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VERTICAL INTEGRATIONINDISTRIBUTIONChapter 9
Prof. Aisha Zahid
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Outline IntroductionThe costs and benefits of vertical
integration in marketing channelsDeciding when to vertically
integrate forwardVertical integration forward when competition is
lowVertical integration to cope with environmental uncertainty
Vertical integration to reduce performance ambiguity Summary of the
decision frameworkVertical integration as an observatory on the
market or as an option
Prof. Aisha Zahid
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Distribution Networks: Activities1) Hold the goods (storage,
delivery costs)2) Own the goods (inventory carrying costs)3)
Promote (sell, advertise, public relations, trade deals)4)
Negotiate (takes time and money)
Prof. Aisha Zahid
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Distribution Networks: Activities5) Finance (credit, terms and
conditions of sale)6) Assume risks (price guarantees, warranties,
insurance, repair, after-sales service)7) Assume costs of
processing orders (often greater than cost of items!)8) Handle
payment (collection, bad debt)
Prof. Aisha Zahid
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What Value Does Distribution Provide?Conventional wisdom: not
muchAssumption: most of the value added is in productionGoods and
services appear Most buyers (and managers!) dont see the elaborate
structure of distribution that makes transactions happen
Prof. Aisha Zahid
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Distribution: The Real
ValueSolvecustomersproblemGaincustomerknowledge
Prof. Aisha Zahid
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What Distribution Really DoesSolve problems for prospective
buyersThereby solve problems for prospective sellersMake
marketsHelp define needsFind provider-customer matchesFacilitate
transactions
Prof. Aisha Zahid
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Its A Big IndustryThe sales side alone1 in 10 jobs worldwide is
in sales and related industriesBusiness-to-Consumer (B2C)The worlds
largest company is a retailerBusiness-to-BusinessIndependent
wholesalers alone1 in 20 jobs in the U.S. throughout the last
centuryWholesaling is a key industry to mergers and acquisitions
specialistsConsolidation due to opportunities to achieve advantage
through massive information technology and logistics
investments
Prof. Aisha Zahid
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And Its Not EasyGetting it rightintricate, detailedand getting
costs downIs a challengeDistribution is a competence in itselfNew
Institutional Economics has a great deal to say about how to
contract for this competence
Prof. Aisha Zahid
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Vertical Integration DefinedA channel member assumes
responsibility for additional channel flows rather than have them
performed by other channel membersAcquire other channel membersMake
or buyForward integrationBackward integrationFlow by flowNot a
binary decision of fully integrating or fully outsourcing
Prof. Aisha Zahid
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The costs and benefits of Vertical Integration in Marketing
ChannelsDegree of Vertical IntegrationClassical Market Contracting
(Outsourcing)Quasi-Vertical Integration (Relational
Governance)Vertical IntegrationCosts and benefits of the Choice to
MakeThe choice to buy distribution : The terms of payments to third
parties
Prof. Aisha Zahid
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The Continuum of vertical integration
Prof. Aisha Zahid
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Costs and benefits of the Choice to MakeAll accounting costs of
distribution, which includes the cost of personnel and channel flow
costs.Heaviest cost is the opportunity cost of the
personnelControl; it has no value unless it improves profitsA
business PropositionTo cut costTo explore new opportunitiesExisting
operations loosing their attractivenessTheoretically integrated
entity is better off financially , weighing total returns against
total assets employed , adjusting for the risk assumed.
