The Japanese Economy, vol. 32, no. 3, Fall 2004, pp. 526. 2005 M.E. Sharpe, Inc.

. All rights reserved. ISSN 1097203X / 2005 $9.50 + 0.00.

AKIO TORII AND TATSUHIKO NARIU

On the Length of Wholesale Marketing Channels in Japan

Abstract: Wholesalers enter distribution channels to capitalize on their private information about demand and supply. The channels become long only when such private information is valuable. In this article, we document the close link between wholesalers private information and length of the marketing channel, based on analysis of panel data for five wholesale industries drawn from the last three decades of Japans Census of Commerce. Specifically, we show that marketing channels tend to be longerthat is, they have more wholesale stepswhere wholesalers tend to be in close geographic proximity to the final demanders, where wholesalers tend not to be organized into distribution keiretsu by manufacturers, where regional variation in demand tends to be idiosyncratic, where producers advertise less intensely and distributors advertise more intensely, and where the density and heterogeneity of retail outlets is greater. All of these are factors likely to be associated with the value of wholesalers private information. A frequent complaint about the Japanese distribution system is that wholesale distribution channels are too long. This kind of criticism implicitly presumes that middlemen provide no valuable services, and merely add to the costs of marketing. Nothing could be more wrong. See Nariu and Flath (1993) for an elaboration. Here suffice it to say that wholesalers and retailers both provide essential services. For instance, retailers make appropriate assortments for customers convenience, and they also inform their customers about the merchandise. Wholesalers offer services that buttress those of the retailers. Each retailers activity is typically confined to a local area. In addition, retailers
Akio Torii is affiliated with Yokohama National University. Tatsuhiko Nariu is affiliated with Kyoto University.
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THE JAPANESE ECONOMY

usually lack the information that manufacturers need in planning new models. Nor do the retailers necessarily know which producer is providing each commodity. Neither do producers know the specific requirements of each retailer. Here then is an opening for wholesalers to profitably mediate between producers and retailers, bridging the information gap that separates them. This is particularly so when producers and retailers are small and numerous, as is frequently the case in Japan. In contrast, when a large-scale producer establishes its own brand, and most of the retailers come to know the merchandise it produces, information gaps between producers and retailers become small and wholesaling has little to contribute. The market dominance of large-scale retail stores has a similar effect. In these situations, wholesaling loses its importance, and mediation between producers and retailers need not be accomplished by an independent wholesale dealer. It can be accomplished instead by the producer or the retailers themselves. Sales subsidiaries of manufacturers and purchase headquarters of chain stores are examples of this. Under these circumstances, the importance of wholesaling decreases, and the distribution channels remain short. In this article, we analyze determinates of the length of the wholesale distribution channel for five kinds of consumer goods from 1968 to 1997, using panel data from Japans Census of Commerce. The main conclusions are that a large information gap between producers and retailers induces intervention by wholesalers to bridge the gap, which makes the distribution channel long, and a small information gap due to the establishment of producers brands and the presence of large-scale retailers makes the distribution channel short. Structure of Distribution Channels Role of Information in Distribution Channels Capturing and transmitting information is indispensable for smooth management of distribution, so that appropriate merchandise is planned, produced, and provided to consumers. In planning new merchandise, it is necessary to collect and analyze information about demand to assure profitable choices. Information about supply is also relevant, including the relation between product quality and costs, and what kinds of products are provided by rivals and on what terms. Knowledge of the manufacturing process is also useful for organizing efficient production of the planned merchandise. And, of course, an important aspect of marketing is to inform consumers of the existence, price, and quality of the merchandise, where they can get it, and so on. To accomplish this requires a great deal of very specific information, including information

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about customers preferences and shopping behavior. And yet, sales agents may well lack complete information about which producers supply what merchandise. Similarly, producers may themselves not know relevant details about the assortments of merchandise likely to be chosen by each sales agent. These information gaps afford profit opportunities for wholesalers. One method of exploiting information is to sell it directly. But, trading information is not always possible due to its specific characteristics. In many cases, the owner of information (seller) is often the only one capable of thoroughly evaluating it. Buyers of information cannot determine its value ex ante, and often cannot correctly judge its quality, even after it is acquired. When a buyer cannot evaluate the quality of the information for sale, the seller may not divulge all the information he knows but only a portion of it; he may even intentionally transmit false information. For instance, when newly introduced merchandise does not sell, it may be an instance of failure at sales promotion and not a case of incorrect information about the demand. Thus it can be difficult to know even after the fact whether correct information was supplied. In this situation, the seller of information will have little incentive to collect accurate information involving high cost. There is no perfect solution to this problem. Consider a contract under which a set portion of sales or profit from a newly developed product is promised in exchange for the traded information. Such a contract induces the buyer of information to understate his sales or profits. In order to suppress this type of opportunism, the buyer must monitor the performance of the seller. However, monitoring is not easy for a seller who does not have the requisite know-how about planning and sales promotions. When monitoring costs are prohibitively great, the trading of information is thus inhibited. Where selling valuable information is impossible, those who hold it may still profit from it by utilizing the information directly. The holder of valuable information about demand and supply would benefit from participating in the distribution process. This is the essential nature of wholesaling, as elaborated by Nariu and Torii (2000). The basic role of a wholesaler is to bridge the information gap between the producer and the retailer. Consider a situation in which numerous small producers and retailers coexist. To form an appropriate assortment, each retailer should understand the supply trends. And to plan and produce appropriate merchandise, the producer should also collect information on consumption trends. If the producers and retailers each gather information separately in this situation, their costs would be huge. But if a wholesaler mediates between them, each producer would have to gather information only from the one wholesaler. It is the same for the retailers. Thus, information costs are avoided by wholesalers mediation.

