Unit 5 - Distribution and Promotion 2

Pricing and Distribution 373
vice versa. Demand for these items is therefore elastic. But in the case of everyday
items such as newspapers, groceries and other foods, if the price goes up, it does not
significantly affect the quantities sold. The cost is relatively small and the increase is
not really noticed that much. Here, the demand for the goods is inelastic.
E. PRICE AND VALUE FOR MONEY

We started this pricing section by considering the different concepts of price that exist and
noted that, while consumers do make decisions based on price, price is not the only factor.
We know that consumers buy benefits. These benefits "add value" to the product and make
up the concept of "value for money" which consumers feel constitutes an important element
in the buying decision.
The range of benefits available can have a distinct bearing on price – both in terms of the
cost of the offer and what consumers will pay. It is, therefore, important to be aware of the
implications of the following factors.
z After-sales service – consumers feel that they have had value for money if they feel
that any problems would be rectified quickly and efficiently if they needed to contact the
after-sales service people.
z Reputation – a company's reputation amongst its buyers is very important in instilling
confidence and trust.
z Guarantee/warranty period – in buying a second-hand car, the addition of a three-
year warranty for the price of two years is another example of value for money.
z Additional benefits offered – these are direct incentives which are seen as offering
increased value to the purchaser – for example, a ladies' fashion shop that offers free
alterations and an expert cleaning service.
F. THE CHAIN OF DISTRIBUTION

We now start the second theme of this chapter, that of distribution.
When we refer to a channel of distribution, we are speaking about the chain which links
the manufacturer and the user.
The shorter the chain, the fewer the links and the closer the ties between the manufacturer
and user. As channels lengthen, problems associated with loss of control and profit become
more pronounced, and the responsibilities of the manufacturer will increase.
The basic decision in the choice of a distribution channel can only ever be between a direct
and indirect channel.
Direct channels
Direct distribution means that the manufacturer delivers the product straight to the buyer –
the product goes directly from the producer to the consumer without the use of a specific
intermediary. We are seeing a growing trend for farmers to bypass wholesale markets and
sell their produce direct at farmers' markets. These are proving very successful, particularly
as the call for organic produce develops. Many companies who want to reach a wider
audience use the pages of the national newspapers and magazines to sell off the page. This
method of selling is now being transferred to the Internet where ordering, payment and in
some cases electronic delivery are made easy. Initially, it was mainly travel and book
companies that used the Internet to sell their goods and services, but today we are
witnessing an explosion in many other fields, including property, jobs, travel, insurance,
banking, cars, furniture and even groceries, which are then home delivered.
© ABE
374 Pricing and Distribution
Guarantees have to be given to buyers in case the merchandise is not what they want and
so a full refund has to be offered.
Direct channels mean total control over quality, price and profit and more involvement with
the customer. This closer involvement adds many responsibilities – order processing,
transport arrangements, marketing, promotion and after-sales service. This can be too much
for some organisations, so they prefer to use indirect methods of distribution.
Indirect Channels
Indirect distribution means that delivery is made through an intermediary of some kind. The
intermediary is a "link in the chain". There may be multiple links in the chain with many
intermediaries before the buyer, or user, comes into contact with the product.
Using indirect channels means that manufacturers will lose some element of control and
profit. They may never get to know, in great detail, anything about the actual users of their
product, which could result in a reduced capability of knowing what the users are looking for.
We must also recognise that using an intermediary can never be as quick as going direct to a
customer.
In many sectors, there are now intermediary websites that enable potential customers to
compare products and then “link” through to their preferred supplier. The intermediary is paid
a “click through” fee for directing each enquiry. Examples of such intermediaries are
www.compare.com and www.expedia.com.
Figure 15.6 displays the main channels in terms of the directness of contact between the
producer and the consumer, and the length of the distribution chain.
Figure 15.6: The Chain of Distribution
Decreasing Decreasing
directness length
Producer Consumer
Producer Retailer Consumer
Producer Wholesaler Retailer Consumer
Producer Agent Wholesaler Retailer Consumer
Both the number and types of intermediaries selected in designing a channel depend upon
the range and nature of the tasks required in moving goods and services from the
manufacturer to the final buyer. They also depend on the extent to which one channel is
superior to another. That said, the following table highlights a variety of factors influencing
` choice between direct and more indirect channels of distribution.
© ABE
Export Markets
If a company is engaged in international marketing, i.e. having separate marketing operations
in overseas countries, the distribution channel options will be similar to those we have
already illustrated. If the company is engaged in export marketing, i.e. manufacturing at
home and selling overseas, the following channels may be used.
z Buying agencies in foreign countries
Several large retailing concerns located overseas, and certain foreign governments
particularly in Eastern Europe, have buying agencies located in the United Kingdom.
z Export merchants
These people take title to the goods, which they ship to their own overseas agents or
customers. They may publish their own catalogues featuring assortments of goods.
z Manufacturers' export agents
Manufacturers may employ export agents located in overseas countries who operate
on a similar basis to manufacturers' agents in the domestic market.
z Overseas branches
The company may have overseas sales offices or depots selling to and supplying the
overseas market.
z Overseas import houses
These companies receive and take title to goods, relieving the manufacturer of
overseas manufacturing operations.
z Joint venture operations
The company may enter into an association with an overseas company which agrees
to market the firm's products.
H. DISTRIBUTION MANAGEMENT
For distribution to be effective, it must be planned, and the distribution plan is developed from
the objectives and strategies contained within the main marketing plan. It is therefore
tailored to suit the company products, the market segments targeted, and the performance
criteria and standards set.
Choice of Distribution Channel

For many products, it may be possible to use several methods (channels) of distribution,
which implies that the seller must decide which channel(s) will be the most beneficial to his
requirements.
This can be a difficult choice to make and a number of factors come into play.
(a) Basic requirements
Initial considerations on this aspect of the marketing effort will be mainly based on the
following factors.
z Requirements of the product
The characteristics of the product will dictate the type of distribution channel that
can be used – for example, in respect of the kind of storage required.
The following are the most important characteristics.
© ABE
(i) Rate of turnover – frequently-purchased, low-cost items such as

newspapers must be widely available to a mass, changing market, whereas
for high cost items which are purchased infrequently, such as cars (and
particularly exclusive cars such as a Rolls Royce), customers will seek you
out and there is no need to have a presence on every street corner.
(ii) Seasonality – seasonal products require a reseller system that can handle
the stress caused by distribution at certain times of the year.
(iii) Product complexity – highly technical products, requiring assembly or
installation or service, need specialist middlemen. If these are not
available, direct sale is indicated.
(iv) Perishability – these products often require a direct channel or specialised
equipment. Obviously, if the product is something as perishable as ice
cream, unless you operate or hire a fleet of refrigerated vehicles, you could
seriously damage your chances of widening your distribution beyond a very
local area. Note that because of improvements in science and technology,
many traditional perishable products are being developed into longlife
products, such as UHT milk.
(v) Product life cycle – where a product has reached maturity in the product
life cycle, it has to be widely available if the sales are to be maintained.
(vi) Image – the type of image associated with the brand may affect the type of
channel which is acceptable – for example, Rolex watches are highly-
priced, sought-after items which are only found in exclusive jewellers, and it
would not suit the image of the product if they could be bought in a tacky
seaside discount shop.
z Requirements of the seller
The size and reputation of the company, its product mix, its past channel
experience and its present marketing policies will affect its channel strategy. In
addition, the following factors will be important.
(i) Attitude towards intermediaries – How much control does the supplier
want to have? How much of the overall potential profit are they prepared to
pass on to an intermediary? Do they want to have information on the end-
user?
For example; (ii) Competition – The extent to which competitors dominate existing channels
DRONE as distribution and to which manufacturers wish to compete directly against competitors or
avoid them affects channel choice.
has less competition
z Requirements of the buyer
This is the way in which the characteristics of the market segment – for example,
location, purchasing preferences and patterns, and overall number of buyers –
influences the form of distribution.
(i) Where the number of customers is large, long channels are normally
necessary. (The role of the bulk-buying multiple has changed this.)
(ii) Wide geographical dispersion of customers may require long channels.
(iii) High frequency in the purchasing pattern of low unit-value items may
indicate the need for long channels because of the high cost of direct sale.
© ABE
durable manufacturers. The product is not placed in all potential outlets, thus
selected dealers can specialise and afford after-sales back-up and support.
(c) Final choice
The final choice between channels will depend on a balance between the following.
z Cost – Investment
– Maintenance
z Coverage – Large/small area
– Many/few outlets
– All/few products
z Control – Maximum/minimum
– Strict/lenient
z Continuity – Channel growth
– Channel stagnation
– Channel decline.
Distribution Channel Maintenance