Prof. Aisha Zahid
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Some Channel FunctionsMarketQuasi-verticalVertical
ContractingIntegrationIntegration
Selling (only)ManufacturersCaptive Company
SalesRepresentativesSales AgencyForce (directsalespeople)
WholesaleIndependentDistributionDistributionDistributionWholesalerJoint
VentureArm
RetailIndependentFranchiseCompanyDistribution(3rd
party)StoreStoresStores
Prof. Aisha Zahid
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The choice to buy distribution : The terms of payments to third
parties
Price:MarginsCommissionA percentage of resellers
businessFunctional discountRights to future businessPercentage of
equity in the manufacturer
Prof. Aisha Zahid
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Deciding when to vertically Integrate Forward: An economical
FrameworkReturn on Investment: The usual CriterionOutsourcing as a
starting pointSix reasons to outsource distribution
Prof. Aisha Zahid
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Deciding When To Integrate ForwardPreliminary decision:
outsource, do not integrateThen challenge preliminary
decisionCriterion: long-run ROICompare ROI for integrating versus
outsourcing
Revenues Direct Costs Net Effectiveness Overhead Overhead =
Efficiency
Compare ROI for integrating with ROI for other possible
investmentsIntegrating as a business opportunityControl has no
economic value =
Prof. Aisha Zahid
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Outsourcing as a starting pointThe fundamental rationale is that
under normal circumstances in a developed economy , markets for
distribution services are efficient.
Prof. Aisha Zahid
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THE EFFECTS OF OUTSOURCINGnot given in the book
Prof. Aisha Zahid
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Six Reasons To Outsource
DistributionMotivationSpecializationSurvival of the economically
fittestEconomies of scale Heavier market coverageIndependence from
any single manufacturer
Prof. Aisha Zahid
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Vertical Integration Forward When Competition Is LowVertical
Integration always involves substantial set up costs and overheads;
therefore it is only worth considering if a substantial amount of
business is at stakeIt is only worth considering if the firm is
prosperous enough to be able to muster the necessary resources-and
does not have a better use for them
Prof. Aisha Zahid
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Vertical Integration Forward When Competition Is LowCompany
specific capabilitiesSix types of company specific capabilities in
distributionSpecific assets can change to general purpose
assetsSwitching CostRarity vs. Specificity
Prof. Aisha Zahid
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Company specific capabilitiesIdiosyncrasiesGreater the value of
company specific capabilities , greater the economic rationale for
the manufacturers to vertically integrate forward into the
distributionIrreplaceable nature of holders of capabilitiesTo cope
with shirking, misrepresenting the products, unethical behaviors,
falsifying expense accounts and demands for more compensation to do
the same work Vertical integration creates an administrative
mechanism .Vertical integration gives the ability to employ
negative sanctionsVertical integration leads to the control of
monetary and non monetary compensationsThreat of vertical
integration will improve the performance of distributors.
Prof. Aisha Zahid
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Company specific capabilities ContTwo benefits of Vertical
Integration are :The producer can make sure its employees really do
make the investment and acquire the needed capabilitiesThe producer
can show potential customers and other constituents (investors )
that it is dedicated to the markets and its products
Prof. Aisha Zahid
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Company specific capabilities ContAssets : tangible or
intangible can be used to create economic value Specific: made to
specifications , customized, tailored, particular to , or
idiosyncratic.
Prof. Aisha Zahid
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Six types of company specific capabilities in distribution
Idiosyncratic knowledgeRelationshipBrand equity that drives from
the channels partner activitiesCustomized physical
facilitiesDedicated capacitySite specificity
Prof. Aisha Zahid
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Six types of company specific capabilities in distribution
ContSpecific assets can change to general purpose assetsInnovative
productsEntering Foreign MarketsCompetitors copy the products and
practices which change the company specific assets to general
purpose assets.
Prof. Aisha Zahid
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Six types of company specific capabilities in distribution
ContSwitching CostThese are the one time losses incurred in taking
down the current operations and setting up a new
operationTerminating positionCreative solutions:Transfer of
personnelSetting up former employees as third party providers of
distribution services Setting up independent agenciesSwitching cost
give late movers an advantage over established firms.
Prof. Aisha Zahid
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Rarity vs. Specificity
Selling Ability and Technical CompetencesConsolidation of
industries
Prof. Aisha Zahid
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HOW ENVIRONMENTAL UNCERTAINTY IMPACTS VERTICAL INTEGRATION
Prof. Aisha Zahid
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HOW ENVIRONMENTAL UNCERTAINTY IMPACTS VERTICAL INTEGRATION
Cont
Prof. Aisha Zahid
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ROAD MAP TO THE VERTICAL INTEGRATION DECISION
Prof. Aisha Zahid
