers, such as Liz Claiborne, have opened stores
selling their ‘‘power brands’’—Juicy Couture, Lucky, Sigrid
Olsen, and Mexx. This practice has angered traditional retailers
that buy from these manufacturers and can have an adverse
effect on manufacturer–retailer relationships. Other
manufacturers, such as Oakley and Tommy Bahama, believe that
their stores help build brand awareness and thereby sales for the
traditional establishments. The fear of upsetting current sales

24. reps caused Tupperware to pull its products out of Target’s
1,200 stores. The attempt at dual distribution was meant to
reach shoppers too busy to attend sales parties or deal with
door-to-door salespeople. However, the easy availability of
Tupperware products in the giant retailer’s stores had a
‘‘detrimental effect’’ on Tupperware parties.17 When Walmart
sold its McLane’s wholesaling subsidiary to Warren Buffett’s
Berkshire Hathaway Inc., many retailing experts felt that this
action would ultimately enable Walmart to expand into the
convenience store market. If the giant retailer had entered the
convenience store market without selling McLane’s, the
nation’s largest wholesaler serving convenience stores, it would
have established a dual-distribution network whereby Walmart
would operate its own retail outlets in competition with its
McLane’s division wholesale customers. In such a case, the
convenience store operators likely would have dropped McLane.
Why would they want to financially support a competitor? The
problem of goal incompatibility is not necessarily one of profit
versus image goals. Even if the retailer and supplier both have a
return on investment (ROI) goal, they can still be incompatible,
because what is good for the retailer’s ROI may not be good for
the supplier’s ROI. Consider the price element in the
transaction between the supplier and the retailer. If the supplier
obtains a higher price, then its ROI will be higher but the ROI
of the retailer will be lower. Similarly, other key elements in
the transaction between the retailer and supplier, such as
advertising allowances, cash discounts, order quantity, and
freight charges, can result in conflict. A third source of conflict
is domain disagreements. Domain refers to the decision
variables that each member of the marketing channel feels it
should be able to control. When the members of the marketing
channel agree on who should make which decisions, domain
consensus exists. When there is disagreement about who should
make decisions, domain disagreement exists. Consider the
situation mentioned earlier where manufacturers were
reluctantly forced to sell their upscale wares to off-price

25. retailers. Many of the major department store chains that
initially helped the manufacturer position those items as high-
image brand names in the mind of the consumer felt betrayed.
Another controversial domain disagreement practice in today’s
retail marketing channels occurs when retailers sell merchandise
purchased from the vendor to discounters that the manufacturer
does not want selling its products. A diverter is an unauthorized
member of a channel that buys and sells excess merchandise to
and from authorized channel members. For instance, suppose a
retailer could buy a name-brand appliance intended to retail for
$389 at $185 if it purchases 100 units. However, if the retailer
orders 200 units it can purchase the item at $158. What does the
retailer do? Some retailers will purchase 200 units even though
they need only100. They in turn sell the 100 extra units at as
light loss, say $155, to a discount store that may retail the item
for $219. The net result is the retailer loses $3 a unit on 100
units or $300; however, it bought the remaining 100 units at $27
a unit less, for a savings of $2,700.As a result of this price
arbitrage, the retailer is $2,400 ahead on the transaction.
However, the manufacturer is likely to be upset because the
appliance has been diverted into a retail channel it did not
intend and over which it has no direct control. Several
manufacturers claim it is because of diverting that Target has
been able to offer high-end beauty products from such labels as
Kiehl’s, Origins, and Bare Escentuals in its stores.19 Similar to
diverting is a practice known as gray marketing, whereby
genuinely branded merchandise flows through unauthorized
channels that cross national boundaries. Gray market channels
develop when global conditions are conducive to profits. For
example, consider the retailing of prescription drugs. Since
Americans pay 67 percent more on average than Canadians for
these drugs, the gray market, especially from Canada, has
increased substantially. Diverting and gray marketing can lead
to another supply-chain problem: free riding. Free riding occurs
when consumers seek product information and usage
instructions about products, ranging from computers to home