Most of what we have said so far has related to the setting up of a distribution channel and
has taken no account of the continuity aspects of channel management. Continuity is
equally important. Distribution managers want good channels, and good channels only
happen if they are well-managed. There should be no channel conflict; there should be
channel harmony.
Channel conflict is caused by not treating channel members equally. For example, if one
distributor is given better discounts than another it will cause problems; if one channel
member is given product training for the sales force, and another is not, it will also cause
conflict.
Fair treatment of channel members on every aspect of the business is of utmost importance
if a distribution channel is to remain effective. Once relationships begin to suffer business
can be lost and it can take a great deal of time to recover lost ground.
Managers should be working towards the development of their distribution channels and,
although this may simply be a case of managing and controlling existing channel members in
terms of supply, targets, reporting, etc., there may be times when a channel needs to be
changed.
Change may become necessary because of environmental factors such as legislation,
competition or customer preferences. The fact that channel member(s) have proved to be
incapable of giving the level of coverage that a manufacturer requires, or are failing in some
other aspect (e.g. spiralling costs) may also lead to the need for change.
Whatever the reason for changing a channel, change can only be effected with care.
The original supplier needs to consider all aspects.
z What will the effect be on the other channel members?
z How will the customers react?
z How will the competition react?
z What costs will be incurred?
z What level of profits can be expected?
© ABE
Put another way, making any change to a distribution channel is a similar exercise to setting
up a new distribution channel. The same type of research has to be undertaken and similar
decisions made.
If we assume that it is not simply a case of getting rid of a channel member who is
performing badly, changing a distribution channel can, in some circumstances, be made
much easier if channel harmony exists. Harmony among channel members leads to
smoother operating procedures, better communications and a greater willingness to
cooperate. This is helped by building relationships.
Relationship Marketing
Increasingly, competitive markets, resource restrictions and buyer power have heightened
the need for good relationships in distribution. When manufacturers and intermediaries work
together, communicate well and discuss plans, etc., they become interdependent and the
relationships formed are less likely to suffer.
Not only will control be much more effective, it will also be much easier to make changes to
improve efficiency and effectiveness for both parties.
However, there is a word of warning. Relationship marketing is excellent in all ways apart
from the fact that it can cause complacency. If a manufacturer becomes too lax in his
treatment of an intermediary (or a supplier), he may miss some factor which is indicative of
an underlying problem. If that problem is not settled, it can lead to a break-up of the
relationship. This also applies to intermediaries being careless in their attitude to
manufacturers.
I. DEALING WITH INTERMEDIARIES

An intermediary is an external agency that is acting, in some form or another, as a link in the
distribution chain between manufacturer and user.
Using intermediaries is something which manufacturers do as and when necessary, but the
decision on the type of intermediary to use will be based upon many influencing factors.
Such decisions can never be taken lightly as so much depends on the satisfactory
distribution of a product.
Thus, when choosing intermediaries manufacturers will be concerned with the following
aspects.
z Does the intermediary have access to the target market?
z Will the intermediary help exploit the advantages of the product?
z Will the intermediary help in promotion costs, etc.?
z Will there be enough profit for the manufacturer?
z Will the intermediary be dealing in competing products?
z What contractual obligations are involved?
What you must remember is that an intermediary is a customer. They are entitled to be
treated with respect and given as much consideration as the individual user of a product.
Indeed, treatment of intermediaries may be crucial to the long-term success of a
manufacturer.
© ABE
Working with Retailers

The role of the retailer is to buy in bulk and sell in small quantities. The retailer removes from
the consumer the risk of deterioration and the need to commit relatively large sums, in return
for an enhanced profit. The consumer could go to a miller and buy a large bag of flour
cheaply, but generally we would all rather pay the retailer's higher price for the convenience
of buying small quantities of several commodities regularly.
One of the anxieties associated with the retail trade is the risk of being left with stock that
cannot be sold when times are hard. Most of the other people in the chain are, to some
extent, protected from this danger by the fact that the retailer signals fluctuations in trade to
others further upstream. If consumers stop purchasing, the retailer reduces his order from
the wholesaler or manufacturer, who can quickly respond by reducing or stopping their own
commitment. He is thus the signaller of demand, allowing those further up the chain to plan
more accurately and therefore reducing their risk. For this, he expects manufacturers and
wholesalers to keep their own profits to a reasonable level, so that he has a profit margin on
the price customers will pay.
A retailer's willingness to stock a product therefore has a pivotal role in the relationship
between manufacturers and consumers. If the retailer will not stock your product, it makes it
difficult for you to sell to his local customers and he will not stock it if he cannot be assured of
a sizeable reward for his two-way risk. The manufacturer can provide adequate reward in
one of two ways. Either he can enhance the profit per item by keeping his own price to the
shopkeeper low or he can encourage the shopkeeper to accept a smaller price margin by
promising to stimulate demand for the product so that the shopkeeper turns over his stock
more quickly.
This is why the manufacturer needs three main forms of marketing communications in his
dealing with retailers.
z Personal selling is key to the process of negotiating a deal, whereby the retailer is
persuaded to become and remain a stockist.
z Sales promotion is used to make the retailer's profit more attractive without damaging
the price attractiveness of the goods to the consumer, and advertising is used to
stimulate consumer demand to increase the rapidity of the retailer's turnover.
z Advertising can also be used (in "trade" media) to inform retailers of forthcoming
promotional activities and encourage them to increase their stock levels.
Working with Wholesalers

So far we have looked at the short channel that links manufacturers, through the larger
retailers, to the consumers. However, where smaller (or independent) retailers are your end
outlet, there is often another intermediary in the chain. This is the wholesaler, who buys in
bulk from the manufacturer and sells, in what are normally known as "case quantities" (the
number of items usually contained in a single outer package or box), to shopkeepers.
This, of course, implies a need for yet another profit to be taken out of the final selling price
to the consumer. Partly for this reason, prices of goods in small shops tend to be rather
higher than in supermarkets. (The other part of the reason is, of course, that these shops do
not purchase anything like the huge quantities that the supermarket chains do.) The great
advantage to manufacturers of using wholesalers is that they take over the expensive
problem of storage and transportation of relatively small consignments of product.
Manufacturers planning their marketing communications should therefore not ignore these
intermediaries. They handle a relatively small slice of the consumer market in total, in the
more common trades such as food or household products, but it is still a worthwhile slice to
have. If they do not stock your goods, you are missing out on a valuable market opportunity.
© ABE
There is almost always no way to approach the wholesalers except directly or semi-directly
through personal selling (public relations (exhibitions and trade launches) and sometimes
direct mail. Sales promotions aimed at the trade may also affect them.
One of the main weapons in the salesman's armoury when dealing with wholesalers is terms
of credit. Wholesalers make relatively small actual profit margins on the goods they sell.
But they can make a healthy profit on the "spread" between the credit terms they buy on, and
those they offer their own customers. Many of their customers pay cash when they buy
(hence the appellation "cash-and-carry wholesalers"), whereas others who have a credit
account are expected to settle up in seven days, or perhaps two weeks. If the manufacturer
allows the wholesaler thirty days credit (or even longer), he may be prevailed upon to take
quite large quantities of goods and actively promote them to his retail customers because he
can make a certain amount of money from the interest he receives in the time between
receiving his customers' money and paying his own bill.
Following our comments on own-brand and own-product items where retailers are
concerned, it is worth pointing out that some of the bigger wholesalers have attempted, for
their own purposes and in support of their shopkeeper customers, to build their own brand
also. Whenever you buy something from a small corner-shop or similar outlet, take careful
note of the brand name on the boxes of tissues, the toilet paper or the cooking foil that are
offered for sale; they often carry the same brand name, a brand invented by the wholesaler.
Here again there is an opportunity for a far-sighted manufacturer to get into a deal with such
a wholesaler to provide goods for this kind of umbrella brand. It is often work that can be
done at reasonable margins when times are quiet and keeps the factory ticking over.
Such negotiations can be complex and delicate when the wholesaler is one of only a few in
his particular market. Pharmaceuticals, for instance, is a trade in which a small handful of
very powerful wholesalers supply practically every independent chemist's shop in the land.
Of course, the up-side of this feature is that the manufacturer does not need to keep a large
sales force as one or two key accounts managers will cover the entire national trade of
perhaps several thousand shops.
Business-to-Business Dealings
A large part of the business in any developed economy is not directed towards the individual,
private consumer but by one firm to another. There are several points where this kind of
business differs from consumer-directed business.
(a) Nature of demand
Business-to-business (or industrial) transactions are very often the result not of direct
demand but of derived demand. The motor manufacturer earlier does not buy engine
oil because he wants, craves or desires to possess engine oil – he does so because he
cannot sell his own product without it. This means that in some situations, a push and
pull strategy can be followed – you can sell directly to the firm that is your own
customer on the basis of price, terms, delivery, etc (push), but you can also market
your goods to the end user (or at any rate the firm next down the line) on grounds of,
for instance, reliability and quality, so that they demand of your customer that your
product be specified (pulling the product through the chain).
A brick manufacturer might be a good example. He would sell his product to builders'
merchants and construction firms (push), but he would also be energetically courting
architects, project engineers, quantity surveyors and the like, in the hope that they
would specify his product when commissioning the builders or drawing up procurement
schedules (pull).
It would obviously be useless to try to sell, in this kind of situation, on grounds of the
intrinsic desirability of the article you are offering. The job of marketing
communications here is to persuade the customer that your product's qualities will
© ABE
the consumer will "click" onto the appropriate website, where they can compare prices of all
the main suppliers who have agreed to be represented on the site. Whenever an interested
party "clicks through" to a particular supplier, that supplier pays a commission to the
intermediary. Examples of such intermediaries are www.compare.com, www.trustnet.com
and www.moneyextra.com. Some markets have set up their own intermediary to compete
with the existing intermediaries and this is referred to as countermediation. A group of
airlines, for instance, set up www.opodo.com as an alternative to www.expedia.com to offer
airline tickets. The Thomson Travel Group set up www.latedeals.com to compete with
www.lastminute.com.
The Impact of Technology

