PART 1: Defining Marketing and the Marketing Process (Chapters 1–2) PART 2: Understanding the Marketplace and Consumer Value (Chapters 3–6) PART 3: Designing a Customer Value–Driven Strategy and Mix (Chapters 7–17) PART 4: Extending Marketing (Chapters 18–20)

Marketing Channels 12 Delivering Customer Value We now look at the third marketing mix tool—distribution. distribution—or logistics—an area that has grown dramatically Companies rarely work alone in engaging custom- in importance and sophistication. In the next chapter, we’ll look ers, creating customer value, and building profitable more closely at two major channel intermediaries: retailers and customer relationships. Instead, most are only a single wholesalers. review

Chapter p link in a larger supply chain and marketing channel. As We start by looking at Uber, the fast-growing, app-based such, a firm’s success depends not only on how well it performs car-hailing service that has recently sprouted up in cities around but also on how well its entire marketing channel competes with the world. Uber has radically reinvented urban transportation competitors’ channels. The first part of this chapter explores channels, posing a serious threat to conventional taxicab and car the nature of marketing channels and the marketer’s channel service companies. As Uber grows, traditional competitors must design and management decisions. We then examine physical innovate or risk being pushed aside.

Uber: radically reshaping Urban Transportation Channels

t’s rare. But every now and then a company comes along eliminating guesswork and uncertainty. After the ride, pas- that completely disrupts the traditional ways of distribut- sengers simply exit and walk away. Uber automatically pays ing a product or service. FedEx revolutionized small pack- the driver (including tip) from the passenger’s prepaid Uber age delivery channels, Amazon.com radically transformed account, eliminating the often-inconvenient and awkward Ionline selling, and Apple’s iTunes and iPod turned music moment of payment. And it’s the same process anywhere in distribution on its ear. Now comes Uber, the app-based ride the world, from San Francisco, London, Paris, or Abu Dhabi to service that is revolutionizing urban transportation. Fast- Ashville, North Carolina, or Athens, Georgia. growing Uber is giving conventional taxicab and car services Compare the Uber experience to the uncertain and often- a real ride for their money. In just seven short years, Uber unsettling experience of using a standard taxicab. One business has revved up operations in hundreds of major cities in 67 reporter describes waiting in line at a taxi stand while a driver countries, already booking more tried to convince another would- than $10 billion in rides annually be passenger—a total stranger—to through its massive network of Uber—the fast-growing app-based share the cab, thereby increasing more than a million drivers. ride service—is revolutionizing urban his fare. The cab itself was ancient Why are so many customers and filthy, with ripped and worn transportation channels in cities around the around the world bypassing good seats. During the entire ride, the globe. As Uber grows, traditional taxicab old taxicabs in favor of newcomer cabbie carried on a phone conver- Uber? It’s all about convenience services must innovate or risk extinction. sation in a foreign language via his and peace of mind. No more step- headset, causing safety concerns ping out into busy city streets to while distractedly navigating busy wave down a passing cab. Instead, Uber’s smartphone app city streets. The driver spoke only poor, hard-to-understand lets passengers hail the nearest cab or limo from any location, English. “That turned out to be a good thing,” says the reporter, then track the vehicle on a map as it approaches. The Uber app “because I couldn’t understand what he was trying to say when gives riders an accurate estimate in advance of the fare to their he insulted me for not tipping him enough.” The reporter’s destinations (usually less than that charged by a regular cab), conclusion: “I stepped out of the taxi in front of my house and ChApter 12 | Marketing Channels: Delivering Customer Value 357 realized I just don’t have to put up with this garbage anymore. Uber has changed my life, and as God is my witness, [wherever Uber is available] I will never take a taxi again.” Uber drivers range from professional drivers who’ve switched over from conventional cab and transportation companies to regular people looking for a little adventure and some extra income in their spare time. All Uber drivers go through an orienta- tion that requires proficiency in a market area’s dominant language, ensuring that they can com- municate effectively with customers. Uber vehicles must be at least 2010-year models or newer, and cus- tomers can often choose the type of car they want, from an entry-level Prius to a stretch Mercedes Uber lets passengers hail the nearest cab from any location using its smartphone app, then track the vehicle on a map as it approaches. S-Class. A two-way rating system—by which riders PAUL J. RICHARDS/AFP/Getty Images rate drivers and drivers rate riders in return—helps keep both sides on their best behavior. Poorly rated drivers risk being rejected by future passengers; poorly rated major Uber investor) is reported to be readying the launch of its passengers risk rejection by drivers, who can choose which own ride-hailing service, one that would eventually utilize the fares they accept. driverless vehicles Google is developing. But Uber has a huge Uber’s disruptive innovation has brought a breath of fresh first-to-market advantage. Its bookings are 10 times those of air to an industry begging for change. Urban transportation nearest competitor Lyft, and Uber is adding new customers at channels have long been characterized by cartel-like relation- a faster rate. ships between cab companies and local governments, high Moreover, even as competition stiffens, Uber has little fixed fares, poor service, and little accountability. As one eco- to fear from like-minded competitors. In fact, the more com- nomics professor points out, the taxicab industry “was ripe for petitors adopt the new model, the more the revolutionary entry [by start-ups] because everybody hates it.” channel will grow and thrive versus traditional channels, creat- Like any innovator, upstart Uber faces some significant ing opportunities for all new car-hailing entrants. Instead, the challenges. For example, Uber has been criticized for exer- new distribution model poses the biggest threat to traditional cising too little control over driver quality and security. So taxicab and car-for-hire companies, which are now losing both far, the company has ridden beneath the radar of industry customers and drivers to Uber and its competitors. regulators by not directly employing drivers (all Uber drivers Based on its U.S. success, Uber is now expanding rapidly are independent contractors) and not owning any vehicles abroad. Huge markets such as China and India are especially (all vehicles are driver-owned). However, although some attractive, with their massive populations of people who don’t municipalities have passed ordinances favorable to Uber’s own cars. Uber is already operating in 37 Chinese cities and operations, others are imposing new regulatory restrictions plans to be shuttling riders around 100 large metro areas in the and licensing requirements or even banning ride-hailing ser- country within 12 months. In China, however, Uber is playing vices altogether. catch-up to market leader Didi Kuaidi, which already operates Uber has also been criticized for its “surge pricing” in 360 Chinese cities and towns. Similarly, in India, Uber is tak- practices—a dynamic pricing mechanism that kicks in to raise ing on established market leader Ola. prices when demand exceeds supply, sometimes resulting in Despite its explosive growth, Uber—like every other shockingly high fares and accusations of price gouging. Uber ride-hailing company—has yet to turn a profit. Like justifies surge pricing by pointing that it provides an incentive Facebook, Amazon, and so many other revolutionary com- for more drivers to be available during periods when passen- panies in today’s internet-driven economy, Uber’s start-up gers need them most. According to Uber, if a passenger faces model is to build a big user base first, then worry about mak- a higher-than-normal fare because of surge pricing, the alter- ing money later. Uber keeps 20 to 30 percent of each fare—the native without Uber would more than likely be no taxi at all. rest goes to the driver. But Uber plows back most of its take Moreover, Uber informs passengers in advance what the fares into expansion and promotional expenses. Investors seem will be. If they don’t like the fare, they can find another cab, confident. Uber has raised more than $10 billion in venture take public transportation, or walk. capital and currently has a valuation of more than $62 billion, Uber’s huge success has attracted a garage full of competi- making it the world’s most valuable privately held technol- tors, such as Lyft, Gett, Carma, and Curb. Even Google (itself a ogy firm. 358 pArt 3 | Designing a Customer Value–Driven Strategy and Mix Objectives Outline

Objective 12-1 explain why companies use marketing channels and discuss the functions these channels perform. Supply Chains and the Value Delivery Network (pp 358–361)

Objective 12-2 Discuss how channel members interact and how they organize to perform the work of the channel. Channel Behavior and Organization (pp 362–368)

Objective 12-3 Identify the major channel alternatives open to a company. Channel Design Decisions (pp 368–372)

Objective 12-4 explain how companies select, motivate, and evaluate channel members. Channel Management Decisions (pp 372–376)

Objective 12-5 Discuss the nature and importance of marketing logistics and integrated supply chain management. Marketing Logistics and Supply Chain Management (pp 376–383)

Uber-mania is even catching on in other industries. It just delivering people to their destinations. Once Uber has seems like there’s an app-based on-demand “Uber” for almost established a dense network of cars in every city, he predicts anything these days—laundry and dry cleaning (Washio), in- using the network to deliver everything from packages from home massage (Zeel), 24/7 delivery services (Postmates), and retailers to takeout food. As Kalanick puts it, “Once you’re even booze (Minibar). In fact, Uber CEO Travis Kalanick sees delivering cars in five minutes, there are a lot of other things no end of future applications for Uber’s services, well beyond you can deliver in five minutes.”1

AS ThE UbER SToRy ShowS, good distribution strategies can contribute strongly to customer value and create competitive advantage for a firm. But firms cannot bring value to customers by themselves. Instead, they must work closely with other firms in a larger value delivery network.

Author These are pretty hefty Comment terms for a really simple Supply Chains and the Value Delivery Network concept: A company can’t go it Producing a product or service and making it available to buyers requires building relation- alone in creating customer value. It ships not only with customers but also with key suppliers and resellers in the company’s sup- must work within a broader network of partners to accomplish this task. ply chain. This supply chain consists of upstream and downstream partners. Upstream from Individual companies and brands don’t the company is the set of firms that supply the raw materials, components, parts, informa- compete; their entire value delivery tion, finances, and expertise needed to create a product or service. Marketers, however, have networks do. traditionally focused on the downstream side of the supply chain—the marketing channels (or distribution channels) that look toward the customer. Downstream marketing channel part- ners, such as wholesalers and retailers, form a vital link between the firm and its customers. The term supply chain may be too limited, as it takes a make-and-sell view of the busi- ness. It suggests that raw materials, productive inputs, and factory capacity should serve as the starting point for market planning. A better term would be demand chain because it ChApter 12 | Marketing Channels: Delivering Customer Value 359

suggests a sense-and-respond view of the market. Under this view, planning starts by identi- fying the needs of target customers, to which the company responds by organizing a chain Value delivery network of resources and activities with the goal of creating customer value. A network composed of the company, Yet even a demand chain view of a business may be too limited because it takes a step- suppliers, distributors, and, ultimately, by-step, linear view of purchase-production-consumption activities. Instead, most large customers who partner with each other companies today are engaged in building and managing a complex, continuously evolv- to improve the performance of the entire ing value delivery network. As defined in Chapter 2, a value delivery network is made system in delivering customer value. up of the company, suppliers, distributors, and, ultimately, customers who “partner” with each other to improve the performance of the entire system. For example, Pepsi makes great beverages. But to make and market just one of its many lines—say, its classic colas— Pepsi manages a huge network of people within the com- pany, from marketing and sales people to folks in finance and operations. It also coordinates the efforts of thousands of suppliers, bottlers, retailers ranging from Kroger and Walmart to Papa John’s Pizza, and advertising agencies and other marketing service firms. The entire network must function together to create customer value and establish the brand’s “Pepsi: Live for Now” positioning. This chapter focuses on marketing channels—on the downstream side of the value delivery network. We exam- ine four major questions concerning marketing channels: What is the nature of marketing channels, and why are they important? How do channel firms interact and organize to do the work of the channel? What problems do companies face in designing and managing their channels? What role Value delivery network: In making and marketing even just its classic colas, Pepsi manages a huge network of people within the do physical distribution and supply chain management play company plus thousands of outside suppliers, bottlers, retailers, and in attracting and satisfying customers? In the next chapter, marketing service firms that must work together to create customer we will look at marketing channel issues from the view- value and establish the brand’s “Pepsi: Live for Now” positioning. points of retailers and wholesalers. AP Images for Pepsi

Author In this section, we look at Comment the downstream side of the The Nature and Importance of Marketing Channels value delivery network—the marketing Few producers sell their goods directly to final users. Instead, most use intermediaries to channel organizations that connect bring their products to market. They try to forge a marketing channel (or distribution the company and its customers. To channel)—a set of interdependent organizations that help make a product or service understand their value, imagine life without retailers—say, without grocery available for use or consumption by the consumer or business user. stores or department stores. A company’s channel decisions directly affect every other marketing decision. Pricing depends on whether the company works with national discount chains, uses high-quality specialty stores, or sells directly to consumers online. The firm’s sales force and commu- nications decisions depend on how much persuasion, training, motivation, and support Marketing channel (distribution its channel partners need. Whether a company develops or acquires certain new products channel) may depend on how well those products fit the capabilities of its channel members. A set of interdependent organizations that Companies often pay too little attention to their distribution channels—sometimes help make a product or service available with damaging results. In contrast, many companies have used imaginative distribu- for use or consumption by the consumer tion systems to gain a competitive advantage. Enterprise Rent-A-Car revolutionized the or business user. car-rental business by setting up off-airport rental offices. Apple turned the retail music business on its head by selling music for the iPod via the internet on iTunes. FedEx’s cre- ative and imposing distribution system made it a leader in express package delivery. And Amazon.com forever changed the face of retailing and became the Walmart of the internet by selling anything and everything without using physical stores. Distribution channel decisions often involve long-term commitments to other firms. For example, companies such as Ford, McDonald’s, or Nike can easily change their advertising, pricing, or promotion programs. They can scrap old products and introduce new ones as market tastes demand. But when they set up distribution channels through contracts with franchisees, independent dealers, or large retailers, they cannot readily replace these channels with company-owned stores or internet sites if the conditions change. Therefore, management must design its channels carefully, with an eye on both today’s likely selling environment and tomorrow’s as well. 360 pArt 3 | Designing a Customer Value–Driven Strategy and Mix How Channel Members Add Value Why do producers give some of the selling job to channel partners? After all, doing so means giving up some control over how and to whom they sell their products. Producers use intermediaries because they create greater efficiency in making goods available to target markets. Through their contacts, experience, specialization, and scale of operation, intermediaries usually offer the firm more than it can achieve on its own. Figure 12.1 shows how using intermediaries can provide economies. Figure 12.1A shows three manufacturers, each using direct marketing to reach three customers. This sys- tem requires nine different contacts. Figure 12.1B shows the three manufacturers working through one distributor, which contacts the three customers. This system requires only six contacts. In this way, intermediaries reduce the amount of work that must be done by both producers and consumers. From the economic system’s point of view, the role of marketing intermediaries is to transform the assortments of products made by producers into the assortments wanted by consumers. Producers make narrow assortments of products in large quantities, but consumers want broad assortments of products in small quantities. Marketing channel members buy large quantities from many producers and break them down into the smaller quantities and broader assortments desired by consumers. For example, Unilever makes millions of bars of Lever 2000 hand soap each week. However, you most likely want to buy only a few bars at a time. Therefore, big food, drug, and discount retailers, such as Safeway, Walgreens, and Target, buy Lever 2000 by the truckload and stock it on their stores’ shelves. In turn, you can buy a single bar of Lever 2000 along with a shopping cart full of small quantities of toothpaste, shampoo, and other related products as you need them. Thus, intermediaries play an important role in match- ing supply and demand. In making products and services available to consumers, channel members add value by bridging the major time, place, and possession gaps that separate goods and services from those who use them. Members of the marketing channel perform many key functions. Some help to complete transactions: • Information. Gathering and distributing information about consumers, producers, and other actors and forces in the marketing environment needed for planning and aiding exchange. • Promotion. Developing and spreading persuasive communications about an offer. • Contact. Finding and engaging customers and prospective buyers. • Matching. Shaping offers to meet the buyer’s needs, including activities such as manu- facturing, grading, assembling, and packaging. • Negotiation. Reaching an agreement on price and other terms so that ownership or pos- session can be transferred. Others help to fulfill the completed transactions: • Physical distribution. Transporting and storing goods. FIgUre | 12.1 • Financing. Acquiring and using funds to cover the costs of the channel work. How a Distributor Reduces the • Risk taking. Assuming the risks of carrying out the channel work. Number of Channel Transactions