THE JAPANESE ECONOMY

Role of Wholesalers One raison dtre of wholesalers lies in information about demand that is specific to local regions. It is difficult to sell this type of information due to the nature of information, so the wholesaler itself participates in trading in the channel to convert the information to profit. Certainly, producers themselves could gain a lot of information about local demand from direct dealing with the retailers. But their information will be less complete than would be that of a wholesaler who deals with all the retailers rather than just some of them and who deals in a wider assortment of brands than that of just the one manufacturer. An independent wholesaler is thus uniquely positioned to exploit economies of scale and scope in collecting and analyzing relevant information. This point has long been recognized in the marketing literature, as in Alderson (1957, 1965). Another raison dtre of wholesalers is information about supply. Wholesalers collect information on which producer is supplying what merchandise. Wholesalers select what merchandise to handle and what to offer each retailer, based on their own information about demand, which obviates the need for each retailer to collect detailed information about supply. This can achieve significant economies, because it avoids unnecessary duplication of effort and because the wholesaler has a more global perspective than any one retailer could. Consider the production of woven fabrics in Japan. In this field, many small producers gather in sanchi (specific geographic areas) where sanchi-oroshi (wholesalers located in sanchi) play a crucial role. There are numerous small independent producers, which represents an extreme division of labor. Sanchioroshi wholesalers mediate between each process. They organize and coordinate production after collecting necessary information for the product planning. In this situation, it would be unnecessarily duplicative and wasteful for each producer to collect demand information and engage in production based on it. The sanchi-oroshi wholesalers achieve scale economies and avoid this waste, as argued by Kurasawa, Nariu, and Torii (2002). Sanchi-oroshi wholesalers also collect information about demand. In some cases, the supply information of the sanchi-oroshi wholesaler might be very local, concerning only its region. In this situation, there is an opening for another wholesaler that stands downstream in the channel to also collect supply information. Similarly, demand information acquired by wholesalers located in close geographic proximity to retailers (hereafter, consumption area wholesalers) might also be local and limited. Then, wholesalers that stand upstream are needed, for example, ones located in close geographic proximity to the supplier.

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Wholesalers categorize and evaluate goods provided by manufacturers, a process subject to economies of scale. Wholesalers handle the merchandise of many different producers, and so are well-positioned to supply each retailer with an optimal assortment. In this way, wholesalers bridge the information gap between manufacturers and retailers. Wholesalers who themselves evaluate goods may profit from doing so, by guaranteeing the goods or by maintaining a reputation for veracity in their dealings with retailers. See Hall (1948) for an early recognition of this, and see Shapiro (1983) for a modern treatment of the economics of reputations. The services of wholesalers are thus not merely logistic ones, the transporting of goods, although that, too, is a frequent task of wholesalers, complementary to the other ones just described. Wholesalers are able to pool risks and economize on inventory costs, precisely because they deal with many suppliers and many retailers. This point too was recognized by Hall (1948), an early student of wholesaling. Viability of Wholesalers The economic viability of wholesalers depends on the size of information gaps between producers and retailers. Where these gaps are small, independent wholesalers may not emerge. For instance, if large-scale producers establish their own brands, and most of the retailers know what merchandise they are supplying, information gaps between production and retailers become small, and the wholesalers have little role to play. Similarly, when there exist largescale retailers, and most of the producers have information on their purchasing behavior, there is little opening for wholesalers. And yet another example of when wholesalers may not be viable is that in which a single producerfor instance an integrated appliance makersupplies a wide range of goods, and retailers form their assortments from this stock. For further elaboration of this point with respect to Japans consumer electronic industries see Niida and Mishima (1991). We should also note that in some cases, manufacturers may not want independent wholesalers to handle their merchandise. Consider the case of search goods such as apparel. For these goods consumers are apt to visit several shops to learn about and compare products, and so recommendations by retailers have a significant effect, and become an important aspect of sales promotion. Accordingly, manufacturers of these products wish to establish and preserve cooperative relations with retailers in order that their products get a proper evaluation. Here, too, independent wholesalers may not be economically viable. In any channel, information gaps between production and consumption

