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© 2000 1
Design Principles for Design Principles for Distribution ChannelsDistribution Channels
Distribution Channel StrategyBA266: 2000-3L. P. Bucklin
© 2000 2
OverviewOverview
• Channel Design
– Market based
– Plan based
• Dual Channel Sectors
– Commercial sector provides services to end-user
– Channel design endeavors to balance cost of service vs. added value to the end-user
• Major service dimensions– Logistic
– Information
© 2000 3
Market Channel DesignMarket Channel Design
• Most channels result from evolutionary forces rather than planned design
• Evolutionary channels, as opposed to planned, are the consequence of:– Decisions by innovative firms to enter a
channel to provide a set of services– Imitation of innovators– Adaptation of existing channel members to
the new entrants
© 2000 4
End-User
Butcher
Grower
Super-market
MeatWholesaler
MeatMarket
Abattoir
Restaurant
PackingHouseGrower
Grower
Grower
MeatFabricator
MeatWholesaler
PortionControl
Wholesaler
Evolution of Natural Channelsfor Fresh Meat
© 2000 5
Planned Channel DesignPlanned Channel Design
• The specification of the set of channel members to provide the value-added services desired by a targeted market by means of cost-benefit analysis
• Channel member assignments– Activities they perform, e.g., transport, inventory,
information, financing– Number, location & connectivity with other channel
members
• Individual member firms may sub-divide operations into a number of individual business units
© 2000 6
Principle IPrinciple I
• End users incur real and opportunity costs in the acquisition and preparation of products and services for production
© 2000 7
Channel Value-Added ServicesChannel Value-Added Services
• Logistic– Access--convenience
– Availability--delivery time, accuracy
– Order size, frequency
– Assortment--breadth, variety
– Product availability, freshness
• Information– Richness, vividness, accuracy
– Responsiveness to information requests
© 2000 8
Channel SectorsChannel Sectors
• Two channel sectors– The end-user sector including
the household industrial, institutional buyers
– The commercial sector including The end-user interface (EUI) Supply channel members to the EUI
• Total channel costs: sum of all costs incurred by the commercial channel and the end user to delivery/acquire and consume the product
• These are equivalent to the price paid by the end user for the product/service plus ancillary costs of acquisition and preparation for use
© 2000 9
The Two Channel Sectors
Suppliers
End-User
SeparateMarketingFunctions
Indirect Channel Direct Channel CommercialSector: Manufacturers, Intermediaries, Agents
End-userSector
Total Channel Costs = Commercial Sector Costs + End-user Costs
© 2000 10
Factors Affecting End-User Factors Affecting End-User Service DemandService Demand
• Opportunity costs for end-user shopping time– Size of family, dual careers, income
• Travel technology– Availability of transport options to shoppers– City densities affecting travel times
• Cost of buying in large lots– Rate of consumption, storage space availability – Capital to stock products, risk in holding inventories
• Predictability of needs• Product knowledge, frequency of purchase• Product cost relative to income
© 2000 11
Factors Affecting the Cost of Factors Affecting the Cost of Value-added (VA) ServiceValue-added (VA) Service
• Product cost (interest, risk of products in channel pipeline)– Rate of product obsolescence, introductions, interest rate
• Product physical characteristics– Weight to value ratio (bulkiness)– Fragility, toxicity
• The cost of channel inputs– Labor, cost of capital, land– Purchased services, e.g., transportation, advertising, website
• Assortment breadth, depth• Assortment variety, breadth, depth• Distance between supplier and end-user
© 2000 12
Principle IIPrinciple II
• The Commercial Channel evolves so as to provide the set of services demanded by the end user. The design of a channel requires an in-depth understanding of the set of needs possessed by end users and what they will pay for these.