1 Manufacturer Customer Manufacturer Customer 2 1 4 3 Marketing channel intermediaries make 4 buying a lot easier for 2 5 consumers. Again, Manufacturer 5 Manufacturer Distributor think about life without Customer Customer grocery retailers. How would you go about 6 buying that 12-pack of 6 Coke or any of the 7 3 hundreds of other items 8 that you now routinely Manufacturer Customer Manufacturer Customer drop into your shopping 9 cart? A. Number of contacts without a distributor B. Number of contacts with a distributor ChApter 12 | Marketing Channels: Delivering Customer Value 361

The question is not whether these functions need to be performed—they must be—but rather who will perform them. To the extent that the manufacturer performs these func- tions, its costs go up; therefore, its prices must be higher. When some of these functions are shifted to intermediaries, the producer’s costs and prices may be lower, but the inter- mediaries must charge more to cover the costs of their work. In dividing the work of the channel, the various functions should be assigned to the channel members that can add the most value for the cost. Number of Channel Levels Companies can design their distribution channels to make products and services avail- able to customers in different ways. Each layer of marketing intermediaries that performs some work in bringing the product and its ownership closer to the final buyer is a channel Channel level level. Because both the producer and the final consumer perform some work, they are part A layer of intermediaries that performs of every channel. some work in bringing the product and its Figure 12.2 ownership closer to the final buyer. The number of intermediary levels indicates the length of a channel. shows both consumer and business channels of different lengths. Figure 12.2A shows sev- Direct marketing channel eral common consumer distribution channels. Channel 1, a direct marketing channel, A marketing channel that has no has no intermediary levels—the company sells directly to consumers. For example, Mary intermediary levels. Kay Cosmetics and Amway sell their products through home and office sales parties and online websites and social media; companies ranging from GEICO insurance to Omaha Steaks sell directly to customers via internet, mobile, and telephone channels. The remain- Indirect marketing channel ing channels in Figure 12.2A are indirect marketing channels, containing one or more A marketing channel containing one or intermediaries. more intermediary levels. Figure 12.2B shows some common business distribution channels. The business marketer can use its own sales force to sell directly to business customers. Or it can sell to various types of intermediaries, which in turn sell to these customers. Although consumer and business marketing channels with even more levels can sometimes be found, these are less common. From the producer’s point of view, a greater number of levels means less control and greater channel complexity. Moreover, all the institutions in the channel are connected by several types of flows. These include the physical flow of products, the flow of ownership, the payment flow, the information flow, and the promotion flow. These flows can make even channels with only one or a few levels very complex.

FIgUre | 12.2 Consumer and Business Marketing Channels Using direct channels, a Using indirect channels, the company uses one or company sells directly to more levels of intermediaries to help bring its products consumers (no surprise there!). to final buyers. Examples: most of the things you Examples: GEICO and Amway. buy—everything from toothpaste to cameras to cars.

Producer Producer Producer Producer Producer Producer

Wholesaler Manufacturer’s representatives or sales branch

Retailer Retailer Business Business distributor distributor

Consumer Consumer Consumer Business Business Business customer customer customer

Channel 1 Channel 2 Channel 3 Channel 1 Channel 2 Channel 3

A. Consumer marketing channels B. Business marketing channels 362 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

Author Channels are made up of Comment more than just boxes and Channel Behavior and Organization arrows on paper. They are behavioral Distribution channels are more than simple collections of firms tied together by various systems consisting of real companies flows. They are complex behavioral systems in which people and companies interact and people who interact to accomplish to accomplish individual, company, and channel goals. Some channel systems consist their individual and collective goals. Like groups of people, sometimes they of only informal interactions among loosely organized firms. Others consist of formal work well together and sometimes interactions guided by strong organizational structures. Moreover, channel systems do they don’t. not stand still—new types of intermediaries emerge and whole new channel systems evolve. Here we look at channel behavior and how members organize to do the work of the channel. Channel Behavior A marketing channel consists of firms that have partnered for their common good. Each channel member depends on the others. For example, a Ford dealer depends on Ford to design cars that meet customer needs. In turn, Ford depends on the dealer to engage customers, persuade them to buy Ford cars, and service the cars after the sale. Each Ford dealer also depends on other dealers to provide good sales and service that will uphold the brand’s reputation. In fact, the success of individual Ford dealers depends on how well the entire Ford marketing channel competes with the channels of Toyota, GM, Honda, and other auto manufacturers. Each channel member plays a specialized role in the channel. For example, Samsung’s role is to produce electronics products that consumers will covet and create demand through national advertising. Best Buy’s role is to display these Samsung products in con- venient locations, answer buyers’ questions, and complete sales. The channel will be most effective when each member assumes the tasks it can do best. Channel conflict Ideally, because the success of individual channel members depends on the over- Disagreements among marketing all channel’s success, all channel firms should work together smoothly. They should channel members on goals, roles, and understand and accept their roles, coordinate their activities, and cooperate to attain rewards—who should do what and for overall channel goals. However, individual channel members rarely take such a broad what rewards. view. Cooperating to achieve overall channel goals sometimes means giving up indi- vidual company goals. Although channel members depend on one another, they often act alone in their own short-run best interests. They often disagree on who should do what and for what rewards. Such disagreements over goals, roles, and rewards gener- ate channel conflict. Horizontal conflict occurs among firms at the same level of the channel. For instance, some Ford dealers in Chicago might complain that other dealers in the city steal sales from them by pricing too low or advertising outside their assigned territories. Or Holiday Inn franchisees might complain about other Holiday Inn operators overcharging guests or giv- ing poor service, hurting the overall Holiday Inn image. Vertical conflict, conflict between different levels of the same channel, is even more common. For example, McDonald’s has recently faced growing conflict with its corps of 3,100 independent franchisees:2 Recent surveys of McDonald’s franchise owners have reflected substantial franchisee dis- content with the corporation. Some of the conflict has stemmed from a slowdown in system-wide sales in recent years that put both sides on edge. The most basic conflicts are financial. McDonald’s makes its money from franchisee royalties based on total system sales. In contrast, franchisees make money on margins—what’s left over after their costs. To reverse slumping sales, McDonald’s increased its emphasis on aggressive discounting, a strategy that increases corporate sales but squeezes franchisee profits. Franchisees also grumble about adding popular but more complex menu items—such as customizable burgers, McCafe beverages, and all-day breakfasts—that increase the top-line growth for McDonald’s but add preparation, equipment, and staffing costs for franchisees while slowing down service. McDonald’s has also asked franchisees to make costly restaurant upgrades and overhauls. Channel conflict: A high level of In all, despite recently rebounding sales, franchisees remain disgruntled. The most recent sur- franchisee discontent is worrisome vey rates McDonald’s current franchisee relations at an all-time low 1.81 out of a possible 5, in to McDonald’s. Franchisees operate the “fair” to “poor” range. That’s worrisome for McDonald’s, whose franchise owners oper- more than 90 percent of the chain’s restaurants, and there’s a huge ate 90 percent of its locations. Studies show that there’s a huge connection between franchisee connection between franchisee satisfaction and customer service. satisfaction and customer service. Some conflict in the channel takes the form of healthy competition. Such competi- © Greg Balfour Evans/Alamy tion can be good for the channel; without it, the channel could become passive and ChApter 12 | Marketing Channels: Delivering Customer Value 363

noninnovative. For example, the McDonald’s conflict with its franchisees might represent normal give-and-take over the respective rights of the channel partners. However, severe or prolonged conflict can disrupt channel effectiveness and cause lasting harm to channel relationships. McDonald’s should manage the channel conflict carefully to keep it from get- ting out of hand. Vertical Marketing Systems For the channel as a whole to perform well, each channel member’s role must be specified, and channel conflict must be managed. The channel will perform better if it includes a firm, agency, or mechanism that provides leadership and has the power to assign roles and manage conflict. Historically, conventional distribution channels have lacked such leadership and power, often resulting in damaging conflict and poor performance. One of the biggest channel developments over the years has been the emergence of vertical marketing systems that pro- vide channel leadership. Figure 12.3 contrasts the two types of channel arrangements. Conventional distribution channel A conventional distribution channel consists of one or more independent produc- A channel consisting of one or more ers, wholesalers, and retailers. Each is a separate business seeking to maximize its own independent producers, wholesalers, profits, perhaps even at the expense of the system as a whole. No channel member has and retailers, each a separate business much control over the other members, and no formal means exists for assigning roles and seeking to maximize its own profits, resolving channel conflict. perhaps even at the expense of profits In contrast, a vertical marketing system (VMS) consists of producers, wholesalers, for the system as a whole. and retailers acting as a unified system. One channel member owns the others, has con- Vertical marketing system (VMS) tracts with them, or wields so much power that they must all cooperate. The VMS can be A channel structure in which producers, dominated by the producer, the wholesaler, or the retailer. wholesalers, and retailers act as a unified We look now at three major types of VMSs: corporate, contractual, and administered. system. One channel member owns the Each uses a different means for setting up leadership and power in the channel. others, has contracts with them, or has so much power that they all cooperate. Corporate VMS A corporate VMS integrates successive stages of production and distribution under single Corporate VMS ownership. Coordination and conflict management are attained through regular organiza- A vertical marketing system that tional channels. For example, grocery giant Kroger owns and operates 37 manufacturing combines successive stages of plants—17 dairies, 6 bakery plants, 5 grocery plants, 1 deli plant, 2 frozen dough plants, production and distribution under single ownership—channel leadership is 2 beverage plants, 2 cheese plants, and 2 meat plants. That gives it factory-to-store channel 3 established through common ownership. control over 40 percent of the 13,000 private-label items found on its shelves. Similarly, little-known Italian eyewear maker Luxottica produces many famous eyewear brands—including its own Ray-Ban, Oakley, Persol, and Vogue Eyewear

FIgUre | 12.3 Comparison of Conventional Producer Distribution Channel with Vertical Producer Marketing System

Retailer Wholesaler Wholesaler

Vertical marketing system—here’s Retailer another fancy term for a simple concept. It’s simply a channel in which members at dierent levels (hence, vertical) work together in a unified way (hence, system) to accomplish the work of the channel. Consumer Consumer

Conventional Vertical marketing marketing channel system 364 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

brands and licensed brands such as Burberry, Chanel, Polo Ralph Lauren, Dolce & Gabbana, DKNY, Prada, Versace, and Michael Kors. Luxottica then controls the distribu- tion of these brands through some of the world’s largest optical chains—LensCrafters, Pearle Vision, Sunglass Hut, Target Optical, Sears Optical—which it also owns. In all, through vertical integration, Luxottica controls an estimated 60 to 80 percent of the U.S. eyewear market.4 Contractual VMS A vertical marketing system in which Contractual VMS independent firms at different levels of A contractual VMS consists of independent firms at different levels of production and production and distribution join together distribution that join together through contracts to obtain more economies or sales impact through contracts. than each could achieve alone. Channel members coordinate their activities and manage conflict through contractual agreements. Franchise organization The franchise organization is the most common type of contractual relationship. A contractual vertical marketing system In this system, a channel member called a franchisor links several stages in the production- in which a channel member, called a distribution process. In the United States alone, almost 800,000 franchise outlets account franchisor, links several stages in the for $994 billion of economic output. Industry analysts estimate that a new franchise outlet production-distribution process. opens somewhere in the United States every eight minutes and that about one out of every 12 retail business outlets is a franchised business.5 Almost every kind of business has been franchised—from motels and fast-food restaurants to dental centers and dating services, from wedding con- sultants and handyman services to funeral homes, fitness centers, and moving services. For example, through franchising, Two Men and a Truck moving services—“Movers Who Care”—grew quickly from two high school students looking to make extra money with a pickup truck to an international network of over 380 franchise locations that’s experienced record growth over the past six years and completed more than 5.5 million moves.6 There are three types of franchises. The first type is the manufacturer-sponsored retailer franchise system—for example, Ford and its network of independent fran- chised dealers. The second type is the manufacturer-sponsored wholesaler franchise system—Coca-Cola licenses bottlers (wholesalers) in various world markets that buy Coca-Cola syrup concentrate and then bottle and sell the finished product to retailers locally. The third type is the service-firm-sponsored retailer franchise system—for example, Burger King and its more than 12,000 franchisee-operated restaurants around the world. Other examples can be found in everything from auto rentals (Hertz, Avis), apparel retailers (The Athlete’s Foot, Plato’s Closet), and motels (Holiday Inn, Hampton Inn) to supplemental education (Huntington Learning Center, Mathnasium) and personal services (Great Clips, Mr. Handyman, Anytime Fitness). The fact that most consumers cannot tell the difference between contractual and corporate VMSs shows how successfully the contractual organizations com- pete with corporate chains. The next chapter presents a fuller discussion of the various contractual VMSs.