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should be bridged. However, this need not be accomplished only by wholesalers. When producers sell merchandise directly to the consumers, the producers themselves chiefly carry out the information function. In recent years, large-scale retailers have planned their private brand (PB) merchandise only after having analyzed the demand, and have left the production itself to others. In this situation, retailers are chiefly accomplishing the information function. Independent wholesalers are not needed in every case. It may be instructive to take a general overview of the historical trends in Japanese wholesaling, in light of the previous discussion. Historical Transition We discern three successive regimes in the evolution of Japanese distribution channels over the past half-century. From the situation of shortages of consumer items in the 1950s and 1960s, through the age of mass production and mass consumption of the 1970s and 1980s, and finally now toward more individuality and variety, Japanese marketing channels have changed significantly. At first wholesalers played the dominant role in collecting and acting on market information, then large-scale producers, and now large-scale chain stores. The Age of Consumer Product ShortagesWholesalers Take the Initiative In Japans age of consumer product shortages before 1960 (it sells if it is made), neither product planning nor sales promotion seems to have been very important. There was little need to base production planning on detailed information about demand. But retailers did require information about the available supply. At that time, producers and retailers both tended to be small and numerous, and information gaps between them were large. In this situation, wholesalers who bridged those gaps played an important role and emerged as channel leaders. Actually, even if an individual retailer collected merchandise supply information, it could still not realize a great profit because of its smallness. In this situation, wholesalers came to the fore, to capitalize on the economies of scale in collecting and analyzing information. Because of the peculiar character of information as discussed above, to sell information is difficult. Therefore, wholesalers profited from their information, not by selling it separately, but by construing their arrangements with retailers in such a way that the wholesalers themselves bore both the risks and rewards of their own correct choices of which merchandise to ship to each retailer and in what quantities. This was accomplished by the wholesalers

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liberally accepting returns by retailers of any unsold merchandise. This aspect of a liberal returns policy has been explored in a series of articles by Nariu (1996) and Flath and Nariu (1989, 2000). Under a liberal returns policy, wholesalers themselves bear the risks from unsold goods, and inappropriate assortments are penalized. Therefore, wholesalers attempt to make appropriate assortments based on the market information they themselves have gathered and analyzed. In Japan in the 1950s and 1960s, wholesalers liberal acceptance of retailers returns of unsold merchandise improved the reliability of the assortments and the quality of information. Moreover, information was efficiently exploited through the channel. The Age of Mass ProductionProducers Take the Initiative With the advent of mass production of consumer goods in Japan in the 1970s and 1980s, the scale of some producers grew large and they themselves took on tasks that had previously been left to independent wholesalers. The essential impetus for mass production was to achieve scale economies. But as consumer product makers grew large, they gained market power and began themselves to intensely promote their own brands. Once a brand was established, information gaps between producers and retailers were closed, and little necessity for intermediation by wholesalers remained. The establishment of a brand enables the price elasticity of demand to be kept low, and makes stable production possible. Therefore, it becomes easy to sustain long-term relationships, and investment in relation-specific resources is promoted. This may have prompted Japanese producers of consumer goods to organize wholesalers and retailers of their wares into distribution keiretsu, as proposed by Nariu and Torii (2000). The essential character of a distribution keiretsu is administration and enforcement of a system of vertical restraints. For specific examples of these in Japan refer to Flath (1989) and for generic analysis of the economics of vertical restraints see Tirole (1988). The basic impetus behind vertical restraints seldom is cartelization. Rather, the usual intent of vertical restraints is to align the economic interest of the retailers and wholesalers with that of the manufacturer, and elicit efficient and profitable marketing efforts from all of them. As manufacturers in Japan organized wholesalers into distribution keiretsu, displacing the wholesalers as channel leaders, they introduced the same sort of liberal returns policy with the wholesalers that the wholesalers had earlier adopted with respect to retailers, and for the same reason. It shifted the risks and rewards of supply decisions to those making the decisions, who were also the best informed.

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THE JAPANESE ECONOMY

As brands of consumer products became established, recommendations by retailers became important to sales promotion efforts. To elicit such efforts, producers began to deal directly with retailers and side-stepped wholesalers in some cases. This gave rise to virtuous cycles in which retailers cooperated with manufacturers to plan and develop products that better fit the needs of their customers, which in turn led to stronger recommendations by retailers and still greater scale economies for manufacturers. Some retailers, too, began to grow large as their own product endorsements came to carry more weight with customers. None of these changes crowded out independent wholesalers completely. In part this was because the share of large-scale retail stores, that is, chain stores, was small, and independent wholesalers continued to mediate between the producers and the still numerous small stores. In this situation, it was more advantageous for large-scale retailers to leave distribution to incumbent wholesalers than to construct a whole new logistic system. Thus, the structure of distribution channels did not change abruptly, but changed gradually, as parts of the earlier system persisted. The Age of Small-Scale Production of Diversified Types Large-Scale Retailers Take the Initiative Since the 1990s, advances in technology have enabled the supply of a greater variety of goods than ever before without the sacrifice of scale economies. As it has become economical for producers to more completely accommodate the diverse preferences of consumers, rapid analyses of demand information have become more valuable in fine product planning. This is especially crucial for merchandise such as womens fashion apparel, where products are highly varied and consumers preferences change quite rapidly, but in a malleable way that can be influenced through marketing and promotion. For these types of products, direct contact with consumers has become more important as a means of gathering information and influencing fashions. For this reason, some manufacturers of womens apparel in Japan have now advanced into the retail market. Moreover, as large-scale retailers, that is, chain stores, have gained larger shares and their names have become popular among consumers, the information gap between producers and retailers has narrowed. Indeed, the retailers themselves can exploit the economies of scale in gathering and analyzing information about the demand. Under this situation, large-scale retailers need not utilize wholesalers, and can make assortments based on their own information. Recent growth of information technology has even allowed some largescale retailers to access more information than wholesalers. Under these circumstances, large-scale retailers have gained advantages in planning and