(a) Data Exchange
The distribution industry has seen many changes in recent years, with systems
becoming predominantly technology based, which has improved efficiency and
reduced costs quite dramatically in some cases.
The growth of electronic data exchange has resulted in massive changes in how
distribution is handled. An increasing number of manufacturers are using central
depots to cover huge areas rather than having multiple "regional" depots. In the past,
stock handling and replenishment was extremely difficult to control when all the
paperwork had to be processed by the regions before it went to the central point and
vice versa. In many cases those difficulties restricted growth.
If you consider the opportunities for the European region alone you can see how
beneficial electronic data processing can be. Now, because of easier systems and
faster communications, manufacturers are able to have one central distribution point
with a system which covers all member nations. No longer is it necessary to hold
stocks in each location, as they can be moved very quickly from a central point to
anywhere within the continent. The cost savings of not having to have distribution
points in each country can be immense. Stock control and manufacturing schedules
can be much better controlled than in the past. The use of satellite tracking systems
now enables assignments to be located anywhere in the world and has drastically
reduced "losses".
The advent of computerised systems has meant that it can now be routine to:
z download sales orders by telelink from anywhere in the world;
z produce documentation and records that are customised to the needs of each
internal department;
z produce invoices in picking order to speed up warehouse operations;
z generate journey schedules for delivery vans.
In many cases the information is downloaded from an Electronic Point of Sale (EPOS)
system, so management can arrange for restocking without on-site managers having to
requisition new supplies.
EPOS also aids research into usage of products which, in turn, allows for better
forecasting and planning of stocks to be held in an outlet and to be manufactured by a
supplier.
(b) Just-in-Time
Developments in technology have enabled businesses of all sizes to benefit from “just
in time” (JIT) processes and procedures. The goal of JIT is to reduce the delivery lead
time, cut stock levels, reduce the number of defects or returns, improve staff
productivity and make sure products are delivered on time. It is based on the idea that
holding too much stock is a waste of money, and that a business can work more
© ABE
efficiently by ordering and receiving stock and materials when they are required, rather
than stockpiling, and thus reduce cash flow requirements.
Technology has now made it possible for marketing, purchasing, production, finance
and distribution to work closely together, to enable organisations to streamline the
process and reduce the time from receiving an order to delivering the finished article.
A good example of an organisation using “just in time” is Dell, the computer company.
They don’t hold stock, but, as orders are received, they automatically place orders for
the parts, which are delivered within a day. They can then assemble the products and
dispatch them within a very short period of time.
Many top distributors and retailers are seeing major gains by exploiting “just in time”
techniques.
(c) Online distribution
The growth of organisations like Amazon as an online retailer shows just how the
power of the internet can have an impact on a conventional distribution channel. The
impact will grow in the future, as consumers gain more confidence in online purchasing
and access becomes even more widespread. There are a number of advantages of
online distribution.
z It is simple for consumers to search for what they want and compare competitor
offers, all within the comfort of your own home.
z Businesses can reduce print and mailing costs, and change prices and other
details almost instantly.
z Order processing and handling costs can be reduced with online ordering, as
everything is in electronic format.
z Real time information flows are available between the customer, customer
support, distribution and the supply chain.
z Better after-sales service can be provided online, as not only is it cheaper, but it
can also provides feedback links, usage information, news flashes and product
fault finding.
z Digital products such as magazines, music, video and software can be distributed
via the internet, which is faster and cheaper than sending by post or mail.
z Manufacturers can get closer to customers through disintermediation (cutting out
the middleman).
© ABE
Distribution Strategies 449
446 PART 6 Marketing Strategies
economy, five producers produce one type of item each: hats, hoes, knives, bas-
kets, or pots. Because each producer needs all the other producers’ products, a
total of 10 exchanges are required to accomplish trade. However, with a market
(or middlemen), once the economy reaches equilibrium (i.e., each producer-
consumer has visited the market once), only five exchanges need to take place to
meet everyone’s needs. Let n denote the number of producer-consumers. Then
the total number of transactions (T) without a market is given by:
n( n − 1)
Twithout =
2
and the total number of transactions with a market is given by:

Twith = n
The efficiency created in distribution by using an intermediary may be
viewed using this equation:
Twithout n( n − 1) 1 n − 1
Efficiency = = × =
Twith 2 n 2
In the example of five producer-consumers, the efficiency of having a middle-

man is 2. The efficiency increases as n increases. Thus, in many cases, intermedi-
aries may perform the task of distribution more efficiently than manufacturers
alone.
Postponement- Conceptually, the selection of channel structure may be explained with reference
Speculation Theory to Bucklin’s postponement-speculation framework.2 The framework is based on
risk, uncertainty, and costs involved in facilitating exchanges. Postponement
seeks to eliminate risk by matching production/distribution with actual customer
demand. Presumably, postponement should produce efficiency in marketing
channels. For example, the manufacturer may produce and ship goods only on
confirmed orders. Speculation, on the other hand, requires undertaking risk
through changes in form and movement of goods within channels. Speculation
leads to economies of scale in manufacturing, reduces costs of frequent ordering,
and eliminates opportunity cost.
Exhibit 16-2 shows the behavior of variables involved in the postponement-
speculation framework. The vertical axis shows the average cost of undertaking
a function for one unit of any given commodity; the horizontal axis shows the
time involved in delivering a confirmed order. Together, the average cost and the
delivery time measure the cost of marketing tasks performed in a channel with
reference to delivery time. The nature of the three curves depicted in Exhibit 16-2
should be understood: C represents costs to the buyer for holding an inventory;
AD´, costs involved in supplying goods directly from a manufacturer to a buyer;
and DB, costs involved in shipping and maintaining speculative inventories (i.e.,
in anticipation of demand).
450 Distribution Strategies
C represents costs to the buyer for holding an inventory;

--
AD´ is the costs involved in supplying goods directly from a manufacturer to a buyer;
--
DB is the costs involved in shipping and maintaining speculative inventories (i.e., in anticipation of demand).
CHAPTER 16 Distribution Strategies 447
EXHIBIT 16-2
Using the Postponement-Speculation Concept to Determine Channel Structure
(With Intermediaries) (Without Intermediaries)

Source: Louis P. Bucklin and Leslie Halpert, “Exploring Channels of Distribution for Cement with
the Principle of Postponement-Speculation,” in Marketing and Economic Development, ed. Peter D.
Bennett (Chicago: American Marketing Association, 1965): 698. Reprinted by permission of the
American Marketing Association.
Following Bucklin’s framework, one determines the channel structure by