Franchising systems: Through franchising, Administered VMS Two Men and a Truck—“Movers who Care”— In an administered VMS, leadership is assumed not through common owner- grew quickly from two high school students with ship or contractual ties but through the size and power of one or a few dominant a pickup truck to an international network of over 380 franchise locations that’s experienced channel members. Manufacturers of a top brand can obtain strong trade coop- record growth over the past six years. eration and support from resellers. For example, P&G and Apple can command Two Men and a Truck International unusual cooperation from many resellers regarding displays, shelf space, promo- tions, and price policies. In turn, large retailers such as Walmart, Home Depot, Kroger, and Walgreens can exert strong influence on the many manufacturers that supply the products they sell. Administered VMS For example, in the normal push and pull between Walmart and its consumer goods A vertical marketing system that suppliers, giant Walmart—the biggest grocer in the United States with a more than 25 per- coordinates successive stages of cent share of all U.S. grocery sales—usually gets its way. Take supplier Clorox, for instance. production and distribution through the Although The Clorox Company’s strong consumer brand preference gives it significant size and power of one of the parties. negotiating power, Walmart simply holds more cards. Sales to Walmart make up 25 per- cent of Clorox’s sales, whereas Clorox products account for only one-third of 1 percent of Walmart’s purchases, making Walmart by far the dominant partner. Things get even worse for Cal-Maine Foods and its Eggland’s Best brand, which relies on Walmart for nearly ChApter 12 | Marketing Channels: Delivering Customer Value 365

one-third of its sales but tallies only about one-tenth of 1 percent of Walmart’s volume. For such brands, maintaining a strong relationship with the giant retailer is crucial.7

Horizontal Marketing Systems horizontal marketing system Another channel development is the horizontal marketing system, in which two A channel arrangement in which two or or more companies at one level join together to follow a new marketing opportunity. more companies at one level join together By working together, companies can combine their financial, production, or marketing to follow a new marketing opportunity. resources to accomplish more than any one company could alone. Companies might join forces with competitors or noncompetitors. They might work with each other on a temporary or permanent basis, or they may create a sepa- rate company. For example, Walmart part- ners with noncompetitor McDonald’s to place “express” versions of McDonald’s restaurants in Walmart stores. McDonald’s benefits from Walmart’s heavy store traffic, and Walmart keeps hungry shoppers from needing to go elsewhere to eat. Horizontal channel arrangements also work well globally. For example, most of the world’s major airlines have joined to together in one of three global alliances: Star Alliance, Skyteam, or Oneworld. Star Alliance consists of 27 airlines “working in harmony,” includ- ing United, Air Canada, Lufthansa, Air China, Turkish Airlines, and almost two dozen others. It offers more than 18,500 combined daily de- partures to more than 190 destinations around the world. Such alliances tie the individual carri- ers into massive worldwide air travel networks with joint branding and marketing, co-locations horizontal marketing systems: Star Alliance consists of 27 airlines “working at airports, interline scheduling and smoother in harmony” with shared branding and marketing to smooth and extend each member’s global air travel capabilities. global flight connections, and shared rewards and membership privileges.8 Felix Gottwald Multichannel Distribution Systems In the past, many companies used a single channel to sell to a single market or market seg- ment. Today, with the proliferation of customer segments and channel possibilities, more Multichannel distribution system and more companies have adopted multichannel distribution systems. Such multi- A distribution system in which a single channel marketing occurs when a single firm sets up two or more marketing channels to firm sets up two or more marketing reach one or more customer segments. channels to reach one or more customer Figure 12.4 shows a multichannel marketing system. In the figure, the producer segments. sells directly to consumer segment 1 using catalogs, online, and mobile channels and reaches consumer segment 2 through retailers. It sells indirectly to business segment 1 through distributors and dealers and to business segment 2 through its own sales force. These days, almost every large company and many small ones distribute through multiple channels. For example, John Deere sells its familiar green-and-yellow lawn and garden tractors, mowers, and outdoor power products to consumers and commercial users through several channels, including John Deere retailers, Lowe’s home improve- ment stores, and online. It sells and services its tractors, combines, planters, and other agricultural equipment through its premium John Deere dealer network. And it sells large construction and forestry equipment through selected large, full-service John Deere deal- ers and their sales forces. Multichannel distribution systems offer many advantages to companies facing large and complex markets. With each new channel, the company expands its sales and market coverage and gains opportunities to tailor its products and services to the specific needs of diverse customer segments. But such multichannel systems are harder to control, and they can generate conflict as more channels compete for customers and sales. For example, 366 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

FIgUre | 12.4 Multichannel Distribution System Producer

Most large companies distribute through multiple channels. For example, you could buy a familiar green-and-yellow DisDistributtributors John Deere lawn tractor from a neighborhood John Deere dealer or from Lowe’s. A large farm or forestry business would buy larger John Deere equipment from a premium Catalogs, Sales full-service John Deere dealer and its online, force sales force. mobile RetailersRetailers DealersDealers

Consumer Consumer Business Business segment 1 segment 2 segment 1 segment 2

when John Deere first began selling selected consumer products through Lowe’s home improvement stores, many of its independent dealers complained loudly. To avoid such conflicts in its online marketing channels, the company routes all of its online sales to John Deere dealers.

Changing Channel Organization Changes in technology and the explosive growth of direct and online marketing are having a profound impact on the nature and design of marketing channels. One major trend is to- Disintermediation ward disintermediation—a big term with a clear message and important consequences. The cutting out of marketing channel Disintermediation occurs when product or service producers cut out intermediaries and intermediaries by product or service go directly to final buyers or when radically new types of channel intermediaries displace producers or the displacement of traditional ones. traditional resellers by radical new types Thus, in many industries, traditional intermediaries are dropping by the wayside, of intermediaries. as is the case with online marketers taking business from traditional brick-and-mortar retailers. For example, online music download services such as iTunes and Amazon MP3 have pretty much put traditional music-store retail- ers out of business, with physical CDs sinking fast and now capturing less than a third of the music market. In turn, however, streaming music services such as Spotify, Rhapsody, and Apple Music are now disinter- mediating digital download services—digital downloads peaked last year while music streaming increased 29 percent.9 Disintermediation presents both opportunities and problems for producers and resellers. Channel innova- tors who find new ways to add value in the channel can displace traditional resellers and reap the rewards. In turn, traditional intermediaries must continue to innovate to avoid being swept aside. For example, when Netflix pioneered online DVD-by-mail video rentals, it sent tradi- tional brick-and-mortar video stores such as Blockbuster Disintermediation: Streaming music services such as Spotify are into ruin. Then Netflix itself faced disintermediation rapidly disintermediating both traditional music-store retailers and threats from an even hotter channel—video streaming. But even music download services such as iTunes. instead of simply watching developments, Netflix has led © DADO RUVIC/Reuters/Corbis them profitably. Similarly, superstore booksellers Barnes & Noble and Borders pioneered huge book selections and low prices, shutting down most small independent bookstores. Then along came Amazon.com, which threatened even the largest brick-and-mortar bookstores. ChApter 12 | Marketing Channels: Delivering Customer Value 367

12.1 Zara: Though Disintermediation to the Top of world Fashion

Unlike their competitors Gap, staggering pace, helped by the fact that be- by the store managers and reach the store Beneton, and H&M, Spanish cloth- tween 51 to 55 percent of its clothing is man- within one to two days. At the same time, the ing and accessories retailer Zara ufactured in what the company describes as commercial team liaises with the designers controls most of the steps in the “proximity” markets—Spain, Portugal, Turkey and sales trends are identified, either from evi- supply chain, designing, manu- and Morocco—instead of Asia. Zara’s key dence in stores or the catwalk, to develop new facturing, and distributing of its competitive advantage lies in its ability to products to follow them. New fashions are Real Marketing Real Marketing products. So while some competi- match fashion trends that change quickly. It is produced in relatively small batches so failures tors outsource all production to developing no wonder that versions of latest designs by can be disregarded after their first appearance countries, particularly in Asia, Zara makes fashion designers in Paris, London, New York, and hits can be followed quickly. By produc- its most fashionable items—half of all its or Tokyo are in Zara stores within a very short ing smaller batches of clothing, Zara adds an merchandise—at a dozen company-owned time of appearing on the runway. One of the air of exclusivity that encourages customers factories in Spain and Portugal. Zara, which most fascinating things about Zara is that it to shop more often. As garments are made in was founded in 1975 and is the flagship became popular not in spite of but because small production runs and no item stays in the brand of the Inditex group, has over 2,000 of its lack of originality, as shoppers around shops for more than four weeks, Zara shop- stores strategically located in leading cities, the world are thrilled to buy Zara’s catwalk pers are encouraged to make repeat visits. such as New York, Paris, Tokyo, and Buenos copycat designs at affordable prices. Whereas the average high-street store in Spain Aires, and operates in 88 countries in Europe, Zara stores are located in city center expects shoppers to visit three times a year on South America, Oceania, and Africa. In the streets, are owned by the company, and average, Zara shoppers visit up to 17 times. fiscal year 2015, Inditex had sales of $21.9 thereby have total control of its image and As fresh inventory is key to Zara’s sales billion, which is an 15 percent increase, far sales data. Zara uses its stores to find out strategy, its stores are stocked with new stronger than its competitors, making Zara what consumers want, what styles are sell- designs twice a week faster than most of its the world’s largest apparel retailer—not de- ing best, what colors are in demand, and competitors. The result of this structure is spite but because of its production and man- which items are hot sellers. The data are fed that the product range in Zara stores evolves ufacturing strategy. back to Zara headquarters in Spain through a quickly. Rather than relying on one product The secret of its success stems from sophisticated marketing information system. range per season, Zara promotes four or Zara’s vertically integrated marketing system At the end of each day, Zara sales assistants five waves of new products after the initial (VMS), which combines successive stages of report inventory levels to the respective store seasonal launch. In the stores, around 60 production and distribution under single own- manager, who immediately informs Zara’s cen- percent of Zara’s products are lasting and the ership. Controlling the entire distribution chain tral design and distribution departments about remaining 40 percent vary continually. Thus, from design and production to its own world- what consumers are buying, asking for, and the retailer can offer considerably more prod- wide distribution network has turned Zara into avoiding, all of which have to be recorded ucts than its rivals. It launches about 30,000 the world’s fastest growing retailer. Zara re- accordingly. Top-selling items are requested model items annually compared with 10,000 sisted the temptation of locating its production in Asian countries like China, where labor cost is low. By going against the trend, Zara was able to hold control over its supply chain. As a vertically integrated retailer, Zara pursues a disintermediation strategy, which as the name suggests involves the removal of intermediar- ies in a supply chain. Instead of going through traditional distribution channels (which has distributors, wholesalers, brokers, or agents), Zara deals with every customer directly. The company designs, produces, and distributes the products by itself. Disintermediation means that Zara has to monitor all its processes clearly in order to be efficient and fast. Effective disintermediation and vertical integration makes Zara faster, more flexible, and more efficient than inter- national competitors such as Gap and H&M. Zara can make a new line from start to finish in less than 15 days and a look seen on MTV Zara’s key competitive advantage lies in its ability to match fashion trends can be in Zara stores within a month, versus that change quickly. an industry average of 6 months. This is a Mira/Alamy Stock Photo 368 pArt 3 | Designing a Customer Value–Driven Strategy and Mix items for its main competitors. Consequently, has hailed Zara as possibly the most innova- Burberry has an eye on their techniques. The the chain does not have to slash prices, as tive and devastating retailer. so-called Spanish success story has reset the rivals often do, to move mass quantities of Stacey Cartwright, former CFO of boundaries for what shoppers expect from out-of-season stock. Burberry Group plc, stated that Zara is a a high-street clothing store and promises to Zara has grown with little or no advertis- fantastic case study of how to get products continue to thrive as one of the world’s big- ing, and it has been observed that it hardly to the stores at amazing speeds; indeed, gest fashion retailers. even has a marketing department. Instead of spending money on TV spots or print ads, the company invests heavily in the design, appeal, and location of its shops, which are the best Sources: “Zara,” Intidex, http://www.inditex.com/en/brands/zara; Rupal Parekh, “How Zara Ballooned into a Multi- Billion Dollar Brand without Advertising,” Advertising Age, August 19, 2013,http://adage.com/article/cmo-strategy/ display and advertisement for Zara and its zara-grew-a-multi-billion-dollar-brand-sans-ads/243730/; “ZARA and Its Awesome Supply Chain Management,” brand image. Zara’s flexibility and speed has Internationalas, August 17, 2014, https://internationalas.wordpress.com/2012/04/17/zara-and-its-awesome-sup- helped the fashion retailer to expand and grow ply-chain-management-2/; “Zara on the World’s Most Valuable Brands,” Forbes, May 2015, http://www.forbes. steadily. In the last few years, like-for-like sales com/companies/zara/; Walter Loeb, “Zara Leads in Fast Fashion,” Forbes, March 30, 2015, http://www.forbes. have grown by 17 percent and Zara wants to com/sites/walterloeb/2015/03/30/zara-leads-in-fast-fashion/; Svend Hollensen and Marc Opresnik, Marketing: expand its shop space by 8 to 10 percent ev- A Relationship Perspective, 2nd ed. (Vahlen 2015); “The Best 100 Brands,” Interbrand, http://www.bestglo- ery year for the next three to five years. balbrands.com/2014/zara/; Graham Ruddick, “How Zara Became the World’s Biggest Fashion Retailer,” The Zara continues to enhance its amazing Telegraph, October 20, 2014,http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11172562/ channel management system and disinterme- How-Inditex-became-the-worlds-biggest-fashion-retailer.html; “Zara: Managing Chain of Value and Driving CSR diation strategy, which has left thousands of with Consumers,” JL Nueno, http://www.jlnueno.com/wordpress/index.php/2011/07/29/gestionando-la-cadena- de-valor-y-accionando-la-rsc-con-los-consumidores/?lang=en; The Economist, Chain Reaction, February 2, 2002, fashion retailers worldwide pop-eyed. It is the pp. 1–3; C. Roux, “The Reign of Spain,” The Guardian, October 28, 2002, pp. 6–7; “Store Wars: Fast Fashion, The prototype of the “fast-fashion” retailer. Daniel Monet”, The Money Programme, BBC, February19, 2003, television; A. Mitthell, “When Push Comes to Shove, It’s Piette, the chairman of LVMH Investment All About Pull,” Marketing Week, January 9, 2003, pp. 26–27; K. Capell, “Zara Thrives by Breaking All the Rules,” Funds and the former fashion director for Business Week, October 20, 2008, p. 66; M. Johnson and A. Falstead, “Inditex Breaks New Ground for Season the luxury house that owns brands like Louis in the South,” Financial Times, May 2011, p. 17; http://www.inditex.com/en/investors/investors_relations/finan- Vuitton, Givenchy, Marc Jacobs, and Hublot cial_data, accessed April 1, 2017.