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designing new products, which they commission from manufacturers directly, themselves retaining the risks and rewards from having done so. In this way, the large retail chains have taken on the role of gathering information that had earlier been performed by wholesalers or by producers. Econometric Analysis Basic Foci Based on the arguments elaborated in the previous sections, here we analyze econometrically the determinants of the structure of distribution channels for Japans consumer goods. The econometric analysis uses panel data on five wholesale sectorstextiles; clothes and accessories; farm, livestock, and aquatic products; food and beverages; and drugs and toiletriesfor more than two decades of Japans Census of Commerce (1972, 1974, 1976, 1979, 1982, 1985, 1988, 1991, 1994, and 1997). Japans Census of Commerce classifies wholesalers according to the place each mainly occupies in a distribution channel. Direct wholesalers (jika oroshi) mainly buy from producers and sell to retailers. Primary wholesalers (moto oroshi) mainly buy from producers but sell to other wholesalers. Final wholesalers (saishu oroshi) mainly sell to retailers but buy from other wholesalers. And secondary wholesalers (naka oroshi) mainly buy from other wholesalers and sell to other wholesalers. In other words, marketing channels with one wholesale step have direct wholesalers. Those with two steps have primary wholesalers and secondary wholesalers. And those with three or more steps have primary wholesalers, secondary wholesalers, and final wholesalers. In the previous section, we argued that wholesalers enter marketing channels to profit from their valuable private information about demand and supply. Wholesalers that enter a marketing channel to collect information about local demand, and profit from it, are likely to enter as final wholesalers in close geographic proximity to their retail customers. Their presence will enable upstream wholesalers to move closer to distant producers and to better collect information about supply, an example of the Hotelling principle of maximal product differentiation. Accordingly, a good proxy for the incidence of wholesalers that specialize in information about local demand (consumption area wholesalers) would be the following1: CW = (purchases of final wholesalers from other prefectures) / (purchases of primary wholesalers from other prefectures). This statistic is correlated both with the close geographic proximity of final

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wholesalers to local retailers, and that of primary wholesalers to distant producers. Each of these indicates the presence in the marketing channel of wholesalers who are profiting from information about the local demand. Our econometric analysis has two foci. The first is an exploration of the sensitivity of our proxy for the incidence of consumption area wholesalers CW, to factors associated with the value of local information about demand. These factors include intensity of advertising, number and heterogeneity of retail outlets, and idiosyncrasy of local demand. The other focus is on how the incidence of consumption area wholesalers interacts with other factors to determine the length of marketing channels N. These factors include the incidence of intracompany shipments between manufacturing firms and their own wholesale subsidiaries, the incidence of distribution keiretsu affiliation, and, again, the number and heterogeneity of retail outlets. Our measure N of the length of the distribution channel, that is, the average number of wholesale steps, is the same as that of Nariu and Flath (1993). Specifically, it is the total markup for each kind of business, that is, the difference between the price paid to the manufacturer and that paid by the retailer divided by the average markup per wholesaler in that line of business.2 This is a rough estimate of the number of independent wholesalers through whose hands products flow before reaching the retailer. Tables 1 and 2 report observations for the dependent variables in our analyses, our proxy for incidence of consumption area wholesalers CW, and our measure of number of wholesale steps N, for each of the Census of Commerce years 1972 to 1997, for each of ten broadly defined product categories. All of the values for N reported in Table 1 are less than two, except for those of farm, livestock, and aquatic products. The number of steps has declined slightly for apparel and accessories, but shows little trend in the other industries. The transition of CW depicted in Table 2 shows an influx of consumption area wholesalers in food and beverages, and their withdrawal from apparel and accessories distribution. We next construct econometric models for analysis of N and CW for the five of the ten lines of business that are consumer products. Incidence of Consumption Area Wholesalers The working hypothesis, on which our econometric analysis of CW is based, is that consumption area wholesalers are more prevalent where local information about demand is more valuable. We propose several correlates of the value of local information about demand. The first is advertising intensity. We expect that producer advertising ought to vary inversely with the value of wholesalers local information about demand. Advertising by producers indicates that the brand has become established and is likely to be familiar to retailers as

Table 1 Estimated Changes in Number of Wholesale Steps

Wholesale industries Textiles Apparel and accessories Farm, livestock, and aquatic products Food and beverages Drugs and toiletries Chemicals Mineral and metallic raw materials Machinery Building materials Furniture and fixtures

1968 1.48 1.58 2.19 1.63 1.38 1.45 1.48 1.33 1.71 1.44

1970 1.41 1.53 2.09 1.66 1.40 1.48 1.55 1.36 1.76 1.42

1972 1.51 1.56 2.07 1.58 1.31 1.46 1.53 1.34 1.69 1.37

1974 1.61 1.54 2.11 1.66 1.31 1.50 1.64 1.38 1.75 1.43

1976 1.69 1.48 2.31 1.63 1.28 1.47 1.60 1.37 1.73 1.41

1979 1.73 1.52 2.33 1.65 1.28 1.49 1.76 1.35 1.75 1.45

1982 1.72 1.50 2.43 1.66 1.34 1.55 2.09 1.33 1.75 1.31

1985 1.62 1.45 2.24 1.66 1.37 1.46 1.87 1.39 1.73 1.46

1988 1.72 1.49 2.25 1.45 1.33 1.42 1.58 1.39 1.68 1.48

1991 1.54 1.36 2.25 1.55 1.36 1.40 1.63 1.35 1.68 1.38

1994 1.52 1.35 2.24 1.51 1.34 1.40 1.59 1.38 1.67 1.36

1997 1.64 1.45 1.99 1.55 1.34 1.44 1.67 1.40 1.68 1.43
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Table 2 Changes in the Incidence of Consumption Area Wholesalers

Wholesale industries Textiles Apparel and accessories Farm, livestock, and aquatic products Food and beverages Drugs and toiletries Chemicals Mineral and metallic raw materials Machinery Building materials Furniture and fixtures

1968 0.260 0.307 0.093 0.122 0.229 0.164 0.088 0.089 0.138 0.164

1970 0.182 0.328 0.132 0.124 0.094 0.147 0.128 0.116 0.174 0.183

1972 0.342 0.335 0.151 0.092 0.147 0.207 0.266 0.125 0.146 0.148

1974 0.300 0.316 0.106 0.212 0.101 0.120 0.119 0.137 0.214 0.170

1976 0.271 0.290 0.116 0.127 0.078 0.114 0.132 0.110 0.170 0.167

1979 0.217 0.273 0.181 0.127 0.075 0.116 0.284 0.089 0.166 0.255

1982 0.277 0.275 0.189 0.165 0.108 0.170 0.180 0.160 0.198 0.324

1985 0.177 0.276 0.123 0.182 0.106 0.149 0.289 0.125 0.228 0.213

1988 0.129 0.250 0.207 0.131 0.178 0.149 0.075 0.123 0.220 0.216

1991 0.204 0.200 0.199 0.189 0.280 0.183 0.135 0.145 0.214 0.177

1994 1997 0.121 0.223 0.209 0.227 0.167 0.198 0.126 0.176 0.358 0.144 0.199 0.145 0.159 0.242 0.146 0.163 0.110 0.204 0.355 0.213

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well as consumers, so that the information gap between the producer and retailers is narrow, with little opening for wholesalers. Advertising by wholesalers and retailers may well have the opposite effect. Accordingly, we expect that CW is inversely related to the advertising to sales ratio of producers ADM, but may be positively related to the advertising to sales ratio of wholesalers and retailers in the channel ADD.3 The second factor associated with the value of information available to consumption area wholesalers is the idiosyncrasy of local demand. Our proxy for this is: VR = ln(s i.t. si.t. si.t. 1 ) where ln shows natural logarithmic function and si.t. is the fraction of sales of all wholesalers in the ith prefecture in year t to someone (retailer, wholesaler, or user) in the same ith prefecture, which is obtained in Census of Commerce industry statistics (prefecture tables). In words, VR represents the weighted average of the absolute value of the difference between the previous year and the current one as a fraction of all wholesalers sales to buyers located in the same prefectures as they. This index shows to what extent the wholesale sales within one prefecture tend to fluctuate independently of wholesale sales in the other prefectures. When the changes in demand are in the same direction in each prefecture, so that VR is small, demand information specific to the one prefecture would become less valuable, and afford less of an opening for consumption area wholesalers. And in the opposite case, the local demand information is more valuable, leaving a greater opening. Accordingly, we expect that the incidence of consumption area wholesalers CW is positively related to our index of the prefectural idiosyncracy of demand VR. A third set of factors associated with the value of wholesalers information about the local demand is the number and heterogeneity of retailers. As retailers become more numerous, the scale advantages of wholesalers become greater, as detailed in the previous section. Accordingly, we expect CW to vary positively with each prefectures total number of retailers in related product lines NUM.4 Not only the number but also the size distribution of retailers matter here. In general, the wholesale services required by small retailers are larger than those of large-scale retailers. Accordingly, we might expect that where retailers are more heterogenous in scale of employment, the incidence of consumption area wholesalers is greater. That is, CW might vary inversely with GN, defined as the Gini coefficient of the size distribution of retail establishments.5 In some of the regressions we also include two additional control variables. One of them is a dummy variable DUM equal to one for the farm, livestock,

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and aquatic products industry. In this industry, there is high possibility that commodities are traded by wholesalers at vegetable and fruit markets or fish markets. These markets are different from the wholesale markets for other goods. They operate very efficiently and the publicly announced prices in these markets change frequently and reveal much relevant information about local demand. This may well leave a smaller information gap for consumption area wholesalers to exploit. Another control variable is suggested by concern that the dependent variable CW can be increased simply because the sales of final wholesalers are disproportionately large relative to the sales of primary wholesalers, for reasons unrelated to the incidence of consumption area wholesalers. To control for this effect, we include as a control variable: LW = (total sales by final wholesalers) / (total sales by primary wholesalers) The total sales are obtained from Census of Commerce. It is expected that larger LW means larger CW. To summarize the previous, we propose the following statistical regression model: ? + + + CW = f(ADM, ADD, VR, NUM, GN, DUM, LW) Number of Wholesale Steps A further object of our analysis is the number of wholesale steps N. Our conjecture is that where the incidence of consumption area wholesalers is greater, the number of wholesale steps also tends to be greater. That is, we expect that N varies postively with CW. But there are also other factors that influence the length of distribution channels. The first of these is the incidence of producers forward integration into wholesaling. Where producers maintain wholesale subsidiaries, the information gap between the producers and retailers is more completely filled than if they did not do so, which leaves a smaller opening for other wholesalers. We thus expect that the number of wholesale steps is less where the incidence of such producer affiliate wholesalers is greater. We define: DI = (total sales by wholesale subsidiaries of producers) / (sum of sales of primary, secondary, and final wholesalers).

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Notice that the denominator is the sum of sales by wholesale dealers other than subsidiaries of producers. We expect that the number of wholesale steps N varies inversely with the incidence of producer-subsidiary wholesalers DI. Table 3 represents the time series for this variable for the ten industries. It rises remarkably in machinery, drugs and toiletries, and food and beverages, which reflects a trend toward vertical integration of production and wholesaling in those industries. Further, we expect that the incidence of distribution keiretsu interacts with the number of wholesale steps. As argued in the previous section and as demonstrated by Torii (1982, 1987), producers who organize wholesalers and retailers into distribution keiretsu, themselves provide some of the services that would otherwise be the domain of independent wholesalers. We prepared a variable KR as the proxy for keiretsu affiliation calculated from BSCSA (Report on the Basic Survey of Commercial Structure and Activity), where: KR = 1 (the number of enterprises NOT organized into distribution keiretsu) / (number of all enterprises). That is KR shows the fraction of wholesale dealers that belong to a distribution keiretsu, whether organized by the producer or by another wholesaler. We expect the number of steps N to vary inversely with KR. Finally, we expect the number and heterogeneity of retailers to influence the number of wholesale steps in the same way as they influence the incidence of consumption area wholesalers. And again we introduce a dummy variable for the farm, livestock, and aquatic products industry. To summarize, our econometric specification for explaining a number of wholesale steps is the following: + + + N = f(CW, DI, KR, NUM, GN, DUM) Results In this section results of the econometric analyses are provided. Results for the Incidence of Consumption-Area Wholesale Dealers (CW) The result of the estimation of the regression explaining CW (incidence of consumption area wholesalers) is shown in Table 4. Independent variables

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Table 3 Changes in the Share of Producer Subsidiary Wholesalers

Wholesale industries Textiles Apparel and accessories Farm, livestock, and aquatic products Food and beverages Drugs and toiletries Chemicals Mineral and metallic raw materials Machinery Building materials Furniture and fixtures 1968 0.210 0.221 0.160 0.366 0.617 0.378 0.409 0.516 0.247 0.186 1970 0.221 0.279 0.165 0.433 0.727 0.506 0.421 0.758 0.289 0.268 1972 0.221 0.310 0.259 0.463 0.863 0.466 0.445 0.699 0.314 0.288 1974 0.159 0.414 0.250 0.519 0.934 0.498 0.497 0.803 0.368 0.343 1976 0.175 0.320 0.424 0.546 0.828 0.444 0.644 0.790 0.328 0.315 1979 0.192 0.286 0.296 0.582 0.852 0.574 0.604 0.964 0.318 0.373 1982 0.238 0.311 0.435 0.706 1.125 0.698 0.756 0.943 0.378 0.336 1985 0.177 0.372 0.501 0.674 1.138 0.568 0.710 1.240 0.378 0.478 1988 0.187 0.407 0.401 0.602 1.215 0.581 0.588 1.318 0.416 0.509 1991 0.147 0.339 0.360 0.738 1.431 0.561 0.598 1.151 0.404 0.451 1994 0.191 0.313 0.281 0.733 1.316 0.473 0.587 1.184 0.357 0.437 1997 0.329 0.301 0.225 0.768 1.395 0.519 0.664 1.353 0.338 0.440

