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Distribution Strategies 2 - Channel Design (13:39)
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Christian TerwieschAndrew M. Heller Professor at the Wharton School, Senior Fellow Leonard Davis Institute for Health Economics Co-Director, Mack Institute of Innovation Management
The Wharton School
[MUSIC]
So in addition to figuring out what activities have to be done and
who is going to do them, we need to make some other important
decisions about the design of our distribution channel.
And one framework that's often helpful for doing this for us,
is to think about the intensity of distribution.
What do I mean by that?
The intensity, I mean, is how many outlets or
how many channels of distribution do we have serving us in a particular market.
So, if we have an exclusive distribution channel,
that means in a particular market, Philadelphia, Los Angeles, Tokyo,
wherever it is, we just have one individual or one distributor or
one entity that's bringing our product to market.
If, on the other hand, we have intensive distribution, that means there are many,
many providers of the product or service in a given market.
Obviously, if there are many of them,
this may be creating some competition between them.
So what are some rules of thumb that we need to think about
in determining whether or not we want to go with intensive distribution
versus exclusive distribution or the midpoint which is selective distribution?
So intensive distribution might be a good thing
when we don't really need any selling support.
If it's a product like Coca-Cola, we might want it in every store,
every vending machine, every place possible, just so it's made available
in order to minimize the consumer's cost of accessing or obtaining a product.
On the other hand, exclusive distribution might be really, really important
if we want to try to find the strongest provider and somehow reward them.
This is often used in the automobile market.
If I'm selling expensive cars like Ferrari,
I don't want somebody right next door doing the same thing.
I might want the rights to have an exclusive territory.
So that's a reason for having exclusive distribution,
is to partake the reseller and give them a chance to make a bit of margin.
In the middle is selective distribution where
neither of those other two extremes really seem to fit.
The customers need to get access to the product, but
there's also some consultitative selling that's required in order to encourage
the end consumer to buy the product.
So now I'd like to reintroduce something that we talked about earlier and
something that we're familiar with from our discussion of how to
generate those lead users and expand the market beyond the early customers
all the way to the larger target base.
Here I'm showing the product life cycle.
As you may remember, it goes through four phases.
Phase one is the introduction phase, then there's a growth phase, a maturity phase.
And finally, with most products or services at some point,
or brands at least enter into a decline phase.
So let me give you an example with a very, very simple product or service.
A piece of home equipment for an entertainment system,
for showing movies and things in your own home.
When the product's first introduced, let's imagine it's initially introduced in
a very kind of selective way, with home video specialists.
As the product gets into the growth phase and we want it to be more
widely available, then maybe it goes into a larger distributor,
like a base file something like that if we're talking about United States.
Finally, as the product gets into maturity,
you might expand to other channels such as Walmart.
And then finally, as it goes into decline,
the product my end up being sold on Ebay or other kinds of secondhand markets.
So what you could see, as the product goes through the life cycle,
the amount of information that's required to sell it goes down,
because people are familiar with the product or
service, but the intensity of the distribution tends to go up.
We want the product available almost everywhere and because of that,
the logistical needs also kind of increase.
So again,
hopefully what you're seeing from this is when we're accessing customers,
the access to customers is also related to how the product is going through its own
life cycle from introduction, to growth, to maturity and then to decline.
So let's continue with this idea of the hybrid grid, namely that there were
certain entities doing certain activities in sort of an optimal way.
So what are the implications of this view, or using a tool like the hybrid grid to
understand your own customer access plan, your own channel of distribution?
So the first thing to keep in mind is that the kinds of activities that get done
really depend on the complexity of your product.
If you have a very, very complex product,
like that bovine growth hormone that I mentioned in the example,
there may be many, many things that need to be done from education to awareness
to retrieval of the products through after sale service and so on.
And so that's the first thing.
How complex is my productile service that will determine the list of activities.
The second thing to keep in mind is activities,
once you've decided what needs to be done, cannot be eliminated.
Once you've figured out the columns, they are what they are,
you cannot change those.
You can't suddenly decide not to provide after sales service typically or
suddenly decide not to generate new leads.
What you can do however, is you can change who is performing what activity and
that often leads to some very, very interesting innovations.
So let me give you three examples.
So you could think about the notion of a forward shift and function.
And that would be Ikea for example,
who used to in the early days do their own delivery and
installation decided at a certain point, you know what, we can't really do that.
We're going to let some third party do it.
So they're sort of farming off an activity to another entity that's able to do it
better.
You might also think about a backwards integration as well.
This would be the case of Apple taking over some of the function of selling
the goods and services themselves in their own stores as opposed to having
independent retailers do it for them.
And then thirdly, we could think of a sideways shift.
This would be Amazon using a parallel company like FedEx or
UPS to do the delivery of its goods and services rather than doing it themselves.
So this is a very, very important implication,
you cannot eliminate activities, but you can change or eliminate certain players.
And often that's a vital source of innovation,
like the Michael Dell innovation for example, diapers.com.
Many, many innovative businesses don't eliminate activities, but
what they do do is they change who's doing them.
The important thing of course to keep in mind
is that anyone who's performing an activity needs to be compensated
usually in the form of some kind of channel margin for doing that.
Otherwise they're going to stop there.
And this is sort of a nice segue for us now into thinking about the next thing
on our list after the structure of the channel and
the design of the channel, which is how does one keep a channel coordinated.
So, now, let's get to our third piece on the discussion of access to customers and
channels of distribution.
This is kind of a fun one.
This is the idea of coordinating a channel and when a channel often has conflict,
this can be kind of a tricky thing to do.