Amazon.com almost single-handedly bankrupted Borders in less than 10 years. Now, both offline and online sellers of physical books are being threatened by digital book downloads and e-readers. Rather than yielding to digital developments, however, Amazon.com is leading them with its highly successful Kindle e-readers and tablets. By contrast, Barnes & Noble—the giant that put so many independent bookstores out of business—was a late- comer with its struggling Nook e-reader and now finds itself locked in a battle for survival.10 Like resellers, to remain competitive, product and service producers must develop new channel opportunities, such as the internet and other direct channels. However, devel- oping these new channels often brings them into direct competition with their established channels, resulting in conflict. To ease this problem, companies often look for ways to make going direct a plus for the entire channel. For example, Volvo Car Group (now owned by Chinese car maker Geeley) recently announced plans to start selling Volvo vehicles online in all of its markets. Some 80 percent of Volvo buyers already shop online for other goods, so cars seem like a natural extension. Few auto makers have tried selling directly, with the exception of Tesla, which sells its all-electric cars online, bypassing dealers altogether. Other car companies worry that selling directly would alienate their independent dealer networks. “If you say e- commerce, initially dealers get nervous,” says Volvo’s head of marketing. So, to avoid channel conflicts, Volvo will pass all online sales through established dealers for delivery. In that way, boosting sales through direct marketing will benefit both Volvo and its chan- nel partners.11

Author Like everything else in Comment marketing, good channel Channel Design Decisions design begins with analyzing customer We now look at several channel design decisions manufacturers face. In designing market- needs. Remember, marketing channels ing channels, manufacturers struggle between what is ideal and what is practical. A new are really customer value delivery networks. firm with limited capital usually starts by selling in a limited market area. In this case, deciding on the best channels might not be a problem: The problem might simply be how to convince one or a few good intermediaries to handle the line. If successful, the new firm can branch out to new markets through existing intermedi- aries. In smaller markets, the firm might sell directly to retailers; in larger markets, it might sell through distributors. In one part of the country, it might grant exclusive franchises; in ChApter 12 | Marketing Channels: Delivering Customer Value 369

another, it might sell through all available outlets. Then it might add an online store that sells directly to hard-to-reach customers. In this way, channel systems often evolve to meet market opportunities and conditions. For maximum effectiveness, however, channel analysis and decision making should Marketing channel design be more purposeful. Marketing channel design calls for analyzing consumer needs, Designing effective marketing channels setting channel objectives, identifying major channel alternatives, and evaluating the by analyzing customer needs, setting alternatives. channel objectives, identifying major channel alternatives, and evaluating those alternatives. Analyzing Consumer Needs As noted previously, marketing channels are part of the overall customer value delivery network. Each channel member and level adds value for the customer. Thus, designing the marketing channel starts with finding out what target consumers want from the channel. Do consumers want to buy nearby, or are they willing to travel to more centralized loca- tions? Would customers rather buy in person, by phone, or online? Do they value breadth of assortment, or do they prefer specialization? Do consumers want many add-on services (delivery, installation, repairs), or will they obtain these services elsewhere? The faster the delivery, the greater the assortment provided, and the more add-on services supplied, the greater the channel’s service level. Providing the fastest delivery, the greatest assortment, and the most services, how- ever, may not be possible, practical, or desired. The company and its channel members may not have the resources or skills needed to provide all the desired services. Also, higher levels of service result in higher costs for the channel and higher prices for consum- ers. The success of modern discount retailing shows that consumers often accept lower service levels in exchange for lower prices. For example, Walmart typically rates dead last in Consumer Reports rankings of grocery retailers on customer shopping experience and satisfaction compared to the likes of Wegmans, Publix, Kroger, Whole Foods, or about any other grocery retailer. Yet it captures a 25 percent share of the U.S. grocery market.12 Many companies, however, position them- selves on higher service levels, and customers will- ingly pay the higher prices. For example, whereas Walmart typically rates last in Consumers Reports rankings of grocery retailer customer satisfaction, East Coast supermarket chain Wegmans consis- tently ranks first:13 Wegmans prides itself on its broad and deep selection, clean stores, very high service levels, and well-trained and friendly employees. “Best supermarket around, hands down,” says one cus- tomer in a Yelp review. “The knowledge and help- fulness of the workers is beyond amazing.” Says another, “Aside from the overwhelming options of everything on the planet to choose from, it’s an amazing place. I walk around thinking…ok, I’m impressed!” The result is avidly loyal cus- tomers. Actor Alec Baldwin’s mother reportedly refused to move from New York to Los Angeles because she didn’t want to abandon her favor- Meeting customers’ channel service needs: wegmans is the “best ite Wegmans store. So even though they could supermarket around, hands down.” To devoted wegmans shoppers, retailer’s probably save money by shopping at Walmart, extraordinary people and service are well worth its somewhat higher prices. to devoted Wegmans shoppers, the higher qual- Associated Press ity and extraordinary service are well worth the somewhat-higher prices. Thus, companies must balance consumer needs not only against the feasibility and costs of meeting these needs but also against customer price preferences.

Setting Channel Objectives Companies should state their marketing channel objectives in terms of targeted levels of customer service. Usually, a company can identify several segments wanting different 370 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

levels of service. The company should decide which segments to serve and the best chan- nels to use in each case. In each segment, the company wants to minimize the total channel cost of meeting customer service requirements. The company’s channel objectives are also influenced by the nature of the company, its products, its marketing intermediaries, its competitors, and the environment. For example, the company’s size and financial situation determine which marketing functions it can handle itself and which it must give to intermediaries. Companies selling perishable products, for example, may require more direct marketing to avoid delays and too much handling. In some cases, a company may want to compete in or near the same outlets that carry competitors’ products. For example, Maytag and other appliance makers want their products displayed alongside competing brands to facilitate comparison shopping. In other cases, companies may avoid the channels used by competitors. The Pampered Chef, for instance, sells high-quality kitchen tools directly to consumers through its corps of more than 60,000 consultants worldwide rather than going head-to-head with other kitchen tool makers for scarce positions in retail stores. And Stella & Dot sells quality jewelry through more than 30,000 independent reps—called stylists—who hold Tupperware-like in-home “trunk shows.”14 GEICO and USAA primarily market insur- ance and banking products to consumers via phone and internet channels rather than through agents. Finally, environmental factors such as economic conditions and legal constraints may affect channel objectives and design. For example, in a depressed economy, producers will want to distribute their goods in the most economical way, using shorter channels and dropping unneeded services that add to the final price of the goods.

Identifying Major Alternatives When the company has defined its channel objectives, it should next identify its major channel alternatives in terms of the types of intermediaries, the number of intermediaries, and the responsibilities of each channel member. Types of Intermediaries A firm should identify the types of channel members available to carry out its channel work. Most companies face many channel member choices. For example, Dell initially sold directly to final consumers and business buyers only through its sophisticated phone and online marketing channel. It also sold directly to large corporate, institutional, and govern- ment buyers using its direct sales force. However, to reach more consumers and match competitors such as Samsung and Apple, Dell now sells indirectly through retailers such as Best Buy, Staples, and Walmart. It also sells indirectly through value-added resellers, inde- pendent distributors and dealers that develop computer systems and applications tailored to the special needs of small and medium-sized business customers. Using many types of resellers in a channel provides both benefits and drawbacks. For example, by selling through retailers and value-added resellers in addition to its own di- rect channels, Dell can reach more and different kinds of buyers. However, these are more difficult to manage and control. In addition, the direct and indirect channels compete with each other for many of the same customers, causing potential conflict. In fact, Dell often finds itself “stuck in the middle,” with its direct sales reps complaining about competition from retail stores, whereas its value-added resellers complain that the direct sales reps are undercutting their business. Number of Marketing Intermediaries Companies must also determine the number of channel members to use at each level. Three strategies are available: intensive distribution, exclusive distribution, and selective distribution. Producers of convenience products and common raw materials typically seek Intensive distribution intensive distribution—a strategy in which they stock their products in as many outlets Stocking the product in as many outlets as possible. These products must be available where and when consumers want them. For as possible. example, toothpaste, candy, and other similar items are sold in millions of outlets to pro- vide maximum brand exposure and consumer convenience. Kraft, Coca-Cola, Kimberly- Clark, and other consumer goods companies distribute their products in this way. ChApter 12 | Marketing Channels: Delivering Customer Value 371

By contrast, some producers purposely limit the number of intermediar- ies handling their products. The extreme form of this practice is exclusive distribution, in which the producer gives only a limited number of dealers the exclusive right to distribute its products in their territories. Exclusive distribu- tion is often found in the distribution of luxury brands. Breitling watches—po- sitioned as “Instruments for Professionals” and selling at prices from $5,000 to more than $100,000—are sold by only a few authorized dealers in any given market area. For example, the brand sells through only one jeweler in Chicago and only six jewelers in the entire state of Illinois. Exclusive distribution en- hances Breitling’s distinctive positioning and earns greater dealer support and customer service. Between intensive and exclusive distribution lies selective distribution— the use of more than one but fewer than all of the intermediaries who are willing to carry a company’s products. Most consumer electronics, furniture, and home appliance brands are distributed in this manner. For example, outdoor power equipment maker STIHL doesn’t sell its chain saws, blowers, hedge trimmers, and other products through mass merchandisers such as Lowe’s, Home Depot, or Sears. Instead, it sells through a select corps of independent hardware and lawn and garden dealers. By using selective distribution, STIHL can develop good working relationships with dealers and expect a better-than-average sell- ing effort. Selective distribution also enhances the STIHL brand’s image and allows for higher markups resulting from greater value-added dealer service. “We count on our select dealers every day and so can you,” says one STIHL ad. Selective distribution: STIhL sells its chain saws, blowers, hedge trimmers, and other Responsibilities of Channel Members products through a select corps of independent hardware and lawn and garden retailers. “we The producer and intermediaries need to agree on the terms and responsibili- count on them every day and so can you.” ties of each channel member. They should agree on price policies, conditions STIHL Incorporated of sale, territory rights, and the specific services to be performed by each party. The producer should establish a list price and a fair set of discounts for the intermediaries. It must define each channel member’s territory, and it should be care- exclusive distribution ful about where it places new resellers. Giving a limited number of dealers the Mutual services and duties need to be spelled out carefully, especially in franchise and exclusive right to distribute the company’s exclusive distribution channels. For example, McDonald’s provides franchisees with pro- products in their territories. motional support, a record-keeping system, training at Hamburger University, and general management assistance. In turn, franchisees must meet company standards for physical Selective distribution facilities and food quality, cooperate with new promotion programs, provide requested The use of more than one but fewer than information, and buy specified food products. all of the intermediaries that are willing to carry the company’s products. Evaluating the Major Alternatives Suppose a company has identified several channel alternatives and wants to select the one that will best satisfy its long-run objectives. Each alternative should be evaluated against economic, control, and adaptability criteria. Using economic criteria, a company compares the likely sales, costs, and profitability of different channel alternatives. What will be the investment required by each channel alternative, and what returns will result? The company must also consider control issues. Using intermediaries usually means giving them some control over the marketing of the product, and some intermediaries take more control than others. Other things being equal, the company prefers to keep as much control as possible. Finally, the company must ap- ply adaptability criteria. Channels often involve long-term commitments, yet the company wants to keep the channel flexible so that it can adapt to environmental changes. Thus, to be considered, a channel involving long-term commitments should be greatly superior on economic and control grounds.

Designing International Distribution Channels International marketers face many additional complexities in designing their channels. Each country has its own unique distribution system that has evolved over time and changes very slowly. These channel systems can vary widely from country to country. 372 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

Thus, global marketers must usually adapt their channel strategies to the existing struc- tures within each country. In some markets, the distribution system is complex, competitive, and hard to pen- etrate. For example, many Western companies find India’s distribution system difficult to navigate. Large discount, department store, and supermarket retailers still account for only a small portion of the huge Indian market. Instead, most shopping is done in small neigh- borhood stores called kirana shops, run by their owners and popular because they offer personal service and credit. In addition, large Western retailers have difficulty dealing with India’s complex government regulations and poor infrastructure. Distribution systems in developing countries may be scattered, inefficient, or alto- gether lacking. For example, China’s rural markets are highly decentralized, made of many distinct submarkets, each with its own subculture. And, because of inadequate distribution systems, most companies can profitably access only a small portion of China’s massive population located in affluent cities. China’s distribution system is so fragmented that logistics costs to wrap, bundle, load, unload, sort, reload, and transport goods amount to 16 percent of the nation’s GDP, far higher than in most other countries. (In comparison, U.S. logistics costs ac- count for about 8.3 percent of the nation’s GDP.) After years of effort, even Walmart executives admit that they have been unable to assemble an efficient supply chain in China.15 Sometimes local conditions can greatly influ- ence how a company distributes products in global markets. For example, in low-income neighborhoods in Brazil where consumers have limited access to supermarkets, Nestlé supplements its distribution with thousands of self-employed salespeople who sell Nestlé products from refrigerated carts door to door. And in big cities in Asia and Africa, where crowded streets and high real estate costs make drive-thrus impractical, fast-food restaurants such as McDonald’s and KFC offer delivery. Legions of motorbike delivery drivers in colorful uniforms dis- pense Big Macs and buckets of chicken to customers who call in. More than 30 percent of McDonald’s KFC delivers: Delivery accounts for large chunks of KFC sales in many total sales in Egypt and 12 percent of its Singapore crowded Asian and African cities. sales come from delivery. Similarly, for KFC, deliv- © FogStock / Alamy Stock Photo ery accounts for nearly half of all sales in Kuwait and a third of sales in Egypt.16 Thus, international marketers face a wide range of channel alternatives. Designing efficient and effective channel systems between and within various country markets poses a difficult challenge. We discuss international distribution decisions further in Chapter 15.

Author Now it’s time to implement Comment the chosen channel design Channel Management Decisions and work with selected channel Once the company has reviewed its channel alternatives and determined the best chan- members to manage and motivate them. nel design, it must implement and manage the chosen channel. Marketing channel management calls for selecting, managing, and motivating individual channel members and evaluating their performance over time. Marketing channel management Selecting, managing, and motivating individual channel members and Selecting Channel Members evaluating their performance over time. Producers vary in their ability to attract qualified marketing intermediaries. Some produc- ers have no trouble signing up channel members. For example, when Toyota first intro- duced its Lexus line in the United States, it had no trouble attracting new dealers. In fact, it had to turn down many would-be resellers. At the other extreme are producers that have to work hard to line up enough qualified intermediaries. For example, when Timex first tried to sell its inexpensive watches through regular jewelry stores, most jewelry stores refused to carry them. The company then ChApter 12 | Marketing Channels: Delivering Customer Value 373

managed to get its watches into mass-merchandise outlets. This turned out to be a wise decision because of the rapid growth of mass merchandising. Even established brands may have difficulty gaining and keeping their desired distribution, especially when dealing with powerful resellers. For example, you won’t find Marlboro, Winston, Camel, or any other cigarette brand at your local CVS pharmacy store. CVS Health recently announced that it will no longer sell cigarettes in its stores, despite the resulting loss of more than $2 billion in annual sales. “This is the right thing to do,” says the company. “We came to the decision that cigarettes and providing healthcare just don’t go together in the same set- ting.” Target dropped cigarettes nearly 20 years ago, and public advocates are pressuring Walmart to do the same. If the major discount stores and other drugstore chains such as Walgreens and Rite Aid follow suit, Philip Morris, R.J. Reynolds, and other tobacco companies will have to seek new channels for selling their brands.17 When selecting intermediaries, the company should de- termine what characteristics distinguish the better ones. It will This is the right thing to do. want to evaluate each channel member’s years in business, other lines carried, location, growth and profit record, coopera- tiveness, and reputation.

