© Design Principles for Distribution Channels Distribution Channel Strategy BA266: L. P. Bucklin

© Overview Channel Design –Market based –Plan based Dual Channel Sectors –Commercial sector provides services to end-user –Channel design endeavors to balance cost of service vs. added value to the end-user Major service dimensions –Logistic –Information

© Market Channel Design Most channels result from evolutionary forces rather than planned design Evolutionary channels, as opposed to planned, are the consequence of: –Decisions by innovative firms to enter a channel to provide a set of services –Imitation of innovators –Adaptation of existing channel members to the new entrants

© End-User Butcher Grower Super- market Meat Wholesaler Meat Market Abattoir Restaurant Packing House Grower Meat Fabricator Meat Wholesaler Portion Control Wholesaler Evolution of Natural Channels for Fresh Meat

© Planned Channel Design The specification of the set of channel members to provide the value-added services desired by a targeted market by means of cost-benefit analysis Channel member assignments –Activities they perform, e.g., transport, inventory, information, financing –Number, location & connectivity with other channel members Individual member firms may sub-divide operations into a number of individual business units

© Principle I End users incur real and opportunity costs in the acquisition and preparation of products and services for production

© Channel Value-Added Services Logistic –Access--convenience –Availability--delivery time, accuracy –Order size, frequency –Assortment--breadth, variety –Product availability, freshness Information –Richness, vividness, accuracy –Responsiveness to information requests

© Channel Sectors Two channel sectors –The end-user sector including Þ the household Þ industrial, institutional buyers –The commercial sector including Þ The end-user interface (EUI) Þ Supply channel members to the EUI Total channel costs: sum of all costs incurred by the commercial channel and the end user to delivery/acquire and consume the product These are equivalent to the price paid by the end user for the product/service plus ancillary costs of acquisition and preparation for use

© The Two Channel Sectors Suppliers End-User Separate Marketing Functions Indirect ChannelDirect Channel Commercial Sector: Manufacturers, Intermediaries, Agents End-user Sector Total Channel Costs = Commercial Sector Costs + End-user Costs

© Factors Affecting End-User Service Demand Opportunity costs for end-user shopping time –Size of family, dual careers, income Travel technology –Availability of transport options to shoppers –City densities affecting travel times Cost of buying in large lots –Rate of consumption, storage space availability –Capital to stock products, risk in holding inventories Predictability of needs Product knowledge, frequency of purchase Product cost relative to income

© Factors Affecting the Cost of Value-added (VA) Service Product cost (interest, risk of products in channel pipeline) –Rate of product obsolescence, introductions, interest rate Product physical characteristics –Weight to value ratio (bulkiness) –Fragility, toxicity The cost of channel inputs –Labor, cost of capital, land –Purchased services, e.g., transportation, advertising, website Assortment breadth, depth Assortment variety, breadth, depth Distance between supplier and end-user

© Principle II The Commercial Channel evolves so as to provide the set of services demanded by the end user. The design of a channel requires an in-depth understanding of the set of needs possessed by end users and what they will pay for these.

© Channel System Costs The commercial sector incurs greater costs as it provides higher levels of value added End-user acquisition costs decline as commercial sector value-added services increase –Value-added services reduce the level of effort, time and ancillary resources incurred by the end user to acquire and prepare products/services for consumption –These resources involve real, opportunity and emotional costs

© Channel Service Equilibrium Costs/Transaction Service Output End-user Costs (A) Commercial Sector Costs (B) Total Channel Costs (A+B) Equilibrium total channel costs commercial channel costs end-user costs Service level provided

© Channel Cost Balance Total channel costs take a U-shape At equilibrium, the interests of the end-user are maximized when the marginal benefits for V-A service equal the marginal cost to the commercial channel of supplying these services Equilibrium determines: –Total costs for the system –The level of service provided to the end-user –The share of total channel costs performed by the end-user

© Channel Evolution Channel members enter, depart, and reassign duties in order to alter and improve efficiency of value-added services Channels evolve by balancing the incremental costs of additional services against the value that they provide to the end user Competitive forces, over time, cause value-added prices to reach competitive levels – Channel innovators are copied by new entrants – Channel systems incur life cycles with accelerating, then waning profit levels

© Principle III Competitive channel systems seek equilibrium over time in order to balance the incremental costs of additional services against the value that these would add for the end user

© Logistic Channel Design Logistic channels comprise those members of the channel that provide logistic services

© Channel Length Channel length is a rough approximation of channel structure From a logistics point of view, it is measured by the number of firms (and related establishments) that hold title or manage inventories in the commercial channel An establishment is a separate place of business where channel service generating activities are performed; i.e., a warehouse and chain of stores

© Historic Automobile Logistics Channel End-users Supplier Auto Store Logistic services include ease of access to product, assortment breadth, immediate availability American end users want to drive car away if they like one at a lot

© Cadillac Test Channel End-users Supplier EUI inventory costs are high in order to provide services Test system provides warehouse for intermediate storage Savings in commercial channel cost occur while maintaining easy end user access But, inventory at warehouse may be at high risk Auto Store Warehouse

© Logistic Channel Components Logistics systems comprise a sequence of inventory and transit/product handling systems To provide high level logistic service, the EUI is locates proximate to the end user; e.g., a drug store –The more proximate to the end user, the: Þ Greater the channel’s ability to provide fast replenishment, such as a convenience store, but Þ EUI inventory turnover declines and inventory risk increases Þ Transport costs increase since goods must be sold transported to the EUI in small quantities

© Principle IV: The addition of higher value-added logistic services leads to longer channels with incremental inventory points as the means to reduce logistic costs at the EUI

© Two Inventory Types Speculative Inventory (Risk Holding Point) –Inventories comprised of fungible products on first come/first basis; such as typical store inventories –Efficient when future demand is not accurately forecast Transit Point (Ship-Through-Inventory Point) –Inventories comprised of packages marked for specific destinations /customers ; no break bulk is performed –Facilitate rapid ingress, egress with little time at the inventory point; no back-up stocks are held; e.g., FedEx –Typically used in rapid response channels to large scale EUI

© Efficient Consumer Response Efficient consumer response seeks to limit inventories and inventory points in the distribution system, yet retain the same level of logistic service Inventory is shifted up the channel to higher points in the system, often at the supplier level Transit inventories are established Improvements in communication and fast delivery systems through air-truck combinations employed –Match delivery to time when expected inventory is zero –System knowledge of current demand widely shared –Employs cross-docking, transit inventories

© Corollary to Principle IV Employing rapid response design transforms speculative inventories to transit inventories, reducing inventory cost but at the cost of higher transportation cost.

© Information Channel Design Information channels comprise the subset of members that provide product information services in the channel

© Information Services for Products Information VA services include: –The speed by which a message can be prepared, sent, and interpreted –The complexity or richness of information that is carried by a message –The extent to which the message can sufficiently describe a product’s characteristics –The accuracy and interpretability of the information in a message

© Channel Design and Comparative Information VA Supplier Store Wholesaler EUI-1 Desktop EU-3 Big Iron VAR EU-2 Server Fastest, most accurate from supplier to EU Slowest, least accurate from supplier to EU

© Long channels provide information at a relatively low cost, but at a low quality The flow of information through multiple intermediaries in a channel system takes longer, corrupts & degrades the information When the end user requires complex products and rich information infor- mation intermediaries are eliminated Information Costs

© Principle V Higher information value added provided to the end user requires a reduced channel length as information intermediaries are eliminated to prevent information degeneration

© Interactions Between Information and Logistic Services Hybrid Direct Commercial Warehouse Pure Indirect Channel Hybrid Broker Drop-ship Pure Direct Channel EU Information Needs EU-Logistical Needs High Low Pure channel: same logistic and information structure Hybrid channel: different logistic and information structure

© Principle VI The presence of similar end user needs for information and logistics leads to hybrid channels with information and logistics traveling separate routes The presence of dissimilar end user needs for information and logistics leads to pure or integrated channels where information and logistics services are provided by the same organizations