BUAD 307--DISTRIBUTION Lars Perner, Instructor
BUAD 307
DISTRIBUTION AND THE SUPPLY CHAIN
BUAD 307 DISTRIBUTION Lars Perner, Instructor 1
Distribution (also known as the place variable in the marketing mix, or the 4 Ps) involves getting the product from the manufacturer to the ultimate consumer. Distribution is often a much underestimated factor in marketing. Many marketers fall for the trap that if you make a better product, consumers will buy it. The problem is that retailers may not be willing to devote shelf-space to new products. Retailers would often rather use that shelf-space for existing products have that proven records of selling.
1 BUAD 307--DISTRIBUTION Lars Perner, Instructor
LEARNING OBJECTIVES
• Identify customer value added by intermediaries (discrepancies addressed) • Identify economic efficiencies of intermediaries • Identify distribution structures appropriate for different types of products and situations
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The learning objectives above have to do mostly with the value added by intermediaries and the efficiencies these introduce. We also examine when different distribution structures (e.g., distribution chains of different lengths) are appropriate.
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SEGMENTATION IDENTIFYING MEANINGFULLY DIFFERENT GROUPS OF CUSTOMERS TARGETING PROUDCT PRICE SELECTING WHICH SEGMENT(S) TO SERVE
POSITIONING IMPLEMENTING CHOSEN IMAGE AND PROMOTION APPEAL TO CHOSEN SEGMENT
DISTRIBUTION
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Distribution is one of the marketing mix components that can be used to position an offering.
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DISTRIBUTION
• Intermediaries (wholesalers, retailers, and others) generally increase efficiency and reduce costs through – Specialization of labor – Economies of scale – Allowing the customer to do some of the work under self service conditions • Intermediaries help reduce discrepancies between what is produced and what the customer wants
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Intermediaries—including both wholesalers and retailers—help address three discrepancies that occur between the manufacturer and the end consumer. First, there is a discrepancy of quantity. The manufacturer prefers to sell in large quantities so that it can focus on manufacturing rather than selling, a task in which it does not specialize. A pen manufacturer, for example, may like to sell quantities of 100,000. These are bought by a wholesaler who, in turn, may sell to retailers such as the USC Bookstore in quantities of 500. A bookstore customer may, then, in turn buy just one or a few pens. Secondly, there is the discrepancy of assortment. Manufacturers make only a limited number of different products, often confined to a few product categories, but the customer likes to be able to buy many different products in one location. Major supermarkets and large discounters such as Walmart and Target allow the customer to buy, at one time in one convenient location, products from large numbers of manufacturers. Finally, there is the discrepancy of time. Consumers like to buy a large number of turkeys around Thanksgiving—much larger numbers than the manufacturer can produce within that time period. However, intermediaries cooperate to stock items such that plenty of turkeys will be available when they are needed.
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REMINDER
In the vast majority of instances, “eliminating the middleman” will greatly increase—rather than decrease—costs. The middleman—who specializes and thus is highly skilled and has economies of scale—can offer its services at a much lower cost than what it would cost for the manufacturer to perform these services by itself.
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Although many firms advertise that they save the consumer money by selling direct and “eliminating the middleman,” this is a dubious claim under most circumstances. The truth is that intermediaries, such as retailers and wholesalers, tend to add efficiency because they can do specialized tasks better than the consumer or the manufacturer.
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Discrepancies
• Differences between the way products emerge from protection and the needs of end customers
MANUFACTURERS DISCREPANCIES END CUSTOMERS
• Generally produce in large • Generally consumer in quantities modest quantities • Not usually in the business of • Want to buy in a convenient distribution (not their manner specialty) • Local retail store • Often need to produce • Online steady quantities • Will often seek products during concentrated periods • Holiday gifts Note: Exam questions on this issue have • Seasonal foods • Back to school historically been missed at high rates! • Seasonal fashions
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Manufacturers tend to specialize in manufacturing products in a cost-effective manner. Competition requires them to do so. Firms that run up costs higher than necessary in getting products to the end customer will have difficulty competing.