Selecting channels: Even established brands may have difficulty keeping desired channels. CVS health’s decision to stop Managing and Motivating Channel Members selling cigarettes has left tobacco companies seeking new sales channels. Once selected, channel members must be continuously man- aged and motivated to do their best. The company must sell CVS Health not only through the intermediaries but also to and with them. Most companies see their intermediaries as first-line customers and partners. They practice strong partner relationship management to forge long-term partnerships with channel mem- bers. This creates a value delivery system that meets the needs of both the company and its marketing partners. In managing its channels, a company must convince suppliers and distributors that they can succeed better by working together as a part of a cohesive value delivery system. Companies must work in close harmony with others in the channel to find better ways to bring value to customers. Thus, Amazon and P&G work closely to accomplish their joint goal of selling consumer package goods profitably online. And companies ranging from automaker Toyota to cosmetics maker L’Oréal forge beneficial relationships with their large networks of suppliers to gain mutual competitive advantage (see Real Marketing 12.2). For example, heavy-equipment manufacturer Caterpillar works hand-in-hand with its superb dealer network—together they dominate the world’s construction, mining, and logging equipment business: Heavy-equipment manufacturer Caterpillar produces innovative, high-quality industrial equip- ment products. But ask anyone at Caterpillar, and they’ll tell you that the most important reason for Caterpillar’s dominance is its outstanding distribution network of 189 independent dealers in more than 180 countries. Dealers are the ones on the front line. Once the product leaves the factory, the dealers take over. They’re the ones that customers see. So rather than selling to or through its dealers, Caterpillar treats dealers as inside partners. When a big piece of Caterpillar equipment breaks down, customers know that they can count on both Caterpillar and its dealer network for support. A strong dealer network makes for a strong Caterpillar, and the other way around. On a deeper level, dealers play a vital role in almost every aspect of Caterpillar’s opera- tions, from product design and delivery to service and support. As a result of its close partner- ship with dealers, Caterpillar dominates the world’s markets for heavy construction, mining, and logging equipment. Its familiar yellow tractors, crawlers, loaders, bulldozers, and trucks capture a commanding share of the worldwide heavy-equipment business, nearly twice that of number-two Komatsu. Many companies are now installing integrated high-tech partnership relationship management (PRM) systems to coordinate their whole-channel marketing efforts. Just as they use customer relationship management (CRM) software systems to help manage 374 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

12.2 working with Channel Partners to Create Value for Customers

Today’s successful companies know in, trusting that Toyota will help them achieve joint efforts. L’Oréal seeks not only to help its that they can’t go it alone in cre- the targeted reductions, in turn making them suppliers meet its expectations but also to ating value for customers. Instead more competitive and profitable in the fu- contribute to their growth through opportuni- they must create effective value de- ture. In all, creating satisfied suppliers helps ties for innovation and competitiveness.” As livery systems, consisting of suppli- Toyota produce lower-cost, higher-quality a result, more than 75 percent of L’Oréal’s ers, producers, and distributors who cars, which in turn results in more satisfied supplier partners have been working with Real Marketing Real Marketing work together to get the job done. customers. the company for 10 years or more and the Partnering with suppliers and distributors can majority of them for several decades. Says L’Oréal yield big competitive advantages. Consider the company’s head of purchasing, “The L’Oréal is the world’s largest cosmetics these examples. CEO wants to make L’Oréal a top performer maker, with 23 global brands ranging from and one of the world’s most respected com- toyota Maybelline and Kiehl’s to Lancôme and panies. Being respected also means being Achieving satisfying supplier relationships Redken. Like Toyota, L’Oréal’s extensive sup- respected by our suppliers.” has been a cornerstone of Toyota’s stunning plier network—which supplies everything from success. Historically, Toyota’s U.S. competi- polymers and fats to spray cans and pack- Amazon–p&g tors often alienated their suppliers through aging to production equipment and office Until recently, if you ordered Bounty paper self-serving, heavy-handed dealings. “The supplies—is crucial to its success. towels, Pampers diapers, Charmin toilet pa- [U. S. automakers] set annual cost-reduction As a result, L’Oréal treats suppliers as re- per, or any of the dozens of other P&G con- targets [for the parts they buy],” said one spected partners. On the one hand, it expects sumer products from Amazon.com, they supplier. “To realize those targets, they’ll do a lot from suppliers in terms of design innova- probably came to your doorstep by a circu- anything. [They’ve unleashed] a reign of terror, tion, quality, and socially responsible actions. itous distribution route. The paper towels, for and it gets worse every year.” Says another, The company carefully screens new suppliers example, might well have been produced in “[One automaker] seems to send its people and regularly assesses the performance of P&G’s large northeastern Pennsylvania fac- to ‘hate school’ so that they learn how to hate current suppliers. On the other hand, L’Oréal tory and shipped by the trailer-truck load to suppliers.” works closely with suppliers to help them its nearby Tunkhannock warehouse, where By contrast, Toyota has long known the meet its exacting standards. Whereas some they were unloaded and repacked with other importance of building close relationships companies make unreasonable demands of P&G goods and shipped to Amazon’s Dinwid- with suppliers. Rather than bullying them, their suppliers and “squeeze” them for short- die, Virginia, fulfillment center. At the fulfillment Toyota partners with suppliers and helps term gains, L’Oréal builds long-term supplier center, they were unloaded and shelved and them to meet its very high expectations. It relationships based on mutual benefit and then finally picked and packed by Amazon learns about their businesses, conducts joint growth. employees for shipment to you via UPS, Fe- improvement activities, helps train supplier According to the company’s supplier web- dEx, or the USPS. employees, gives daily performance feed- site, it treats suppliers with “fundamental re- But these days, Amazon and P&G have back, and actively seeks out supplier con- spect for their business, their culture, their partnered to blaze a new, simpler, lower-cost cerns. It even recognizes top suppliers with growth, and the individuals who work there.” distribution trail for such goods. Now, for ex- annual performance awards. Each relationship is based on “dialogue and ample, at the Pennsylvania warehouse, rather As a result, for 13 of the past 15 years, Toyota has received the top supplier relations score in the respected North American Automotive Supplier Working Relations Index Study. The study rates companies on finan- cial dealings with suppliers, valuing suppliers and treating them fairly, open and honest communication, and providing opportunities to make profits. The study suggests that Toyota suppliers consider themselves true partners with the automotive giant. Such high supplier satisfaction means that Toyota can rely on suppliers to help it improve its own quality, reduce costs, and develop new products quickly. For example, when Toyota recently launched a program to reduce Partnering in the distribution channel: Under Amazon’s Vendor Flex program, P&G and prices by 30 percent on 170 parts that it Amazon share warehouse facilities, creating distribution cost and delivery advantages would buy for its next generation of cars, sup- for both partners. pliers didn’t complain. Instead, they pitched © raywoo/Fotolia; © grzegorz knec/Alamy; E.G. Pors/Shutterstock.com; © Sergio Azenha /Alamy ChApter 12 | Marketing Channels: Delivering Customer Value 375 than reloading truckloads of P&G products Tide laundry detergent. Finally, locating at the So the Amazon–P&G Vendor Flex part- and shipping them to Amazon fulfillment cen- source guarantees Amazon immediate avail- nership looks like an ideal match for both ters, P&G employees simply cart the goods ability and facilitates quick delivery of P&G companies. If P&G wants to be more ef- to a fenced-off area inside their own ware- products to customers. fective in selling its brands online, what house. The fenced-in area is run by Amazon. P&G also benefits from the Vendor Flex better partner could it have than Amazon, From there, Amazon employees pack, label, partnership. It saves money by cutting out the undisputed master of online retailing? If and ship items directly to customers who’ve the costs of transporting goods to Amazon’s Amazon wants to be more effective in sell- ordered them online. Amazon calls this ven- fulfillment centers, which in turn lets it charge ing household staples, what better partner ture Vendor Flex—and it’s revolutionizing how more competitive prices to the e-commerce could it have than P&G, the acknowledged people buy low-priced, low-margin everyday giant. And although P&G is a superb in-store master of consumer package goods mar- household products. brand marketer, it is still a relative newcomer keting? Together, under Amazon’s Vendor Amazon’s Vendor Flex program takes to online selling, one of the company’s top Flex, these respective industry leaders can channel partnering to an entirely new level. priorities. By partnering more closely with flex their distribution muscles to their own Co-locating “in the same tent” creates ad- Amazon, P&G gets Amazon’s expert help in benefit, and to the benefit of the consumers vantages for both partners. For Amazon, moving its brands online. they jointly serve. Vendor Flex reduces the costs of storing bulky items in its own distribution centers, and it frees up space for more higher-margin Sources: Alex Short, “Amazon and P&G Blow Business Collaboration Wide Open!” Vizibl, July 21, 2015, http://blog. vizibl.co/amazon-pg-blow-business-collaboration-wide-open/; Serena Ng, “Soap Opera: Amazon Moves In with goods. The sharing arrangement lets Amazon P&G,” Wall Street Journal, October 15, 2013, p. A1; Jeffery K. Liker and Thomas Y. Choi, “Building Deep Supplier extend its consumer package goods selec- Relationships,” Harvard Business Review, 2004, pp.104–113; “OEM-Supplier Relations Study Shows Strong tion without building more distribution center Gains for Toyota and Honda, with Ford, Nissan, FCA and GM Falling Well Behind,” PR Newswire, May 8, 2015, space. For example, the P&G warehouse also www.prnewswire.com/news-releases/oem-supplier-relations-study-shows-strong-gains-for-toyota-and-honda- stocks other popular P&G household brands, with-ford-nissan-fca-and-gm-falling-well-behind-300084605.html; and www.toyotasupplier.com and www.loreal. from Gillette razors to Pantene shampoo to com/_en/_ww/html/suppliers/, accessed October, 2016.

relationships with important customers, companies can now use PRM and supply chain management (SCM) software to help recruit, train, organize, manage, motivate, and evalu- ate relationships with channel partners.

Evaluating Channel Members The company must regularly check channel member performance against standards such as sales quotas, average inventory levels, customer delivery time, treatment of damaged and lost goods, cooperation in company promotion and training programs, and services to the customer. The company should recognize and reward intermediaries that are perform- ing well and adding good value for consumers. Those that are performing poorly should be assisted or, as a last resort, replaced. Finally, companies need to be sensitive to the needs of their channel partners. Those that treat their partners poorly risk not only losing their support but also causing some le- gal problems. The next section describes various rights and duties pertaining to companies and other channel members.

Public Policy and Distribution Decisions For the most part, companies are legally free to develop whatever channel arrangements suit them. In fact, the laws affecting channels seek to prevent the exclusionary tactics of some companies that might keep another company from using a desired channel. Most channel law deals with the mutual rights and duties of channel members once they have formed a relationship. Many producers and wholesalers like to develop exclusive channels for their prod- ucts. When the seller allows only certain outlets to carry its products, this strategy is called exclusive distribution. When the seller requires that these dealers not handle competitors’ products, its strategy is called exclusive dealing. Both parties can benefit from exclusive arrangements: The seller obtains more loyal and dependable outlets, and the dealers obtain a steady source of supply and stronger seller support. But exclusive arrangements also ex- clude other producers from selling to these dealers. This situation brings exclusive dealing contracts under the scope of the Clayton Act of 1914. They are legal as long as they do not 376 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

substantially lessen competition or tend to create a monopoly and as long as both parties enter into the agreement voluntarily. Exclusive dealing often includes exclusive territorial agreements. The producer may agree not to sell to other dealers in a given area, or the buyer may agree to sell only in its own territory. The first practice is normal under franchise systems as a way to increase dealer enthusiasm and commitment. It is also perfectly legal—a seller has no legal ob- ligation to sell through more outlets than it wishes. The second practice, whereby the producer tries to keep a dealer from selling outside its territory, has become a major legal issue. Producers of a strong brand sometimes sell it to dealers only if the dealers will take some or all of the rest of its line. This is called full-line forcing. Such tying agreements are not necessarily illegal, but they violate the Clayton Act if they tend to lessen competition substantially. The practice may prevent consumers from freely choosing among competing suppliers of these other brands. Finally, producers are free to select their dealers, but their right to terminate dealers is somewhat restricted. In general, sellers can drop dealers “for cause.” However, they cannot drop dealers if, for example, the dealers refuse to cooperate in a doubtful legal arrange- ment, such as exclusive dealing or tying agreements.

