Marketing Management: A Systems Framework (13)
Chapter 13: Channels
Christie L. Nordhielm
Georgetown University
© 2021 Christie L. Nordhielm all rights reserved
This is part 13 in a 15-chapter collection that makes up this book. Enjoy!
Channel strategy and execution concerns the flows of product, money, services, information, and risk up and down the supply chain. In the past two decades much of the value created in the marketplace has come from channel innovations; changes in how these flows transpire. Amazon and Vroom disrupted the flow of product, PayPal and Affirm have altered the flow of payments, firms like Uber Eats and Task Rabbit offer alternatives in the services sector, Google and Wikipedia have transformed information access and dissemination and the burgeoning DeFi (decentralized finance) industry is in the midst of overturning the traditional risk/reward relationship in financial markets. Whether we are seeking to disrupt an industry or simply get our products to our consumers, no coherent marketing plan is complete without a robust channel strategy.
Because this area is so dynamic, it is crucial to return to first principles as we think about how to build this strategy. As has been eloquently articulated by Louis Stern, the goal of any channel is to deliver a benefit to the end consumer. We must always bear this goal in mind, regardless of our position in the supply chain or how distant this consumer may appear. If all channel members clearly understand this fact, they have a far better prospect of achieving profitability.
Of all the executional modules in the Framework, channel strategy presents the greatest number of challenges. First and foremost, channels can be exceptionally difficult to change; hence, channel strategy development requires both advanced planning and skill at forecasting future market conditions. Unfortunately, as markets have become increasingly dynamic and volatile, our ability to forecast future conditions has become more limited. This limitation means that often we must rely on our executional abilities — our ability to change our channel strategy and implementation as conditions change. But channels are not prices, and changing a channel is not simply a matter of leveraging a pricing algorithm and then pushing a price revision out to our web page.
In contrast to other executional elements in the framework, a channel is a system. Instead of one organization, a channel is often made up of many interrelated organizations, some which we may control directly, others which we may not control at all; some which share our goals, and some which have goals of their own. Channel control is thus another key challenge that we address in this chapter. The systemic character of channels also means that it is often difficult to observe and measure the impact of our actions on the end consumer. As a manufacturer we may elect to launch a new product with a benefit that we hope will increase consumer interest and demand. If we are marketing and delivering our product directly to the end consumer, we will be in a good position to observe and interpret the results of our actions. In many cases, however, there will be other members in the supply chain between us and the end user, perhaps a distributor and a retailer, for example. These members often have a significant ability: 1) to influence customer behavior, potentially in ways that conflict with our marketing strategy; and 2) to restrict or distort customer feedback, reducing our ability to clearly gauge the impact of our strategy.
Finally, we must consider the human element of channel execution. A price is a price; an ad is an ad; a package is a package. These elements of the marketing mix are observable, stable, and for the most part within our control. In contrast, a channel inevitably relies on the actions of humans, and as we all know humans don’t always do exactly what we want them to do. For example, a retailer may be most interested in attracting customers to the store and may use our product as a loss leader, pricing it near or below cost even though we may be seeking to implement a premium pricing and positioning strategy. Further, even if we manage to fully align the objectives of all channel partners, humans differ in their emotional, physical, social, and intellectual capacity to execute these objectives. Humans make mistakes, they get tired, they get confused, they get frustrated, they get angry. Of course, they also can adapt, navigate complex and dynamic situations, recognize emotional cues, and customize their responses on an individual basis. Humans play an important part in even the most technological or standardized supply chain, so to manage a channel effectively is to manage humans effectively.
Thus, in our study of channels we face several substantial challenges, both strategic and executional. It is hence crucial for us to leverage the framework to develop and apply a disciplined strategy that will increase the efficiency of our decision making and our chances for success.
Channel Purpose and Definition
A channel is defined as a set of interdependent organizations involved in the process of making a product or service available for consumption or use to the final consumer. There are several important aspects of this definition. First and foremost, it is crucial to remember that the ultimate purpose of a channel is to deliver a benefit to the end consumer. No matter how far away in space and time a particular channel member is from this end consumer, their long-term survival depends not on how well they satisfy their customers, but how well the channel satisfies the end consumer. Of course, the farther away a channel member is from this end consumer, the less tenable this position may seem. The immediate pressures and demands of our nearest neighbors in the supply chain often loom larger than the remote needs of the end consumers. However, if channel members lose sight of their primary objective of delivering value to the end consumer, the consumer will inevitably abandon that channel in favor of another more responsive one. Without end customers, there is no channel. Thus, regardless of how distant the end consumer may seem, the first purpose of all channel members is clear: maximize profits for the channel as a whole by profitably meeting the needs of this end consumer. After profit maximization has been achieved, the channel members can allocate profits among the members. Again, this may seem like an onerous task as most channel members will inevitably consider themselves deserving of the lion’s share of profits. If, however, a channel leader can emerge and rise to the challenge of supply chain profit maximization and equitable profit allocation, this firm will ensure the long-term survival of the channel and all its members.