examining the behavior of the C, AD’, and DB curves:
1. The minimal cost of supplying the buyer for every possible delivery time is
derived from curves AD’ and DB. As may be seen in Exhibit 16-2, especially fast
delivery service can be provided only by the indirect channel (i.e., by using a
stocking intermediary). However, at some delivery time, I’, the cost of serving the
consumer directly from the producer will intersect and fall below the cost of indi-
rect shipment. The minimal costs derived from both curves are designated DD’.
From the perspective of channel cost, it will be cheaper to service the buyer from
a speculative inventory if delivery times shorter than I’ are demanded. If the con-
sumer is willing to accept delivery times longer than I’, then direct shipment will
be the least expensive.
2. The minimal total cost curve for the channel with respect to delivery time is
derived by summing the cost of moving goods to the buyer, DD’, and the buyer’s
costs of holding inventory, C. The curve is represented in Exhibit 16-2 by DD’ +
thereafter increased
C. Total channel costs initially fall as delivery time lengthens because it rises
buyer expenses are more than made up for by savings in other parts of the chan-
nel. Gradually, however, the savings from these sources diminish and buyer costs
Postponement, Speculation and the Structure
of Distribution Channels
LOUIS P. BUCKLIN*
,>.While the study of marketing has long been concerned with the creation of time, space, and
possession utilities, much of the literature of the field has dealt with the problems of ownership.
Issues involving space and time, in particular, have been scarcely touched. The role of time with
respect to the character of the structure of distribution channels, for example, has just begun to
be charted. The purpose of this article is to derive a principle describing the effect of temporal
factors upon distribution systems.
THE CONCEPT OF SUBSTITUTABILITY and to retain the resulting profits. The consequence
. Underlying the logic of the principle to be developed of this action is the formation of a new and alternate
is the hypothesis that economic interaction among basic channel for the product.
marketing functions, and between these functions and The momentum of change, however, is not halted at
production, provides much of the force that shapes this point. Unless there is protection against the full
the structure of the distribution channel. These inter- brunt of competitive forces, the institutions remaining
actions occur because of the capability of the various in the original, and now high-cost channel, will either
functions to be used as substitutes for each other within be driven out of business or forced to convert to the
certain broad limitations. This capability is compar- new system as well. With continued competitive pres-
able to the opportunities available to the entrepreneur sure the excess profits, initially earned by the institu-
to use varying ratios of land, labor, and capital in the tions which innovated the new channel, will eventually
production of his firm's output. The substitutability be eliminated and total channel costs will fall.
of marketing functions may occur both within the In essense, the concept of substitutability states that
firm and among the various institutions of the channel, under competitive conditions institutions of the chan-
e.g., producers, middlemen, and consumers. This sub- nel will interchange the work load among functions,
stitutability permits the work load of one function to not to minimize the cost of some individual function,
be shrunk and shifted to another without affecting the but the total costs of the channel. It provides, thereby,
output of the channel. These functional relationships a basis for the study of distribution channels. By under-
may also be seen to be at the root of the "total cost" standing the various types of interactions among the
concept employed in the growing literature of the man- marketing functions and production that could occur,
agement of the physical distribution system [3, 9]. one may determine the type of distribution structure
A familiar example of one type of substitution that that should appear to minimize the total channel costs
may appear in the channel is the use of inventories to including those of the consumer. The principle of
reduce the costs of production stemming from cyclical postponement-speculation, to be developed below, eval-
demand. Without the inventory, production could only uates the conditions under which one type of substitu-
occur during the time of consumption. Use of the tion may occur. Manufacturer +
inventory permits production to be spread over a longer Middlemen +
period of time. If some institution of the channel POSTPONEMENT Customer
senses that the costs of creating a seasonal inventory In 1950, Wroe Alderson proposed a concept which
would be less than the savings accruing from a constant uniquely related certain aspects of uncertainty and risk
rate of production, it would seek to create such a stock to time. He labelled this concept the "principle of
postponement," and argued that it could be used to
reduce various marketing costs [2]. Risk and uncer-
tainty costs were tied to the differentiation of goods.
*Louis P. Bucklin is assistant professor of business admin- Differentiation could occur in the product itself
istration, University of California, Berkeley. He wishes to ex-
pre~s hi_s apprecia~ion to the Research Program in Marketing, and/ or the geographical dispersion of inventories.
University of California, Berkeley, and the Ford Foundation Alderson held that "the most general method which can
for the support of the research for this article. be applied in promoting the efficiency of a marketing
26
POSTPONEMENT, SPECULATION, AND STRUCTURE OF DISTRIBUTION CHANNELS 27
system is the postponement of differentiation ... post- Since most manufacturers do produce for stock, and
pone changes in form and identity to the latest possible the ownership of intermediate inventories by middle-
point in the marketing flow; postpone change in inven- men is characteristic of a large proportion of channels,
tory location to the latest possible point in time." [1] it is clear that the principle of postponement can reach
Savings in costs related to uncertainty would be its limit very quickly. As a result, it provides no
achieved "by moving the differentiation nearer to the rationale for the forces which create these inventories.
Confirmed time of purchase," where demand, presumably, would Hence, postponement is really only half a principle.
Demand be more predictable. Savings in the physical move- It must have a converse, a converse equally significant
ment of the goods could be achieved by sorting prod- to channel structure.
ucts in "large lots," and "in relatively undifferentiated Converse of
states." SPECULATION postponement
Despite its potential importance, the principle has This converse may be labelled the principle of
received relatively little attention since it was first speculation. It represents a shift of risk to the insti-
published. Reavis Cox and Charles Goodman [4] have tution, rather than away from it. The principle of
made some use of the concept in their study of chan- speculation holds that changes in form, and the move-
nels for house building materials. The Vaile, Grether, ment of goods to forward inventories, should be made
and Cox marketing text [10] also makes mention of it. at the earliest possible time in the marketing flow in
As far as can be determined, this is the totality of its order to reduce the costs of the marketing system.
further development. As in the case of postponement, application of the
As a result, the principle still constitutes only a principle of speculation can lead to the reduction of
somewhat loose, and possibly misleading, guide to various types of costs. By changing form at the earliest
the study of the distribution channel structure. The point, one makes possible the use of plants with large-
major defect is a failure to specify the character of scale economies. Speculation permits goods to be
the limits which prevent it from being applied. The ordered in large quantities rather than in small fre-
principle, which states that changes in form and inven- quent orders. This reduces the costs of sorting and
tory location are to be delayed to the latest possible transportation. Speculation limits the loss of con-
moment, must also explain why in many channels these sumer good will due to stock outs. Finally, it permits
changes appear at the earliest. As it stands, the prin- the reduction of uncertainty in a variety of ways.
ciple of postponement requires modification if it is to This last point has already been well developed in
be applied effectively to the study of channels. the literature. It received early and effective treatment
from Frank H. Knight [6]. He held that speculators,
Postponement and the Shifting of Risk another by shifting uncertainty to themselves, used the principle
If one views postponement from the point of view of grouping, as insurance, to transform it into the more
of the distribution channel as a whole, it may be seen manageable form of a relatively predictable risk.
as a device for individual institutions to shift the risk Further, through better knowledge of the risks to be
of owning goods to another. The manufacturer who handled, and more informed opinion as to the course of
postpones by refusing to produce except to order is future events, risk could be further reduced.
shifting the risk forward to the buyer. The middleman
postpones by either refusing to buy except from a seller THE COMBINED PRINCIPLE
who provides next day delivery (backward postpone- From the point of view of the distribution channel,
ment), or by purchasing only when he has made a the creation of inventories for holding goods before they
sale (forward postponement). The consumer post- are sold is the physical activity which shifts risk and
pones by buying from those retail facilities which per- uncertainty. Such inventories serve to move risk away
mit him to take immediate possession directly from from those institutions which supply, or are supplied
the store shelf. Further, where the consumer first by, the inventory. Such inventories, however, will not
contacts a number of stores before buying, the shop- be created in the channel if the increased costs attend-
ping process itself may be seen as a process of post- ing their operation outweigh potential savings in risk.
ponement-a process which advertising seeks to elimi- Risk costs, according to the substitutability hypothesis,
nate. cannot be minimized if other costs increase beyond
From this perspective it becomes obvious that every the savings in risk.
institution in the channel, including the consumer, can- This discussion shows the principle of speculation to
not postpone to the latest possible moment. The be the limit to the principle of postponement, and vice
channel, in its totality, cannot avoid ownership respon- versa. Together they form a basis for determining
sibilities. Some institution, or group of institutions, whether speculative inventories, those that hold goods
must continually bear this uncertainty from the time prior to their sale, will appear in distribution channels
the goods start through production until they are con- subject to competitive conditions. Operationally, post-
sumed. ponement may be measured by the notion of delivery
28 JOURNAL OF MARKETING RESEARCH, FEBRUARY 1965
time. Delivery time is the number of days (or hours) Diagram I

elapsing between the placing of an order and the AVERAGE COST OF DISTRIBUTING ONE UNIT OF
physical receipt of the goods by the buyer [9, p. 93]. A COMMODITY TO A CUSTOMER WITH RESPECT
For the seller, postponement increases, and costs de- TO DELIVERY TIME IN DAYS
cline, as delivery time lengthens. For the buyer, post-
ponement increases, and costs decline, as delivery time Average Costs
\Dollars)
shortens. The combined principle of postponement- 3
speculation may be stated as follows: A speculative in-
D
ventory will appear at each point in a distribution
channel whenever its costs are less than the net savings
to both buyer and seller from postponement.
OPERATION OF THE PRINCIPLE

The following hypothetical example illustrates how
the postponement-speculation principle can be applied
to the study of distribution channels. The specific
problem to be considered is whether an inventory, 0'----~5,.------c!IO~--+,
I
-"'*'1s-----,2""0,.----=-oe1ivery Time
located between the manufacturer and the consumer, ..,..__ Indirect channel~ I +---Direct channel-
will appear in the channel. This inventory may be
managed by the manufacturer, a consumer cooperative moving one unit of the commodity from the producer
or an independent middleman. to the consumer. The abscissa measures the time in
Assume that trade for some commodity occurs be- days for delivery of an order to the consumer after it
tween a set of manufacturers and a set of customers, has been placed. The curve DB measures the cost of
both sets being large enough to insure active price using the speculative inventory to supply the consumer
competition. The manufacturers are located close to for the various possible delivery times. Curve AD'
each other in a city some significant distance from the shows the cost of supplying the consumer direct with-
community in which the customers are situated. All out use of such an inventory. DD' is the minimum
of the customers buy in quantities sufficiently large to average cost achievable by either direct or indirect dis-
eliminate the possibility of savings from sorting. Manu- tribution of the commodity.
facturing and consumption are not affected by seasonal The diagram shows that DD' declines as the delivery
variations. Assume, further, that production costs will time is allowed to increase [7]. With very short delivery
not be affected by the presence of such an intermediate times the intermediate inventory is absolutely necessary
inventory. because only in this way can goods be rushed quickly
To determine whether the intermediate inventory will to the consumer. Further, when virtually immediate
appear, one must first ascertain the shape of the vari- delivery is required, the safety stock of the inventory
ous relevant cost functions with respect to time. In must be kept high in order to prevent temporary stock-
any empirical evaluation of channel structure this is outs from delaying shipment. Also, delivery trucks
likely to be the most difficult part of the task. For must always be available for short notice. These fac-
present purposes, however, it will be sufficient to gen- tors create high costs.
eralize about their character. As the delivery time to be allowed increases, it be-
The costs incurred by the relevant functions are comes possible to reduce the safety stocks, increase
divided into two broad categories. The first includes the turnover and reduce the size of the facilities and
those costs originating from activities associated with interest cost. Further increases permit continued sav-
the potential inventory, such as handling, storage, in- ings. Eventually, a point will be reached, I in Diagram
terest, uncertainty, and costs of selling and buying if 1, where the delivery time will be sufficiently long to
the inventory is operated by a middleman. It also make it cheaper to ship goods directly from the fac-
includes those costs emanating from transportation, tory to the consumer than to move them indirectly
whether the transportation is direct from producer to through the inventory. This creates the discontinuity
consumer or routed through the inventory. All of at I as the costs of maintaining the inventory and the
these costs will, in turn, be affected by the particular handling of goods are eliminated.
location of the inventory between the producer and In part, the steepness of the slope of DD' will be
the consumer. In the present instance, it is assumed affected by the uncertainties of holding the inventory.
that the inventory will be located in the consumer city. Where prices fluctuate rapidly, or goods are subject
In general, this first category includes all the rele- to obsolescence, these costs will be high. The exten-
vant costs incurred by the producer and intermediary, sion of delivery time, in permitting the intermediate
if any. These are aggregated on Diagram 1. In this inventory to be reduced in size, and eventually elimi-
diagram, the ordinate represents the average cost for nated, should bring significant relief.
POSTPONEMENT, SPECULATION, AND STRUCTURE OF DISTRIBUTION CHANNELS 29
The second category of costs involves those emanat- Diagram 2