Author Marketers used to call Comment this plain-old “ physical Marketing Logistics and Supply Chain Management distribution.” But as these titles suggest, In today’s global marketplace, selling a product is sometimes easier than getting it to cus- the topic has grown in importance, tomers. Companies must decide on the best way to store, handle, and move their products complexity, and sophistication. and services so that they are available to customers in the right assortments, at the right time, and in the right place. Logistics effectiveness has a major impact on both customer satisfaction and company costs. Here we consider the nature and importance of logistics management in the supply chain, the goals of the logistics system, major logistics func- tions, and the need for integrated supply chain management. Nature and Importance of Marketing Logistics To some managers, marketing logistics means only trucks and warehouses. But modern lo- Marketing logistics (physical gistics is much more than this. Marketing logistics—also called physical distribution— distribution) involves planning, implementing, and controlling the physical flow of goods, services, Planning, implementing, and controlling and related information from points of origin to points of consumption to meet customer the physical flow of materials, final goods, requirements at a profit. In short, it involves getting the right product to the right customer and related information from points of in the right place at the right time profitably. origin to points of consumption to meet In the past, physical distribution planners typically started with products at the plant customer requirements at a profit. and then tried to find low-cost solutions to get them to customers. However, today’s cus- tomer-centered logistics starts with the marketplace and works backward to the factory or even to sources of supply. Marketing logistics involves not only outbound logistics (moving Supply chain management products from the factory to resellers and ultimately to customers) but also inbound logistics Managing upstream and downstream (moving products and materials from suppliers to the factory) and reverse logistics (reusing, value-added flows of materials, final recycling, refurbishing, or disposing of broken, unwanted, or excess products returned by goods, and related information among consumers or resellers). That is, it involves the entirety of supply chain management— suppliers, the company, resellers, and managing upstream and downstream value-added flows of materials, final goods, and re- final consumers. lated information among suppliers, the company, resellers, and final consumers, as shown in Figure 12.5. The logistics manager’s task is to coordinate the activities of suppliers, purchasing agents, marketers, Managing the supply chain calls for customer-centered thinking. Remember, it’s also called the customer value delivery network. FIgUre | 12.5 Inbound Outbound logistics logistics Supply Chain Management Suppliers Company Resellers Customers

Reverse logistics ChApter 12 | Marketing Channels: Delivering Customer Value 377

channel members, and customers. These activities include forecasting, information systems, purchasing, production planning, order processing, inventory, warehousing, and transporta- tion planning. Companies today are placing greater emphasis on logistics for several reasons. First, companies can gain a powerful competitive advantage by using improved logistics to give customers better service or lower prices. Second, improved logistics can yield tremendous cost savings to both a company and its customers. As much as 20 percent of an average product’s price is accounted for by shipping and transport alone. American companies spend $1.45 trillion each year—about 8.3 percent of GDP—to wrap, bundle, load, unload, sort, reload, and transport goods. That’s more than the total national GDPs of all but 12 countries worldwide. By itself, General Motors has hundreds of millions of tons of finished vehicles, production parts, and aftermarket parts in transit at any given time, running up an annual logistics bill of around $8 billion dollars. Shaving off even a small fraction of logistics costs can mean substantial savings. For example, GM recently announced a logistical overhaul that would save nearly $2 billion over two years in North America alone.18 Third, the explosion in product variety has created a need for improved logistics management. For example, in 1916 the typical Piggly Wiggly gro- cery store carried only 605 items. Today, a Piggly Wiggly carries a bewildering stock of between 20,000 and 35,000 items, depending on store size. A Walmart Supercenter store carries more than 140,000 products, 30,000 of which are grocery prod- 19 The importance or logistics: At any given time, GM has hundreds of millions ucts. Ordering, shipping, stocking, and control- of tons of finished vehicles and parts in transit, running up an annual logistics ling such a variety of products presents a sizable bill of about $8 billion. Even small savings can be substantial. logistics challenge. Bloomberg/Getty Images Improvements in information technology have also created opportunities for major gains in distribution efficiency. Today’s companies are us- ing sophisticated supply chain management software, internet-based logistics systems, point- of-sale scanners, RFID tags, satellite tracking, and electronic transfer of order and payment data. Such technology lets them quickly and efficiently manage the flow of goods, informa- tion, and finances through the supply chain. Finally, more than almost any other marketing function, logistics affects the environ- ment and a firm’s environmental sustainability efforts. Transportation, warehousing, pack- aging, and other logistics functions are typically the biggest supply chain contributors to the company’s environmental footprint. Therefore, many companies are now developing green supply chains.

Sustainable Supply Chains Companies have many reasons for reducing the environmental impact of their supply chains. For one thing, if they don’t green up voluntarily, a host of sustainability regulations enacted around the world will soon require them to. For another, many large customers— from Walmart and Nike to the federal government—are demanding it. Even consumers are demanding it: According to one survey, 50 percent of millennials are willing to pay more for sustainable products and 39 percent do research into the sustainability practices of companies before making a purchase.20 Thus, environmental sustainability has become an important fac- tor in supplier selection and performance evaluation. But perhaps even more important than having to do it, designing sustainable supply chains is simply the right thing to do. It’s one more way that companies can contribute to saving our world for future generations. But that’s all pretty heady stuff. As it turns out, companies have a more immediate and practical reason for turning their supply chains green. Not only are sustainable chan- nels good for the world, they’re also good for a company’s bottom line. The very logistics activities that create the biggest environmental footprint—such as transportation, 378 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

warehousing, and packaging—also account for a lion’s share of logistics costs. Companies green up their supply chains through greater efficiency, and greater efficiency means lower costs and higher profits. In other words, developing a sustainable supply chain is not only environmentally responsible, it can also be profitable. Consider Nike:21 Nike, the iconic sports shoe and apparel company, has developed a sweeping strategy for greening every The Higg Index phase of its supply chain. For example, Nike re- cently teamed with Levi’s, REI, Target, and other mem- Sustainable Apparel Coalition bers of the Sustainable Apparel Coalition to develop the Higg Index—a tool that measures how a single ap- parel product affects the environment across the entire supply chain. Nike uses the Higg Index to work with suppliers and distributors to reduce its supply chain’s environmental footprint. For instance, during just the past three years, the more than 900 contract factories that make Nike footwear worldwide have reduced their carbon emissions by 6 percent, despite production increases of 20 percent. That’s equivalent to an emis- sions savings equal to more than 1 billion car-miles. Nike has found that even seemingly simple supply chain adjustments can produce big benefits. For example, the company sources its shoes in Asia, but most are sold in North America. Until about a decade ago, the shoes were shipped from factory to store by airfreight. After analyzing distribution costs more carefully, Nike shifted Green supply chains: Nike has developed a sweeping strategy for a sizable portion of its cargo to ocean freight. That simple greening its supply chain. The higg Index lets Nike work with suppliers and shoes-to-ships shift reduced emissions per product by 4 distributors to reduce the supply chain’s environmental footprint while at percent, making environmentalists smile. But it also put the same time reducing its logistics costs. a smile on the faces of Nike’s accountants by saving the Thanapun/Shutterstock company some $8 million a year in shipping costs.

Goals of the Logistics System Some companies state their logistics objective as providing maximum customer service at the least cost. Unfortunately, as nice as this sounds, no logistics system can both maximize customer service and minimize distribution costs. Maximum customer service implies rapid delivery, large inventories, flexible assortments, liberal returns policies, and other services—all of which raise distribution costs. In contrast, minimum distribution costs im- ply slower delivery, smaller inventories, and larger shipping lots—which represent a lower level of overall customer service. The goal of marketing logistics should be to provide a targeted level of customer ser- vice at the least cost. A company must first research the importance of various distribution services to customers and then set desired service levels for each segment. The objective is to maximize profits, not sales. Therefore, the company must weigh the benefits of providing higher levels of service against the costs. Some companies offer less service than their com- petitors and charge a lower price. Other companies offer more service and charge higher prices to cover higher costs.

Major Logistics Functions Given a set of logistics objectives, the company designs a logistics system that will mini- mize the cost of attaining these objectives. The major logistics functions are warehousing, inventory management, transportation, and logistics information management.

Warehousing Production and consumption cycles rarely match, so most companies must store their goods while they wait to be sold. For example, Snapper, Toro, and other lawn mower man- ufacturers run their factories all year long and store up products for the heavy spring and summer buying seasons. The storage function overcomes differences in needed quantities and timing, ensuring that products are available when customers are ready to buy them. ChApter 12 | Marketing Channels: Delivering Customer Value 379

A company must decide on how many and what types of warehouses it needs and where they will be located. The company might use either storage warehouses or distribution centers. Distribution center Storage warehouses store goods for moderate to long periods. In contrast, distribution A large, highly automated warehouse centers are designed to move goods rather than just store them. They are large and highly designed to receive goods from various automated warehouses designed to receive goods from various plants and suppliers, take plants and suppliers, take orders, fill orders, fill them efficiently, and deliver goods to customers as quickly as possible. them efficiently, and deliver goods to For example, Amazon operates more than 100 giant distribution centers, called customers as quickly as possible. fulfillment centers, which fill online orders and handle returns. These centers are huge and highly automated. For example, the Amazon fulfillment center in Tracy, California, covers 1.2 million square feet (equivalent to 27 football fields). At the center, 4,000 employees control an inventory of 21 million items and ship out up to 700,000 packages a day to Amazon customers in Northern California and parts of the Pacific Northwest. During last year’s Cyber Monday, Amazon’s fulfillment center network filled customer orders at a rate of more than 500 items per second globally.22 Like almost everything else these days, warehousing has seen dramatic changes in technology in recent years. Outdated materials-handling methods are steadily being re- placed by newer, computer-controlled systems requiring fewer employees. Computers and scanners read orders and direct lift trucks, electric hoists, or robots to gather goods, move them to loading docks, and issue invoices. For exam- ple, to improve efficiency in its massive fulfillment centers, Amazon recently purchased robot maker Kiva Systems:23

When you buy from Amazon, the chances are still good that your order will be plucked and packed by human hands. However, the humans in Amazon’s fulfillment centers are increasingly being assisted by an army of squat, ottoman-size, day-glo orange robots. Amazon now has more than 30,000 of them in 13 fulfillment centers, double the number from a year ago. The robots bring racks of merchandise to workers, who in turn fill boxes. Dubbed the “magic shelf,” racks of items simply materialize in front of workers, with red lasers point- ing to items to be picked. The robots then drive off and new shelves appear. The super-efficient robots work tirelessly 16 hours a day, seven days a week. They never complain about high-tech distribution centers: Amazon employs teams the workload or ask for pay raises, and they are pretty much of super-retrievers—day-glo orange Kiva robots—to keep its maintenance free. “When they run low on power, they head to fulfillment centers humming. battery-charging terminals,” notes one observer, “or, as ware- Bloomberg via Getty Images house personnel say, ‘They get themselves a drink of water.’”

Inventory Management Inventory management also affects customer satisfaction. Here, managers must maintain the delicate balance between carrying too little inventory and carrying too much. With too little stock, the firm risks not having products when customers want to buy. To remedy this, the firm may need costly emergency shipments or production. Carrying too much in- ventory results in higher-than-necessary inventory-carrying costs and stock obsolescence. Thus, in managing inventory, firms must balance the costs of carrying larger inventories against resulting sales and profits. Many companies have greatly reduced their inventories and related costs through just-in-time logistics systems. With such systems, producers and retailers carry only small inventories of parts or merchandise, often enough for only a few days of operations. New stock arrives exactly when needed rather than being stored in inventory until being used. Just-in-time systems require accurate forecasting along with fast, frequent, and flexible de- livery so that new supplies will be available when needed. However, these systems result in substantial savings in inventory-carrying and inventory-handling costs. Marketers are always looking for new ways to make inventory management more ef- ficient. In the not-too-distant future, handling inventory might even become fully automated. For example, many companies now use some form of RFID or “smart tag” technology, by which small transmitter chips are embedded in or placed on products and packaging for ev- erything from flowers and razors to tires. Such “smart” products could make the entire supply chain—which accounts for up to 75 percent of a product’s cost—intelligent and automated. 380 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

Companies using RFID know, at any time, exactly where a product is located physi- cally within the supply chain. “Smart shelves” would not only tell them when it’s time to reorder but also place the order automatically with their suppliers. Such exciting new information technology is revolutionizing distribution as we know it. Many large and re- sourceful marketing companies, such as Walmart, Macy’s, P&G, Kraft, and IBM, are invest- ing heavily to make the full use of RFID technology a reality. Transportation The choice of transportation carriers affects the pricing of products, delivery performance, and the condition of goods when they arrive—all of which will affect customer satisfaction. In shipping goods to its warehouses, dealers, and customers, the company can choose among five main transportation modes: truck, rail, water, pipeline, and air along with an alternative mode for digital products—the internet. Trucks have increased their share of transpor- tation steadily and now account for 40 percent of total cargo ton-miles (a ton of freight moved one mile) transported in the United States. Trucks are highly flexible in their routing and time sched- ules, and they can usually offer faster service than railroads. They are efficient for short hauls of high-value merchandise. Trucking firms have evolved in recent years to become full-service providers of global transportation services. For example, large trucking firms now offer ev- erything from satellite tracking, internet-based shipment management, and logistics planning software to cross-border shipping operations.24 Railroads account for 26 percent of the total cargo ton-miles moved. They are one of the most cost-effective modes for shipping large amounts of bulk products—coal, sand, minerals, and farm and forest products—over long dis- Transportation: In shipping goods to their warehouses, dealers, and tances. In recent years, railroads have increased customers, companies can choose among many transportation modes, their customer services by designing new equip- including truck, rail, water, pipeline, and air. Much of today’s shipping requires ment to handle special categories of goods, pro- multiple modes. viding flatcars for carrying truck trailers by rail Thanapun/Shutterstock (piggyback), and providing in-transit services such as the diversion of shipped goods to other destinations en route and the processing of goods en route. Water carriers, which account for 7 percent of the cargo ton-miles, transport large amounts of goods by ships and barges on U.S. coastal and inland waterways. Although the cost of water transportation is very low for shipping bulky, low-value, nonperishable prod- ucts such as sand, coal, grain, oil, and metallic ores, water transportation is the slowest mode and may be affected by the weather. Pipelines, which account for 17 percent of the cargo ton-miles, are a specialized means of shipping petroleum, natural gas, and chemicals from sources to markets. Most pipelines are used by their owners to ship their own products. Although air carriers transport less than 1 percent of the cargo ton-miles of the nation’s goods, they are an important transportation mode. Airfreight rates are much higher than rail or truck rates, but airfreight is ideal when speed is needed or distant markets have to be reached. Among the most frequently airfreighted products are perishables (such as fresh fish, cut flowers) and high-value, low-bulk items (technical instruments, jewelry). Companies find that airfreight also reduces inventory levels, packaging costs, and the num- ber of warehouses needed. The internet carries digital products from producer to customer via satellite, cable, phone wire, or wireless signal. Software firms, the media, music and video companies, and education all make use of the internet to deliver digital content. The internet holds the potential for lower product distribution costs. Whereas planes, trucks, and trains move Multimodal transportation freight and packages, digital technology moves information bits. Combining two or more modes Shippers also use multimodal transportation—combining two or more modes of of transportation. transportation. Eight percent of the total cargo ton-miles are moved via multiple modes. ChApter 12 | Marketing Channels: Delivering Customer Value 381

Piggyback describes the use of rail and trucks; fishyback, water and trucks; trainship, water and rail; and airtruck, air and trucks. Combining modes provides advantages that no single mode can deliver. Each combination offers advantages to the shipper. For example, not only is piggyback cheaper than trucking alone, but it also provides flexibility and conve- nience. Numerous logistics companies provide single-source multimodal transportation solutions. Logistics Information Management Companies manage their supply chains through information. Channel partners often link up to share information and make better joint logistics decisions. From a logistics perspec- tive, flows of information, such as customer transactions, billing, shipment and inventory levels, and even customer data, are closely linked to channel performance. Companies need simple, accessible, fast, and accurate processes for capturing, processing, and sharing channel information. Information can be shared and managed in many ways, but most sharing takes place through electronic data interchange (EDI), the digital exchange of data between organiza- tions, which primarily is transmitted via the internet. Walmart, for example, requires EDI links with its more than 100,000 suppliers through its Retail Link sales data system. If new suppliers don’t have the required EDI capability, Walmart will work with them to find and implement the needed tools.25 In some cases, suppliers might actually be asked to generate orders and arrange deliv- eries for their customers. Many large retailers—such as Walmart and Home Depot—work closely with major suppliers such as P&G or Moen to set up vendor-managed inventory (VMI) systems or continuous inventory replenishment systems. Using VMI, the customer shares real-time data on sales and current inventory levels with the supplier. The supplier then takes full responsibility for managing inventories and deliveries. Some retailers even go so far as to shift inventory and delivery costs to the supplier. Such systems require close cooperation between the buyer and seller.

Integrated Logistics Management Integrated logistics management Today, more and more companies are adopting the concept of integrated logistics The logistics concept that emphasizes management. This concept recognizes that providing better customer service and trim- teamwork—both inside the company ming distribution costs require teamwork, both inside the company and among all the and among all the marketing channel marketing channel organizations. Inside, the company’s various departments must work organizations—to maximize the closely together to maximize its own logistics performance. Outside, the company must performance of the entire distribution integrate its logistics system with those of its suppliers and customers to maximize the per- system. formance of the entire distribution network. Cross-Functional Teamwork Inside the Company Most companies assign responsibility for various logistics activities to many different departments—marketing, sales, finance, operations, and purchasing. Too often, each func- tion tries to optimize its own logistics performance without regard for the activities of the other functions. However, transportation, inventory, warehousing, and information management activities interact, often in an inverse way. Lower inventory levels reduce inventory-carrying costs. But they may also reduce customer service and increase costs from stockouts, backorders, special production runs, and costly fast-freight shipments. Because distribution activities involve strong trade-offs, decisions by different functions must be coordinated to achieve better overall logistics performance. The goal of integrated supply chain management is to harmonize all of the company’s logistics decisions. Close working relationships among departments can be achieved in several ways. Some companies have created permanent logistics committees composed of managers responsible for different physical distribution activities. Companies can also create supply chain manager positions that link the logistics activities of functional areas. For example, P&G has created product supply managers who manage all the supply chain activities for each product category. Many companies have a vice president of logistics or a supply chain VP with cross-functional authority. Finally, companies can employ sophisticated, system-wide supply chain management software, now available from a wide range of software enterprises large and small, from 382 pArt 3 | Designing a Customer Value–Driven Strategy and Mix

Oracle and SAP to Infor and Logility. For example, Oracle’s supply chain management software solutions help companies to “gain sustainable advantage and drive innovation by trans- forming their traditional supply chains into integrated value chains.”26 It coordinates every aspect of the supply chain, from value chain collaboration to inventory optimization to transportation and logistics management. The important thing is that the company must coordinate its logistics, inven- tory investments, demand forecasting, and marketing activi- ties to create high market satisfaction at a reasonable cost.

Building Logistics Partnerships Companies must do more than improve their own logis- tics. They must also work with other channel partners to improve whole-channel distribution. The members of a marketing channel are linked closely in creating customer value and building customer relationships. One company’s distribution system is another company’s supply system. The success of each channel member depends on the per- formance of the entire supply chain. For example, furniture Integrated logistics management: oracle’s supply chain retailer IKEA can create its stylish but affordable furniture management software solutions help companies to “gain sustainable and deliver the “IKEA lifestyle” only if its entire supply advantage and drive innovation by transforming their traditional chain—consisting of thousands of merchandise designers supply chains into integrated value chains.” and suppliers, transport companies, warehouses, and ser- Oracle Corporation vice providers—operates at maximum efficiency and with customer-focused effectiveness. Smart companies coordinate their logistics strategies and forge strong partnerships with suppliers and customers to improve customer service and reduce channel costs. Many companies have created cross-functional, cross-company teams. For example, Nestlé’s Purina pet food unit has a team of dozens of people working in Bentonville, Arkansas, the home base of Walmart. The Purina Walmart team members work jointly with their counterparts at Walmart to find ways to squeeze costs out of their distribution system. Working together benefits not only Purina and Walmart but also their shared, final consumers. Other companies partner through shared projects. For example, many large retailers conduct joint in-store programs with suppliers. Home Depot allows key suppliers to use its stores as a testing ground for new merchandising programs. The suppliers spend time at Home Depot stores watching how their product sells and how customers relate to it. They then create programs specially tailored to Home Depot and its customers. Clearly, both the supplier and the customer benefit from such partnerships. The point is that all supply chain members must work together in the cause of bringing value to final consumers.

Third-Party Logistics Although most big companies love to make and sell their products, many loathe the associ- ated logistics “grunt work.” They detest the bundling, loading, unloading, sorting, storing, reloading, transporting, customs clearing, and tracking required to supply their factories and get products to their customers. They hate it so much that many firms outsource some third-party logistics (3pL) provider or all of their logistics to third-party logistics (3PL) providers such as Ryder, Penske An independent logistics provider that Logistics, BAX Global, DHL Logistics, FedEx Logistics, and UPS Business Solutions. performs any or all of the functions For example, UPS knows that, for many companies, logistics can be a real nightmare. required to get a client’s product to But logistics is exactly what UPS does best. To UPS, logistics is today’s most powerful force market. for creating competitive advantage. “We logistics,” proclaims UPS. “It makes running your business easier. It can make your customers happier. It’s a whole new way of think- ing.” As one UPS ad concludes: “We love logistics. Put UPS to work for you and you’ll love logistics too.” At one level, UPS can simply handle a company’s package shipments. But on a deeper level, UPS can help businesses sharpen their own logistics systems to cut costs and serve customers better. At a still deeper level, companies can let UPS take over and manage part or all of their logistics operations. For example, consumer electronics maker Toshiba lets UPS ChApter 12 | Marketing Channels: Delivering Customer Value 383

handle its entire laptop PC repair process—lock, stock, and barrel. And UPS not only delivers packages for online shoe and accessories marketer Zappos, it also manages Zappos’s impor- tant and complex order returns process in an efficient, customer-pleasing way.27 3PL providers like UPS can help clients tighten up sluggish, overstuffed supply chains; slash inventories; and get products to customers more quickly and reliably. According to one report, 86 percent of Fortune 500 companies use 3PL (also called out- sourced logistics or contract logistics) services. General Motors, P&G, and Walmart each use 50 or more 3PLs.28 Companies use third-party logistics providers for several reasons. First, because get- ting the product to market is their main focus, using these providers makes the most sense, as they can often do it more efficiently and at lower cost. Outsourcing logistics typically results in a 10 to 25 percent cost savings.29 Second, outsourcing logistics frees a company to focus more intensely on its core business. Finally, integrated logistics companies under- stand increasingly complex logistics environments.

12 Reviewing and Extending the Concepts ObjeCTives review and Key Terms Objectives review Some companies pay too little attention to their distribution transactions by offering physical distribution (transporting and channels; others, however, have used imaginative distribution storing goods), financing (acquiring and using funds to cover the systems to gain a competitive advantage. A company’s chan- costs of the channel work), and risk taking (assuming the risks of nel decisions directly affect every other marketing decision. carrying out the channel work. Management must make channel decisions carefully, incorporat- ing today’s needs with tomorrow’s likely selling environment. Objective 12-2 Discuss how channel members Objective 12-1 explain why companies use marketing interact and how they organize to perform the channels and discuss the functions these channels work of the channel. (pp 362–368) perform. (pp 358–361) The channel will be most effective when each member assumes the tasks it can do best. Ideally, because the success of indi- In creating customer engagement and value, a company can’t vidual channel members depends on overall channel success, go it alone. It must work within an entire network of partners— all channel firms should work together smoothly. They should a value delivery network—to accomplish this task. Individual understand and accept their roles, coordinate their goals and companies and brands don’t compete; their entire value delivery activities, and cooperate to attain overall channel goals. By co- networks do. operating, they can more effectively sense, serve, and satisfy the Most producers use intermediaries to bring their products target market. to market. They forge a marketing channel (or distribution In a large company, the formal organization structure assigns channel)—a set of interdependent organizations involved in roles and provides needed leadership. But in a distribution chan- the process of making a product or service available for use or nel composed of independent firms, leadership and power are consumption by the consumer or business user. Through their not formally set. Traditionally, distribution channels have lacked contacts, experience, specialization, and scale of operation, the leadership needed to assign roles and manage conflict. intermediaries usually offer the firm more than it can achieve on In recent years, however, new types of channel organizations its own. have appeared that provide stronger leadership and improved Marketing channels perform many key functions. Some help performance. complete transactions by gathering and distributing informa- tion needed for planning and aiding exchange, developing and spreading persuasive communications about an offer, perform- Objective 12-3 Identify the major channel alternatives ing contact work (finding and communicating with prospective open to a company. (pp 368–372) buyers), matching (shaping and fitting the offer to the buyer’s needs), and entering into negotiation to reach an agreement Channel alternatives vary from direct selling to using one, two, on price and other terms of the offer so that ownership can three, or more intermediary channel levels. Marketing channels be transferred. Other functions help to fulfill the completed face continuous and sometimes dramatic change. Three of the 384 pArt 3 | Designing a Customer Value–Driven Strategy and Mix most important trends are the growth of vertical, horizontal, and Objective 12-5 Discuss the nature and importance multichannel marketing systems. These trends affect channel of marketing logistics and integrated supply chain cooperation, conflict, and competition. management. (pp 376–383) Channel design begins with assessing customer channel service needs and company channel objectives and constraints. Marketing logistics (or physical distribution) is an area of po- The company then identifies the major channel alternatives in tentially high cost savings and improved customer satisfaction. terms of the types of intermediaries, the number of intermedi- Marketing logistics addresses not only outbound logistics but aries, and the channel responsibilities of each. Each channel also inbound logistics and reverse logistics. That is, it involves alternative must be evaluated according to economic, control, the entire supply chain management—managing value-added and adaptive criteria. Channel management calls for selecting flows between suppliers, the company, resellers, and final users. qualified intermediaries and motivating them. Individual channel No logistics system can both maximize customer service and members must be evaluated regularly. minimize distribution costs. Instead, the goal of logistics man- agement is to provide a targeted level of service at the least cost. Objective 12-4 explain how companies select, The major logistics functions are warehousing, inventory man- agement, transportation, and logistics information management. motivate, and evaluate channel members. (pp 372–376) The integrated supply chain management concept recognizes Producers vary in their ability to attract qualified marketing inter- that improved logistics requires teamwork in the form of close mediaries. Some producers have no trouble signing up channel working relationships across functional areas inside the company members, whereas others have to work hard to line up enough and across various organizations in the supply chain. Companies qualified intermediaries. When selecting intermediaries, the com- can achieve logistics harmony among functions by creating pany should evaluate each channel member’s qualifications and cross-functional logistics teams, integrative supply manager po- select those that best fit its channel objectives. sitions, and senior-level logistics executive positions with cross- Once selected, channel members must be continuously functional authority. Channel partnerships can take the form of motivated to do their best. The company must sell not only cross-company teams, shared projects, and information-sharing through the intermediaries but also with them. It should forge systems. Today, some companies are outsourcing their logistics strong partnerships with channel members to create a marketing functions to third-party logistics (3PL) providers to save costs, system that meets the needs of both the manufacturer and the increase efficiency, and gain faster and more effective access to partners. global markets.

Key terms

Objective 12-1 Corporate VMS (p 363) Objective 12-4 Value delivery network (p 359) Contractual VMS (p 364) Marketing channel management Marketing channel (distribution Franchise organization (p 364) (p 372) channel) (p 359) Administered VMS (p 364) Channel level (p 361) horizontal marketing system (p 365) Objective 12-5 Direct marketing channel (p 361) Multichannel distribution Marketing logistics (physical Indirect marketing channel (p 361) system (p 365) distribution) (p 376) Disintermediation (p 366) Supply chain management (p 376) Objective 12-2 Distribution center (p 379) Channel conflict (p 362) Objective 12-3 Multimodal transportation (p 380) Conventional distribution Marketing channel design (p 369) Integrated logistics channel (p 363) Intensive distribution (p 370) management (p 381) Vertical marketing system exclusive distribution (p 371) third-party logistics (3pL) (VMS) (p 363) Selective distribution (p 371) provider (p 382) ChApter 12 | Marketing Channels: Delivering Customer Value 385 disCUssiOn and CriTiCal ThinKing MyLab Marketing Go to mymktlab.com to complete the problems marked with this icon .

Discussion Questions 12-1 Compare and contrast upstream and downstream part- 12-4 Name and describe the three strategies available when ners in a company’s supply chain. Explain why value determining the number of marketing intermediaries. delivery network might be a better term to use than (AACSB: Communication; Reflective Thinking) supply chain. (AACSB: Communication) 12-5 List and briefly describe the major logistics functions. 12-2 Why is it often necessary and advantageous to have inter- Provide an example of a decision a logistics man- mediaries in a marketing or distribution channel? (AACSB: ager would make for each major function. (AACSB: Communication; Reflective Thinking) Communication; Reflective Thinking) 12-3 How would you distinguish between exclusive and sel- ective distribution? (AACSB: Communication; Reflective Thinking)

Critical thinking exercises 12-6 Form a small group and research the distribution chal- What companies are major players in the last mile, and lenges faced by companies expanding into emerging how does the concept of net neutrality fit in? (AACSB: international markets such as China, Africa, and India. Communication; Reflective Thinking) Develop a multimedia presentation on how one company 12-8 It has been estimated that the top 100 third-party overcame these challenges. (AACSB: Communication; logistics companies worldwide control around a third of Reflective Thinking; Use of IT) the estimated $270 billion outsourced logistics. Market 12-7 The term last mile is often used in the telecommuni- growth is between 6 and 8 percent. Do some research cations industry. Research what is going on in this to find out why this logistics model is so success- industry and how the last mile has evolved in recent ful. (AACSB: Communication; Use of IT; Reflective years, and then predict where it is heading in the future. Thinking)

appliCaTiOns and Cases

Online, Mobile, and Social Media Marketing Fabletics Changing Channels According to Fabletics company website, www.fabletics.com, $150 million. Although initially internet-based, Fabletics moved “JustFab Inc. co-CEOs, Don Ressler and Adam Goldenberg, into brick-and-mortar retailing in 2015. It plans to open 75 to launched Fabletics with Kate Hudson after they saw a gap in the 100 stores by 2020. (AACSB: Communication; Reflective Think- activewear marketplace. There were plenty of luxury brands, but ing; Use of IT) none that offered stylish and high-quality gear at an accessible 12-9 Conduct your own research to learn more about price point. These three unstoppable innovators joined forces to Fabletics. Discuss how Fabletics is meeting customer create the Fabletics brand in 2013.” Fabletics, a division of Just- needs through its value delivery network. What contro- Fab, offers affordable, high-quality, and stylish workout clothes versy surrounds the company? including yoga pants, leggings, joggers, tops, tees, and more for women and men at every fitness level. After being in busi- 12-10 What type of marketing channel is Fabletics using? ness just a few short years, the company ranked number 98 What is its distribution strategy? Does opening brick- in the Internet Retailer 2015 Top 500 Guide with revenues of and-mortar stores make sense for Fabletics? Explain. 386 pArt 3 | Designing a Customer Value–Driven Strategy and Mix Marketing ethics Ethical Sourcing Lush, the fresh handmade cosmetics company, was launched in for the cosmetics should be vegetarian, not tested on animals, 1994, and included the same creative team who designed many and have minimal impact as far as transportation is concerned. amazing products for The Body Shop. In less than 20 years of its Today, the company indirectly supports 400 women in Ghana establishment, Lush has grown to a network of over 850 stores who supply fair-trade Shea Butter and has stopped using palm in more than 50 countries worldwide and over 6,000 employees. oil from Indonesia in order to protect the natural habitat of the From the outset, the company was keen on ensuring that they orangutan. They also buy directly from small farmers in Tunisia, sourced their product ingredients ethically. This has become their Costa Rica, the Dominican Republic, and Laos. key USP, and together with the anti-animal-testing stance and 12-11 Write a brief report on a business of your choice that the ethos of making fresh cosmetics, the business stands apart supports ethical sourcing. What criteria are being used from most of its competitors. It does mean that the prices of their to establish the ethical standards under which they products are marginally higher, but this is offset by the unique, operate? (AACSB: Written and Oral Communication; minimalist packaging and general vibe of the brand. When Lush Reflective Thinking) looks for suppliers, they consider the whole picture; they take into account the conditions under which the workers may operate and 12-12 Should ethical sourcing be the default standard for all also consider how the production of the ingredients affects the businesses? (AACSB: Written and Oral Communication; environment. For Lush, it is important that the ingredients used Reflective Thinking; Ethical Understanding and Reasoning)

Marketing by the Numbers Tyson Expanding Distribution

Tyson Foods is the largest U.S. beef and chicken supplier, pro- store is expected to generate an average of $50,000 in revenue cessing more than 100,000 head of cattle and 40-plus million for Tyson. Refer to Appendix 2: Marketing by the Numbers to chickens weekly. Primary distribution channels are supermarket answer the following questions. meat departments. However, the company is now expanding 12-13 If Tyson’s contribution margin is 30 percent on this distribution into convenience stores. There are almost 150,000 product, what increase in sales will it need to break gas stations and convenience stores where the company would even on the increase in fixed costs to hire the new sales like to sell hot buffalo chicken bites near the checkout. This is a reps? (AACSB: Communication; Analytical Reasoning) promising channel, as sales are growing considerably at these 12-14 How many new retail accounts must the company retail outlets and profit margins on prepared foods are higher acquire to break even on this tactic? What average than selling raw meat to grocery stores. Tyson will have to hire number of accounts must each new rep acquire? 10 more sales representatives at a salary of $45,000 each to (AACSB: Communication; Analytical Reasoning) expand into this distribution channel because many of these types of stores are independently owned. Each convenience

Video Case Progressive

Progressive has attained top-tier status in the insurance industry do everything from managing their own account information to by focusing on innovation. Progressive was the first company to reporting claims directly. Progressive even offers one-stop con- offer drive-in claims service, installment payment of premiums, cierge claim service. and 24/7 customer service. But perhaps Progressive’s most in- After viewing the Progressive video segment, answer the fol- novative moves involve its channels of distribution. Whereas most lowing questions about marketing channels. insurance companies distribute via intermediary agents or direct- 12-15 Apply the concept of the supply chain to Progressive. to-consumer methods, Progressive was one of the first to see value in doing both. In the late 1980s, it augmented its agency 12-16 Using the model of consumer and business channels distribution with a direct 800-number channel. found in the chapter, sketch out as many channels for Two decades ago, Progressive moved into the digital future Progressive as you can. How does each of these chan- by becoming the first major insurer to launch a website. Soon nels meet distinct customer needs? after, it allowed customers to buy auto insurance policies online 12-17 Discuss the various ways that Progressive has had an in real time. Today, customers can use Progressive’s website to impact on the insurance industry. ChApter 12 | Marketing Channels: Delivering Customer Value 387 Company Case Apple Pay: Taking Mobile Payments Mainstream

After leaving his office in Manhattan, Tag stopped at a nearby app backed by Walmart and a consortium of U.S. retailers in Panera to grab a Frontega Chicken Panini and Green Passion hopes of cutting credit card companies and their fees out of the Power Smoothie as a quick dinner on his way to see some friends buying loop. in Soho. Upon ordering, he held his Apple Watch to the con- But none of these players—individually or together—has tactless reader near the register, gently pressed his finger to the made much of a dent in replacing traditional credit cards and TouchID fingerprint sensor on the small screen, and let Apple Pay cash as a form of payment in the multitrillion-dollar U.S. retail do the rest. market. Although the mobile payments concept may seem like Wanting to get across town as soon as possible, Tag used a no-brainer for convenience-loving American consumers, nu- his Uber app to summon an UberX car. During the car ride, he merous barriers on both the buyer and seller sides have kept remembered that he needed a couple of new dress shirts. With the concept from gaining momentum. Late to the game with a few quick clicks on his watch, he selected the shirts through Apple Pay, Apple is clearly a market follower. But it’s a feat that his Macy’s app. With a simple tap, he used Apple Pay to seam- the innovative company has performed to perfection time and lessly complete the transaction. As he neared his destination, again—take a new technology, make it better than any of the Tag added a tip to the bill for the ride through the Uber app, initial offerings, then watch the market explode as the Apple ver- which he’d already configured to use Apple Pay as the default. sion becomes the runaway market leader. With one simple press of his finger to TouchID on his watch, he exited the cab. Three purchases—offline, online, and, well, sort of in be- Overcoming Negative Consumer Perceptions tween—no wallet required. No traditional wallet, that is. This As with every new technology that involves paying for things, new reality—one that many early adopters are already living—is consumers have concerns about the security of mobile pay- rapidly expanding toward what some experts predict will be- ments. PayPal, Google, and the others took significant mea- come the future for everyone. Folks like Tag don’t even carry tra- sures to design secure systems. However, most consumers just ditional wallets anymore, only their mobile devices and perhaps weren’t comfortable with the idea that their phone might be used an ID and a backup credit card for retailers that don’t accept as a portal to their credit cards and bank accounts if it fell into the mobile payments—yet. After years of predictions that mobile wrong hands. Never mind that the same could be said of a wallet payments would replace cash and credit cards, there are finally or handbag, “devices” that are far less secure. signs that it might actually be happening. And Apple is leading Recognizing consumer reluctance to place digital versions of the way. their financial devices in one app, Apple took security to a higher level. Requiring a fingerprint makes the process much more se- cure than the more common safeguard of entering a passcode. Hardly New And if a mobile device is ever lost or stolen, the owner can use its The ability to pay for transactions with a mobile device is hardly Find My iPhone feature to immediately lock down Apple Pay or new. In fact, the first technology for mobile payments was in- even wipe the device completely clean. vented by Sony way back in 1989. It was first put into use in Hong Additionally, every compatible Apple device is assigned a Kong’s subway system in 1997 and began taking root in Japan in unique device account number. This is encrypted and securely 2001. The tech-savvy Japanese warmed to the idea quickly, and stored in a dedicated security chip on the device. It and a trans- mobile wallet apps were being used on mobile phones through- action-specific security code are the only numbers that Apple out Japan by 2004. Ever since, more than 245 million Japanese transmits to merchants. In fact, the merchant doesn’t even need mobile phones have been equipped with the capability to make to know the customer’s name. Credit and debit card numbers mobile payments, and Japanese consumers use mobile pay- are stored only on the local device, not on Apple servers. This ments for everything from transportation to food and household makes Apple Pay even more secure and more private than pay- purchases. ing by credit card. So it seems odd that a similar system has not taken root in Beyond consumer security concerns, previous adoption of the United States, although it has not been for lack of trying. mobile payment apps has been slowed by perceptions of a Companies have been experimenting with different approaches clunky user experience. If convenience is the biggest draw for years. PayPal was the first to take advantage of the smart- for consumers, then anything more arduous than the already- phone revolution by creating a payment app that gave just about convenient swipe of a credit card simply won’t cut it. Setting up every smartphone the potential for mobile payments. About a any of the existing mobile payment apps takes time and effort. year later, Google entered the mobile payment game with the Using such apps at the point of purchase is far from seamless, launch of Google Wallet. In the past six years, numerous other especially if the technology isn’t working quite right. “I don’t want companies—from small start-ups to retailing giants—have tried to be that guy holding up the line while we fumble around to to gain market acceptance in mobile payments. They include the get it all to work,” says one business columnist, “just like I don’t likes of Samsung, Square, and CurrentC—a failed mobile wallet want to be the guy who holds up the line boarding an airplane 388 pArt 3 | Designing a Customer Value–Driven Strategy and Mix because his mobile boarding pass can’t be read.” Mobile apps LevelUp. What’s more, most of these digital wallets utilize the that hit the market prior to Apple Pay required entering a pass- contactless-reader technologies that are already part of existing code and—in some cases—hitting multiple buttons. That took point-of-sale terminals, eliminating retailer acceptance as a bar- longer than the traditional swipe of the card, even if everything rier to entry. worked as intended. In addition to the competition, Apple still faces other chal- With Apple Pay, users still need to configure the app. But lenges. For starters, while Apple’s market penetration far Apple entered the digital wallet business with 800 million credit exceeds that of the competition and continues to grow by a cards already on file within its existing iTunes store. Not only can million new users each week, the mobile payments leader has this facilitate a setup that is already streamlined compared with a long way to go before reaching critical mass as digital wal- existing apps, it’s a sign that iTunes users may be more comfort- lets are still being used for only a sliver of all retail transactions. able with using the app given that they have already given their Additionally, the complexity of the payments industry has re- credit card information to Apple. And with the TouchID sensor, quired Apple and other companies to focus on developing one Apple has the transaction down to a one-touch process. That’s system. And with everything from smartwatches to refrigerators quicker than swiping a card and going through the typical menu, now featuring payment capabilities, changes in consumer pay- not to mention quicker than inputting a passcode. ment behaviors are inevitable. In an environment as volatile as this one, an alternative technology could certainly upset the apple cart. Establishing Points of Acceptance Still, Apple remains confident. With in-browser and peer- to-peer payments on the horizon, there is more potential than For mobile payments to penetrate the market, consumer accep- ever to boost transactions. And don’t count out an Apple Pay tance is necessary. But companies face a twofold challenge in app for Android devices. In short, experts predict that this year making such a technology successful. Consumers won’t adopt it will be a watershed one for the payments industry. Although if retailers don’t accept it, and retailers won’t invest the resources there are still plenty of doubters that mobile payments will re- necessary to accept it unless there is sufficient consumer de- place plastic as the go-to method for purchasing goods and mand. And the lack of consumer demand is the biggest factor services, there are also plenty of believers. And although Apple that has kept retailers from jumping onto the mobile payments is clearly ahead at this point, its success also bodes well for bandwagon. As a result, having too few retailers accept mobile the competition. As the concept catches on and technologies payments was a barrier to convincing people to leave their credit become more compatible, demand among non-Apple users will cards at home. increase as well. But thanks to Apple that situation is changing rapidly. It may be because of Apple’s clout or because of its massive and loyal user base. But in less than a year, Apple signed up far more retailers than all the previous mobile payment providers Questions for Discussion combined. Today, more than 2.5 million contactless-enabled 12-18 As completely as possible, sketch the value delivery terminals in the United States accept Apple Pay, a level that network for Apple Pay. demonstrates the type of momentum that will keep Apple on a growth trajectory. “You need so many points of acceptance 12-19 With respect to Apple Pay, is Apple a producer, a con- to make mobile payments work,” says a mobile payments sumer, or an intermediary? Explain. analyst for Forrester Research. “Apple has made that happen, 12-20 Identify all the reasons why Apple’s partnerships are striking partnerships with top national brands across a variety essential to the success of Apple Pay. of categories that will give consumers plenty of opportunity 12-21 With respect to marketing channels, what are some to use the service.” Apple has also signed up enough credit threats to Apple Pay’s future? card–issuing banks and credit unions to cover the vast majority of charge volume. Sources: Andrew Meola, “Apple Pay Is Showing Promising Growth,” Given the tremendous potential for this market, the competi- Business Insider, April 28, 2016, www.businessinsider.com/apple-pay-is- tion has been very active. Google has pulled back on Google showing-promising-growth-2016-4; Jason Del Rey, “Apple Pay Coming Wallet, even as it has released a more user-friendly and more to Mobile Websites before Holiday Shopping Season,” Recode, March widely accepted Android Pay. PayPal has the advantage of its 23, 2016, www.recode.net/2016/3/23/11587214/apple-pay-coming-to- massive online payments network as well as the first-mover mobile-websites-before-holiday-shopping-season; Robert Hof, “Apple Pay Starts to Take Off, Leaving Competition in the Dust,” Forbes, January advantage. Samsung intends for Samsung Pay to be a fluid 27, 2015, www.forbes.com/sites/roberthof/2015/01/27/apple-pay- component for its foray into the Internet of Things. Banks such starts-to- take-off-leaving-competition-in-the-dust/; Robert Hof, “Apple as Capital One, JPMorgan Chase, and Wells Fargo are intent Pay Momentum Keeps Growing Despite Challenges in Stores,” Forbes, on keeping payment transactions in the banking business April 27, 2015, www.forbes.com/sites/roberthof/2015/04/27/apple-pay- with apps of their own. And numerous startups are pushing momentum-keeps-growing-despite-challenges-in-stores/; and informa- digital wallet apps, including Coin, eWallet, Gyft, KeyRing, and tion from www.apple.com/apple-pay/, accessed June 2016. ChApter 12 | Marketing Channels: Delivering Customer Value 389 MyLab Marketing Go to mymktlab.com for the following Assisted-graded writing questions: 12-22 Describe multichannel distribution systems and the advantages and disadvan- tages of using them. 12-23 Why does channel conflict occur? Name and describe the various types of channel conflict.