26. appliances, from a full-service specialty store. Then, armed with
the brand’s model number, consumers purchase the product
from a limited-service discounter or over the Internet. Not all
conflict in a channel is bad. Low levels of conflict will probably
not affect any channel member’s behavior and may not even be
noticed. A moderate level of conflict might even cause the
members to improve their efficiency, much the same as happens
with some of your classmates when you are working on a team
project. However, high levels of conflict will probably be
dysfunctional to the channel and lead to inefficiencies and
channel restructuring. Although all supply chains experience
some degree of conflict, the dominant behavior in successful
supply chains is collaboration. Collaboration, where both
parties seek to solve all problems with a win–win attitude, is
necessary and beneficial because of the interdependency of
retailers and suppliers. Retailers and suppliers must develop a
partnership if they want to deal with each other on a long-term
and continuing basis. As a result, many supply-chain members
have begun to follow a set of best practices as listed in Exhibit
5.7. This vendor partnership is often a critical factor for the
retailer who does not want to confuse the final consumer with
constant adjustments in product offerings resulting from
constant changes in suppliers.
Facilitating Supply-Chain Collaboration
Collaboration in channel, or supply-chain, relations is
facilitated by three important types of behavior and attitude.
These are mutual trust, two-way communication, and solidarity.
Mutual Trust
Mutual trust occurs when the retailer trusts the supplier, and the
supplier trusts the retailer. In continuing relations between
retailers and suppliers, mutual trust, which is built on past and
present performance between members, is critical. This trust
allows short-term inequities to exist. If mutual trust is present,
both parties will tolerate inequities because they know in the
long term they will be fairly treated.20 For example, a vendor
suggests that a retailer purchase a certain product. The retailer

27. does not believe that the product will be successful in its
market. However, the vendor insists that many buyers in other
markets are purchasing that particular item and even agrees to
‘‘make it good’’ if the product does not sell. In this instance,
the buyer will probably buy the merchandise knowing that the
supplier can be trusted to make an appropriate adjustment on
the invoice amount, provide markdown money, or make up this
inequity in some other way in the future if the product does not
sell. Without mutual trust, retail supply chains would
disintegrate. On the other hand, when trust exists, it is
contagious and allows the channel to grow and prosper. This
occurs because of reciprocity. If a retailer trusts a supplier to do
the right thing and the supplier treats the retailer fairly, then the
retailer develops more trust and the process of mutual trust
continues to build. In fact, during the past recession, many
smaller or retailers were able to cut costs by renegotiating
contract terms with manufacturers to match deals that the high-
volume chains obtained. Here the manufacturers and smaller
operators knew that they would need each other, further
enhancing the trust between parties and allowing economic
recovery to take place. Two-Way Communication As noted
earlier, conflict is inevitable in retail supply chains.
Consequently, two-way communication becomes the pathway
for resolving disputes and allowing the channel relationship to
continue. Two-way communication occurs when both parties
openly communicate their ideas, concerns, and plans. Because
of the interdependency of the retailer and supplier, two-way
communication is necessary to coordinate actions. For example,
when Jockey decides to run a national promotion on its
underwear, it needs to coordinate this promotion with its retail
supply chains so that when customers enter stores to shop for
the nationally advertised items, they will find them displayed
and in stock. Two-way communication is critical to
accomplishing this coordination. Communication is not
independent of trust. Disputes can be resolved by good two-way
communication, and this improves trust. Furthermore, trust