ing from the relevant marketing functions performed
by the customer. Essentially, these costs will be those AVERAGE INVENTORY COST FOR ONE UNIT OF A
of bearing the risk and costs of operating any inventory COMMODITY TO A CUSTOMER WITH RESPECT TO
on the customer's premises. These costs are shown as DELIVERY TIME IN DAYS
C on Diagram 2, with the ordinate and abscissa labelled Average Costs
as in Diagram 1. (Dollars)
3
The shape of C is one that increases with delivery
time. The longer the delivery time allowed by the cus-
tomer, the greater the safety stock he will have to carry.
Such stock is necessary to protect against failures in
transport and unpredictable surges in requirements.
Hence, his costs will increase. The greater the uncer-
tainty cost of inventory holding, the steeper will the
slope of this function be.
Determination of the character of the distribution
channel is made from the joint consideration of these
two cost categories, C and DD'. Whether an interme-
diate inventory will appear in the channel depends upon
the relationship of the costs for operating the two sets
of functions and how their sum may be minimized. uncommitted stocks of goods available for general sale
Functions DD' + C on Diagram 3 represents the sum in order to fulfill their purpose. For example, the REA
of functions DD' and C. The diagram reveals, in this Express, the parcel post system, freight forwarders, and
instance, that costs of postponement are minimized by even the Greyhound Bus Corporation's freight system
use of a speculative inventory as the minimal cost sort a substantial volume of goods through many non-
point, M, falls to the left of I. If, however, the risk speculative type inventories each day. Milk producers
costs to the customer had been less, or the general establish handling depots where bottled milk is trans-
cost of holding inventories at the customer's home (or ferred from large, long-distance vehicles to city delivery
plant site, as the case may be) had been lower, then C trucks. Catalogue sellers discharge full truck shipments
would be farther to the right. M would also shift to upon the post offices of distant cities where customers
the right. With a sufficient reduction in consumer cost, reside. None of these inventories involves the risk of
M would appear to the right of the discontinuity, indi- unsold goods. None of these inventories provides the
cating that direct shipment in the channel would be basis for the emergence of a title-holding middleman.
the means to minimize postponement cost.
Diagram 3
SIGNIFICANCE OF THE PRINCIPLE
TOTAL OF AVERAGE DISTRIBUTING AND
As developed, the principle of postponement-specu-
CUSTOMER INVENTORY COSTS WITH RESPECT
lation provides a basis for expecting inventories to be
TO DELIVERY TIME IN DAYS
present in channels because of production and distribu-
tion time requirements. In particular, it treats the role Average Costs
(Dollars)
of speculative inventories in the channel. The concept,
as a consequence, extends beyond the physical flow of 4
the goods themselves to the flow of their title. Specu-

lative inventories create the opportunity for new insti- DD'+ C
tutions to hold title in the channel. Without such 3
inventories, there may be little economic justification c
for a title holding intermediary to enter the channel.
The economic need to have such an inventory in the
physical flow opens the door to a middleman to show
whether he is capable of reducing the risk cost of that
inventory below the level atta"-1able by either the pro-
ducer or some consumer cooperative.
The presence of an inventory in the channel for
either collecting, sorting, or dispersing does not create DD'
the same type of opportunity for a title-taking inter-
mediary to appear in the channel. Such inventories are O'--~.....::::---'--'-~----'~---'-~--'----~~---'-~~
5 ID : 15 20 Delivery Time
not speculative in character. They do not need to hold - Indirect channel - - I - Direct channel -
Increasing the delivery time decreases postponement costs for the

seller, increases them for the buyer and vice versa.
begin to rise more rapidly. A minimal cost point is reached, and expenses for the
channel rise thereafter. Channel structure is controlled by the location of this min-
imum point. If, as in the present case, it falls to the left of I’, then goods would be
expected to flow through the speculative inventory (i.e., an intermediary). If, on
the other hand, the savings of the buyer from postponement had not been as
great as those depicted, the minimum point would have fallen to the right of I’
and shipments would have been made directly from the producer to the con-
sumer.3
Benetton, an Italian apparel maker, offers an excellent example of a distribu-

tion strategy that combines speculation with postponement in an effort to opti-
mize both service and cost. Speculation involves commitment by retailers to
specific inventory items months before the start of the selling season. It leads to
such advantages for Benetton as low-cost production (via use of subcontractors)
and good quality control (via centralized warehousing and assembly of orders).
Postponement of orders requires last-minute dyeing of woolen items at an added
cost. The advantages of speculation are flexibility in meeting market needs and
reduced inventory levels.4
Additional The postponement-speculation theory provides an economic explanation of the

Consideration in way the channels are structured. Examined in this section are a variety of envi-
Determining ronmental influences on channel-structure strategy formulation. These influences
Channel Structure may be technological, social and ethical, governmental, geographical, or cultural.
Many aspects of channel structure are affected by technological advances. For
example, mass retailing in food has become feasible because of the development
Technology --> AI, Robotics, of automobiles, highways, refrigerated cars, cash registers, packaging improve-
Drones ments, and mass communications (television). In the coming years, television
- shopping with household computer terminals should have a far-reaching impact
Govt./Legal--> Some on distribution structures.5 Technological advances permitted Sony to become
products may not be legal to dominant in the U.S. market for low-priced CD players. Sony developed prepack-
aged players that could be sold through mass retailers so that even sales clerks
distribute e.g. liquor home without technical know-how could handle customers.
delivery How technology may be used to revamp the operations of a wholesaler, mak-
- ing it worthwhile to adopt indirect channels, is illustrated by the case of
Ethical--> Prohibition on Foremost-McKesson, the nation’s largest wholesale distributor. A few years ago,
distribution of narcotics the company found itself in a precarious position. Distribution, though one of the
company’s most pervasive business functions, did not pay. Foremost-McKesson
product near educational merely took manufacturers’ goods and resold them to small retailers through a
institutions routine process of warehousing, transportation, and simple marketing that
offered thin profits. As a matter of fact, at one time the company came close to
selling off drug wholesaling, its biggest business. Instead, however, its new chief
executive decided to add sophisticated technology to its operations in order to
make the company so efficient at distribution that manufacturers could not pos-
sibly do as well on their own. It virtually redefined the function of the intermedi-
ary. Having used the computer to make its own operations efficient, it devised
ways to make its data processing useful to suppliers and customers, in essence
making Foremost part of their marketing teams. Since the company computer-
ized its operations, Foremost has turned around dramatically. Here are the high-
lights of Foremost’s steps in reshaping its role:
• Acting as middleman between drugstores and insurance offices by processing
medical insurance claims.
• Creating a massive “rack jobbing” service by providing crews to set up racks of
goods inside retail stores, offering what amounts to a temporary labor force that
brings both marketing know-how and Foremost merchandise along with it.
• Taking waste products as well as finished goods from chemical manufacturers,
and recycling the wastes through its own plants—-its first entry into chemical
waste management.
• Designing, as well as supplying, drugstores.
• Researching new uses for products it receives from manufacturers. Foremost
found new customers, for example, for a Monsanto Co. food preservative from
among its contacts in the cosmetics industry.6
Another example of the use of technology to overhaul distribution is pro-