To be efficient, then, manufacturers generally produce products in large quantities. In order to create a sufficient quantity of goods that are needed in large quantities during “concentrated” demand periods (e.g., toys during the holiday season, turkeys at Thanksgiving), they must often produce ahead of time. Customers, in contrast, usually want to buy products in modest quantities, at a convenient time, and at a convenient location.
For these reasons, then, intermediaries (e.g., retailers [including online ones such as Amazon] and wholesalers) step in to help bridge the gap in question.
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Discrepancies
• Manufacturers generally prefer to sell in VERY large quantities to a limited number of parties (they do not generally specialize in distribution) • Retailers want to buy in large to moderately large quantities depending on their size and the product category • End customers typically want to buy in single units or in small to modest quantities • Wholesalers and other intermediaries help overcome these discrepancies
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Because wholesalers and retailers exist, the consumer can buy one pen at a time in a store located conveniently rather than having to order it from a distant factory. Thus, distributors add efficiency by: • Breaking bulk—the consumer can buy small quantities at a time. Small and modest scale retailers (e.g., the USC bookstore) can buy modest quantities. This service reduces quantity discrepancy in the supply-demand relationship between manufacturers and end customers. • Consolidation and Distribution.
The three discrepancies of consumer demand and manufacturing are discussed on the next slide.
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Discrepancies Between Producers and End Customers
• Quantity: Delivering products in quantities desired – By end consumer (e.g., 1 pen instead of 100,000) – By retailers (e.g., 500 pens instead of 100,000) • Assortment: Wholesalers and retailers can combine products from several manufacturers for convenience of – Retailers – Consumers • Temporal: Having products available at the right time—e.g., – Thanksgiving Turkeys – Summer fashions
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• Carrying inventory. This service reduces the temporal discrepancy between manufacturers who may need to schedule production at relatively constant levels and consumers who need certain products only at certain times (e.g., turkeys needed mostly at Thanksgiving and Christmas) • Financing. Certain small manufacturers may have difficulty waiting for payment until goods are sold to the end-customer. Wholesalers and retailers may negotiate lower prices from the manufacturer in return for quick payment. • Temporal discrepancy: The distribution system arranges to have items available to customers when they need them. Preparations have been made a long time before Thanksgiving to have enough turkeys processed and frozen so that they can be shipped to supermarkets in large quantities during the two weeks preceding Thanksgiving. Arrangements have also been made for large assortments of snacks and beverages to be available during the summer and before special events such as the Super Bowl.
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Benefits of retail stores to customers
• Consolidation: Customers can buy a large variety in the same store – Large discount store (e.g., Target or Walmart) – Supermarket (large assortment of both food and other items) • Quantity: Customers can buy products in quantities desired – Those who want to buy can save – Products are available in smaller quantities if desired • Timing: Customers can buy products when these are needed rather than when they are produced
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Consolidation and Distribution. It would be highly inconvenient for customers to have to buy each product at a different store. Most American consumers today also have limited patience with specialty stores in most categories. Rather than having to go to one store to buy produce, one store to buy meat, and other stores for other household products, there is considerable value in having everything available in a supermarket. The consumers can buy at a neighborhood store, which in turn can buy from a regional warehouse. It would also be very inconvenient for supermarkets and most other retailers to have to receive deliveries individually from each manufacturer. Wholesalers consolidate products from different manufacturers so that a large number of different products can be received in one shipment. This reduces costs by increasing the efficiency with which products can be (1) delivered and (2) received. Consolidation and distribution services offered by wholesalers reduce the assortment discrepancy between manufacturers on the one hand and local retailers and consumers on the other. NOTE: Some very large retail chains such as Walmart may be able to handle distribution more effectively than outside wholesalers. Walmart often insists on sales directly to the chain from the manufacturer rather than sales through wholesalers. This is the exception to the rule since Wal-Mart is large enough to be able to handle distribution itself rather than going through retailers. It should be noted that Wal-Mart has made very large investments to make this possible, and these capabilities have taken a long time to develop. Wal-Mart had a very difficult time breaking into the grocery business—especially for perishable items—and took several years to perfect this capability.
