Chapter 9 Vertical Integration in Distribution

FIGURE 8.1: CONTINUUM OF DEGREES OF (Relational Governance) VERTICAL INTEGRATION Buy Make Classical Market Contracting Quasi-Vertical Integration (Relational Governance) Vertical Integration How does the the work get done Third Party Does it (for a price) You do it Their people Their money Their risk Their responsibility Your people Your money Your risk Your responsibility The costs You and third party share costs and benefits Their operation (control) Their gain or loss Your operation (control) Your gain or loss The benefits

The Continuum of Interfirm Exchange Format* Franchise Systems Hierarchy (within firm) Buying Groups Market Setting (outside firm)

TABLE 8.2: EXAMPLES OF INSTITUTIONS PERFORMING SOME CHANNEL FLOWS Function Classical Market Contracting Quasi-vertical Integration Vertical Integration 1) Selling (only) Manufacturers’ “Captive” or Exclusive Producer Sales Representatives Sales Agency * Force (direct sales force) 2) Wholesale Independent Distribution Distribution Distribution Wholesaler Joint Venture Arm of Producer 3) Retail Independent Franchise Company Distribution (3rd party) Store Store * Operationally, a sales agency deriving more than 50% of its revenues from one principal

Distribution Objectives 6 Distribution Objectives Economic Theories of Vertical Integration Transaction Cost Analaysis Control Rights Theory

Transaction Cost Analysis (TCA) Focus: Economic Efficiency Costs occur whenever firms perform “functions” Fixed and variable components. TCA states that firms should purse the most efficient channel arrangement based on cost avoidance. “Make” = Direct channel = Vertical Integration “Buy” = Indirect channel

Key Assumptions and Conditions for TCA* Channel members negotiate, monitor, and enforce exchange aspects by considering: Bounded rationality Opportunism Uncertainty (Internal and External) Specificity of assets Frequency of transactions

Internal versus External Transactions Conditions for choosing hierarchy (Internal) over market (external): A high level of environmental uncertainty should exist in the transaction cost assessment. The assets involved should be highly specialized and unique to the exchange process. The transaction should occur frequently. Examples: Sherwin-Williams; Curtis Mathes Third Breed: Clan Mechanism

FG 7.2: HOW ENVIRONMENTAL UNCERTAINTY IMPACTS VERTICAL INTEGRATION Low Specificity High Specificity Highly Volatile Market Outsource Distribution to Retain Flexibility Until Uncertainty Is Reduced Highly Promising Market Less Promising Vertically Integrate to Gain Control Over Employees And Avoid Small-Numbers Bargaining In Changing Circumstances Do Not Enter

FIGURE 7.4: ROAD MAP TO THE VERTICAL INTEGRATION DECISION Presume outsourcing is more attractive than vertical integration Start here GO! NO Is potential business major or substantial? Outsourcing preferable YES Examine how function will develop (Take both roads and see where they go) Will substantial company-specific investments accrue? Will performance ambiguity be high? NO NO Outsourcing remains attractive YES YES Volatile, uncertain environment (accelerates effect of company-specific investments) Consider overturning outsource presumption: Vertical Integration, increasingly attractive

II. Control Rights Theory (Jensen and Meckling 1976) 1 II. Control Rights Theory (Jensen and Meckling 1976) 1. Two Types of Knowledge - General Knowledge: Easy to transfer - Specific Knowledge: Costly to transfer 2. Channel Organizing Principle: - Ownership is not the focus - Collocate control with knowledge

Chapter 8 Strategic Alliances in Distribution  Skip!

Motivating the Channel Members

Major Topics for Motivating Channel Members 9 Major Topics for Motivating Channel Members General Discussion Finding out Channel Member Needs Three Types of Programs that Motivate Channel Members* Another Approach on Channel Member Motivation*

Motivation Management The actions taken by the manufacturers to foster channel member cooperation in implementing the manufacturer’s distribution objectives

Motivating Channel Members Basic Framework 1. Find out the needs and problems of channel members. 2.Offer support to the channel members that matches with their needs and problems. 3.Provide leadership through the effective use of power.

Supporting Channel Members* 9 3 Types of Channel Trade Programs Cooperative Arrangements 2. Partnership or strategic alliance 3. Distribution programming

1. Cooperative Arrangements 9 Focuses on channel member needs & problems Simple & straightforward Conveys a clear sense of mutual benefit

Cooperative Arrangements 9 Typical types of cooperative programs provided by Manufacturers to channel members Cooperative advertising allowances Payments for interior displays Contests for buyers, salespeople, etc. Allowances for warehousing functions Payments for window display space Detail men who check inventory Demonstrators Coupon-handling allowance Free goods = A Common Element of above programs?

2. Partnerships & Strategic Alliances 9 Focus on a continuing and mutually supportive relationship between the manufacturer and its channel members

Partnerships & Strategic Alliances 9 Three basic phases Manufacturer should make explicit statement of policies in areas such as product availability, technical support, pricing, etc. Manufacturer should assess all existing distributors as to their capabilities for fulfilling their roles 3. Manufacturer should continually appraise the appropriateness of the policies guiding his or her relationship with the channel members

Strategic Distribution Alliance Characteristics Enduring connections Substantial connections What sets SDA apart from others Trust Commitment Like Marriage? Building Commitment Expectation of continuity Bilateral communication Balanced Power between the two Commitment is mutual

Strategic Distribution Alliance How to gauge the commitment by the other side? Previous relationship Actions A word of caution: Not for every relationship One side has special needs The other side has the capability to meet those needs Each side faces exit barriers

3. Distribution Programming 9 A comprehensive set of policies for the promotion of a product through the channel Developed as a joint effort between the manufacturer and the channel members to incorporate the needs of both

Distribution Programming 9 Steps for developing a program: Analysis of marketing objectives & the kinds of levels of support needed from channel members • Ascertains channel members’ needs & problem areas Formulate specific channel policies that offer: • Price concessions to channel members • Financial advice • Some kind of protection for channel members 3. An Example: Category Management

Relationship Differences 9 Cooperative Arrangements Intermittent interactions between manufacturer & channel members Partnerships & Strategic Alliances Continuing & mutually supportive relationship Distribution Programming Deals with virtually all aspects of the channel relationship

Another Approach on Motivating Channel Members* 9 Another Approach on Motivating Channel Members* Theoretical foundation: Agency theory Before you begin… Screening and Qualification Selection As you begin… Role Specification Joint Planning

Another Approach (Cont’d) 9 Another Approach (Cont’d) 3. After You Begin… 1. Channel Incentive: More than $$$! 2. Monitoring: Outcome Monitoring Behavior Monitoring 3. Enforcement: Legal Enforcement Market Enforcement Self Enforcement * Is this all?