4

CHAPTER  

CHANNEL STRUCTURE

CHAPTER OUTLINE

EMERGENCE OF DISTRIBUTION CHANNELS 
Direct Distribution 
Direct Distribution versus Central Marketplace 
Multistage Distribution 
A THEORY OF DISTRIBUTION PROCESSES 
Sorting 
Spatial Closure 
Temporal Closure 
COMPLEX DISTRIBUTION ARRANGEMENTS 
Structural Separation 
Postponement , 
STRUCTURAL CLASSIFICATION 
Single­Transaction Channels 
Conventional Channels 
Vertical Marketing Systems 
Conclusion: Channel Classification 
SUMMARY
The   practices   of   individual   businesses   and   their   working   relations   with   one   another   combine   to   form
channel structure. Channel structure is a by ­ product of negotiation and the accumulated result of past
business practice. When  firms carefully  evaluate alternative channel arrangements and  then negotiate
alignments with specified trading partners, they, in effect, design their channel structure. Such design
effort is often the result of joint planning among businesses that desire to participate in a specific channel
arrangement.  In  contrast  to carefully  designed  channels many  distribution arrangements have evolved
without   the   benefit   of   analysis   or   deliberation.   Businesses   are   often   loosely   aligned   in   distribution
arrangements based on their perception that continued work together is in their individual best interest.
Channel alignments can grow out of interactions such as participation in trade shows or routine sales­force
prospecting.   Based   upon   mutually   perceived   success,   firms   may   continue   their   business   relationship
indefinitely,   Thus,   a   channel   may   be   created   with   successful   experience   as   contrasted   with   careful
deliberation analysis and negotiation. Most channels are typically the result of both successful experience
and planning. The result is a channel structure that often endures for a long time. 

A  basic  premise  of   Strategic  Marketing   Channel   Management  is  that  channel   structure  arrangements
represent a fundamental way to gain and maintain competitive superiority. A carefully planned channel
strategy may enable a firm to position itself in a way that is difficult for competitors to duplicate. The
potential to gain competitive advantage as a result of channel alignment is why the process of designing
and implementing channel arrangements represents a fundamental part of overall marketing strategy. 

This   chapter   begins   with   an   examination   of   channel   structure   from   the   vantage   point   of   relative
directness. Complex channels emerge as individual participants increase their degree of specialization. The
forces that lead to multistage distribution are discussed. 

The second section reviews theory that explains how and why complex channels emerge. Intermediaries
serve to improve overall channel efficiency by resolving three fundamental distribution problems. Each of
these three fundamental aspects of the distribution process is examined and illustrated. 

The result of   firms  seeking   to  satisfy   and  strategically   exploit  distribution  requirements  is  a  series  of
complex   channel   structures.   To   facilitate   efficiency,   firms   reviewing   channel   design   often   find   it
advantageous   to   implement   separate   and   unique   structures   to   achieve   basic   marketing   and   logistic
requirements. A channel notion of long standing, structural separation has become increasingly practical
and   easier   to   implement,   given  the   improved   control   capabilities   resulting   from   advanced   information
technology. A second concept of importance in designing channels is postponement. Postponement offers a
way to reduce risk in a complex channel arrangement. The nature of complex channel structure and the
concepts of separation and postponement are reviewed in the third section. 

The variety of basic channel relationships that can be observed in contemporary business are described
and   clarified   in   the   final   section   of   the   chapter.   The   classification   is   based   upon   the   intensity   of
acknowledged dependency among channel participants. 

In total, Chapter 4 serves to integrate many of the ideas initially presented in Chapters 1., 2, and 3. The
integrated   treatment   of   structural   considerations   provides   the   foundation   for   implementing   the
managerial   planning   and   implementation   process   (Figure   1­6),   which   provides   the   structure   used   to
present Parts Two and Three.
EMERGENCE OF DISTRIBUTlON CHANNELS 
The most fundamental distinction among distribution arrangements is the inherent degree of directness
that   alternative   channel   structures   provide.   Directness   in   marketing   channels   refers   to   the   lack   of
intermediary stages in the sales or product flow from point of origin to consumption destination. Indirect
channels,  which include intermediary  stages of product  handling,  emerge as the  most  effective  way  to
execute   exchange   in   a   highly   developed   society.   In   this   section,   direct   and   multistage   channel
arrangements are contrasted.

Direct Distribution
Channels   that   involve   manufacturers’   sales   direct   to   end   users   offer   the   simplest   and   least­refined
distribution arrangements. Direct­marketing arrangements such as vending, telephone solicitation, mail­
order and door­to­door sales, and television home shopping have emerged as forms of nonstore retailing.
The high percentage of affluent double­wage­eaming households and the widespread availability of instant
financing have served to increase the attractiveness of nonstore retailing for busy consumers. Many firms
such   as   L.   L.   Bean,   Eddie   Bauer,   Lillian   Vernon,   Hammacher   Schlemmer,   and   Cabelas   have   created
unique and uptempo markets for specialized merchandise by offering quality products, rapid delivery, and
extensive  satisfaction  guarantees.   Other  direct­marketing   organizations  have  developed  assortments   of
merchandise that appeal to the lower­ end market. 

Business­to­business  sales  have  always  been  relatively  more   direct  than  marketing   to  consumers.   The
industrial buying process is specification driven and generally committed to total­quality performance. As
a result, intermediaries only emerge in business­to­business marketing channel structures when they offer
unique   advantages   to   either   the   buyer   or   the   seller.   The   most   fundamental   departure   from   direct
distribution is the establishment of,a central marketplace.

Direct Distribution versus Central Marketplace 
Figure   4­1   illustrates   three   alternative   exchange   structures   for   a   hypothetical   economy   having   five
households.   Each  household   produces   a  product   desired  by   other   house­  holds.  In  a  direct­distribution
structure, each household must conduct business with all other households in order to procure a product
assortment. To complete the exchange process, the direct­distribution structure requires ten transactions.
The number of transactions are expressed by [n(n — l)]/2, where n represents the number of households.
Direct   distribution   would   be   impractical   in   a   complex   society.   However,  in   developing   nations   direct
distribution often represents the dominant method of conducting business.