vided by Britain’s supermarket chain Tesco. The firm’s nine composite (variable
temperature) distribution centers use a just-in-time system (known as pick-by-
line or cross-docking). That means goods amounting to around 40% of total sales
go straight out to the stores within hours of arrival.7
Social taboos and ethical standards may also affect the channel-structure deci-
sion. For example, Mallen reports that Viva, a woman’s magazine, had achieved a
high circulation in supermarkets and drugstores in Canada. When Viva
responded to readers’ insistence and to competition from Playgirl by introducing
nude male photos, most supermarkets banned the magazine. Because supermar-
kets accounted for more than half of Viva’s circulation, Viva dropped the photos
so that it could continue to be sold through this channel.
The channel-structure strategy can also be influenced by local, state, and fed-
eral laws in a variety of ways. For example, door-to-door selling of certain goods
may be prohibited by local laws. In many states (e.g., California and Ohio) wine
can be sold through supermarkets, but other states (e.g., Connecticut) do not per-
mit this.
Geographic size, population patterns, and typology also influence the chan-
nel-structure strategy. In urban areas, direct distribution to large retailers may
make sense. Rural areas, however, may be covered only by wholesalers.
With the inception of large grocery chains, it may often appear that indepen-
dent grocery stores are dying. The truth is, however, that independent grocery
stores as recently as 1992 accounted for 46 percent of all grocery sales in the coun-
try—over $175 billion. Thus, a manufacturer can ill afford not to deal with inde-
pendents and to reach them it must go through wholesalers. Wetterau, for
example, is a grocery wholesale firm in Hazelwood, Missouri, which did over $6
billion worth of business serving almost 3,000 retail grocery stores. It does not do
any business with chain stores. But because of Wetterau’s determination to offer
its customers relatively low prices, a wide selection of brands, service programs
carefully designed to make brands more profitable, and a personal interest in
their success, its customers are almost fanatically loyal. The company offers its
customers—small independent retail stores—a variety of services, including lease
arrangements, store design, financing packages, training, and computerized
inventory systems. These services tend to enhance customers’ competitiveness by
reducing their operating costs and by simplifying their bookkeeping, which in
turn helps Wetterau to earn profits.8 The Wetterau example shows that to reach
smaller retailers, particularly in areas far removed from large metropolises, the
indirect distribution strategy is appropriate. The wholesaler provides services to
small retailers that a large manufacturer can never match on its own.
Finally, cultural traits may require the adoption of a certain channel structure
in a setting that otherwise might seem an odd place for it. For example, in many
parts of Switzerland, fruits and vegetables are sold in a central marketplace in the
morning by small vendors, even though there are modern supermarkets all over.
This practice continues because it gives customers a chance to socialize while
shopping. Similarly, changing lifestyles among average American consumers and
their desire to have more discretionary income for life-fulfillment activities
appear to be making warehouse retailing (e.g., Sam’s Club) more popular. This is
so because prices at warehouse outlets—grocery warehouses, for example—are
substantially lower than at traditional stores.
Channel Design Presented below is a channel design model that can be used to make the
Model direct/indirect distribution decision. The model involves six basic steps.
Number & Nature of
1. List the factors that could potentially influence the direct/indirect decision. Each consumer, Types of
factor must be evaluated carefully in terms of the firm’s industry position and Product & Market
competitive strategy.
Market concentration
2. Pick out the factors that will have the most impact on the channel design deci-
Customer Service required by the customer sion. No factor with a dominant impact should be left out. For example, assume
Asset Specific (Uncertainty in the environment) that the following four factors have been identified as having particular signifi-
Working Capital cance: market concentration, customer service level, asset specificity, and avail-
ability of working capital.
Market concentration = 3. Decide how each factor identified is related to the attractiveness of a direct or an
High --> Direct Distribution indirect channel. For example, market concentration reflects the size distribution
Low --> Indirect Distribution of the firm’s customers as well as their geographical dispersion. Therefore, the
more concentrated the market, the more desirable the direct channel because of
-------------------------------------------------------------------
the lower costs of serving that market (high = direct; low = indirect). Customer
Service required by the Customer--> Delivery Time + service level is made up of at least three factors: delivery time, lot size, and prod-
Lot Size + Product Availability uct availability. The more customer service required by customers, the less desir-
High Customer Service --> Indirect Distribution able is the direct channel (high = indirect; low = direct). The direct channel is
Low Customer Service --> Direct Distribution more desirable, at least under conditions of high uncertainty in the environment,
with a high level of asset specificity (high = direct; low = indirect). Finally, the
---------------------------------------------------------------------
greater the availability of working capital, the more likely it is that a manufac-
Asset Specific (Uncertainty in the environment) turer can afford and consider a direct channel (high = direct; low = indirect). Note
High --> Direct Distribution that a high level on a factor does not always correspond to a direct channel.
Low --> Indirect Distribution 4. Create a matrix based on the key factors to consider the interactions among key
-------------------------------------------------------------- factors. If only two factors are being considered, a two-by-two matrix of four cells
would result. For three factors, a three-by-three matrix of nine cells would result.
Working Capital
More --> Direct Distribution
Less --> Indirect Distribution
For four factors, a four-by-four matrix of sixteen cells would result, and so on. If
more than five or six factors are involved, a series of smaller models could be
constructed to make this fourth step more manageable. Exhibit 16-3 presents a
four-by-four matrix developed for this example.
5. Decide (for each cell in the matrix) whether a direct channel, an indirect channel,
or a combination of both a direct and an indirect channel is most appropriate,
considering the factors involved. Combination channels are becoming more com-
mon in business practice, especially in industrial markets.
For some cells in the matrix, deciding which channel design is best is rather
easy to do. For example, Cell 1 in Exhibit 16-3 has all four factors in agreement
that an indirect channel is best. This is also true for Cell 16: a direct channel is the
obvious choice. For other cells, choosing between a direct channel and an indirect
channel is not as easy because factors conflict with each other to some extent. For
example, in Cell 14, asset specificity is low, suggesting that an indirect channel is
best. The other three factors suggest otherwise, however; the market is concen-
trated, customer service requirements are low, and the availability of capital to
the manufacturer is high. Taken together, the factors in Cell 14 reveal that a direct
channel would be most attractive. In the cells that have factors that conflict with
one another, the strategist must make trade-offs among them to decide whether a
direct channel, indirect channel, or combination of channels is best.
EXHIBIT 16-3
Designing a Distribution Channel Matrix
Asset Specificity
Low High
Capital Availability Capital Availability
Low High Low High
High cell 1 cell 3 cell 2 cell 4

indirect indirect indirect combination
Customer
Low Service
Level
Low cell 5 cell 7 cell 6 cell 8
indirect combination combination direct
Market
Concentration
High cell 9 cell 11 cell 10 cell 12
indirect combination direct direct
Customer
High Service
Level
Low cell 13 cell 15 cell 14 cell 16
combination combination direct direct
Source: Gary L. Frazier, “Designing Channels of Distribution,” The Channel for Communication (Seattle, Wash.: Center for Retail
Distribution Management, University of Washington, 1987): 3–7.
6. For each product or service in question, locate the corresponding cell in the box
model. The prediction in this cell is the one that should be followed or at least the
one that should be most seriously considered by the firm.
The accuracy of the model generated by this method depends totally on the
expertise and skills of the person who builds and uses it. If carefully constructed,
such a model can be invaluable in designing more efficient and effective channels
of distribution
6. For each product or service in question, locate the corresponding cell in the box
model. The prediction in this cell is the one that should be followed or at least the
one that should be most seriously considered by the firm.
The accuracy of the model generated by this method depends totally on the
expertise and skills of the person who builds and uses it. If carefully constructed,
such a model can be invaluable in designing more efficient and effective channels
of distribution.9
DISTRIBUTION-SCOPE STRATEGY
For an efficient channel network, the manufacturer should clearly define the tar-
get customers it intends to reach. Implicit in the definition of target customers is
a decision about the scope of distribution the manufacturer wants to pursue. The
strategic alternatives here are exclusive distribution, selective distribution, and
intensive distribution.
Exclusive Exclusive distribution means that one particular retailer serving a given area is
Distribution granted sole rights to carry a product. For example, Coach leather goods are dis-
tributed exclusively through select stores in an area. Several advantages may be
gained by the use of exclusive distribution. It promotes tremendous dealer loy-
alty, greater sales support, a higher degree of control over the retail market, bet-
ter forecasting, and better inventory and merchandising control. The impact of
dealer loyalty can be helpful when a manufacturer has seasonal or other kinds of
fluctuating sales. An exclusive dealership is more willing to finance inventories
and thus bear a higher degree of risk than a more extensive dealership. Having a
smaller number of dealers gives a manufacturer or wholesaler greater opportu-
nity to provide each dealer with promotional support. And with fewer outlets, it
is easier to control such aspects as margin, price, and inventory. Dealers are also
more willing to provide data that may be used for marketing research and fore-
casts. Exclusive distribution is especially relevant for products that customers
seek out. Examples of such products include Rolex watches, Gucci bags, Regal
shoes, Celine neckties, and Mark Cross wallets.
On the other hand, there are several obvious disadvantages to exclusive dis-
tribution. First, sales volume may be lost. Second, the manufacturer places all its
fortunes in a geographic area in the hands of one dealer. Exclusive distribution
brings with it the characteristics of high price, high margin, and low volume. If
the product is highly price elastic in nature, this combination of characteristics can
mean significantly less than optimal performance. Relying on one retailer can
mean that if sales are depressed for any reason, the retailer is then likely to be in
a position to dictate terms to other channel members (i.e., the retailer becomes the
channel captain).
For example, assume that a company manufacturing traditional toys deals
exclusively with Toys “R” Us. For a variety of reasons, its line of toys may not do
well. These reasons may be a continuing decline in the birthrate, an economic
recession, the emerging popularity of electronic toys, higher prices of the com-
pany’s toys compared to competitive brands, a poor promotional effort by Toys
“R” Us, and so on. Because it is the exclusive distributor, however, Toys “R” Us
may put the blame on the manufacturer’s prices, and it may demand a reduction
in prices from the manufacturer. Inasmuch as the manufacturer has no other
reasons to give that could explain its poor performance, it must depend on Toys
“R” Us’s analysis.
The last disadvantage of exclusive distribution is one that is easy to overlook.
In certain circumstances, exclusive distribution has been found to be in violation of
antitrust laws because of its restraint on trade. The legality of an exclusive contract
varies from case to case. As long as an exclusive contract does not undermine com-
petition and create a monopoly, it is acceptable. The courts appear to use the fol-
lowing criteria to determine if indeed an exclusive distribution lessens competition:
1. Whether the volume of the product in question is a substantial part of the total
volume for that product type.
2. Whether the exclusive dealership excludes competitive products from a substan-
tial share of the market.
Thus, a company considering an exclusive distribution strategy should

review its decision in the light of these two ground rules.
Intensive The inverse of exclusive distribution is intensive distribution. Intensive distribu-