28. facilitates open two-way communication. The process is circular
and builds over time. For example, Walmart is not only phasing
in energy-efficiency requirements with its suppliers but also
pushing gold miners to adopt strict environmental and social
standards, verified by independent third parties. With allies
Tiffany’s and Richline Group, the world’s biggest manufacturer
of gold jewelry, the retail giant is upsetting miners. However,
since mining enough gold to make a typical 18-carat wedding
ring leaves behind 20 tons of waste, it appears that two-way
communication will demonstrate the benefits of such standards
to all parties.21 Solidarity Solidarity exists when a high value is
placed on the relationship between a supplier and a retailer.22
Solidarity is an attitude and thus is hard to explicitly create.
Essentially, as trust and two-way communication increase, a
higher degree of solidarity develops. Solidarity results in
flexible dealings where adaptations are made as circumstances
change. When solidarity exists, each party will come to the
rescue of the other in times of trouble. For example, several
years ago, Walmart had a problem with shoplifting. It
discovered that several Procter & Gamble products were easy to
steal. Because of the relationship that existed between the
retailer and supplier, P&G soon altered the packaging of the
vulnerable products. Among the changes it made were enlarging
and adding an extra layer of plastic to the Crest Whitestrips
package and using a clamshell, a flat piece of cardboard covered
with plastic, on its Oil of Olay products.23 another example of
supply-chain partners working together to the benefit of each
other recently occurred in the book-publishing industry. Here an
industry practice dating from the 1930s allowed retailers to
return unsold titles, which amounted to more than a third of all
titles shipped, to publishers for full credit and without incurring
shipping costs. Later these books were sent back to the same
bookstore chains, where they are sold for a substantial discount
on the list price. The idea of taking back inventory and then
returning it wasn’t a good idea for anybody. Meanwhile, as
mentioned in Chapter 2, Borders Books was facing financial

29. issues. Thus, as a sign of the industry’s solidarity, the retailer
agreed to accept books on a nonreturnable basis in return for a
lower price. Experts were quoted as saying that the economic
downturn has made publishers and booksellers more open to
departing from tradition and willing to experiment with models
that might decrease waste and increase profits for all parties.24
Nowhere is this collaboration in today’s channels exhibited
more clearly than in the shift toward category management.
Category Management25 Category management involves the
simultaneous management of price, shelf-space, merchandising
strategy, promotional efforts, and other elements of the retail
mix within the merchandise category based on the firm’s goals,
the changing environment, and consumer behavior. The task of
category management is accomplished by members of a supply
chain working as a team, not acting independently, to apply the
ECR concept to an entire category of merchandise such as all
hand tools, and not just a particular brand such as Stanley. The
manager’s goal is to enable the retailer to meet specific business
goals such as profitability, sales volume, or inventory levels.
Retailers designate a category manager from among their
employees for each category sold. The retailer begins the
process by defining specific business goals for each category.
The category manager then leverages detailed knowledge of the
consumer and consumer trends, detailed point-of-sale (POS)
information, and specific analysis provided by each supplier to
the category. With this information, the category manager
creates specific modular’s that may have different facings for
different stores as the retailer tailors its offerings to the specific
needs of each market. In addition, category managers work with
suppliers to plan promotions throughout the year to achieve the
designated business goals for the category. In cases where the
solidarity of the channel partners is high, a supplier may serve
as the retailer’s category manager. In this case, the chosen
supplier takes on the designation of category advisor. Walmart,
for example, uses this strategy wherein the category advisor
works closely with the Walmart buyer to ensure that the

30. category achieves peak performance in all stores. Normally, a
supplier is chosen to become a category advisor because it is a
trend leader in the specific category and can contribute
merchandising and market analysis. Often, but not always, this
supplier is also the dominant provider within the specific
category. As each buyer has responsibility for several related
product categories, each category may have a separate category
advisor, depending on need. Further, while a supplier may be
recognized as a trend leader in one category, a different supplier
may be recognized as the trend leader in another. At one point,
category advisers were called category captains. While the
responsibilities have not changed, retailers have adopted the
new terminology (category advisors) to avoid speculation and
confusion about who is responsible for making decisions. Also,
to ensure fairness, the individual fulfilling the category advisor
position is not supposed to have any sales relationships with
Walmart. In fact, this person is not supposed to report to anyone
with selling responsibility for Walmart. The category advisor
receives access to the sales information for all items and
suppliers in the designated category. To keep business
confidentiality, advisors do not receive access to data on
profitability. Also, they are not allowed to share the information
with anyone in their company. Given these boundaries, the
question arises, why would a vendor want to pay for the
category advisor? Most companies would agree that the ability
to better understand the retailer’s merchandise direction (or
thinking and strategy) is enough of a benefit to justify the cost.
If you consider, for example, that Walmart purchases $200
million in greeting cards annually from Hallmark, you quickly
see the economic logic of investing in a category advisor. The
category captain or category advisor, working closely with the
retail buyer, must make sure that the retailer has the best
assortment for each store in order to achieve the greatest sales
possible. This includes carrying the competition’s merchandise.
As a result, the supplier’s role as the category captain or
category advisor has changed greatly in recent years. Whereas