Table 4 Regression Equations to Determine the Incidence of Consumption Area Wholesalers

Adj. R 2 Hausman 0.439 0.100 0.472 0.236 0.452 0.071 0.471 0.168 0.481 0.236 0.449 0.101 0.470 0.295
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Equation no. 1 RE 2 RE 3 RE 4 RE 5 RE 6 RE 7 RE

Constant 0.136 (1.22) 0.275 (1.02) 0.417 (1.51) 0.407 (1.74) 0.376 (1.73) 0.554 (2.39) 0.327 (2.78)

LW
0.348 (3.34) 0.317 (3.01) 0.317 (3.01 0.268 (3.11) 0.273 (3.26) 0.270 (3.07) 0.273 (3.22)

ADM
0.632 (0.57) 0.621 (0.58) 1.68 (2.10) 0.385 (0.37)

ADD
4.22 (2.14) 7.61 (2.83) 8.54 (3.02) 9.00 (4.05) 8.81 (4.16) 10.00 (4.46) 5.60 (3.17)

VR
0.0241 (1.50) 0.0247 (1.56)

DUM
0.100 (2.10) 0.0474 (0.86) 0.492 (0.84)

NUM GN

0.0249 (1.59) 0.0299 (2.75)

1.42 (1.76)

0.0198 (1.70)

0.0294 NUM (1.68) 0.0296 NUM (1.55) 0.0388 NUM (2.64) 0.0384 NUM (2.77) 0.0390 NUM (2.43) 0.412 GN (2.71)

Notes: RErandom effect model; FEfixed effects model; HausmanRE vs. FE Hausman test p-value.

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prepared to explain the value of information about the local demand are advertising to sales ratios (ADM, ADD), index of idiosyncrasy of prefectural demand movement (natural log of VR), number and heterogeneity of retailers (natural log of NUM, and GN), farm, livestock, and aquatic products industry dummy (DUM), and control for the ratio of sales by final wholesaers relative to those by primary wholesalers (LW). The random effect model (hereafter, REM) is recommended by the Hausman test statistic for all regression equations. The coefficient of the control variable LW is consistently positive, as predicted. The coefficient of proxy variable ADM expressing the establishment of the producer brand by product differentiation is negative, as expected, although it is not significant (Equation 1). Here it is important to note that ADM has a high correlation with VR (simple correlation coefficient 0.691). Therefore, a multicolinearity problem seems to be present. In Equation 3, where VR is excluded from explanatory variables, the coefficient of ADM is negatively significant, by two-tailed test at the 5 percent level. Meanwhile, the coefficient of ADD, which indicates the importance of downstream sales promotion activity, is positively significant, as expected in all the estimated equations. The coefficient of VR, the importance of information characteristic to each region, is consistently positive as expected, although it is not significant in Equation 1. However, the insignificance might be due to multicolinearity bias as VR has high correlation with ADM. Indeed, in Equation 5, where ADM is excluded from the explanatory variables the coefficient is highly significant. Therefore, our main hypotheses are supported: (1) that as the value of local information about demand is higher, the incidence of consumption area wholesale dealers is also higher; and (2) the distribution channel becomes longer as consumption area wholesalers enter into the channel. The negative coefficient of DUM shows the tendency that there are few final wholesalers in the farm, livestock, and aquatic products industry. It is weakly supported that as the number of retail establishments is larger, the role of consumption area wholesalers is more important. GN, an index of relative size distribution of retailers, has a negative coefficient as expected, though not significant, which implies that as sizes of retailers become more evenly distributed the role of consumption area wholesalers becomes more important. Results for the Number of Wholesale Steps (N) For the last part, we estimated the regression equation explaining number of wholesale steps N. The result is summarized in Table 5. We investigated the determinants of length of the wholesale channel, employing the incidence of consumption area wholesalers (CW), which has been explained in the first

Table 5 Regression Equations to Determine the Number of Wholesale Steps

Equation no. 1 RE 2 FE 3 RE 4 FE 5 RE 6 FE

Constant 1.42 (13.26)

CW
1.04 (2.48) 1.47 (2.89) 1.03 (2.44) 1.48 (2.81) 0.971 (2.33) 1.48 (2.90)

DI
0.188 (1.30) 0.185 (1.06) 0.187 (1.24) 0.189 (1.02) 0.201 (1.33) 0.167 (0.94)

KR
0.912 (2.61) 0.785 (2.22) 0.913 (2.49) 0.802 (1.97) 0.968 (2.57) 0.659 (1.65)

NUM GN

DUM
0.728 (8.77)

Adj. R 2 Hausman 0.874 0.033 0.952 0.871 0.035 0.950 0.877 0.017 0.951
FALL 2004

1.42 (3.37)

1.49 (7.05)

0.000160 NUM (0.00) 0.00975 NUM (0.09) 0.0872 GN (0.29) 0.235 GN (0.71)

0.728 (8.59)

0.732 (8.95)

Notes: RErandom effect model; FEfixed effects model; HausmanRE vs. FE Hausman test p-value.