Distribution tion makes a product available at all possible retail outlets. This may mean that
the product is carried at a wide variety of different and also competing retail insti-
tutions in a given area. The distribution of convenience goods is most consistent
with this strategy. If the nature of a product is such that a consumer generally
does not bother to seek out the product but will buy it on sight if available, then
it is to the seller’s advantage to have the product visible in as many places as pos-
sible. The Bic Pen Corporation is an example of a firm that uses this type of strat-
egy. Bic makes its products available in a wide variety of retail establishments,
ranging from drugstores, to “the corner grocery store,” to large supermarkets. In
all, Bic sells through 250,000 retail outlets, which represent competing as well as
noncompeting stores. The advantages to be gained from this strategy are
increased sales, wider customer recognition, and impulse buying. All of these
qualities are desirable for convenience goods.
There are two main disadvantages associated with intensive distribution. First,
intensively distributed goods are characteristically low-priced and low-margin
products that require a fast turnover. Second, it is difficult to provide any degree
of control over a large number of retailers. In the short run, uncontrolled distribu-
tion may not pose any problem if the intensive distribution leads to increased
sales. In the long run, however, it may have a variety of devastating effects. For
example, if durable products such as Sony television sets were to be intensively
distributed (i.e., through drugstores, discount stores, variety stores, etc.), Sony’s
sales would probably increase. But such intensive distribution could lead to the
problems of price discounting, inadequate customer service, and noncooperation
among traditional channels (e.g., department stores). Not only might these prob-
lems affect sales revenues in the long run, but the manufacturer might also lose
some of its established channels. For example, a department store might decide to
drop the Sony line for another brand of television sets. In addition, Sony’s distinc-
tive brand image could suffer. In other words, the advantages furnished by inten-
sive distribution should be related carefully to product type to decide if this form
of distribution is suitable. It is because of the problems outlined above that one
finds intensive distribution limited to such products as candy, newspapers, ciga-
rettes, aspirin, and soft drinks. For these types of products, turnover is usually high
and channel control is usually not as strategic as it would be, say, for television sets.
Selective Between exclusive and intensive distribution, there is selective distribution.

Distribution Selective distribution is the strategy in which several but not all retail outlets in
a given area distribute a product. Shopping goods—goods that consumers seek
on the basis of the most attractive price or quality characteristics—are frequently
distributed through selective distribution. Because of this, competition among
retailers is far greater for shopping goods than for convenience goods. Naturally,
retailers wish to reduce competition as much as possible. This causes them to
pressure manufacturers to reduce the number of retail outlets in their area dis-
tributing a given product in order to reduce competition.
The number of retailers under a selective distribution strategy should be lim-
ited by criteria that allow the manufacturer to choose only those retailers who will
make a contribution to the firm’s overall distribution objectives. For example,
some firms may choose retail outlets that can provide acceptable repair and main-
tenance service to consumers who purchase their products. In the automotive
industry, selective criteria are used by manufacturers in granting dealerships.
These criteria consist of such considerations as showroom space, service facilities,
and inventory levels.
The point may be illustrated with reference to Pennsylvania House, a furni-
ture company. The company used to have 800 retail accounts, but it cut this num-
ber to 500. This planned cut obviously limited the number of stores in which the
company’s product line was exposed. More limited distribution provided the
company with much stronger support among surviving dealers. Among these
500 dealers, there was a higher average amount of floor space devoted to
Pennsylvania House merchandise, better customer service, better supplier rela-
tions, and most important for the company, substantially increased sales per
account.
Selective distribution is best applied under circumstances in which high sales
volume can be generated by a relatively small number of retailers or, in other
words, in which the manufacturer would not appreciably increase its coverage by
adding additional dealers. Selective distribution can also be used effectively in
situations in which a manufacturer requires a high-caliber firm to carry a full
product line and provide necessary services. A dealer in this position is likely to
require promotional and technical assistance. The technical assistance is needed
not only in conjunction with the sale but also after the sale in the form of repair
and maintenance service. Again, by limiting the number of retail outlets to a select
few capable of covering the market, the manufacturer can avoid unnecessary
costs associated with signing on additional dealers.
Obviously, the greatest danger associated with a strategy of selective distrib-
ution is the risk of not adequately covering the market. The consequences of this
error are greater than the consequences of initially having one or two extra deal-
ers. Therefore, when in doubt, it is better to have too much coverage than not
enough.
In selective distribution, it is extremely important for a manufacturer to
choose dealers (retailers) who most closely match the marketing goals and image
intended for the product. There can be segments within retail markets; therefore,
identifying the right retailers can be the key to penetrating a chosen market.
Every department store cannot be considered the same. Among them there can be
price, age, and image segmentation. One does not need to be very accurate in dis-
tinguishing among stores of the same type in the case of products that have no
special image (i.e., those that lend themselves to unsegmented market strategies
and mass distribution). But for products with any degree of fashion or style con-
tent or with highly segmented customer groups, a selective distribution strategy
requires a careful choice of outlets.
To appraise what type of product is suitable for what form of distribution,
refer to Exhibit 16-4. This exhibit combines the traditional threefold classification
of consumer goods (convenience, shopping, and specialty goods) with a threefold
classification of retail stores (convenience, shopping, and specialty stores) to
determine the appropriate form of distribution. This initial selection may then be
examined in the light of other considerations to make a final decision on the scope
of distribution.
MULTIPLE-CHANNEL STRATEGY
The multiple-channel strategy refers to a situation in which two or more different
channels are employed to distribute goods and services. The market must be
segmented so that each segment gets the services it needs and pays only for them,
not for services it does not need. This type of segmentation usually cannot be
done effectively by direct selling alone or by exclusive reliance upon distributors.
The Robinson-Patman Act makes the use of price for segmentation almost impos-
sible when selling to the same kind of customer through the same distribution
channel. Market segmentation, however, may be possible when selling directly to
one class of customer and to another only through distributors, which usually
requires different services, prices, and support. Thus, a multiple-channel strategy
permits optimal access to each individual segment.
Basically, there are two types of multiple channels of distribution, comple-
mentary and competitive.
Complementary Complementary channels exist when each channel handles a different noncom-
Channels peting product or noncompeting market segment. An important reason to promote
EXHIBIT 16-4
Selection of Suitable Distribution Policies Based on the Relationship between Type of
Product and Type of Store
Most Likely
Form of
Classification Consumer Behavior Distribution
Convenience store/ The consumer prefers to buy the most Intensive

convenience good readily available brand of a product at
the most accessible store.
Convenience store/shopping The consumer selects his or her purchase Intensive

good from among the assortment carried by
the most accessible store.
Convenience store/specialty The consumer purchases his or her Selective/

good favorite brand from the most accessible exclusive
store carrying the item in stock.
Shopping store/ The consumer is indifferent to the brand Intensive

convenience good of product he or she buys but shops
different stores to secure better retail
service and/or retail price.
Shopping store/shopping The consumer makes comparisons Intensive

good among both retail-controlled factors
and factors associated with the product
(brand).
Shopping store/specialty The consumer has a strong preference as Selective/

good to product brand but shops a number of exclusive
stores to secure the best retail service
and/or price for this brand.
Specialty store/convenience The consumer prefers to trade at a Selective/

good specific store but is indifferent to the exclusive
brand of product purchased.
Specialty store/shopping The consumer prefers to trade at a Selective/

good certain store but is uncertain as to which exclusive
product he or she wishes to buy and
examines the store’s assortment for the
best purchase.
Specialty store/specialty The consumer has both a preference for a Selective/

good particular store and for a specific brand. exclusive
Source: Louis P. Bucklin, “Retail Strategy and the Classification of Consumer Goods,” Journal of
Marketing (January 1963): 50–55; published by the American Marketing Association.
Value Chain Analysis
Definition
Value chain analysis (VCA) is a process where a firm identifies its
primary and support activities that add value to its final product and
then analyze these activities to reduce costs or increase differentiation.
Value chain represents the internal activities a firm engages in when

transforming inputs into outputs.
Understanding the tool

Value chain analysis is a strategy tool used to analyze internal firm
activities. Its goal is to recognize, which activities are the most
valuable (i.e. are the source of cost or differentiation advantage) to the
firm and which ones could be improved to provide competitive
advantage.
In other words, by looking into internal activities, the analysis reveals

where a firm’s competitive advantages or disadvantages are.
The firm that competes through differentiation advantage will try to

perform its activities better than competitors would do.
If it competes through cost advantage, it will try to perform internal

