Channels of Distribution

Prof. Nanda Kumar, University of Texas at Dallas

Marketing Management
Main Issues
• Role of Distribution Channels
• Nature of Conflicts
− Vertical Conflicts
− Horizontal Conflicts
• Trade Promotions
• Design of Distribution Channels
Role of Distribution Channels
• Why have intermediaries?
▪ Can perform activities more efficiently
−Wholesalers – buy from different manufacturers and sell to retailers
−Retailers – provide a one stop shopping experience to consumers (much
like what the wholesalers do for retailers)
▪ Firms may not have the resources to invest in a distribution system
−Manufacturer’s agents – acts on behalf of manufacturers
▪ Lack of information
−Agents/Brokers – real estate market
Cost of Using Distribution Channels

• Each intermediary in the distribution channel is expected to add value

• Each intermediary expects to get compensated for adding value
▪ Compensation must cover costs
▪ Yield a profit
• Results in pricing efficiencies
▪ Double-Marginalization Problem
Vertical Conflict

• Double-Marginalization Problem
▪ Why does this problem arise?
− Incentives of intermediaries not aligned with that of the others

• Bait-Switch
▪ Lure customers into store and switch them to higher margin brands (competing)
 Direct Channel: Manufacturer Owns the Retailer

P Demand Curve

Marginal Revenue
Retail Curve
price (pi)

Marginal
Cost (c) Qty.
Qty. sold (qi)
 Indirect Channel:
Double-Marginalization (DM)

P Demand Curve

Retail
price (pr)

Marginal Revenue
Whole- Curve
sale price

Marginal
Cost (c) Qty.
Qty. sold (qr)
Effects of DM
• Retail prices too high (pr>>pi)
• Quantity sold too low (qr<<qi)

• More importantly profits of the value-chain are

lower with DM:
(pr-c)qr < (pi-c)qi (monopoly profits)
Solving DM
• Quantity Discounts
▪ Provides incentives to enhance volume

• Two-Part Tariffs
▪ Charge a fixed fee (F) upfront, which entitles the retailer to
buy the product at manufacturer’s cost (c)
Moderators of DM
• Retail Competition
▪ DM decreases with intensity of retail competition
• Manufacturer Competition
▪ DM decreases with the intensity of manufacturer
competition
Bait and Switch
• Why?
▪ Retailer maximizing category profits – manufacturer
maximizing brand profits
▪ Brands with higher equity have better leverage with retailers
– resulting in lower per unit margins for retailers
Resolving Bait and Switch
• Exclusive Dealing
▪ Trade-offs
−Reduction in demand relative to being sold at a non-exclusive outlet
−Increase in retail support
• Legal Issues: FTC
▪ Rain-checks
Horizontal Conflicts
• Free-riding
▪ Auto dealers advertise car models
▪ Other dealers carrying the same models benefit from the advertisement
▪ Because of advertising spill-over each dealer expects to benefit from the competing
dealers’ advertisement and lowers advertising expenditures
▪ Advertising levels too low from manufacturer’s perspective
Resolution to Horizontal Free-Riding

• Exclusive Territories
▪ Limits advertising spill-over and ensures that dealers
appropriate the benefits of their advertising investment

• Cooperative Advertising
▪ Manufacturer may provide advertising subsidies to offset
free-riding
Cooperative Advertising
• Subsidizing image advertising resolves horizontal
conflicts

• Why are local price advertisements subsidized?

Subsidizing Local Price Advertising?

• Possibility of Free-riding?
• Retailers advertise prices when they are low
• Benefits from lowering price without advertising
very limited
• When advertising costs are high retailers’
incentive to advertise low prices is low
Subsidizing Local Price Advertising?

• Manufacturers’ benefit from low retail prices –

incentive to lower advertising cost
• Subsidizing local price advertising promotes retail
competition – reduces the DM problem
Trade Promotions
• Why offer trade promotions?
▪ Double-Marginalization problem
−Retail prices too high
−Insufficient market coverage
▪ Offer lower wholesale price to retailers to increase market
coverage
▪ Overcome horizontal free-riding
Problems with Trade Promotions

• Retail Opportunism
• Forward Buying
• Inventory problems and Demand Spikes

• Why not eliminate trade promotions?

Promotions that can help Trade Promotions

• Manufacturers’ advertising ongoing trade promotions

▪ McDonalds advertising ongoing promotions at participating retailers etc.

• Manufacturer’s rebates
▪ Can help decrease the difference in valuation between price insensitive and sensitive consumers
− Therefore increase the retailer’s incentive to discount price
Impact of Market Factors on Channel Choice

• Customers
▪ Who buys where?
▪ What do they need to buy?
− Information/Service before and after purchase
• Competition
▪ Use distribution channels to differentiate from competition
▪ Constrained by demand potential – be where the demand is
Impact of Market Factors on Channel Choice

• Consistency with Overall Strategy

▪ Wal-mart, Land Rover, Amway

• Durable/Non-Durable Product

• Resource Constraints
Impact of the Internet
• A low cost direct channel?
• Some manufacturers sell product through retail outlets and their website –
Compaq, Sony
• Other sell exclusively through retail outlets and primarily provide product
information on their website – Nikon, Minolta
• Why?
Impact of the Internet
• Direct Channel through the internet will compete with the retail outlet –
reducing retail margins
• Retailer will shift service levels to higher margin (competing) brands
• If consumers purchase decision is driven by retail service – selling thro’ the
internet might hurt overall profits