So that efficiency is promoted, direct distribution typically evolves toward a central­market structure. A
central marketplace emerges when the trading households decide to meet at a central location to conduct
business. Trading at a central location offers a distinct advantage over direct distribution. The number of
overall contacts is reduced from ten to five, resulting in a saving of time and lower transportation cost.
However,   when  each   household  performs   its   own  buying   and  selling,   ten  transactions   still   have  to  be
undertaken.

In most developing countries, a significant portion of such products as food, household utensils, textiles,
and   clothing   are   distributed   through   an   elementary   central­market   system.   Such   central­market
structures are typically owned and operated by local government.
A   channel   arrangement   emerges   when   an   independent   business   sees   an   opportunity   to   function   as   a
specialist in the central marketplace. The specialist provides each household with a source to sell or barter
its products by the willingness 

         PART 1: THE SCOPE OF MARKETING AND DISTRIBUTION CHANNELS

FIGURE 4­1: Alternative exchange patterns.

to  assume  risk  of  inventory   ownership.   Because  timing   and   location  of   each  household’s   production  is
different, surpluses will exist. The advent of surplus creates a functional opportunity for the specialist to
maintain inventory. The establishment of inventory reduces the transactions required to satisfy demand
from ten to five. Hence, retailing is born. 

Such   elementary   channels   are   inefficient   in   comparison   to   modern   distribution   arrangements.   The
distribution structure in a developing nation typically involves high variable costs and does not facilitate
economy   of   scale.   Nevertheless,   central   markets   offer   distinct   advantages   in   comparison   to   direct
distribution.   First,   products   move   in   large   quantities   to   the   central   market,   which   introduces
transportation efficiency. Second, the required number of transactions are reduced. Finally, doing business
at a central market with a specialized intermediary is convenient. The cost associated with establishing a
distribution specialist will depend upon the range of services and risk assumed. 

A vestige of the central­market system exists in farmers’ markets, in which produce is sold in a central
location, usually a city’s downtown. A more elaborate variation are the furniture marts that operate in
many cities. In High Point, North Carolina, for example, several large buildings have been constructed.
Many manufacturers lease space in these buildings so that buyers for furniture stores and department
stores from across the country can visit displays of products from many manufacturers at one time. Other
variations of the central­market system are trade fairs such as the Machine Tool Trade Fair and the World
Trade Centers located throughout the globe. In these fairs and centers, producers exhibit merchandise for
the buyers’ examination and potential purchase. These modern variations of the central marketplace are
efficient   for   selected   types   of   trading.   However,   the   dominant   means   of   modern   distribution   is   the
multistage exchange structure.

Multistage Distribution
The limited operating scope of a central market is typically replaced by intermediate specialization. Hence,
wholesaling is born. Wholesalers accumulate and sell assortments of goods to retailers. In many developing
countries, independent businesses that operate out of their trucks perform the wholesale function. Unlike
typical transportation companies in the United States, these independent truckers actually purchase the
goods and therefore assume a significant element of risk. 

As   producers   have   supported   establishment   of   wholesalers   to   facilitate   distribution,   retailers   have

perceived an opportunity to improve customer service by locating stores in places convenient to customers.
As more and more wholesale and retail entrepreneurs have entered the distribution process, multistage
structures have evolved. 

Modern   marketing   channels   are   dominated   by   a   wide   variety   of   distribution   specialists.   Most
manufacturers depend upon the services of specialists for effective distribution. Dependence on the central
marketplace has been replaced by a vast network of wholesalers, retailers, and specialized intermediaries.

A THEORY OF DISTRIBUTION PROCESSES
Three basic problems of exchange must be resolved by the overall distribution processes. The first is a
basic   need   to   match   specialized   production   with   specific   demand.   This   matching   process   resolves
discrepancy of quantity, assortment, and search during the distribution process. The second problem is one
of spatial discrepancy, which involves the transportation of goods from location of production to location of
consumption. The third problem is to reconcile supply with demand when they occur at different times. 

These basic exchange  problems are  resolved by the overall distribution  process.  The manner by which

distribution arrangements resolve these inherent problems represents the core of channel theory. In this
section, the key processes of sorting, spatial closure, and temporal closure are reviewed. Each process is
fundamental to high­level distribution.

Sorting
Specialization and competition for differential advantage creates a wide range of products and services.
Manufacturers   and   producers   supply   large   quantities   of   unique   products   that   are   demanded   by   other
producers,   intermediary   businesses,   and   consumers   in   combination.   Each   buying   unit   seeks   a   unique
assortment of goods. The process of reconciling discrepancies in quantity and assortment is sorting. The
quantity   of   an   individual   product   demanded   for   a   specific   assortment   is   typically   much   less   than   the
quantity manufactured. Furthermore, specialized production tends to be geographically concentrated. In
contrast, demand is typically scattered in time and location. 

Sorting   is   the   distribution   process   used   to   overcome   discrepancy   of   assortments   and   reduce   required
searching. The sorting process was first described by Hovde and more fully developed by Alderson.  Sorting
consists of four basic activities: (1) standardization, (2) accumulation, (3) allocation, and (4) assortment. 

Standardization  Standardization is the task of collecting uniform products from alternative suppliers.
The  idea   of   standardization  evolved   from   agriculture,   where   grains   and   fruits   needed   to  be   sorted   by
quality   grade.   In   an   industrial   context,   standardization   consists   of   grading   manufactured   goods.
Businesses   specializing   in   standardization   typically   concentrate   in   specific   products.   Thus,   they   often
function as the standardization specialists for a specific industry.

Accumulation Because of the vast geography of many producing areas and the dispersion of buying units,
it is necessary to match supply and demand. From a practical viewpoint, no individual business can control
the   entire   supply   of   any   product.   Accumulation   consists   of   assembling   standard   products   into   large
quantities. Accumulation is typically performed geographically closer to demand than is standardization.
For example, standardization of the state of Washington’s apples will typically occur near the orchards,
while accumulation will usually be performed in major markets by product and fruit wholesalers. One
purpose of accumulation is to reduce transportation cost. The transportation cost reduction results from
moving quantities , in truckloads to the accumulating business rather than shipping many small amounts
long distances directly to retailers. 

Allocation  Allocation   is   the   development   of   adequate   supplies   to   satisfy   the   demand   of   numerous
customers. Allocation results in a broad choice of individual goods that have similar or related end use. For
example,   tools,   housewares,   and   building   materials   may   be   purchased   from   the   same   wholesaler.
Similarly, carpets, drapes, and furniture can often be purchased from a single source. Allocation represents
the general wholesale stage of the distribution process. 

Assortment The last stage in sorting activity is the assembly of specific goods into a customized order. A
department   store,   for   example,   must   offer   a   product   assortment   that   appeals   to   a   specific   clientele.
Department   store   buyers   must   arrange   an   overall   merchandise   assortment   consisting   of   men’s   and
women’s   clothing,   appliances,   hardware,   furniture,   and   so   forth.   With   assorting,   a   retailer   achieves   a
customized selection of merchandise designed to satisfy its specific customers. 

Illustration of Sorting Figure 4­2 uses furniture to illustrate the sorting process. Sorting starts with a
number   of   manufacturing   firms   specializing   in   such   items   as   carpets,   drapery   textiles,   and   furniture.
During standardization, production of two suppliers is graded from among all carpet suppliers. During
accumulation, standard carpet is assembled to meet expected demand in a specific market. At the same
time, a similar standardization and accumulation process is occurring for drapery textiles and fumiture.
During   allocation   stage,   the   carpets,   drapery   textiles,   and   furniture   are   combined   into   a   selection   of
household   furnishings.   At   the   assortment   stage,   the   unique   requirements   of   specific   buyers   are
accommodated. 

Sorting resolves the product­discrepancy problem created by specialization. A major distinction between a
developing and a highly industrialized economyris the degree to which the distribution infrastructure is
capable of performing sophisticated sorting. Sorting efficiency is essential in an advanced economy. 

PART 1 :  THE SCOPE OF MARKETING AND DISTRIBUTION CHANNELS

FIGURE 4­2 The sorting process.

Related   to   sorting   is   the   search   aspect   of   distribution.   In   an   economy   characterized   by   freedom   of

consumption and production, a great deal of uncertainty exists concerning what is going on. Manufacturers
are   not   certain   which   products   consumers   will   buy.   On   the   other   hand,   buyers   are   not   certain   that
products they desire will be available. Businesses engaged in sorting are required to anticipate or forecast
customers’ product preferences. A great deal of sorting efficiency depends upon the ability to assemble
products that match demand requirements reasonably well. This process of reconciliation is referred to as
searching. Intermediaries in the marketing channel facilitate the search process. In a free­market system,
sorting and search are both driven by market demand.
Spatial Closure
The  discussion  of  sorting  highlights  the’basic  need  for  the  distribution  process  to  overcome  geographic
problems.   Direct­market,   central­market,   and   multistage   systems   are   examined   from   the   viewpoint   of
space closure. 

As   a   multistage   exchange   system   develops,   additional   complexity   enters   the   distribution   process.   The
multistage   distribution   system   characteristic   of   more   advanced   societies   is   illustrated   in   Figure   4­3.
Assume that there are six manufacturers, two each in food, textiles, and household utensils. A distribution
specialist concentrates on each of the three product lines. To understand the process, assume that the
channel structure consists of a central market­nine retailers and thirty consumers. The three specialists
must make two transactions with each manufacturer,

FIGURE 4­3    A multistage distribution system.

for a total of six transactions. Each specialist also requires a transaction with the central market, for a
total   of  nine  transactions.   The  nine  retailers   will  each   require  a  transaction  to  obtain   goods  from  the
central   market.   Thus,   the   total   system   requires   twenty­four   transactions   for   spatial   closure   to   be
completed to the retail level. For the completion of retailer­to­consumer linkage, a total of 270 additional
transactions (9 X 30) may be necessary should each consumer find it necessary to visit each retail outlet. 
TABLE 4­1  TOTAL COST OF THE DIRECT­, CENTRAL­MARKET, AND
MULTISTAGE DISTRIBUTION STRUCTURES 
Direct distribution 
Transactions
Ten transactions at $1.00 = $10.00 
Movements
Ten movements at $5.00 = 50.00
      Total cost $60.00
Central­market distribution
Transactions
Ten Transactions at $1.00 = $10.00
Movements
Producer to central market
     Five movements at $6.00 = 30.00
Central market to buyer
    Ten movements at $1.00  = 10.00
    Total cost     $50.00
Multistage distribution
Transactions
Producer­specialist, central market 
       Nine transactions at $1.00 = $ 9.00 
Central­market retailer 
       Nine transactions at $1.00        9.00 
Retailers­buyers 
       270 transactions at $.50 = 135.00
              $153.00
Movements
Producer­specialist, central market
       Six movements at $4.00 = $ 24.00
Central­market retailer
       Nine movements at $2.00 = 18.00
             42.00
        Total Cost $195.00

Table   4­1   provides   an   example   of   costs   associated   with   direct­market,   centralmarket,   and   multistage
systems. At the top, five participants in a direct system are illustrated as requiring ten transactions to
match supply and demand. Because of the small quantities demanded by each, the total cost per shipment
is   high.   As   an   illustration,   let’s   assume   that   each   shipment   costs   $5   and   each   transaction   $1   in   a
directdistribution system. The total transportation cost is $50 and the transaction cost $10. The total cost
of direct distribution is $60. With a central market, let’s assume transport from production to market is in
large   quantities   at   $6   per   shipment.   Transportation   from   the   central   market   to   the   buyer   is   $1.   The
inbound per­shipment cost is higher, but the unit cost is less because only five shipments are required. The
transaction cost is still $1 per transaction. Total inbound transportation cost is $30. Total transaction cost
remains at $10. Outbound distribution cost is $10, for a total of $50 using a central market. The central
market   has   a   $10   efficiency   advantage   over   direct   distribution.   With   the   emergence   of   a   specialized
intermediary,   cost   is   further   reduced   to  $45   because   fewer   transactions   are   required.   To  evaluate   the
multistage exchange, assume anintermediate transaction cost of $1 and of $.50 between consumers and
retailers. Assume that the transportation cost from the manufacturer through the specialist to the central
market is $4. All other shipments have a transportation cost of $2. Table 4­1 presents comparative total
cost of the direct­market, centraLmarket, and multistage distribution structures. The least cost or most
efficient distribution results from transaction minimization offered by the multistage approach. 

The   basic   concept   that   facilitates   spatial   closure   is   referred   to   as   the   principle   of   minimum   total
transactions. It illustrates the‘basic justification for using a multistage exchange distribution structure.
The   introduction   of   specialists   serves   to   reduce   total   transactions.   It   also   facilitates   the   transport   of
products in larger quantities over a long distance, thereby reducing transportation cost.

At   least   one   nagging   question   remains   concerning   channel   structure.   Is   it   possible   to   proliferate
intermediaries to the point that a multistage system will increase total cost? An unjustified proliferation of
intermediaries could result in increased transactions and consequently increased distribution cost. The
concern   of   potential   overdevelopment   and   potential   misuse   of   intermediaries   is   the   basic   reason   for
continuous   reexamination   of   the   structural   arrangement   that   a   firm   employs   to   achieve   effective   and
efficient distribution. 

In terms of cost­benefit balance, intermediaries may be added for reasons other than distribution economy.
Each distribution system has what Bucklin has termed service outputs. These outputs include: (1) lot size,
or the ability to procure small quantities; (2) waiting time, or the length of time it takes following purchase
to obtain actual possession of goods; (3) market decentralization, or the proximity of goods to the buyer and
associated   convenience;   and   (4)   product   variety,   or   combinations   of   products   that   most   closely   match
desired   assortments.   As   value­added   service   benefits   increase,   more   intermediaries   are   likely   to   be
involved and distribution costs can be expected to­increase independently of the economics of realizing
minimum total transactions.

Temporal Closure
An additional demand that must be satisfied during the distribution process is related to time limitations.
Temporal closure refers to the fact that there is a difference between the time when products are produced
and the time when products are demanded. This time difference must be overcome. Since manufacturing
often does not occur at the same time as products are demanded, warehousing is required. A second aspect
of temporal closure is concerned with the flow of products throughout the distribution system in a timely
manner, one likely to ensure acceptable customer satisfaction. Both aspects of temporal closure require
product storage. Thus, the economics of maintaininginventory becomes an important concern.

At   first   glance   it   may   appear   that   establishing   a   multistage   distribution   structure   will   automatically
increase   channel   inventory.   On   the   contrary,   inventory   may   be   lower   in   a   multistage   distribution
arrangement. Without the specialization of multistage distribution, each channel participant is required to
maintain   a   large   inventory   to   reduce   inconvenience   and   cost   of   uneconomical   transportation.   In
undeveloped   societies,   consumers   are   required   to   stockpile   inventory.   Since   there   are   many   more
consumers than distribution specialists and producers, the total inventory in a directdistribution economy
would be large. In a multistage system, the flow of goods can be planned to satisfy demand with minimum
inventory. The key to efficient temporal closure is inventory velocity that results in rapid turnover. This
relationship of temporal closure to inventory requirements is known as the principle of massed reserves. In
addition to keeping overall inventory and associated storage costs down, multistage distribution serves to
increase the buyers’ convenience. 

This brief look at channel theory serves to highlight the universal relationships upon which channels are
built. It also serves as a foundation for applying channel concepts to a variety of situations that involve
distribution process, whichwill expand understanding.

COMPLEX DISTRIBUTION ARRANGEMENTS
Channel structures become complicated as firms seek arrangements for the resolution of three distribution
problems  associated   with  sorting,  spatial   closure,   and  temporal   closure.  Unless  all  three   problems  are
simultaneously resolved, the aggregate distribution infrastructure will fail. The 1990 consumer crisis of
the Soviet economy is a prime example of an aggregate infrastructure failing to resolve the three basic
exchange requirements for effective distribution. The primary reasons that specialized intermediaries exist
is that they facilitate resolution of the exchange process. 

From the simple notion of direct marketing, the introduction of specialized intermediaries results in a
complex   channel   structure.   Figure   4­4   illustrates  the  variety   of   channels   used   to  distribute   household
furniture. These variations in distributive arrangements result from the dynamic process of seeking better
ways to resolve the inherent exchange requirements. The concept'of channel separation provides a way to
resolve some aspects of the inherent exchange problems through increased specialization. 

Two concepts are fundamental to the development of complex or specialized channel arrangements. They
are channel separation and postponement. Channel separation provides a way to resolve some aspects of
the inherent exchange problems through increased specialization. Postponement offers a way to reduce
risk   associated   with   exchange.   All   of   these   concepts   are   more   fully   developed   because   they   are
fundamental to channel design, which is discussed in Part Two.

Structural Separation
The separation of channel focus into two activities­demand creation and supply­offers a way to view overall
requirements that may facilitate specialization. Although both physical and legal exchange of ownership
must take place for a distribution channel to achieve its mission, there is no requirement that the work
efforts must be performed simultaneously or by the same network of intermediaries. A product may change
ownership   one  or   more   times   without  physically   moving.   Alternatively,   a   product  may   be   transported
across the nation without changing ownership. 

      FIGURE 4­4  Alternative   distribution   arrangements   household   furniture.

(Source:   Furniture   Marketing,   p.   191.   Courtesy   of   Fairchild   Books,   Division   of   Fairchild
Group.)

The Logic of Separation  Activities involved in logistics are not directly related to transaction­creating
efforts such as advertising, pricing, credit, and personal selling. This basic independence can be exploited
to increase functional specialization. In fact, the most effective network for facilitating profitable sales may
not be the most efficient logistics arrangement. 

The marketing channel consists of primary and specialized intermediaries such as manufacturing agents,
sales personnel, jobbers, wholesalers, and retailers, all of whom are engaged in negotiating, contacting,
and administrating sales on a continuing basis. The logistics channel contains a network of intermediaries
engaged   in   the   functions   of   physical   movement.   Participants   are   logistics   specialists   concerned   with
achieving product transfer. The logistics channel provides time and place utility at a cost consistent with
marketing objectives. 

Examples of Channel Separation Figure 4­5 illustrates potential separation of the overall distribution
channel for color televisions.  The only  time the marketing  and physical  distribution channels  formally
merge   is   at   the   manufacturer’s   factory   and   the   consumer’s   home.   Two   groups   of   intermediaries   are
deployed   within  the  overall   channel   to  maximize  specialization.   Three   specialists   are   employed  in   the
physical   distribution   channel:   a   common   transportation   carrier,   a   public   warehouse,   and   a   specialized
local­delivery firm. In addition, three levels of logistics operations are performed by the manufacturer.
Television sets are initially stored in the company’s factory warehouse, transported in proprietary trucks,
and then stored in a regional warehouse facility before specialized intermediaries begin to participate in
the logistics channel. 

 PART 1: THE SCOPE OF MARKETING AND DISTRIBUTION CHANNELS

FIGURE 4­5 Example of marketing channel senaraiinn for color televisions

The distributor has legal title to the television sets from the time they are shipped from the manufacturer’s
regional   warehouse.   Retailers   are   served   from   the  public   warehouse.   During   the   logistics   process,   the
distributor never physically stores, handles, or transports the television sets. When the retailer sells a set,
delivery is made to the consumer’s home from the distributor’s stock being held in the public warehouse.
The retailer maintains limited stock for point­of­sale display. Sales are negotiated between the retailer and
consumer,  including   a  commitment  to  deliver  a  specified  television  set  model   and  color  directly  to  the
consumer’s residence. Direct­to­home customer shipment is completed from a strategically located public
warehouse which may be many miles from the point­of­sale transaction and product­delivery destination.

Another example of channel separation is a factory branch sales office that does not carry inventory. Such
branches  exist  exclusively   to  facilitate  ownership   transfer   transactions.   The  ultimate  logistics   transfer
between buyer and seller is based on such factors as value, size, weight, and perishability of the shipment.
The  network  of  branch   offices  is  planned   to  provide   the  manufacturer  the  greatest   market  impact  for
purposes   of   stimulating   sales.   The   logistics   process   is   designed   so   that   specified   customerservice
performance levels can be achieved as efficiently as possible. 

The concept of separation should not be interpreted to mean that either the transaction or the logistics
channel can stand alone. Such a conclusion could be drawn from the emphasis placed on the transaction
channel and the neglect of consideration of logistics in recent marketing literature. Both channels must
function   for   a   profitable  sale  to  be  realized.   Both   aspects   of   channel   performance   are  essential   to  the
overall marketing process. 

Separation  should  be  encouraged  to  the  extent  that  it  results  in  improved   performance  as  a   result  of
functional   specialization   or   spin­off.   Separation   does   not   necessitate   separate   legal   entities.   The   same
intermediary   may   be   capable   of   performing   both   transactional   and   logistics   requirements.   Successful
wholesalers typically combine the performance of both basic requirements. 

Postponement
The  concept   of   postponement   has   received   considerable   attention   in  the  marketing   literature   over   the
years.10 However, a considerable gap has existed between the theory and practice of postponement. This
gap has rapidly begun to close as a result of the impact of information technology. Over the past few years,
channel structures have begun to reflect wider managerial implementation of postponement strategies. 

In  traditional   channel   arrangements,   emphasis   has   been   placed   on   forward   positioning   of   products   in
anticipation   of   future   transactions.   Anticipatory   effort   is   characteristic   of   most   manufacturing,
wholesaling,   and   retail   methods   of   distribution.   The   typical   arrangement   is   for   products   to   be
manufactured,   transported,   stored,   handled,   bought,   and   sold   numerous   times   before   they   arrive   at   a
location ready for sale to an industrial user or consumer. The risk associated with anticipatory distribution
has traditionally been viewed as being inherent to the value­added process. 

Postponement is a risk­reducing concept. The basic idea is to seek structural arrangements or agreements
that postpone final­product configuration or geographical positioning until a final customer commitment or
order is received. In other words, postponement strategies do not seek to finalize products or move them to
forward markets until they are sold. To the degree that advanced commitment from customers can be
obtained, anticipatory effort is reduced, resulting in little or no risk of manufacturing or distribution error. 

The ultimate in postponement is manufacturing to order. If a customer is willing to wait for a product to be
built to specification and delivered at some future date, the ideal of postponement is captured. While some
capital   goods   such   as   mainframe   computers,   heavy   machinery,   and   transportation   equipment   have
traditionally enjoyed made­to­order lead time, few consumer products are produced and distributed under
such time­delayed arrangements. However, the speed of response using advanced information technology
makes it increasingly possible to build postponement strategies into some channel arrangements without
sacrificing customers’ satisfaction. 

The benefits of postponement can be incorporated into a channel system around form or time. Each is
described and illustrated. 

Form   Postponement  Form   postponement   consists   of   delaying   final   manufacturing,   assemblygor

packaging until the customer’s preference is established. From an operational viewpoint, the product is
customized   to  the   customers’   specification  during   the  order   cycle  and  delivered   without  time  delay   as
promised. From an ideal perspective, the postponement of final form is completed without the knowledge of
the customer. The channel arrangement in which a postponement strategy is implemented typically has an
overall response time to orders that is equal to that of competitors who follow traditional anticipatory
distribution practices.

The classic example of form postponement  is mixing  paint to  customers’ specifications  in retail  stores.

Many consumers may not remember, but the original paint distribution process consisted of a wide variety
of colors and sizes of paint being factory mixed and then distributed to dealers in anticipation of future
sale. The result was an inventory­intense distribution channel that was prone to excessive out­ofstocks.
There was always the risk of inventory being poorly distributed as a result of the inability to accurately
forecast forced­color assortments, alternative paint varieties, and a limited number of sizes, The perfection
of in­retail­store mixing literally changed paint distribution overnight. As a result of form postponement,
product   lines   offering   consumers   wider   choice   proliferated,   and   out­of­stocks   of   specific   sizes   or   colors
became virtually nonexistent. 

Numerous examples of form postponement, many of which involve final manufacturing, exist in today’s
information­intensive channel arrangements. One of the earliest examples of form postponement involved
consumers being provided with a range of appliance panels for home installation. General Electric and
Whirlpool dishwashers and trash compactors were sold with a kit consisting of a variety of front panels in
different   colors   that   could   be   installed   by   consumers.   Providing   the   kit   served   to   reduce   the   color
assortment of appliances that needed to be manufactured and stocked to accommodate customers’ color
preferences. The kit  feature allowed a standard appliance capable  of accommodating a wide variety of
colors to be manufactured and distributed. 

Information technology has also introduced form postponement flexibility into assembly and packaging.
For   example,   products   such   as   aseptic   juice   drinks   can   be   configured   into   multi­packs   of   different
quantities   and   flavors   during   warehouse   order   processing.   Point­of­sale   product­assortment   displays
designed to fit specific retail stores’ merchandising space can be assembled to specification during order
assembly. Benetton has perfected the process of dying sweaters specific colors that are in popular demand
at their retail stores as part of normal retail inventory replenishment. Many producers of private­label
merchandise delay affixing labels to what are referred to as bright cans until specific customer orders are
received. 

The above examples represent a few of the many unique ways that form postponement is being structured
into   channel   arrangements.   Information   technology   is   increasingly   making   it   possible   to   postpone
performance of selected tasks until orders are being processed. Such arrangements typically require the
cooperation of downstream channel members such as dealers or distributors for the performance of final­
product configuration. Such functional transfer serves to reduce overall channel risk while at the same
time dramatically improving customer­service capabilities. The end result is being at the competitive edge
of highly customized manufacturing while retaining the benefits of mass­production economy of scale. 

Time Postponement In many ways, time postponement operates in a manner directly opposite to that of
form delay strategies. The basic idea of time postponement is to delay product location or positioning until
receipt of the customers’ orders. Once the exact order requirements are identified, then shipment directly
to customers is performed as expeditiously as required to satisfy promised customer­service performance. 

Time postponement exploits a basic principle of inventory management. To the extent that inventories can
be consolidated into one era few stocking locations, the total quantity required to provide a specified level
of   availability   to   customers   can   be   reduced.   The   idea   behind   time   postponement   is   to   complete
manufacturing in the most economical manner but to avoid the risk of poor distribution by maintaining
inventory in a few centralized stockpiles. Thus, a full assortment of products can be maintained at the
central stocking location. The centralization of inventory increases the capability to completely fill orders
because   the   risk   associated   by   anticipatory   forward   distribution   to   field­stocking   locations   has   been
postponed. 

The Parts Bank warehouse that Federal Express operates as part of its Business Logistics Services (BLS)
is a prime example of time postponement. The Parts Bank distribution system operates twenty­four hours
a day and is capable of receiving customer orders as late as 7 P.M. for nationwide delivery before noon the
next day. The Parts Bank integrated distribution program combines advanced information technology and
premium transportation capacity to operationalize time postponement. The benefits of time postponement
are   very   appealing   to   firms   that   confront   extreme   demand   variation   or   that   distribute   high­valued
products. The Parts Bank services areused by over forty medical supply companies, which has resulted in
the facility being labeled the “Bionic Boulevard.”

While  time and form postponement initiate from  different starting  points,  their objectives are similar­

reduce   anticipatory   distribution   risk.   To   avoid   anticipatory   distribution,   both   types   of   postponement
exploit advanced information technology. Form postponement delays final­product configuration until as
late as possible in the distribution process. To operationalize form postponement, channel arrangements
must be negotiated that can accomplish decentralized final­product assembly in a highquality manner.
Time postponement relies upon rapid. distribution for the satisfaction of customers’ requirements. High
levels of product availability result from the strategy of centralized stocking. Naturally, with many channel
designs   structural   arrangements   are   sought   that   will   enable   some   degree   of   both   time   and   form
postponement   to   be   achieved   simultaneously.   The   available   range   of   channel   structure   alternatives
continues to expand as a result of advancements in information technology.

STRUCTURAL CLASSIFICATION
A formal classification of channel arrangements is now presented, based upon the overall presentation of
Part One. Channel structures are classified on the basis of acknowledged dependence of participants.Three
channel classifications are specified, ranging from least­ to most­open acknowledgment of dependence: (1)
single­transaction   channels,   (2)   conventional   channels,   and   (3)   vertical   marketing   systems.   Figure   4­6
provides a graphic illustration of channel arrangement based on relative acknowledged dependence.

Single­Transaction Channels 
A   great   deal   of   marketing   activity   results   from   transactions   negotiated   with   the   expectation   that   the
business relationship will not be repetitive. Business negotiated on the expectation of a single transaction
usually follows a search on the part of both the buyer and seller to locate suitable sources. Prime examples
of single­transaction channels are real estate sales, stock and bond ownership transfers, and the sale of
selected forms of durable industrial equipment. For example, the sale of an asphalt­mixing plant that has
an extended useful economic life is likely to result from a single­transaction negotiation. 

FIGURE 4­6 Classification of channel relationships based on acknowledged dependency. 

In a technical sense, no channel arrangement of lasting duration exists to facilitate ownership transfer in a
single­transaction   channel.   At   the   time   of   the   actual   transaction   negotiation,   a   channel   capability   is
required to meet and fully execute the specified transaction terms. Once all requirements agreed to by
parties  to  the transaction  are  completed,   mutual   obligation  ceases.   To  the  extent  that  warranties  and
guarantees are specified as part of the ownership transfer, they must be fulfilled. However, even if ' the
transaction   proceeds   without   a   hitch   and   all   parties   are   fully   satisfied,   the   likelihood   for   repetitive
transactions is minimal. 

Single­transaction channels are common in international trading. Using the services of an import or export
agent, two firms may undertake a large­scale purchase or may even exchange goods through a barter or
arbitrage arrangement with no expectation of future involvement. However, if the experience is positive,
the   initial   transaction   may   potentially   result   in   repeat   transactions   and   ultimately   evolve   into   a
conventional channel arrangement.

Conventional Channels 
Channels classified as conventional are also often referred to as free­flow. The freefiow notion is descriptive
because   it   clearly   captures   the   basic   nature   of   this   type   of   channel   arrangement.   Firms   engaged   in
conventional channels do not perceive extensive dependence. They do, however, acknowledge the benefitsof
specialization   and   focus   their   performance   to   a   specific   area   of   the   overall   channel.   Enterprises   that
participate in conventional channels seek benefits of specialization whenever and however possible. Thus,
whereas participants  in  conventional  channels  seek  improved  marketing   efficiency,  they  do  so  without
becoming fully committed as members of a behavioral marketing system. 

It follows that, over time; conventional marketing channels will exhibit less stability than expected in more
dependent systems. The primary force for solidarity in a conventional system is the continued perception
by two or more firms that they are benefiting from a satisfactory arrangement. The channel arrangement
can be terminated rapidly by either party if and when the business relationship loses its appeal. 

Three points regarding conventional channels are important. First, the loose arrangement or affiliation of
firms in a conventional channel structure requires a minimal degree of dependency. However, business
negotiations are typically adversely based, and the prime element of channel solidarity is transaction price.
This relationship is described as conventional since it is by far the most common channel arrangement. 

Second, a great many enterprises that function on a conventional basis conduct regular business with one
or   more   vertical   marketing   systems.   However,   because   of   their   failure   to   acknowledge   dependence   or
formalize arrangements, the free­flow firms do not become full participating members of the behavioral
channel system.

Third, the term “conventional” is not meant to include all channel participants that perform a service. For
example, a common­carrier transportation company would not necessarily qualify as a channel member by
providing a transportation service to a single manufacturing firm. However, the combination of a buyer,
seller,   and   carrier   would   constitute   a   three­party   Channel.   Thus,   the   conventional   classification   is
restricted to primary channel participants.

Verticai Marketing Systems
The essential feature of a vertical marketing system is that the primary participants both acknowledge
and   desire   interdependence.   As   such,   they   consider   their   long—term   interest   and   benefits   to   be   best
achieved by participating in what is described as a vertical marketing system (VMS). Participation in a
VMS is a behavioral relationship because of acknowledged dependence. 

In order to participate in a behavioral channel system, each channel member must be willing to accept a
role. The assumption is that the mutual relationship will be something greater than a non­zero­surn game
and that all parties will enjoy the synergistic benefits of the arrangement. In other words, the participants
feel as a result of active channel involvement that their combined organizations will be better off than they
would be in a conventional channel arrangement. In this sense, the relevant competitive unit becomes the
channel system. 

For   the   channel   to   function   as   a   VMS,   typically   one   of   the   member   firms   emerges   and   is   generally
acknowledged as the leader. The leader is most often the dominant firm in terms of size and is typically
committed to significant risk related to channel success. The leader usually has the greatest relative power
within the channel. 

While  dependence  is  the  cohesive  force   in  VMS   arrangements,   it  also  serves  as  a   source   for  potential
conflict. The fundamental perception is that all who enter into a formal channel organization desire to
benefit   from   cooperative   behavior.   However,   conflicts   evolve   occasionally   and   must   be   resolved   if   the
channel structure is to survive. One of the primary roles of channel leadership is to resolve conflict and
thereby   maintain   stability.   Another   important   role   is   to   plan   and   implement   channel   change.   The
importance of leaders providing direction and planned change is second only to leaders providing stability. 

Many behavioral channel systems are classified as VMS because they function as integrated combinations
of two or more independent enterprises. Vertical marketing systems are further classified as corporate,
contractual, and alliance. They are also sometimes administered on the basis of formal cohesive devices
over and above acknowledged dependence. 

Corporate  The corporate VMS is operated as a single business by virtue of ownership. Corporate VMS
arrangements,   in  a  pure  sense,   are  rare  because few   firms  can command  the resources  to  perform  all
activities required at all levels of 3 marketing channel. Perhaps the closest example to a fully integrated
channel of distribution was achieved by Ford Motor Company during the early 19305. Firms that approach
this type of channel in today’s competitive environment are Singer, Otis Elevator, and Thom McAn shoes.
For practical purposes, the corporate vertical marketing system is defined as an arrangement wherein a
single  owns and operates two or more consecutive levels of a distribution Channel.

Contractual  A contractual VMS is one in which dependence is defined in a formal contract. The most
common   form   of   contractual   arrangements   are   franchises,   exclusive   dealerships,   joint   ventures,   and
agreements between cooperative and voluntary groups. The essential difference between a corporate and
contractual   arrangement   is   the   absence   of   single   ownership   of   two   or   more   consecutive   levels   in   the
channel. In many cases. the operating expectations under a contractual VMS are more clearly specified
than   within   a   corporate  system.   Prime  examples   of   contractual   channels  are  found   in  the  automotive
industry. However, all voluntary chains such as TruValue, Spartan Stores, and lGA are classified in this
channel category. Likewise, alignments in the fast­food industry such as Taco Bell, Pizza Hut, and most of
the burger­oriented franchises represent contractual channel arrangements. 

Alliances Alliances are a voluntary form of extended organizations typically not formalized by contractual
arrangements.   When   two   or   more   firms   agree   to   develop   a   close   working   relationship,   the   resulting
alliance can exhibit many different degrees of acknowledged dependence. At the most elementary level, the
alliance and resulting working relationship is classified as a partnership. In a partnership arrangement.
all participants feel and exhibit a sense of loyalty to other businesses in the arrangement. However, their
commitment   typically   falls   short   of   a   willingness   to   modify   fundamental   ways   of   doing   business   to
accommodate their partners. While a desire exists to facilitate the value­added process for the good of the
overall channel, a sense of individuality often causes firms to fall short of full commitment to the alliance. 

In more advanced alliances. participating members are likely to modify their basic ways of doing business
in an effort to gain mutual benefits as a result of their acknowledged dependence. These alliances are often
described   as   strategic   because   the   participants   are   willing   to   alter   basic   business   practices   to   more
effectively synchronize operations. Strategic alliances may be either vertical or horizontal in structural
alignment.   An   example   of   a   vertical   strategic   alliance   is   the   fourtier   arrangement   between   Du   Pont,
Milliken, Leslie Fay, and Dillard Department Stores. An example of a horizontal strategic alliance is the
corporate alliance that includes Abbott Laboratories, 3M, Standard Register, IBM, Kimberly Clark, and C.
R.   Bard.   Alliances   are   common   between   primary   and   support   participants   that   develop   close   working
relationships.   In   selected   situations,   the   support   channel   participant   may   serve   as   the   catalyst   in
formation of the working relationship. Figure 4­7 provides an example of a vertical and horizontal strategic
alliance.

PART 1 : THE SCOPE OF MARKETING AND DISTRIBUTION CHANNELS

FIGURE   4­7   Vertical   and   horizontal   strategic   alliances.   (Source:   Adapted   from   Donald   J.
Bowersox, “The Strategic Benefits of Logistics Alliances,” Harvard Business Review, 68:4, July­
August 1990,)

The key features of alliances are the open acknowledgment of dependency and the potential for synergy.
The alliance is a mutually acknowledged way for channel members to leverage their relationship to gain
competitive advantage. 
Administered  The   administered   vertical   marketing   system   typically   does   not   have   the   mutually
acknowledged dependence typical of an alliance, nor the formalized arrangement of a contractual system,
nor   the   clarity   of   power   characteristic   of   the   corporate   system.   The   member   firms   acknowledge   the
dependence and adhere to dominant­firm leadership. However, dependence is based on the realization by
participating   channel   members   that   it   is   necessary   to   follow   the   leader   if   they   desire   continued
participation in the administered arrangement. With this type of vertical marketing system, operational
stability based upon sharing rewards is capable of being maintained over an extended period of time. The
dominant firms exist and operate from any level of the channel. However, large retail organizations such
as  WalMart,   Sears,   K  mart,   and  J.   C.   Penney   and  their  supplier  relationships  are  prime  examples  of
administered   vertical   marketing   systems.   A   situation   that   illustrates   the  power   of   mutual   recognition
without formal contractual arrangement is the Sears­Whirlpool channel. Although the two firmsdo not
have  a  formal   contract,  their  active  business  relationship  spans  more  than  thirty   years,   during   which
Whirlpool has been a prime supplier of Sears­brand appliances.

Conclusion: Channel Classification 
Classification of channel structural arrangements as behavioral relationships is based on an acknowledged
level   of  mutual   dependence.   Existence   of   dependence   and  willingness   to  participate  on   a  more  or   less
formal basis as a member of a behaviora, system are the main features that result in vertical marketing
systems. Figure 4­6 provides a classification of channel relationships based on acknowledged dependence.
The   four   types   of   vertical   marketing   relationships   vary   significantly   with   respect   to   degree   of   shared
dependence. In an administered system, the clear dominance of one party and its consequential leadership
tends to shape the dependent relationship. When the vertical marketing system results from ownership of
consecutive stages of the channel or the granting of a contractual right such as a franchise, clear lines of
dependence   result.   The   alliance   is   unique   in   that   dependence   appears   to   flow   from   mutual
acknowledgment of the potential synergism of the alignment. Alliances in the form of partnerships and
strategic arrangements are becoming increasingly popular forms of vertical marketing systems. While the
concept   of   alliances   is   not   new.   advancements   in  information   technology   have   greatly   facilitated   their
development. 

The size and relative volume of business conducted by vertical marketing systems render them important
channel  structures.   In  fact,  the  process  of  designing   a   channel   arrangement  implies  that  a   behavioral
relationship can be developed that results in some form of a vertical marketing system. However, it is
incorrect   to   assume   that   the   majority   of   business   transactions   are   dominated   by   vertical   marketing
systems.   Channels   classified   as   conventional   and   single­transaction   constitute   major   segments   of
marketing activity that cannot be ignored when alternative channel strategies are evaluated. The relative
advantages  and efficiencies of  the transactional­based  channels  must  be  evaluated  in  comparison  with
various vertical marketing arrangements when a channel strategy is being formulated.

SUMMARY
Channel structure refers to the working relations among firms involved in a distribution arrangement.
Such structural arrangements include all primary and support members that participate in the overall
ownership transfer process. While channel arrangements are often loose affiliations that evolve over time,
many firms carefully plan their channels in an effort to gain competitive advantage. 
Distribution arrangements emerge for the facilitation of specialization. Three typical channel structures
evolve: (1) direct systems, (2) central marketplaces, and (3) multistage distribution channels. In a direct
structure, there are no middlemen. Each producer or user must visit or be directly contacted by all others
with   whom   specialized   output   has   been   exchanged.   The  number   of   transactions   is   high.   In  a   central­
market structure without intermediaries, each producer assembles output in a central location from which
selling or trading is conducted. Both the number of trips required to complete a central­market exchange
and transportation costs are reduced. In a formal central­market structure, specialists enter to buy and
sell products. The specialists assume inventory ownership risk, and the number of transactions is reduced
over a decentralized structure. The central­market structure offers a savings in transportation cost since
inbound products can be shipped in large quantities. Also, there is a convenience of location for buyers and
producers. In a multistage structure, a wide range of specialists are introduced into the process and serve
to create broader product assortments. 

All   exchange   channels   must   perform   three   basic   activities:   sorting   and   search,   spatial   closure,   and
temporal closure. The constructs within which these activities are accomplished represent basic channel
theory.   Sorting   involves   standardization,   accumulation,  allocation,   and  assortment.   The  overall   sorting
activity requires considerable search on the part of channel participants. The spatial activity involves the
use of structure to achieve movement at minimal transport cost. The temporal activity involves flow of
goods through time and minimization of inventory and associated cost. 

To facilitate specialization, channel structure may be logically separated on the basis of marketing and
logistics requirements. Separation affords the potential for a firm to benefit from a variety of different
support channel participants. 

So that distribution arrangements can be better understood, a classification scheme that differentiates
among   channel   members   by   perceived   dependence   is   used.   In   a   broad   sense,   channel   structures   are
classified, ranging from least to most open acknowledgement of dependence, as: (l) single­transaction, (2)
conventional,   and   (3)  vertical   marketing   systems.   Vertical   marketing   systems   are  further   classified  as
corporate, contractual, alliances, or administrative, based on the existence of formal cohesive devices over
and above acknowledged dependence.

QUESTIONS
1. It has been said that “the exchange system is designed to achieve spatial and temporal closure in
the economic sector.” Explain what is meant by this statement. 
2. What is the difference between a decentralized and a centralized marketplace system? 
3. How does sorting overcome the problems inherent in heterogenous supply and demand? 
4. ls sorting a function designed to cope with the discrepancy of quantity, assortment, and search
activities? Explain. 
5. Given the principle of minimum total transactions, is it possible to have too many intermediaries?
Explain.
6. Why   do   various   forms   of   indirect   or   complex   distribution   arrangements   emerge   in   advanced
industrial economies? 
7. What   is   the   primary   logic   behind   potential   separation   of   transaction   and   logistics   channel
structure? 
8. What is the essential difference between time and form postponement? How do the two forms of
postponement relate to anticipatory distribution? 
9. Why   are   single­transaction   and   conventional   channel   arrangements   important   channel­design
alternatives? 
10. What role does channel­participant dependence play in the different types of vertical marketing
system arrangements? 
11. Which types of vertical marketing system arrangements are currently most prevalent? Which are
growing in prevalence and importance? 
12. What is the importance of channel structure in making managerial decisions?