31. in the past the supplier sought to get as many of its items into
the retailer’s store as possible, today that supplier has to
understand how its products help the retailer achieve its
objectives, even if this means selecting a competitor’s product
over its own. For retailers using a single advisor, a yearly
review and possible reassignment of the advisor’s role to
another supplier helps to keep the category advisor’s
recommendations objective. To survive strong competition from
other retailers, advising suppliers must stay ahead of consumer
trends and meet the ever-changing tastes of the consumer. To
Aid the supplier who serves as a category advisor, the retailer
provides the same POS information (except the competition’s
prices) that it would give its own employee serving as the
category manager. Category managers must be ready to
constantly adjust the space given to each item so that the right
merchandise is in the right stores, at the right time, and in the
right amount. Over the last decade, category management has
enabled retailers to do a better job of staying in stock on the
best-selling items and avoid being over-stocked on merchandise
with a lower turnover rate. The category manager must be able
to recognize what critical items need to remain in stock at all
times to make the assortment complete. In addition, as will be
explained in Chapter 13, the category manager tries to create a
shelf layout based on how the consumer shops. Retailers,
however, are far from passive when it comes to accepting a
supplier’s recommendation. They usually run the supplier’s
category plan by a second supplier known as the validator.
Thus, Unilever, for example, could run a reality check for
supermarkets using Procter & Gamble as their category advisor
or captain. Even more important, retailers must insist that
category advisors adhere to the retailer’s strategy with regard to
pricing, promotions, and so on. Category management is now
standard practice at nearly every U.S. supermarket, convenience
store, mass merchant, and drug chain. Its use is growing
because the results of this collaboration benefit both retailer and
supplier. Retailers using category management report an

32. increase in sales for both parties, a decrease in markdowns,
better in-stock percentages on key items for the retailer, an
increase in turnover rates and a decrease in average inventory
for both retailers and wholesalers, and an increase in both
members’ ROI and profit. However, when all retailers begin to
use the same category management approach to optimize each
store’s layout and maximize the gross margin dollars produced
per unit of space, many times stores end up looking just like
their competitors. This is why Walmart replaced the ‘‘captain’’
with ‘‘advisors’’ so that they could gain the benefits of different
approaches.
WRITING AND SPEAKING EXERCISE
Diva’s is a 55-store upscale women’s shoe chain targeting
businesswomen and college students. Most of its stores are
located in regional malls in the Southeast and Southwest. The
chain has enjoyed rapid growth over the last decade, and its
annual sales volume last year was $167 million. Profitability has
kept pace with the rapid rise in sales volume. Diva’s prices
most of its shoes between $39.95 and $109.95. The top-selling
shoes are sold using the chain’s private label, Avalanche. A
primary reason for the success of Diva’s has been its vertical
marketing channel. The chain has eliminated most suppliers and
relies almost entirely on its own production capabilities. Diva’s
staff designs most of the shoes and has them made to
specification by manufacturers in Mexico. As a result, the
chain’s shoes are priced approximately 20 percent lower than
competitors’ shoes of a similar quality. In addition, the chain
has a higher markup than stores that buy from manufacturers
and wholesalers. Besides these advantages, vertical integration
minimizes potential sources of conflict. This strategy does have
its weaknesses, though. Diva’s needs a large amount of capital.
Money is needed to purchase raw materials and to defray other
costs incurred during manufacture. In addition, since orders are
placed approximately nine months to a year in advance of shoe
sales, predicting sales is difficult. If orders are placed with

33. manufacturers and business slows down, orders cannot be
reduced or canceled. Because they control production, orders
cannot be changed. Finally slow-moving merchandise cannot be
returned to vendors. If something does not sell, it has to be
marked down in hopes that it will. Using this strategy, how
would the retailer’s need for capital affect its ROI during an
economic slowdown? (The student might want to refer to the
strategic profit model discussed in Chapter 2.) In view of your
answer, should the chain change its merchandise mix by adding
more well-known national brands?