© 2000 13
Channel System CostsChannel System Costs
• The commercial sector incurs greater costs as it provides higher levels of value added
• End-user acquisition costs decline as commercial sector value-added services increase– Value-added services reduce the level of effort, time
and ancillary resources incurred by the end user to acquire and prepare products/services for consumption
– These resources involve real, opportunity and emotional costs
© 2000 14
Channel Service EquilibriumChannel Service EquilibriumCosts/Transaction
Service Output
End-user Costs (A)
CommercialSector Costs (B)
Total ChannelCosts (A+B)
Equilibrium
total channelcosts
commercial channel costs
end-user costs
Service levelprovided
© 2000 15
Channel Cost BalanceChannel Cost Balance
• Total channel costs take a U-shape• At equilibrium, the interests of the end-user are
maximized when the marginal benefits for V-A service equal the marginal cost to the commercial channel of supplying these services
• Equilibrium determines: – Total costs for the system
– The level of service provided to the end-user
– The share of total channel costs performed by the end-user
© 2000 16
Channel EvolutionChannel Evolution
Channel members enter, depart, and reassign duties in order to alter and improve efficiency of value-added services
Channels evolve by balancing the incremental costs of additional services against the value that they provide to the end user
Competitive forces, over time, cause value-added prices to reach competitive levels
–Channel innovators are copied by new entrants
–Channel systems incur life cycles with accelerating, then waning profit levels
© 2000 17
Principle IIIPrinciple III
• Competitive channel systems seek equilibrium over time in order to balance the incremental costs of additional services against the value that these would add for the end user
© 2000 18
Logistic Channel DesignLogistic Channel Design
Logistic channels comprise those members of the channel that provide logistic services
© 2000 19
Channel LengthChannel Length
• Channel length is a rough approximation of channel structure
• From a logistics point of view, it is measured by the number of firms (and related establishments) that hold title or manage inventories in the commercial channel
• An establishment is a separate place of business where channel service generating activities are performed; i.e., a warehouse and chain of stores
© 2000 20
Historic Automobile Logistics Historic Automobile Logistics ChannelChannel
End-users
Supplier
Auto Store Auto Store Auto Store
Logistic services include ease of access to product, assortment breadth, immediate availability
American end users want to drivecar away if they like one at a lot
© 2000 21
Cadillac Cadillac Test ChannelTest Channel
End-users
SupplierEUI inventory costs are high in order to provide services
Test system provides warehouse for intermediate storage
Savings in commercial channel cost occur while maintaining easy end user access But, inventory at warehouse may be at high risk
Auto Store Auto Store Auto Store
Warehouse
© 2000 22
Logistic Channel ComponentsLogistic Channel Components
• Logistics systems comprise a sequence of inventory and transit/product handling systems
• To provide high level logistic service, the EUI is locates proximate to the end user; e.g., a drug store– The more proximate to the end user, the:
Greater the channel’s ability to provide fast replenishment, such as a convenience store, but
EUI inventory turnover declines and inventory risk increases
Transport costs increase since goods must be sold transported to the EUI in small quantities
© 2000 23
Principle IV:Principle IV:
• The addition of higher value-added logistic services leads to longer channels with incremental inventory points as the means to reduce logistic costs at the EUI
© 2000 24
Two Inventory TypesTwo Inventory Types
• Speculative Inventory (Risk Holding Point)– Inventories comprised of fungible products on first
come/first basis; such as typical store inventories– Efficient when future demand is not accurately forecast
• Transit Point (Ship-Through-Inventory Point)– Inventories comprised of packages marked for specific
destinations /customers ; no break bulk is performed– Facilitate rapid ingress, egress with little time at the
inventory point; no back-up stocks are held; e.g., FedEx– Typically used in rapid response channels to large scale
EUI
© 2000 25
Efficient Consumer ResponseEfficient Consumer Response
• Efficient consumer response seeks to limit inventories and inventory points in the distribution system, yet retain the same level of logistic service
• Inventory is shifted up the channel to higher points in the system, often at the supplier level
• Transit inventories are established• Improvements in communication and fast delivery
systems through air-truck combinations employed– Match delivery to time when expected inventory is zero– System knowledge of current demand widely shared– Employs cross-docking, transit inventories
© 2000 26
Corollary to Principle IVCorollary to Principle IV
• Employing rapid response design transforms speculative inventories to transit inventories, reducing inventory cost but at the cost of higher transportation cost.
© 2000 27
Information Channel DesignInformation Channel Design
Information channels comprise the subset of members that provide product information services in the channel
© 2000 28
Information Services for ProductsInformation Services for Products
• Information VA services include:– The speed by which a message can be prepared,
sent, and interpreted– The complexity or richness of information that
is carried by a message– The extent to which the message can
sufficiently describe a product’s characteristics– The accuracy and interpretability of the
information in a message
© 2000 29
Channel Design and Channel Design and Comparative Information VAComparative Information VA
Supplier
Store
Wholesaler
EUI-1Desktop
EU-3Big Iron
VAR
EU-2Server
Fastest, mostaccurate fromsupplier to EU
Slowest, leastaccurate fromsupplier to EU
© 2000 30
• Long channels provide information at a relatively low cost, but at a low quality
• The flow of information through multiple intermediaries in a channel system takes longer, corrupts & degrades the information
• When the end user requires complex products and rich information infor-mation intermediaries are eliminated
Information CostsInformation Costs
© 2000 31
Principle VPrinciple V
Higher information value added provided to the end user requires a reduced channel length as information intermediaries are eliminated to prevent information degeneration
© 2000 32
Interactions Between Information and Interactions Between Information and Logistic ServicesLogistic Services
HybridDirect
CommercialWarehouse
PureIndirectChannel
HybridBroker
Drop-ship
PureDirect
ChannelEU Information
Needs
EU-LogisticalNeeds
High
High
Low
Low
Pure channel: same logistic and information structureHybrid channel: different logistic and information structure
© 2000 33
Principle VIPrinciple VI
• The presence of similar end user needs for information and logistics leads to hybrid channels with information and logistics traveling separate routes
• The presence of dissimilar end user needs for information and logistics leads to pure or integrated channels where information and logistics services are provided by the same organizations