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Intermediaries: Adding Value
MANUF. 1 WHOLE- SALER (or agent) 1 END RETAILER CUSTOMER MANUF. 2 WHOLE-WHOLE- SALERSALER (or agent) (or agent) 22 Value added: MANUF. 3 •Breaking bulk (quantity Retailers and wholesalers discrepancy reduced) are both intermediaries— •Consolidating supplies they come in at different (assortment discrepancy PRODUCTS FROM reduced) places between the •Holding inventory (temporal OTHER manufacturer and the MANUFACTURERS. discrepancy reduced) customer.
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Many of the cost savings associated with having an efficient system of intermediaries result from specialization. Manufacturers specialize in what they do well—manufacturing products—while others specialize in handling various phases of the distribution path. Some specialize in retailing—usually selling a large assortment of goods in small quantities to a large number of end customers. Wholesalers, in turn, specialize in moving and goods from numerous manufacturers to a large number of retailers.
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Some Types of Intermediaries
Wholesalers: Typically buy from manufacturers and resell in smaller quantities to retailers. (Some sellers are hybrids—e.g., Costco sells both to businesses and to end consumers).
Retailers: Usually buy from wholesalers and sell to end customers. Retailers can be either brick-and-mortar, online (e.g., Amazon), or a combination (e.g., Staples stores and Staples.com).
Brick-and-mortar retailer: A merchant that sells products to its customers through a physical store.
Online merchant: A merchant which sells merchandise (usually bought from the manufacturer or an intermediary) to end customers through online ordering with delivery to the customer.
Intermediary: Any party that comes between the manufacturer and the end customer. Thus, this category includes both wholesalers and retailers.
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These are a few of the different retail types that exist.
An appendix describes certain types of retailers in more detail. Details are not needed for the exam.
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Some Sources of Intermediary Efficiency
• Specialization of labor – Manufacturers specialize in designing and making products – Wholesalers specialize in distributing the products • Economies of scale: – One wholesaler can • Pick up supplies or take deliveries from multiple manufacturers • Deliver merchandise from multiple manufacturers to each retailer – Thus, costs of supplying each retailer are spread across a number of manufacturers
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Intermediaries get much of their efficiency from two factors:
• Specialization of labor. Wholesalers focus on taking very large quantities of merchandise from manufacturers and then breaking up these larger quantities into smaller quantities sold to retailers. It is usually more efficient for manufacturers to specialize in producing the product and having else distribute these. There are some exceptions here, but these mostly involve situations where distribution involves something intangible or where distribution can be automated. • Economies of scale. When a wholesaler delivers merchandise to a retailer, it will bring items from a number of different manufacturers. This increases efficiency when only one delivery trip has to be made and when the retailer can take delivery of a large number of items in one shipment instead of having to accept a larger number of shipments from different manufacturers.
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Distribution Efficiencies
• Certain VERY LARGE retail chains—e.g., Wal-Mart and Safeway—may be able to distribute more efficiently than independent wholesalers – Integration with own demand forecasts This is the EXCEPTION • For most other retailers, rather than the buying through wholesalers rule! is more efficient
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Some very large retail chains such as Walmart may be able to handle distribution more effectively than outside wholesalers. Walmart often insists on sales directly to the chain from the manufacturer rather than sales through wholesalers. This is the exception to the rule since Wal-Mart is large enough to be able to handle distribution itself rather than going through retailers. It should be noted that Wal-Mart has made very large investments to make this possible, and these capabilities have taken a long time to develop. Wal-Mart had a very difficult time breaking into the grocery business—especially for perishable items—and took several years to perfect this capability.
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Some Potential Channel Structures (U.S.)
Producer Producer Producer Producer Producer
Agents/ Brokers
National Wholesalers
Regional Wholesalers Wholesalers Wholesalers
Retailers Retailers Retailers Retailers
Customer Customer Customer Customer Customer
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Channel structures vary somewhat by the nature of the product.
Commercial jet aircraft are custom made and shipped directly to the airline. Automobiles, because they are difficult to move, are shipped directly to a dealer. It is clearly too difficult for the customer to come to Detroit or Tokyo to buy the car. Therefore, the optimal channel length appears to involve one intermediary (although there is likely to be one or more central import facilities for imported cars). Other products are shipped through a wholesaler who can more efficiently handle, and combine, products from many different suppliers. That is, the wholesaler will take delivery of products from a number of different manufacturers, buying a large quantity from each, and sell to a number of different retailers. The wholesaler will provide each retailer with products from different retailers in a single delivery (consolidation), and in quantities smaller than it is convenient for the manufacturer to sell directly (bulk-breaking). Several layers of wholesalers may exist, depending on the product. Occasionally, agents may also be involved. Agents usually do not handle products, but instead take care of the business aspect of negotiating with distributors, which manufacturers may feel uncomfortable or ill prepared for doing themselves.
