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Design Principles for Design Principles for Distribution ChannelsDistribution Channels

Distribution Channel StrategyBA266: 2000-3L. P. Bucklin

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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

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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

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End-User

Butcher

Grower

Super-market

MeatWholesaler

MeatMarket

Abattoir

Restaurant

PackingHouseGrower

Grower

Grower

MeatFabricator

MeatWholesaler

PortionControl

Wholesaler

Evolution of Natural Channelsfor Fresh Meat

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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

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Principle IPrinciple I

• End users incur real and opportunity costs in the acquisition and preparation of products and services for production

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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

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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

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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

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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

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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

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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.

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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

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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

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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

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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

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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

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Logistic Channel DesignLogistic Channel Design

Logistic channels comprise those members of the channel that provide logistic services

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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

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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

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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

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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

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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

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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

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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

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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.

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Information Channel DesignInformation Channel Design

Information channels comprise the subset of members that provide product information services in the channel

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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

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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

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• 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

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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

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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

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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