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Distribution Channel Management
Chapter 9
Vertical Integration
In Distribution
Chapter 9 Outlines
Learning Objectives
- Understand vertical integration as different degrees from make to buy
- Diagnose the reasons why channel players often integrate forward
and backward
- Explain six reasons why outsourcing is the preferred choice than
vertical integration
- Understand three situation why vertical integration is better choice than
outsourcing
- Define six categories of company-specific capabilities
- Know reasons why vertical integration can cope with volatile environment
- Learn how vertical integration reduce performance ambiguity
Vertical Integration
Points of Discussion
- Why channel players would like to integrate forward
or backward
- Should all the distribution functions rolled into one
company?
- Should distribution flows be outsourced?
Vertical Integration
The Five Puzzles for Our Consideration
- Why Whirlpool let another company perform the
logistic function?
- Why Luxottica take a risk to purchase LensCrafters
acting as its own retailer?
- Why Best Power dismantled its in-house operation
and has turned to independent value-added resellers?
- Why Jean Delatour integrate backward into the
production of Jewelry related products?
- Why supermarkets invest heavily in creating its own
brands, private labels?
Vertical Integration
The Make or Buy Decision
- It is a critical strategic choice in marketing channels
- The manufacturer can gain much of its market
intelligence from its channel
- The decision once made is difficult to reverse and
determines the firm’s future performance path
- For downstream channel members, their decisions to
integrate backward consume resources, put them into
conflict with their other suppliers
Vertical Integration
Points of Discussion
- Do Channel Members have to choose between purely
Make or Buy arrangement?
- If not, what are the other options remaining?
Degrees of Vertical Integration
Vertical Integration
Cost and Benefits of the Choice to Make
- Manufacturer assumes all the costs of distribution i.e.
personnel costs, costs of all other channel flows
(warehousing, logistics, customer outstanding)
- Risk of the distribution operation
- The responsibility of all actions
- Benefits are control of operation, improvement of market
share, return on investment
Outsource Distribution
Point of Discussion
- Why outsourcing is the preferable choice
among channel members?
Outsource Distribution
Six reasons to outsource the channel function to an
outside party
1. Motivation – channel members aim for both positive (profit)
and negative (fear of loss) motivation
2. Specialization – outsourcing allows each party to stick to
their specialties
3. Survival of the economically fittest – there are no places
for incompetent channel members as businesses are
highly competitive, easy to enter and easy to exit
Outsource Distribution
Six reasons to outsource the channel function to an
outside party
4. Economies of scale – justify by deep brand assortment
from multiple manufacturers
5. Heavier market coverage – having assortment of
goods to call on many customers more often
6. Independence from any single manufacturer – channel
members act as independent counsel and know their
customers well which can build strong customer
loyalties
Vertical Integration Forward
Points of Discussion
- What are the meaning of Company-specific
assets?
- How the Company-specific assets creates an
economic rational for Vertical Integration
option?
Vertical Integration Forward
Six types of Company – specific capabilities critical
in distribution
Intangible Capabilities
1. Idiosyncratic knowledge – specific knowledge about products,
operating methods, product application
2. Relationships – connections between distributor personnel and
personnel of the manufacturer or customers
3. Brand equity that derives from the channel partner activities
 two cases can be distinguished
- the brand name that enjoys substantial brand equity
- downstream channel members have a critical impact on the
firm’s brand equity
Vertical Integration Forward
Six types of Company – specific capabilities critical
in distribution
Tangible Capabilities
4. Customized physical facilities – an important transaction
specific asset as in the case of Amazon online bookseller
5. Dedicated capacity – warehousing, transportation, selling,
billing and others
6. Site specificity – a location which is well suited to specific
needs for the business
Vertical Integration
There are switching cost upon changing from vertical
integration to outsourcing
- accounting costs
- opportunity costs
- psychological costs
- recruiting, relocating, training personnel, setting up
infrastructure associated with new operation
- setting up former employees in business as third-party
providers of distribution services
Vertical Integration
Point of Discussion
Why the manufacturer should integrate forward to meet
the uncertain environment?
Vertical Integration
There are two schools of thought for vertical integration
to cope with environmental uncertainty
1. Manufacturer needs to take control in order to cope with
the environment
2. The uncertainty demands distributing through third parties
and changing to another third party as the situation
demands (committing to no one)
How environmental uncertainty impacts
vertical integration
Vertical Integration
Points of Discussion
• What are the areas of unclear performance happening
in channel distribution?
• How vertical integration reduce performance ambiguity?
Vertical Integration
Vertical Integration is preferable as the way to reduce
performance ambiguity
- Unfamiliar market situation that there is no baseline to
judge whether result are good or bad, particularly for
innovation products
- Difficult or impossible to gather relevant, timely, accurate
result indicators