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Farmers’ Markets—Ordinary Circumstances
• Generally very inefficient since the farmer has to travel a significant distance carrying only his or her own produce • Generally a lack of – Specialization of labor – Economies of scale (farmer only brings own crops) – Aggregation of assortment (farmer only brings own crops) • However, some customers will pay a premium for higher quality, “farm fresh” produce BUAD 307 DISTRIBUTION Lars Perner, Instructor 15
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Farmers’ Markets: High Volume Sales
• Under exceptional circumstances, farmers’ markets may be efficient because large volumes are bought in a concentrated time period. This requires VERY HIGH volumes to be efficient. • Under such circumstances, the customer sacrifices the convenience of being able to shop at a desired time—the market may only occur on Tuesdays from 3:00- 6:30 p.m.
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Farmers’ Markets: A Note on the Cost of Labor
• Some farmers may do this as a part time “side business.” • If they do not count the cost of their work time—if this is a “labor of love”— distribution might be seen as efficient. This logic does not work, however, for full time farmers who have alternative demands on their time.
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Approaches to Distribution
• These strategies require tradeoffs: – Wide--essential to low involvement goods – Selective--desire to maintain image – Exclusive--very high prestige needed or very high service requirements
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Most manufacturers would prefer to have their products distributed widely—that is, for the products to be available in as many stores as possible. This is especially the case for convenience products where the customer has little motivation to go to a less convenient retail outlet to get his or her preferred brand. Soft drinks would be an extreme example here. The vast majority of people would settle for their less preferred brand in a vending machine rather than going elsewhere to get their top choice. This is one reason why being a small share brand in certain categories can become a vicious cycle that perpetuates itself.
For most lower tier manufacturers, wide distribution is not realistically obtainable. In food product categories, for example, the larger supermarkets can carry a large number of brands. Smaller convenience stores and warehouse stores, however, are likely to carefully pick a few brands. After all, if convenience stores were to carry as many products as supermarkets, the purpose of having a neighborhood store with easy entry and exit would be defeated.
In a very small number of cases, some manufacturers prefer to have their products selectively, or even exclusively, distributed. This is usually the case for high prestige brands (e.g., Estee Lauder) or premium quality image brands (e.g., high end electronic products) that require considerable before and after sales service.
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Retailer Vulnerability to Online Competition
Level of Types of Retail Comments Vulnerability Higher Specialty with limited service requirement (e.g., Mostly items that are cost electronics); mall type stores; high absolute effective to handle or ship or margin items with little need to inspect (e.g., highly specialized items where smart phones); specialty goods with high variety storing inventory at the local of inventory levels needed; rare collectibles; level is not cost effective intangible items or items for which intangibles can serve as substitutes; (e.g., e-books, music, video content);
Medium Bulk supermarket items (e.g., large quantities of Products where special soft drinks); select luxury goods (e.g., specialty circumstances can make wines, liquor, specialty high end foods); clothing online purchases attractive (most useful for repeat purchases of known sizes) Lower Convenience goods (especially impulse items or Situations where customers items with service included [e.g., cold beverages, do much of the work in retail prepared foods]); most supermarket items settings (especially perishable ones) BUAD 307 DISTRIBUTION Lars Perner, Instructor 19
Retailers vary in the extent to which they are vulnerable to online competition.
Note that certain types of retailers require a certain “critical mass” to be effective. A number of mall stores have gone out of business, making it less attractive to go to mall. This creates a potential vicious cycle. Recently, a number of gyms and other athletic facilities have moved into former retail space that has become available mall space, bringing about regular traffic. This appears to have helped restaurants in malls, but it is less clear how much traffic and sales this has brought to retail stores there.
Historically, malls were a bit of a hangout, especially for teenagers. This is not as much the case today.
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Product Characteristics That May Favor Direct-to-Customer Sales
• High need for customization—especially if the work can be done by the customer • Rapid decline in the value of inventory • High value/bulk ratio • Low need for customer to manually inspect the product • Highly specialized product requiring a very large assortment of inventory • Sufficient absolute margins—a sufficient dollar margin to cover costs of procurement, storage, “picking” of the ordered items, packaging, and shipping.
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Extent of customization needed. Some products need to be customized—e.g., checks have to be personalized and airline tickets have to be issued for a specific departure site, destination time, and travel time. Here, online processing may be useful because the customer can do much of the work.
Vulnerability of inventory to loss of value. Some products—especially high tech products— have a very high effective carrying costs. It has been estimated that because of the rapid technological progress made in the computer field, computer parts may lose as much as 1.5% of their value per week. If shipping directly to the customer can reduce the channel time by five weeks, this potentially “rescues” as much as 7.5% of the product value. In such a situation, then, trying to reach the customer directly may make sense, even if the direct costs of distribution are higher, because of the inventory value issue.
Need to inspect products. Products that are more sensual in nature or where observation is needed to determine quality are less suited for online sales. Exceptions are repeat purchases and products identical to those owned by friends, family, or acquaintances.
Specialization and geographic dispersal of customers. Electronic commerce, when value-to- bulk ratios and absolute margins are not favorable, is often not viable when customers are located conveniently close to a retail outlet. However, for some products—e.g., bee keeping equipment—customers are widely geographically dispersed and thus, a centralized distribution center may be more economically viable. Specialty books—e.g., for collectors of vintage automobiles—may not be worthwhile for bookstores to stock, and these may thus be economically sold online.
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Walmart online and in-store pricing
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Parallel Distribution Structures (Multi-channel Distribution)
MANUFAC- WHOLE- RETAILER TURER SALER (traditional or online)
VERY LARGE CHAIN (e.g., Wal-Mart) CUSTOMER
May reduce value of brand and/or FACTORY retailer relations OUTLET through discounting DIRECT STORE MARKETING Shipment or other delivery from Adds value COMPANY manufacturer to through service STORE (e.g., customer Apple Store)
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Parallel distribution structures (also known as multi-channel distribution) refer to the fact that products may reach consumers in different ways. Most products flow through the traditional manufacturer - -> retailer --> consumer channel. Certain large chains may, however, arrange to buy directly from the manufacturer since they believe they can provide the distribution services at a lower cost themselves. (This only works if you have enough volume to, in effect, efficiently perform the wholesaling task on your own.) In turn, of course, they want lower prices, which may anger the traditional retailers who feel that this represents unfair competition. In some cases, firms may choose to establish their own company stores (e.g., the Apple Store). Although it will usually be more expensive to operate these stores than selling through other retailers that can spread costs over a larger assortment of merchandise, company stores may help provide customers additional service (e.g., repair facilities, support, and demonstration of products).
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Factory Outlet Stores
• Are generally less efficient than stores selling products from multiple brands, but can: – Increase total quantity sold – Be used to liquidate excess merchandise – Help create awareness of the brand • May lower value of brand if the emphasis is on selling lower quality merchandise • Will likely generate resentment among full service retailers who fear they will lose business and/or that the value of the brand will be eroded • Usually put in remote vacation areas so sales will be predominantly incremental (in addition to what customers would otherwise buy) rather than at the expense of sales of full service retailer sales
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Firms may also choose to utilize factory outlet stores. Some of these are intended mostly to sell excess inventory and/or “irregular” merchandise with minor manufacturing defects; others also sell merchandise that was never intended to be sold anywhere other than a factory outlet store. To allay concerns held by conventional stores, however, these factory outlet stores are usually located in areas where they are not easily accessible. Although operating these is less efficient than selling merchandise through traditional channels, it can help unload merchandise not suitable for sales in regular stores and to spur sales that would otherwise not have occurred. If merchandise is sold at significantly lower prices than in other stores, this can erode the value of the brand. In addition, such lower prices can result in loss of goodwill from other channel members. Factory outlet stores are often located in remote vacation areas (e.g., near Palm Springs) that cannot readily be accessed for everyday purchases in order to reduce their competitive threat.
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Company Stores (e.g., Apple Store)
• Are often less efficient than traditional distribution channels • Will likely INCREASE the value of the brand due to services made available • May enhance perceived exclusivity or prestige of brand • May result in resentment from full service retailers
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The purpose of company stores is usually to increase customer service. Generally, these are not intended to sell the manufacturer’s merchandise at a lower price. These stores will generally take away some business from full service retailers, so there may be some resentment. On the other hand, the merchandise is now more valuable due to service available from the company store, so other retailers do get some benefit from carrying these more valuable products.
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REMINDER!
• Intermediaries usually add efficiency through specialization and economies of scale • “Cutting out the middleman” usually increases costs! • Selling directly to the customer is only likely to be cost effective if: – Value-to-bulk ratios are high – Absolute margins are large – Customers for a specialty product are highly dispersed so that there would be few customers for a retailer in any one area • In the retail store, the customer does most of the work. If you ship directly to the customer, you either have to: – Do those tasks yourself – Hire someone else (e.g., UPS) to do them
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Again, if you eliminate an intermediary, you either have to do what that intermediary does or hire someone else to do it. Eliminating retailers may also take away the potential to have the customer do much of the work. There is a great deal of work involved in collecting all items for shipment to the customer in different areas of large warehouses.
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Diversion
• Products often end up where manufacturers did not intend them to go – Trade promotions in one region • Within countries (Difficult to do today since sales at a given time can be verified by scanner data) • Between countries--different price sensitivities and structures may exist (e.g., pharmaceuticals, luxury autos) – “Over-purchases” by small authorized retailers to supply unauthorized distributors (e.g., Levis’ for Costco)—disliked by full service retailers who have to compete
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Diversion occurs when merchandise intended for one market is bought up by a distributor that then ships it to a different market. Sometimes, a manufacturer will run a promotion in one region but not in another, and speculators will then buy extra quantity in the promoted area and ship it another area. The speculator will then sell it to local retailers or distributors for a price slightly lower than what is being charged through the regular channel but at a price that still allows a nice profit. Certain products sell for different prices in different countries. As we discussed in the unit of international marketing, a gray market occurs when a product is bought in one country and exported to another where the price is generally higher. Both Louis Vuitton suitcases and golf clubs were imported to Japan, depressing prices there.
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Over-Purchase Diversion Example
• Joe’s Jeans Shop normally buys and sells 500 pairs of Levi’s XBM/P jeans per week at $22.00 and sells at $32. • A “consolidator” asks Joe to buy his usual 500 plus an extra 200. This increase is not big enough to make Levi’s suspicious. • The consolidator pays Joe 200*($22+$3)=$5,000. • Joe makes an extra $3*200=$600. • The consolidator resells to a large discount chain. • The large discount chain ends up paying a larger price than it would have paid if the manufacturer had been willing to sell to it directly or through wholesalers. This means that the discounter cannot discount as aggressively as they could have if they could have bought with large volume buying power, but they can still undercut the full service retailer dramatically.
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The above example suggests that while it is preferable for full service retailers as a whole that discounters not have access to “protected” merchandise, individual full service retailers can face serious temptation to make significant profits by reselling merchandise they have ostensible bought for sale to end customers in their own stores.
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Some Main Types of Retailers and Retail Markets (With Some Overlap)
• Supermarkets • Full service stores (often full • Local grocery stores (uncommon in service) most areas) • Category killers (e.g., Home Depot, • Convenience stores Staples, Best Buy) • Drug stores • Warehouse stores (e.g., Costco) • Discount stores (e.g., Target, • Combined wholesaler/retailer Walmart, KMart) chains (e.g., Costco, Smart & Final) • Mega stores (e.g., Walmart, Target) • Pop-up stores (seasonal) • Specialty stores • Periodic markets (e.g., farmers’ • Specialty business-to-business markets’) (B2B) stores
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You will not be asked specific questions on the different types of retailers on the exam. This is mostly as a demonstration of the variation that exists.
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Retail Trends
• Divergence—growth in both low cost, low service and high cost, high service stores more than in the middle • Growth of mega stores: Large stores with a wide assortment (e.g., Wal- Mart) – Convenient – Extremely strong buying power due to volumes • “Category killers” (e.g., Home Depot, Best Buy, Staples) are finding it more difficult to compete due to aggressive pricing and economies of scale from mega-merchants (e.g., Walmart, Target) and online sellers • Many traditional brick-and-mortar merchants increasingly attempt to add online offerings even if not yet profitable (Walmart now charges higher prices online than in stores for some items) • The threat to specialty stores started long before the Internet with competition from the likes of Target and Walmart! Online sales are merely an additional nail in the coffin! • Online sales represent a modest part of total retail sales, but – Increase competition for price and convenience – Take away a modest share of sales from brick-and-mortar retailers, resulting in a much larger percentage decrease in profits—malls are especially heavily hit
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Over the past decade, there has been considerable growth in both extremes of the continuum from low price, low service to high price, high service retailers. There has been considerably growth both in the Wal-Mart and Nordstrom-type retailers than there has been in between.
For some time, during difficult economic times in the around 2008-2011, discount stores like Walmart actually tended to increase sales as consumers seemed to switch their purchases of the same products from higher priced to lower priced stores rather than reducing the quantity and quality bought in the product categories.
“Category killer” chains, which specialize in a broad product category such as office supplies, sporting goods, or electronics, were a strong force in the U.S. retail market from the 1990s until fairly recently. Although their overall sales levels are much lower than giants such as Walmart and Target, their purchase volumes within their chosen product categories are potentially even higher. These chains often commit to large orders a long in advance of delivery in return for low prices. Thus, they can potentially offer the customer a good deal at any brand that he or she wants in the category, but potentially a truly exceptional price on the featured brand or model. Today, category killers face increasing competition from online merchants. Categories such as electronics tend to feature large absolute margins and favorable value-to-bulk ratios, playing to the strengths of the online merchants. Note also, as will be illustrated on the next page, that a modest decline in sales volume can have a quite disproportionate impact on profit levels since fixed costs stay relatively constant.
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Impact of Sales Volume on Profitability—An Illustration
In most product categories, online sales account only for a modest portion of total product category sales. Why are online sellers such as threat to brick- mortar chains?
Retailers are highly dependent on having a sufficient volume to cover fixed costs. If a modest part of the volume is lost, earnings can turn negative.
CALCULATIONS TAKEAWAY: ARE NOT A small decrease in volume NEEDED FOR will have a much larger EXAM! impact on profitability!
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Increasingly, established retail chains such as Walmart and Target are attempting to increase their online sales, in part to compete with Amazon and other online merchants. For product categories that lack the needed value-to-bulk ratios and absolute margins, profitability is likely to be low or even negative, but an online presence is generally thought to be needed for the chain to remain competitive (and maintain bricks-and-clicks synergy).
Recently, Walmart has begun to charge higher prices for selected products—typically with low value-to-bulk ratios and/or absolute margins—when these products are bought online rather than in the retail stores. Walmart is quite transparent about this, showing the online customer the lower price at which the product can be bought in the store. This strategy makes the products available to those who are willing to pay extra for the convenience of shopping online and likely also drives a lot of customers into the retail stores where they are likely to buy additional items and can be served more efficiently.
Even Amazon’s total online sales are only a modest fraction of the merchandise that Walmart sells in its brick-and-mortar retail stores, and the vast majority of merchandise bought by consumers is bought in brick-and-mortar stores. It should be noted, however, that a loss in sales volume of, say, 5% will result in a much larger percentage decrease in profits since margins are considerably greater after fixed costs have been met. That is, if you lose five percent in sales volume, you are losing the most profitable five percent, likely among the point at which fixed costs have been covered. The graph shows a situation where a 5% loss in sales volume results in a much larger decrease in total profits. This is largely because fixed costs now have to be covered by a smaller quantity.
30 BUAD 307--DISTRIBUTION Lars Perner, Instructor
The Supply Chain: An Example
Raw materials producers
Component makers
Component distributors
VALUE ADDED Manufacturer AT EACH STEP Logistics, storage, distributors, agents
Wholesaler
Retailer
Delivery
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The supply chain traces products from manufacturers of raw materials and other inputs to end point where the product is received by the customer. Note that although each step involves costs, each also adds value.
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