So let me just illustrate again by way of a chart
what can go on in a distribution channel.
You may have a manufacturer on one side saying hey,
why aren't you taking my entire range of products?
And the distributor or the retailer says well hey, I don't want all the dogs,
I just want the best products.
I only want the three series BMW, I don't want the one series, but
the manufacturer wants all of them to be taken.
The manufacturer may say, we'd like some more information about who's
coming into your store or your channel and buying our product and service.
And the retailer might say, well we don't keep any of that information and
even if we did, we're not going to give it to you.
The manufactures and retailers might also argue over margins.
So the manufacturer might say, gee, you're taking too much margin and
the retailer says well your wholesale prices to me are too high.
So what we have here, typically, in a channel of distribution
are independent businesses that sometimes might be opposing.
And we want to try and figure out what are some solutions to all of this conflict,
so let's go through some of that.
The first thing is that having some level of conflict is good,
it keeps everyone on their toes.
You don't necessarily want all of the conflict in the channel to be
completely eliminated, you want some there just to sort of keep things fresh and
to keep things interesting.
So, let's look at the diagram that explains the two main types of conflict
that occur at a distribution channel and how we can actually resolve these.
So in the blue there, we have a manufacturer,
who's distributing a product to three different retailers A, B and C and
it could be the case that the manufacturer has a conflictual situation with one or
all of the retailers.
Now I'll show you some examples of that in a moment.
Secondly there's also a notion of horizontal conflict.
Horizontal conflict, retailer B and C is somehow competing with each other or
something unfortunate is happening in that relationship.
So let's start with Vertical conflict.
There's a fairly famous case of vertical conflict that I encourage you again to
look up a little bit on the internet.
We have a manufacturer Nike,
who got into a conflictual relationship with its main distributor Foot Locker.
Foot Locker wasn't necessarily interested in selling or promoting every single SKU,
stock keeping unit, of shoes and so on that Nike was selling.
Nike, of course, wanted Foot Locker to make it a prominent brand and
to give it a lot of support in the retail store.
So there was an inherent conflict between these two
entities that was a vertical conflict.
So how could one resolve vertical conflict in a relationship like this?
Well, you could integrate.
So Nike could decide, you know what, we're going to have our own stores,
and that's where we'll sell the product.
In fact, Nike does have some flagship stores in various places around the world,
including the United States.
So there's a flagship store in Chicago, San Francisco, and other places.
That will be one solution to eliminate any conflict.
One of the players just decides,
you know what, I'm going to do the whole thing myself.
The second thing that could be done to eliminate conflicts is we could
change the relationship and we could have franchised stores.
So, a lot of companies in the gasoline industry do this, there franchises for
Exxon Mobil gasoline, fast food.
There's franchises for McDonald's and Dunkin' Donuts.
So, that's also a way of minimizing conflict
by bringing everybody under the same kind of umbrella.
Those are both fairly legal or structural ways of doing things.
You can also minimize conflict by being a little bit more subtle in the way that you
do it by monitoring what's going on with the downstream player.
So another way to minimize conflict, would be to have mystery shoppers go into
the various FootLocker stores and see on earth what's going on there, and
then report back to the other corporate entities and
then negotiate if something was amiss.
So those are various ways,
both implicit and explicit, that vertical conflict could be removed.
Another way you could do it if you were the manufacturer is you could say you know
what, I'll minimize vertical conflict by
only giving the top performing retailers my hot products and my best sellers.
I'll sort of use a carrot and stick approach
to get rid of some of the conflict over who is getting what in the relationship.
So that's vertical conflict.
So now let's move on to Horizontal conflict.
Horizontal conflict is really fascinating and
in many ways more subtle than the notion of Vertical conflict.
So by horizontal conflict,
we mean conflict between players at the same level of the channel.
So conflict between retailers a, b and c in my example.
So why does this horizontal conflict occur?
Well, unless those retailers are literally carbon copies of each other in terms of
the level of service and prices that they provide, there's the potential for
something called horizontal free-riding, which is actually the behavior of you and
I, so let me explain that.
So imagine that there are low price, low service retailers and
high price, high service retailers.
And let's take a simple example of consumer electronics.
And for argument's sake let's imagine that there's a high price,
high service retailer in my local neighborhood.
Let's call that Chris's Hi-fi store and also there's a lower
price retailer in the same neighborhood let's call it let Amy's Discount store.
So there's a high price seller high service and
a low price seller that's offering less service.
So what might I do as a consumer?
Well I might go to Chris' store, I might spend an hour engaging with
the sales person learning about exactly the right kind of Color TV,
sound system, and so on to put into my home.
And then instead of buying it,
what I do is I walk across the street to Amy's store and I get the lower price.
So what I've done is I've taken something that's being provided by Chris,
not compensated him for it and, in fact, got a lower price from Amy.
This is called horizontal free-riding.
And in its most extreme form, we see it in terms of the phenomenon showrooming,
where I go into a store, I engage with a salesperson.
I look at all the variety.
I touch and feel the sweater to make sure it's the one that I want.
And then I go to sweaters.com or amazon.com and by it at a lower price.
So how could we possibly get around that sort of situation?
Well let's start with traditional Horizontal free-riding
before we go into the phenomenon of show room.
So what we could is we could reduce the number of retailers per territory
to separate Chris's store from Amy's store.
We could try and
make those stores more uniform through something like franchising.
But in general, what we could do is we could create more selective or
exclusive distribution.
That would minimize the chance of horizontal free riding.
It's a little bit more difficult though when we get to the Internet.
So we'll look at some statistics on that in a moment.
[MUSIC]
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