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model. The correlation between the residuals in that model and those in this one might cause simultaneous equations bias. Therefore, we avoid this problem by the method of iterative OLS. That is, we replace CW with the predicted values from the first regression, Equation 6 in Table 4. The Hausman test statistic recommends the adoption of a fixed effects model (FEM) in all of the regression equations. It is shown that the higher the incidence of consumption area wholesalers, the longer the distribution channel. The regression coefficient is consistently significant in all regression equations, irrespective of which model we employ, FEM or REM. Note the sign of the regression coefficient for DI, the sales share of producer-subsidiary wholesalers. Intuitively, a higher incidence of these producer subsidiaries should shorten the distribution channel. But the regression coefficient is positive though not significant, which is opposite to the intuition. Perhaps there will be a lagged effect of this sort of vertical integration, which seems to be increasing. It is supported by the negative coefficient of KR that where distribution keiretsu are present, the number of wholesale steps is less. We cannot identify the effect of number of retailers NUM or the relative dispersion of their size distribution GN, on the number of wholesale steps. Thus, it is not supported that the wholesale channel is long because there are so many small-sized retailers in Japanese retail markets. That is, we are unable to affirm the finding of Nariu and Flath (1993) that the higher retail store density causes longer distribution channels. Finally, the effect of the dummy variable DUM for farm, livestock, and aquatic products industry should be obvious. Of course, this dummy variable is valid only in REM. Conclusion In this article, we made an empirical analysis of the factors that determine the number of wholesale steps in Japans consumer good business (five wholesale industries) using panel data from more than two decades of the Census of Commerce. We argued that wholesalers enter distribution channels to capitalize on their private information. Hypotheses supported by econometric analysis are that the length of the distribution channel is influenced by the incidence of consumption area wholesalers, the share of producer subsidiary wholesalers, and the incidence of distribution keiretsu affiliation. As a matter of fact, most of the changes in the length of wholesale channel for the five industries and nine censuses can be explained by these factors. At the same time, we can maintain that determinants

FALL 2004

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of the incidence of consumption area wholesalers are the idiosyncrasy of prefectural demand movements, importance of downstream advertising and promotional activities, and the number and size-distribution of retailers. These factors are all associated with the value of local information about demand available to consumption area wholesalers. In this article, we assumed that the incidence of producer subsidiary wholesalers is an exogenously given factor. However, it may be endogenously determined, because the degree of vertical integration should be closely associated with the degree of keiretsu affiliation or other environmental factors. To investigate more precisely on the determinants of this kind of vertical integration, we need a more general model considering coordination costs and transaction costs. We left this task for further research. Notes
1. The amount the primary wholesaler and the final wholesaler purchased from other prefectures is obtained by subtraction of the purchase from their own prefecture from total purchase presented in the Statistics by Distribution Channel Edition (wholesale) of Census of Commerce. Unfortunately, the statistics reports regional aggregated data only on three prefectures, Tokyo, Aichi, Osaka until recently. Therefore, we had to limit the estimation of the index to only these three major prefectures. 2. Imagine that the typical producer sells to a primary wholesale dealer at price p0, and the wholesale dealer sells to a secondary wholesale dealer at price p1, and so on until the last wholesale dealer in the chain sells to a retailer at price pN. Here the number of wholesale steps is N. Suppose that the average wholesale markup (m = (pi + 1 pi) / pi) is the same for all i = 0, ..., N 1. Now the total markup in the chain is: pN / p0 = (p1 / p0) (p2 / p1)(pN / pN 1) = (pi + 1 / pi)N= (1 + m)N. Thus, from the estimates of the total markup in the chain M = (pN p0) / pN = (1 + m)N 1 and the average markup m, we recover an estimate of the number of steps as: N = ln(pN / p0) / ln(pi + 1 / pi) = ln(1 / (1 M)) / ln(1 / (1 m)). 3. The advertising to sales ratio for retailers is the weighted average of the ratios in each subindustry, from Ministry of Economy, Trade and Industry (METI) Cost Indexes of Small- and Medium-sized Enterprises. For the weights we employed the sales of each subindustry in the Census of Commece. The advertising to sales ratio for the wholesalers is obtained from METI, Report on the Basic Survey of Commercial Structure and Activity (BSCSA). We calculated the advertising to sales ratio in each distribution channel ADD by summation of these two ratios, considering the difference of denominators caused by the existence of distributors margin. The advertising to sales ratio for producers is also the weighted average of each manufacturing subindustry obtained from METI, Cost Indexes of Small- and Mediumsized Enterprises; and the weights are from Census of Commerce. 4. NUM is drawn from the Census of Commerce, retail statistics. 5. GN is calculated using size distribution data by number of workers in Census of Commerce.

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References
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