With the primary objective of the channel understood, the task becomes to conceive and implement a channel strategy where each channel member adds value within the supply chain. In general, channels can be thought of as providing three basic utilities, or benefits:
Product Utility: All channels are concerned with delivering products or services of some kind. It is important to understand the specific benefit each channel member provides vis-à-vis this product. Some members may add value by providing assortment, depth of inventory, or selection. For example, most distributors provide a wide assortment of products, enabling retailers to select those products most suitable for their customers. In contrast, some retailers may focus on a much more limited inventory, selected according to some clear criteria, that allows the customer to make purchase decisions more efficiently and effectively. Crate & Barrel, for example, provides only a limited number of products in each product category, and core customers rely on the belief that all these products will be of a particular quality and reflect a particular style.
Time Utility: Many channel members add value by providing time utility. Any activities that reduce search time, increase speed of delivery, or assure sufficient inventory at times of peak demand are essentially time-utility activities. It is important to recognize that different types of time utility are quite distinct and of varying importance to different consumer groups. For example, a consumer shopping at Amazon.com may value the time utility that the website offers in terms of instant search capability and ease of payment. However, the online customer does not enjoy instantaneous delivery as they would in a brick-and-mortar bookstore. Hence both Amazon and Powell’s books in downtown Portland deliver a measure of time utility.
Place Utility: The final value added by channel members is that of place utility. The shorter the distance the consumer must travel to inspect/pay for/receive their product, the greater the place utility. Perhaps the most famous example of place utility is Starbucks; in many cities in the world, it is possible to stand in one place and see two different Starbucks coffee outlets within a short walking distance. Starbucks ubiquity makes it that much easier for a consumer to decide to stop in for a cup of coffee. It is doubtful that the chain would have experienced the tremendous growth observed throughout the 90s had they not pursued an aggressive store expansion strategy to deliver this utility.
It should be noted that these three utilities represent broad categories of possible benefits that a channel can provide. To understand clearly the potential value added by a channel member, we must dig deeper and characterize the specific nature of the benefit being provided. Even a seemingly simple concept like “assortment,” a further specification of product utility, can mean very different things to different people. For example, a retailer can offer brand assortment — a broad selection of different brands, or product assortment — a broad choice of products from a narrower set of brands. It is thus vital to develop a clear and specific understanding of the various utilities provided by channel members. This understanding will help up link our channel strategy to the other strategic decisions in the Framework, most notably segmentation, targeting and positioning.
Channel Flows and Functions
One of the most notable characteristics of channels vs. other executional elements of marketing is the fact that they involve flows. The most obvious flow is that of product and ownership. In many cases the actual physical possession of the product and the legal ownership of the product are held by different channel members; an agent may purchase inventory and resell it without ever holding the inventory (e.g., a stockbroker) or may alternatively hold the inventory and offer it for sale without ever taking title (e.g., real estate brokers). The competencies associated with holding and transferring physical product are quite distinct from those associated with holding and transferring ownership; it is thus quite sensible to break up these two channel functions when it appears more appropriate.
While we tend to think of channels as dedicated to moving product, they enable flows of many other assets as well. One key commodity that flows backward and forward through a channel is information. Information, primarily regarding the product or service, flows forward through the channel to the end consumer. The various channel members may add value to this information by amassing and presenting (e.g., a technical salesperson), transforming (e.g., unit price information in the grocery store), or interpreting/reinforcing (e.g., an art dealer, an ad agency) the information. Perhaps more importantly, information flows from the customer back up the supply chain as well. Ideally, value also is added to information as it flows in this direction; for example, our in-house sales force returns from the field with crucial information about customer preferences. In some cases, however, consumer information that would prove quite valuable to upstream or downstream channel members does not reach them or is distorted on the way. In some cases, this issue is addressed by setting up a distinct information channel whereby consumer data is sold to third party research firms who then collate and sell the information to other channel members. Direct or digital marketers or those using fewer intermediaries generally have an advantage regarding the flow of information, and many can capitalize on this situation. Dell’s decision to sell personal computers direct not only enabled them to cut costs, but more importantly gave them access to specific consumer preferences. Netflix and Spotify have established strong customer and brand value by making use of the voluminous behavioral data available to them.
Product and information are arguably the two most important assets that flow through channels, but channels also enable several other key flows, such as flows associated with money. Once again, those channel members dedicated to this function must add value in a specific fashion. The most obvious task in this area is that of providing financing or handling payments for/between other channel members and/or the end customer. A specific channel member also may assume the task of negotiation, as is the case with car dealers or real estate agents since they are presumably most cognizant of the needs and interests of each customer and are best able to execute this task. Finally, channel members may assume all or part of the risk associated with a particular channel such as a franchise system whereby many people each invest in one franchise, thus assuming some of the risk for the overall venture.
As we assess or design a channel it is crucial to recognize the various functions in which channel members may engage and the associated value to the end customer of each of these functions. In doing so we can identify the optimal means of efficient delivery value to our end customer.
Channel Design/Management and the Framework
Because of the challenges involved in channel design and management, it is important to establish a strategic link between our overall marketing strategy and channel decisions. As with most executional elements of the Framework, our channel decisions should tie directly back to our business and strategic focus, and most importantly to the core benefit. We structure our channel with these in mind. In aligning our channel structure with our marketing strategy, we will consider three key executional channel decisions we must make: channel length, channel breadth, and channel depth.
Channel length refers to the number of channel members involved in delivering the product to the end customer. At one end of the spectrum is direct distribution, where few or no intermediaries are involved. Examples of direct channels include Dell and Amazon.com, two firms that sell directly to the consumer without using a brick-and-mortar retail store. There are several benefits to direct distribution, most notably the increase in control over product, money, and information flows. At the other end of the spectrum is indirect distribution. The computer chip manufacturer Intel faces an indirect distribution model; the chip must go through a variety of intermediaries, including wholesalers, distributors, OEMs (Original Equipment Manufacturers) such as Dell and Apple, and finally retailers before reaching the end consumer. Firms that are referred to as B2B (business to business) generally participate in a more indirect distribution channel. There are many good reasons to add intermediaries and structure a more indirect channel. Intermediaries add value to the channel by performing the various functions mentioned above. In addition, the use of intermediaries improves exchange effectiveness and efficiency by reducing the number of transactions. Consider an extreme case where each manufacturer of packaged goods might elect to sell directly to the end consumer through company-owned stores, bypassing the grocer. By removing the grocer, the manufacturer can save money and enhance control while lowering costs. However, the consumer would have to visit multiple stores to do their grocery shopping, something they would likely be unwilling to do. Hence, the presence of a brick-and-mortar retail store in the grocery channel makes good sense.
The decision as to whether to add or remove channel members is a cost benefit analysis. Costs are easy to assess, but quantifying benefits, which is equally important, can be far more difficult. For example, the benefit of “going direct” and thereby removing costly intermediaries is strong, but this step should not be taken until the added value of each channel member is realistically assessed. For example, a dedicated customer service center to handle repair may seem expensive until it is eliminated, service levels decline, and long-term customers are lost. It is thus crucial to understand in detail the specific functions provided by each channel member and the benefits associated with these functions. The channel should be long enough to ensure that key benefits and functions are performed, and short enough to ensure sufficient control of product, money, and information in the channel.
Channel breadth refers to the number of different types of outlets involved in distributing the product to the consumer at each stage in the value chain. Most often channel breadth is considered at the end consumer level. Here the two ends of the spectrum are described as exclusive distribution where the number of outlets is limited and carefully controlled, to mass or intensive distribution where the number of outlets is very high, thus minimizing the travel and search costs for the end consumer. Very often the breadth of a channel is determined based on which type of product attribute the firm is seeking to leverage and promote. Consider a case of exclusive distribution: Cartier watches, distributed only in limited, upscale locations by authorized retailers. These high-end watches are awash in credence attributes, and the channel itself helps establish these attributes for consumers. The Cartier retailer is an important part of the packaging and promotion for the product.
When the firm seeks to emphasize search attributes, particularly for a more complex product such as an automobile, the number of outlets may increase somewhat, creating a selective distribution strategy. For this type of strategy, the number of outlets higher than it might be for an exclusive strategy, but is still limited to control brand image, and to enhance the firm’s ability to properly educate the sales force as they market the product. The added value of the Volvo dealer is the knowledgeable salesperson who can identify the needs of the customer and meet those needs by pointing out certain search attributes of the product. Finally, a product may be distributed on a mass or intensive scale. Most items of lower cost and complexity and high in experience attributes (such as packaged goods) tend to fall into this category: HUGGIES® Diapers are available in grocery stores, drug stores, Wal-Mart, Target, etc. The key benefit added by the channel for mass distribution is that of time utility — ease of access. This ease of access encourages consumers to try and experience these low-involvement products without expending substantial effort.
Channel depth refers to the extent to which the channel is controlled, via forward and/or backward integration, by one or a few key channel members. Integration can be accomplished through simple ownership of the channel member, or in the absence of outright ownership, substantial legal control. In a deep, highly integrated channel the same company may own the raw materials providers, manufacturing facilities, transportation companies, distributors, and/or retail outlets. In a shallow, less integrated channel each of these functions will be performed by distinct and separately controlled companies. Of course, the key advantage to integration is the increase in power and control that it confers on the firm. Gallo Winery owns vineyards, cork and bottle manufacturers, trucks, and distributors, enabling them to control virtually all aspects of the wine production and distribution process. However, to the extent that performing each of these functions effectively requires different competencies, a single company might find it quite difficult to administer a substantial portion of the channel. Ideally, a company will outsource any functions for which they do not possess a core competence, thus enabling them to focus on areas where they can establish a competitive advantage.
Channel integration decisions are commonly known as “make-buy” decisions. The firm must decide whether to outsource or purchase a particular function, or to in-source and perform the function themselves. Amazon, for example, has chosen to outsource package delivery to firms such as FedEx and UPS. More recently, however, they have begun integrating forward, taking more control of the delivery function. This integration make sense given Amazon’s core benefit of convenience. Delivery is a key component of this benefit, and as such Amazon would ideally like to develop a competence tied to this benefit. Hence when we make the decision whether to integrate or not, we should consider both the insource/outsource decision, and whether we would like to develop a competence tied to that function. This decision matrix is presented in Figure 4. In a situation where the degree of value-added by the function is high, and our core competence is high, then competence and value add are aligned. An example of this would be Amazon’s core competence at logistics tied to the benefit of convenience. In the lower right-hand corner, we see the opposite situation: the function is low value add and the firm does not have a core competence. Presumably this was the situation for Amazon through the early 2000’s, where they believed that delivery was not a crucial component of the convenience benefit, and they therefore outsourced this function. The two areas of danger for the firm are if the degree of value-add of the function is high but the firm does not have a competence tied to this function. This describes a situation where the firm benefit is not tied to their core competence. In this case it the firm will need to develop a competence in this function. In the upper right quadrant, we have a situation where the firm has a core competence at performing a function that does not add value. In this case the firm needs to leverage communications to change the importance of this benefit, or else outsource the function.
Systems Thinking and Channels
Since channels are systems, systems thinking is an effective tool for considering channel decisions. In Figure 5 we look at the tradeoff between investment in core competence vs. outsourcing and the subsequent impact on differentiation and firm revenue. If the firm increases investment in core competence, the amount of outsourcing should go down and vice-versa. As the firm increases outsourcing there is a direct negative impact on firm competence, and on differentiation. These investments can disrupt the positive feedback loop that firms can develop between core competence and differentiation.
Channels and the Framework
As discussed above, it is important to consider the relationship of our core competencies to our distribution strategy. Our choice of goal and time frame will strongly influence our channel strategy. A short-term time frame may dictate the use of pre-existing indirect channels to quickly build distribution. On the other hand, a profit goal suggests that we might want to remove channel members to lower our cost basis While channel strategy decisions tend to vary widely from industry to industry, our choice of customer focus and competitive focus can still help to direct channel strategy with respect to what channel value we seek to emphasize and leverage. In Figure 6 below present these relationships.
If our primary strategic focus is acquisition/stimulate demand, we are inviting consumers to try our category and brand. In this case we need to leverage the channel to provide product expertise. In the case of acquisition/earn share product expertise will also be important, particularly the ability to help consumers compare our product to the competitor. In addition, the added value of place (location utility) such that our product is available to consumers, particularly when they are considering purchasing the competitor. As we move to retention/stimulate demand, we may still need to provide product expertise, particularly in the case of complex products where this expertise might be leveraged to enhance brand loyalty. In addition, time utility is important: we need to support our customers with parts and consumables quickly and easily to keep them in the franchise. This is important if we are trying to encourage hand loyalty. Finally, for retention/earn share place and time utility are most important. Recall that in this quadrant we are targeting multi-brand users. Our products and services need to be accessible in space and time to maximize the chance that consumers will select our product instead of the competition. Because we wish to encourage comparisons between our brand and our competitor we will likely leverage an indirect and more intensive distribution strategy to ensure we are where our competitor is. At this stage we may also consider integrating forward or backward in to enhance our control of more possible benefits in the value chain.
Proper channel strategy and implementation are crucial for the success of our marketing efforts. Because channels are pervasive and difficult to change, we must leverage the framework in a disciplined fashion to ensure that our channel strategy is fully integrated with our overall marketing strategy.
Thanks for reading!
Chapter 1: Introduction and Ethics
Chapter 2: Systems Thinking
Chapter 3: Business Objective
Chapter 4: Customer Focus
Chapter 5: Competitive Focus
Chapter 6: Estimating Market Potential/The 4 B’s
Chapter 7: Segmentation
Chapter 8: Targeting
Chapter 9: Positioning
Chapter 10: Product
Chapter 11: Service as Product
Chapter 12: Communications
Chapter 13: Channels
Chapter 14: Pricing
Chapter 15: Metrics
