Chapter 9
Vertical Integration in
Distribution
FIGURE 8.1: CONTINUUM OF DEGREES OF
VERTICAL INTEGRATION
Buy
Classical Market
Contracting
Third Party Does it
(for a price)
Their people
Their money
Their risk
Their responsibility
Make
Quasi-Vertical
Integration
(Relational Governance)
How does the
the work get done
The costs
Vertical
Integration
You do it
Your people
Your money
Your risk
Your responsibility
You and third party
share costs and
benefits
Their operation (control)
Their gain or loss
The benefits
Your operation (control)
Your gain or loss
The Continuum of Interfirm
Exchange Format*
Franchise
Systems
Hierarchy
(within firm)
Buying
Groups
Market Setting
(outside firm)
3
TABLE 8.2: EXAMPLES OF INSTITUTIONS PERFORMING
SOME CHANNEL FLOWS
Function
Classical Market
Contracting
Quasi-vertical
Integration
1) Selling (only)
Manufacturers’
Representatives
2) Wholesale
Distribution
Independent
Wholesaler
Distribution
Joint Venture
3)
Independent
(3rd party)
Franchise
Store
Retail
Distribution
“Captive” or Exclusive
Sales Agency *
Vertical
Integration
Producer Sales
Force (direct
sales force)
Distribution
Arm of Producer
Company
Store
* Operationally, a sales agency deriving more than 50% of its revenues from one principal
6
Distribution Objectives
Economic Theories of Vertical Integration
1. Transaction Cost Analaysis
2. Control Rights Theory
Transaction Cost Analysis (TCA)
• Focus: Economic Efficiency
• Costs occur whenever firms perform “functions”
– Fixed and variable components.
• TCA states that firms should purse the most efficient
channel arrangement based on cost avoidance.
– “Make” = Direct channel = Vertical Integration
– “Buy” = Indirect channel
6
Key Assumptions and
Conditions for TCA*
• Channel members negotiate, monitor, and
enforce exchange aspects by considering:
– Bounded rationality
– Opportunism
– Uncertainty (Internal and External)
– Specificity of assets
– Frequency of transactions
7
Internal versus External Transactions
• Conditions for choosing hierarchy (Internal)
over market (external):
– A high level of environmental uncertainty should exist in
the transaction cost assessment.
– The assets involved should be highly specialized and
unique to the exchange process.
– The transaction should occur frequently.
• Examples: Sherwin-Williams; Curtis Mathes
• Third Breed: Clan Mechanism
8
FG 7.2: HOW ENVIRONMENTAL UNCERTAINTY IMPACTS VERTICAL INTEGRATION
Highly Volatile Market
Low Specificity
Outsource Distribution
to Retain Flexibility
Until Uncertainty Is
Reduced
High Specificity
Highly Promising
Market
Vertically Integrate
to Gain Control Over
Employees And Avoid
Small-Numbers Bargaining
In Changing Circumstances
Less Promising
Market
Do Not Enter
FIGURE 7.4: ROAD MAP TO THE VERTICAL INTEGRATION DECISION
Presume outsourcing is more attractive
than vertical integration
Start
here
GO!
NO
Is potential business major or substantial?
Outsourcing
preferable
YES
Examine how function will develop
Will
performance
ambiguity
be high?
NO
(Take both roads and
see where they go)
NO
Outsourcing remains
attractive
YES
Consider overturning
outsource presumption:
Vertical Integration,
increasingly attractive
Will
substantial
companyspecific
investments
accrue?
YES
Volatile, uncertain environment
(accelerates effect of companyspecific investments)
II. Control Rights Theory
(Jensen and Meckling 1976)
1. Two Types of Knowledge
- General Knowledge: Easy to transfer
- Specific Knowledge: Costly to transfer
2. Channel Organizing Principle:
- Ownership is not the focus
- Collocate control with knowledge
Chapter 8
Strategic Alliances in
Distribution  Skip!
Motivating the Channel Members
Major Topics for Motivating Channel
Members
1. General Discussion
2. Finding out Channel Member Needs
3. Three Types of Programs that
Motivate Channel Members*
4. Another Approach on Channel
Member Motivation*
9
Motivation Management
Motivation Management:
The actions taken by the manufacturers to
foster channel member cooperation in
implementing the manufacturer’s
distribution objectives
Motivating Channel Members
Basic Framework
1. Find
out the needs and problems of
channel members.
2.Offer support to the channel
members that matches with their
needs and problems.
3.Provide leadership through the
effective use of power.
Supporting Channel Members*
1. Cooperative
Arrangements
2. Partnership
or
strategic alliance
3. Distribution
programming
3 Types
of
Channel
Trade
Programs
9
1. Cooperative Arrangements
Focuses on channel member needs & problems
Simple & straightforward
Conveys a clear sense of mutual benefit
9
Cooperative Arrangements
Typical types of cooperative programs
provided by Manufacturers to channel members
• Cooperative advertising allowances
• Payments for interior displays
• Contests for buyers, salespeople, etc.
• Allowances for warehousing functions
• Payments for window display space
• Detail men who check inventory
• Demonstrators
• Coupon-handling allowance
• Free goods
= A Common Element of above programs?
9
9
2. Partnerships & Strategic Alliances
Focus on a continuing and mutually
supportive relationship between the
manufacturer and its channel members
Partnerships & Strategic Alliances
Three basic phases
1. Manufacturer should make explicit statement of
policies in areas such as product availability,
technical support, pricing, etc.
2. Manufacturer should assess all existing distributors
as to their capabilities for fulfilling their roles
3. Manufacturer should continually appraise the
appropriateness of the policies guiding his
or her relationship with the channel members
9
Strategic Distribution Alliance
• Characteristics
– Enduring connections
– Substantial connections
• What sets SDA apart from others
– Trust
– Commitment
– Like Marriage?
• Building Commitment
– Expectation of continuity
– Bilateral communication
– Balanced Power between the two
• Commitment is mutual
22
Strategic Distribution Alliance
•
How to gauge the commitment by
the other side?
– Previous relationship
– Actions
• A word of caution: Not for every relationship
– One side has special needs
– The other side has the capability to meet those needs
– Each side faces exit barriers
23
3. Distribution Programming
A comprehensive set of policies for the promotion
of a product through the channel
Developed as a joint effort between the
manufacturer and the channel members
to incorporate the needs of both
9
Distribution Programming
Steps for developing a program:
1. Analysis of marketing objectives & the kinds of
levels of support needed from channel members
• Ascertains channel members’ needs &
problem areas
2. Formulate specific channel policies that offer:
• Price concessions to channel members
• Financial advice
• Some kind of protection for channel members
3. An Example: Category Management
9
9
Relationship Differences
Cooperative Arrangements
Intermittent interactions between manufacturer
& channel members
Partnerships & Strategic Alliances
Continuing & mutually supportive relationship
Distribution Programming
Deals with virtually all aspects of the
channel relationship
Another Approach on Motivating
Channel Members*
Theoretical foundation: Agency theory
1. Before you begin…
1. Screening and Qualification
2. Selection
2. As you begin…
1. Role Specification
2. Joint Planning
9
9
Another Approach (Cont’d)
3. After You Begin…
1. Channel Incentive: More than $$$!
2. Monitoring:
Outcome Monitoring
Behavior Monitoring
3. Enforcement:
Legal Enforcement
Market Enforcement
Self Enforcement
* Is this all?