activities at lower costs than competitors would do. When a company is
capable of producing goods at lower costs than the market price or to
provide superior products, it earns profits.
M. Porter introduced the generic value chain model in 1985. Value

chain represents all the internal activities a firm engages in to produce
goods and services. VC is formed of primary activities that add value to
the final product directly and support activities that add value indirectly.
Cost Advantage
Differentiation advantage
Although, primary activities add value directly to the production process,

they are not necessarily more important than support activities.
Nowadays, competitive advantage mainly derives from technological

improvements or innovations in business models or processes.
Therefore, such support activities as ‘information systems’, ‘R&D’ or
‘general management’ are usually the most important source of
differentiation advantage.
On the other hand, primary activities are usually the source of cost
advantage, where costs can be easily identified for each activity and
properly managed.
Firm’s VC is a part of a larger industry’s VC. The more activities a
company undertakes compared to industry’s VC, the more vertically
integrated it is.
Below you can find an industry’s value chain and its relation to a firm
level VC.
Using the tool
There are two different approaches on how to perform the analysis,
which depend on what type of competitive advantage a company wants
to create (cost or differentiation advantage). The table below lists all
the steps needed to achieve cost or differentiation advantage using VCA.
Competitive advantage types:
Cost advantage Differentiation advantage
This approach is used when organizations The firms that strive to create superior
try to compete on costs and want to products or services use differentiation
understand the sources of their cost advantage approach.
advantage or disadvantage and what (examples: Apple, Google, Samsung
factors drive those costs. Electronics, Starbucks)
(examples: Amazon.com, Wal-
Mart, McDonald’s, Ford, Toyota )
Step 1. Identify the firm’s primary and Step 1. Identify the customers’ value-
support activities. creating activities.
Step 2. Establish the relative importance Step 2. Evaluate the differentiation

of each activity in the total cost of the strategies for improving customer value.
product.
Step 3. Identify the best sustainable
Step 3. Identify cost drivers for each differentiation.
activity.
Step 4. Identify links between activities.
Step 5. Identify opportunities for

reducing costs.
Cost advantage
To gain cost advantage a firm has to go through 5 analysis steps:
Step 1. Identify the firm’s primary and support activities.
All the activities (from receiving and storing materials to marketing,

selling and after sales support) that are undertaken to produce goods or
services have to be clearly identified and separated from each other. This
requires an adequate knowledge of company’s operations because value
chain activities are not organized in the same way as the company itself.
The managers who identify value chain activities have to look into how
work is done to deliver customer value.
Step 2. Establish the relative importance of each activity in the total

cost of the product.
The total costs of producing a product or service must be broken down

and assigned to each activity. Activity based costing is used to calculate
costs for each process. Activities that are the major sources of cost or
done inefficiently (when benchmarked against competitors) must be
addressed first.
Step 3. Identify cost drivers for each activity. Only by understanding

what factors drive the costs, managers can focus on improving them.
Costs for labor-intensive activities will be driven by work hours, work
speed, wage rate, etc. Different activities will have different cost drivers.
Step 4. Identify links between activities. Reduction of costs in one

activity may lead to further cost reductions in subsequent activities. For
example, fewer components in the product design may lead to less faulty
parts and lower service costs. Therefore identifying the links between
activities will lead to better understanding how cost improvements
would affect he whole value chain. Sometimes, cost reductions in one
activity lead to higher costs for other activities.
Step 5. Identify opportunities for reducing costs. When the company

knows its inefficient activities and cost drivers, it can plan on how to
improve them. Too high wage rates can be dealt with by increasing
production speed, outsourcing jobs to low wage countries or installing
more automated processes.
Differentiation advantage
VCA is done differently when a firm competes on differentiation rather
than costs. This is because the source of differentiation advantage
comes from creating superior products, adding more features and
satisfying varying customer needs, which results in higher cost
structure.
Step 1. Identify the customers’ value-creating activities. After

identifying all value chain activities, managers have to focus on those
activities that contribute the most to creating customer value. For
example, Apple products’ success mainly comes not from great product
features (other companies have high-quality offerings too) but from
successful marketing activities.
Step 2. Evaluate the differentiation strategies for improving

customer value. Managers can use the following strategies to increase
product differentiation and customer value:
 Add more product features;

 Focus on customer service and responsiveness;
 Increase customization;
 Offer complementary products.
Step 3. Identify the best sustainable differentiation. Usually, superior

differentiation and customer value will be the result of many interrelated
activities and strategies used. The best combination of them should be
used to pursue sustainable differentiation advantage.
Value Chain Analysis Example
Completing a value chain analysis allows businesses to examine their
activities and find competitive opportunities. For example, McDonald's
mission is to provide customers with low-priced food items. The
analysis helps McDonald's identify areas for improvement and activities
that add value to their products and services.
Below is an example of a value chain analysis for McDonald's and its

cost leadership strategy.
Support Activities - Differentiation Advantage
Primary Activities - Cost Advantage

Primary Activities: McDonald's
 Inbound Logistics: McDonald's has pre-selected, low-cost suppliers
for the raw materials for their food and beverage items. It
sources suppliers for items like vegetables, meat, and coffee.
 Operations: The business is a franchise and each McDonald's
location is owned by a franchisee. There are more than 39,000
McDonald's locations worldwide.
 Outbound Logistics: Instead of formal, sit-down restaurants,
McDonald's has restaurants that focus on counter-service, self-
service, and drive-through service.
 Marketing and Sales: Its marketing strategies focus on media and
print advertising, including social media posts, magazine
advertisements, billboards, and more.
 Services: McDonald's strives to achieve high-quality customer
service. It provides its thousands of employees with in-depth
training and benefits so they can best assist their customers.
"C-suite" refers to the executive-level managers within a

company. Common c-suite executives include chief executive
officer (CEO), chief financial officer (CFO), chief operating
Support Activities; McDonald's officer (COO), and chief information officer (CIO).
 Firm Infrastructure: The McDonald’s corporation has both C-suite

executives and Zone Presidents who oversee the firm’s operations
in various regions, with a general counsel overseeing legal matters.
 Human Resource Management: It maintains a career page where
job seekers can apply to both corporate and restaurant roles. It
pays both hourly and salaried rates and promotes its tuition
assistance program to attract talent.
 Technology Development: The restaurant has invested in touch
kiosks to facilitate ordering and increase operational efficiency.
 Procurement: The firm uses Jaggaer, a digital procurement firm,
to establish relationships with key suppliers across various regions
of the world.

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Pricing and Distribution 373

E. PRICE AND VALUE FOR MONEY

F. THE CHAIN OF DISTRIBUTION

Producer Retailer Consumer

Producer Wholesaler Retailer Consumer

Producer Agent Wholesaler Retailer Consumer

Choice of Distribution Channel

(i) Rate of turnover – frequently-purchased, low-cost items such as

(ii) Wide geographical dispersion of customers may require long channels.

Distribution Channel Maintenance

I. DEALING WITH INTERMEDIARIES

Working with Retailers

Working with Wholesalers

The Impact of Technology

446 PART 6 Marketing Strategies

and the total number of transactions with a market is given by:

In the example of five producer-consumers, the efficiency of having a middle-

C represents costs to the buyer for holding an inventory;

(With Intermediaries) (Without Intermediaries)

Following Bucklin’s framework, one determines the channel structure by

time. Delivery time is the number of days (or hours) Diagram I

OPERATION OF THE PRINCIPLE

The second category of costs involves those emanat- Diagram 2

the goods themselves to the flow of their title. Specu-

Increasing the delivery time decreases postponement costs for the

448 PART 6 Marketing Strategies

Benetton, an Italian apparel maker, offers an excellent example of a distribu-

Additional The postponement-speculation theory provides an economic explanation of the

CHAPTER 16 Distribution Strategies 449

Another example of the use of technology to overhaul distribution is pro-

450 PART 6 Marketing Strategies

CHAPTER 16 Distribution Strategies 451

High cell 1 cell 3 cell 2 cell 4

452 PART 6 Marketing Strategies

CHAPTER 16 Distribution Strategies 453

Thus, a company considering an exclusive distribution strategy should

Intensive The inverse of exclusive distribution is intensive distribution. Intensive distribu-

454 PART 6 Marketing Strategies

Selective Between exclusive and intensive distribution, there is selective distribution.

CHAPTER 16 Distribution Strategies 455

456 PART 6 Marketing Strategies

Convenience store/ The consumer prefers to buy the most Intensive

Convenience store/shopping The consumer selects his or her purchase Intensive

Convenience store/specialty The consumer purchases his or her Selective/

Shopping store/ The consumer is indifferent to the brand Intensive

Shopping store/shopping The consumer makes comparisons Intensive

Shopping store/specialty The consumer has a strong preference as Selective/

Specialty store/convenience The consumer prefers to trade at a Selective/

Specialty store/shopping The consumer prefers to trade at a Selective/

Specialty store/specialty The consumer has both a preference for a Selective/

Value chain represents the internal activities a firm engages in when

Understanding the tool

In other words, by looking into internal activities, the analysis reveals

The firm that competes through differentiation advantage will try to

If it competes through cost advantage, it will try to perform internal

M. Porter introduced the generic value chain model in 1985. Value

Although, primary activities add value directly to the production process,

Nowadays, competitive advantage mainly derives from technological

Competitive advantage types: