The previous discussion was concerned with the length and width of a supply chain.
However, a more pressing issue is who should control the supply chain. Many chains consist of independent business firms who, without the proper leadership, may look out solely for themselves, to the detriment of the other members. For this reason, experts agree that no supply chain will ever operate at a 100 percent efficiency level. Supply chain members must have as their goal ‘‘to minimize the sub-optimization’’ of the supply chain.
Manufacturer
Retailer Retailer Retailer Retailer Retailer Retailer Manufacturer retailers are used in a trade area.
selective distribution
Means that a moderate number of retailers are used in a trade area.
exclusive distribution
Means only one retailer is used to cover a trading area.
Supply chains follow one of two basic patterns: the conventional marketing channel and the vertical marketing channel. Exhibit 5.5 provides an illustration of these major channel patterns.
Conventional Marketing Channel
A conventional marketing channel is one in which each member of the channel is loosely aligned with the others and takes a short-term orientation. Predictably, each member’s orientation is toward the subsequent institution in the channel. The prevailing attitude is ‘‘what is happening today’’ as opposed to ‘‘what will happen in the future.’’ The manufacturer interacts with and focuses efforts on the wholesaler, the wholesaler is primarily concerned with the retailer, and the retailer focuses efforts on the final consumer. In short, all of the members focus on their immediate desire to close the sale or create a transaction. Thus, the conventional marketing channel consists of a series of pairs in which the members of each pair recognize each other, but not necessarily the other components of the supply chain.
The conventional marketing channel, which is historically predominant in the United States, is a sloppy and inefficient method of conducting business. It fosters intense negotiations within each pair of institutions in the supply chain. In addition, members are unable to see the possibility of shifting or dividing the marketing functions among all the participants. Obviously, it is an unproductive method for marketing goods and has been on the decline in the United States since the early 1950s.
Vertical Marketing Channels
Vertical marketing channels are capital-intensive networks of several levels that are professionally managed and rely on centrally programmed systems to realize the technological, managerial, and promotional economies of long-term relationships.
The basic premise of working as a system is to operate as close as possible to that
Exhibit 5.5
Is one in which each channel member is loosely aligned with the others and takes a short-term orientation.
elusive 100 percent efficiency level. This is achieved by eliminating the sub-optimization that exists in conventional channels and improving the channel’s performance by working together.1
Virtually every high-profit performance retailer in the U.S. economy is part of a vertical marketing channel.
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Formerly adversarial relationships between retailers and their suppliers are now giving way to new vertical channel partnerships that minimize such ineffi-ciencies.2Because vertical channel members realize that it is impossible to offer consumers value without being a low-cost, high-efficiency supply chain, they have developed either quick response (QR) systems or efficient consumer response (ECR) systems. These systems, which are identical despite the differing names adopted by various retail industries, are designed to obtain real-time information on consumers’ actions by capturing SKU (stock-keeping units are the lowest level of identification of merchandise) data at point-of-purchase terminals and then transmitting this information through the entire supply chain. This information is used to develop new or modified products, manage channel-wide inventory levels, and lower total channel costs. The final section of this chapter discusses category management, which is accomplished when all the members—who in a conventional channel would have acted independently—work as a team to apply the ECR concept to an entire category of merchandise.
There are three types of vertical marketing channels: corporate, contractual, and administered. Each has grown significantly in the last 50 years.
Corporate Channels Corporate vertical marketing channels typically consist of either a manufacturer that has integrated vertically forward to reach the consumer, or a retailer that has integrated vertically backward to create a self-supply network.
The first type includes manufacturers such as Sherwin Williams, Polo Ralph Lauren, Coach, and Liz Claiborne, which have created their own warehousing and retail outlets. The second type includes Holiday Inn, which for years was vertically integrated to control a carpet mill, furniture manufacturer, and numerous other suppliers needed to build and operate its motels. To illustrate this point, consider that Holiday Inn recently conducted research to overcome manufacturing pro-blems encountered with the production of cinnamon rolls—the trademark of its Holiday Inn Express units.
In corporate channels it is not difficult to program the channel for productivity and profit goals, since a well-established authority structure already exists. Inde-pendent retailers that have aligned themselves in a conventional marketing channel are at a significant disadvantage when competing against a corporate vertical marketing channel.
Contractual Channels Contractual vertical marketing channels, which include wholesaler-sponsored voluntary groups, retailer-owned cooperatives, and fran-chised retail programs, are supply chains that use a contract to govern the working relationship between the members. Each of these variations allows for a more coordinated, systemwide perspective than conventional marketing channels.
However, they are more difficult to manage than corporate vertical marketing channels because the authority and power structures are not as well defined.
quick response (QR) by capturing sales data at point-of-purchase
Are the lowest level of identification of for-ward to reach the con-sumer or a retailer that has integrated vertically backward to create a self-supply network.
contractual vertical marketing channels
Use a contract to govern the working relationship
Channel members must give up some autonomy to gain channel economies of scale and greater market impact.
Wholesaler-Sponsored Voluntary Groups. Wholesaler-sponsored voluntary groups are created when a wholesaler brings together a group of independently owned retailers (independent retailers is a term embracing anything from a single mom-and-pop store to a small local chain), grocers for example, and offers them a coordinated merchandising program (store design and layout, store site and loca-tion analysis, inventory management channels, accounting and bookkeeping channels, insurance services, pension plans, trade area studies, advertising and promotion assistance, employee-training programs) and a buying program that will provide these smaller retailers with economies similar to those obtained by their chain store rivals. In return, the independent retailers agree to concentrate their purchases with that wholesaler. It is a voluntary relationship; that is, there are no membership or franchise fees. The independent retailer may terminate the rela-tionship whenever it desires, so it is to the wholesaler’s advantage to build com-petitive merchandise assortments and offer services that will keep the voluntary group satisfied.
In the past, local food wholesalers got practically all of their business from independent grocers.
Recently, however, as transportation costs have risen, major chains operating over a wide geographic area have also started using local or regional wholesalers.
While welcoming this new business, wholesalers have attempted to keep their independents happy (since they still account for over 40 percent of their business) by offering them additional services.
Wholesaler-sponsored voluntary groups have been a major force in marketing channels since the mid-1960s. They are now prevalent in many lines of trade. Independent Grocers’ Alliance (IGA) and National Auto Parts Association (NAPA) are both examples of wholesaler-sponsored voluntary groups.
Retailer-Owned Cooperatives. Another common type of contractual vertical marketing channel is retailer-owned cooperatives, which are wholesale operations organized and owned by retailers and are most common in hardware retailing. They include such familiar names as True Value, Ace, and Handy Hardware. They offer scale economies and services to member retailers, allowing their members to compete with larger chain-buying organizations.
It should be pointed out that, in theory, wholesale-sponsored groups should be easier to manage since they have only one leader, the wholesaler, versus the many owners of the retailer-owned group. One would assume that in retailer-owned wholesale cooperatives, individual members would desire to keep their autonomy and be less dependent on their supplier-partner for support and direction. In reality, how-ever, just the opposite has been true. A possible explanation is that retailers belonging to a wholesale co-op may make greater transaction-specific investments in the form of stock ownership, vested supplier-based store identity, and end-of-year rebates on pur-chases that combine to erect significant exit barriers from the cooperative.3
APPhoto/TomGannam
Ace Hardware is one of the oldest and largest retailer-owned cooperatives in the United States.
rivals are able to obtain.
retailer-owned
Franchises. The third type of contractual vertical marketing channel is the fran-chise. A franchise is a form of licensing by which the owner of a trademark, service mark, trade name, advertising symbol, or method (the franchisor) obtains distri-bution through affiliated dealers (franchisees). Each franchisee is authorized by the franchisor to sell their goods and/or services either in a retail space or a designated geographical area. The franchise governs the method of conducting business between the two parties. Generally, a franchisee sells goods or services supplied by the franchisor or that meet the franchisor’s quality standards. The Federal Trade Commission and often individual state laws regulate this relationship. In many cases the franchise operation resembles a large chain store. Franchises operate with standardized logos, uniforms, signage, equipment, storefronts, services, products and practices—all as outlined in the franchise agreement. The consumer might never know that each location is independently owned.
Franchising is a convenient and economic means of fulfilling an individual’s desire for independence with a minimum amount of risk and investment, and maximum opportunities for success. This is possible through the utilization of a proven product or service and marketing method. Consider that one of the benefits of franchising is that it permits a franchisee to select a location in a somewhat sophisticated manner based upon the various professional forecasting models that use data from earlier units. Another advantage is in the purchasing of key items.
Holiday Inn, for example, knows more about how to buy mattresses and furniture than most of its franchisees. Many franchisors provide a full range of services, including site selection, training, product supply, marketing plans, and even assistance in obtaining financing.
However, a franchisee/franchisor relationship requires an ongoing commitment, with each party expected to uphold its end of the contract though active communi-cation, solidarity, and mutual trust. In those cases where a franchisee/franchisor relationship does not work, it is usually the result of either a franchisee misunder-standing the franchising model or the franchisor failing to set expectations and/or the franchisee not understanding them at the outset. Remember that a franchisee gives up some freedom in business decisions that the owner of a nonfranchised business would retain. The most common franchise mistakes result from a franchisee’s incorrect perception of himself as a traditional entrepreneur. In order to maintain uniformity of service and to ensure that the operations of each outlet will reflect favorably on the organization as a whole, the franchisor must exercise some degree of control over the operations of franchisees, requiring them to meet stipulated standards of product and service quality and operating procedures. Exhibit 5.6 lists some of the major advan-tages and disadvanadvan-tages of franchising for both parties.
There are some 1,600 franchisors in the United States today, and they can be found at any position in the marketing channel; about 60 percent of them have startup costs of less than $250,000. 4The franchisor could be a manufacturer, such as Chevrolet and Midas Mufflers; a service specialist, such as Sylvan Learning, The UPS Store, AAMCO Transmissions, H&R Block, Lawn Doctor, Merry Maids, Mr. Handyman, Supercuts, and Century 21 Real Estate; a retailer, such as Gingiss Formalwear; or a fast-food retailer, such as McDonald’s, Dunkin’ Donuts, Subway, Domino’s Pizza, and KFC. A more complete list can be found at the International Franchise Association Web site, http://www.franchise.org.
Franchisors that focus their expansion efforts internationally have a higher profit potential.
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franchise
Is a form of licensing by which the owner of a product, service, or busi-ness method (the franchi-sor) obtains distribution through affiliated dealers (franchisees).
Although only a third of U.S. franchisors are currently operating in foreign countries, another third are looking to expand internationally within the next five years. After all, why compete in overcrowded U.S. markets when many foreign markets are available? Although franchising is seen as an economic-development tool for poor countries, the most widely considered foreign markets are the most
Exhibit 5.6
Advantages and Disadvantages of Franchising
ADVANTAGES TO FRANCHISEE ADVANTAGES TO FRANCHISOR 1. Access to a well-known brand name,
trademark, or product 2. Assistance in location decisions 3. Assistance in buying decisions 4. Being part of a successful format 5. Acquiring rights to well-defined
trade area
6. Lower risk of failure
7. Standardized marketing and operational procedures
8. By borrowing from the franchisor, the franchisee has access to a lower cost of capital
1. Since franchisee is the owner, more motivated managers on site 2. Local identification of the owner 3. Economics of scale
4. Franchisee must make royalty payments regardless of profitability
5. The rapid rollout of a successful concept requires less capital
DISADVANTAGES TO FRANCHISEE DISADVANTAGES TO FRANCHISOR 1. Higher costs because of fees due franchisor
2. Must give up some control of the business 3. Franchisor may not fulfill all promises 4. Can be terminated or not renewed
1. Loss of some profits 2. Loss of some control
3. Franchisee may not fulfill all parts of the agreement
GrahamBarclay/BloombergNews/Landov
Domino’s Pizza, by using the franchise marketing channel, has been able to expand rapidly.
prosperous markets of Canada, Japan, Mexico, Germany, the United Kingdom, and, more recently, Southeast Asia—the Philippines, Thailand, Taiwan, Singapore, and Indonesia.
Administered Channels The final type of vertical marketing channel is the admin-istered channel. Adminadmin-istered vertical marketing channels are similar to con-ventional marketing channels, but one of the members takes the initiative to lead the channel by applying the principles of effective interorganizational management, which is the management of relationships between the various organizations in the supply chain. Administered channels, although not new in concept, have grown substantially in recent years. Frequently, manufacturers initiate administered channels because they have historically relied on their administrative expertise to coordinate the retailers’ marketing efforts. Suppliers with dominant brands have predictably experienced the least difficulty in securing strong support from retailers and wholesalers. However, many manufacturers with ‘‘fringe’’ items have been able to elicit such cooperation only through the use of liberal distribution policies that take the form of attractive discounts (or discount substitutes), financial assistance, and various types of concessions that protect resellers from one or more of the risks of doing business.5
Some of the concessions manufacturers offer retailers are liberal return poli-cies, display materials for in-store use, advertising allowances, extra time for merchandise payment, employee-training programs, assistance with store layout and design, inventory maintenance, computer support, and even free merchandise.
Manufacturers that use their administrative powers to lead channels include General Electric (on both major and small appliances), Sealy (on its Posturepedic line of mattresses), Villager (on its dresses and sportswear lines), Scott (on its lawn-care products), Norwalk (on its upholstered furniture), Keepsake (on diamonds), and Stanley (on hand tools). Retailers can also dominate the channel relationship.
For example, Wal-Mart, one of the earliest adopters of ECR systems, administers the relationship with almost all of its suppliers by asking that all money designated for advertising allowances, end display fees, and so forth be, instead, taken off the price of goods.
Managing Retailer-Supplier Relations LO 3
How do dependency, power, and conflict influence channel relations?
Retailers that are not part of a contractual channel or corporate channel will probably participate in different channels, since they will need to acquire mer-chandise from many suppliers. Predictably, these channels will be either conven-tional or administered. If retailers want to improve their performance in these channels, they must understand the principal concepts of interorganizational management. In this case, it involves a retailer strategically managing its relations with wholesalers and manufacturers.
What are the basic concepts of interorganizational management that a retailer needs to understand? They are dependency, power, and conflict.
Dependency
As we mentioned earlier, every supply chain needs to perform eight marketing functions, which can be performed by any combination of the members. None of the respective institutions can isolate itself; each depends on the others to do an effective job.
administered vertical marketing channels
Exist when one of the channel members takes the initiative to lead the channel by applying the principles of effective interorganizational management.
Retailer A is dependent on suppliers X, Y, and Z to make sure that goods are delivered on time and in the right quantities. Conversely, suppliers X, Y, and Z depend on retailer A to put a strong selling effort behind their goods, displaying them properly and maybe even helping to finance consumer purchases. If retailer A does a poor job, each supplier can be adversely affected; if even one supplier does a poor job, retailer A can be adversely affected. In all these alignments, each party depends on the others to do a good job.
When each party is dependent on the others, we say that they are interde-pendent. Interdependency is at the root of the collaboration and the conflict found in channels today. To better comprehend this interdependency, an understanding of channel power is necessary.
Power
We can use the concept of dependency to explain power; but first we must define power. Power is the ability of one member to influence the decisions of the other channel members. The more dependent the supplier is on the retailer, the more power the retailer has over the supplier. For example, a small manufacturer of grocery products would be very dependent on a large supermarket chain, such as Kroger, if it wanted to reach the most consumers. Therefore, that supermarket has power over the small manufacturer. Likewise many suppliers to Wal-Mart are very dependent on Mart because it is their biggest customer. For example, Wal-Mart accounts for 18 percent of Rayovac’s annual sales and 14 percent of Newell Rubbermaid’s annual sales, making Rayovac and Newell highly dependent on Wal-Mart to make their brands as dominant as those of other major manufacturers.6 Thus, the power one member has over another channel member is a function of how dependent the second member is on the first member to achieve its own goals.
There are six types of power:
There are six types of power: