30 words summary
“The emergence of a new distribution channel will always cause disruption and shift
in the marketplace. Before switching over from the old to the new managers should
assess how the new channel will affect their companies existing channels, customers
and competitors,” says the leading professor of marketing from the London Business
School.
100 words summary
When a new distribution channel emerges, managers must ask two essential
questions: To what extent does the new channel complement or replace existing
industry distribution channels? To what extent does the new channel enhance or
devalue our existing capabilities and value network? The answers to the above
questions should help pinpoint the necessary channel migration strategy, the level of
internal resistance, and the external channel conflict that one should anticipate, as
well as provide insight into the migration process.
Keywords: Nirmalya Kumar, marketing, distribution, channels, customers,
competitors, strategy, migration, information technology, personal computers, retail
Authors Summary: Nirmalya Kumar, Director, Centre for Marketing, and Director,
Aditya V Birla India Centre, London Business School
Chart:
figure 01: channel migration strategies
figure 02: value curves: dell direct versus retail
channel transitions in the pc industry
by Nirmalya Kumar
The emergence of a new distribution channel will always cause disruption and shift in
the marketplace. Before switching over from the old to the new, managers should
assess how the new channel will affect their company’s existing channels, customers
and competitors.
When a new distribution channel emerges, managers must ask two essential
questions: To what extent does the new channel complement or replace existing
industry distribution channels? To what extent does the new channel enhance or
devalue our existing capabilities and value network? The answers to the above
questions should help pinpoint the necessary channel migration strategy, the level of
internal resistance, and the external channel conflict that one should anticipate, as
well as provide insight into the migration process (see Figure 01).
replacement versus complementary effects
Supermarkets that displaced 'mom-and-pop' stores in the US illustrate the
replacement effects of new distribution channels. The supermarkets' value
proposition of a better assortment, one-stop shopping, and substantially lower prices
surpassed that of the stores. Consequently, the absolute number of mom-and-pops
and their relative market share declined.
In contrast, television and home video extended the distribution channels of the
motion picture industry. When television first appeared in the 1950s, Hollywood
studio market values fell dramatically. The same happened with cinema companies
when home video first appeared. In each instance, managers and analysts
overlooked two important issues.
First, the value proposition of the new distribution channel was different from, but
not superior to, the existing channel. Home video, for example, offers greater
assortment, time flexibility, informality, and lower prices, whereas cinemas are
venues for a "date" or "an evening out." The two distribution channels have clearly
delineated value propositions for distinct customer usage segments and can
therefore coexist.
Second, home video allowed consumers to watch movies when homebound by
babies or illness or when cinemas were closed or no longer running a particular film.
Television and video expanded the market for motion pictures and provided
substantial additional streams of revenues for the industry. For example, in 2002, US
box office revenues were $10.1bn, but combined sales and rental of VHS tapes and
DVD discs exceeded $25bn.
Whether a new distribution channel complements or displaces existing distribution
channels highlights the nature of channel migration. In replacements, the existing
customer segments buy from the new channels of distribution and abandon the
existing channels. In contrast, complementary distribution channels open up new
segments of customers or new value propositions for existing products.
Cannibalization, channel conflict, and resistance to change occur more in
replacement situations.
Replacement channels force incumbents to abandon existing channels and focus on
new channels of distribution. The ability to purchase airline tickets or book hotel and
car reservations over the Internet will not likely increase the number of vacations or
business trips consumed. Instead, with the necessary information accessible online,
many customers will simply not need a travel agent.
Replacement effects also obligate managers to determine which channels and
segments are affected. For example, leisure consumers for airline travel are
migrating faster to Internet channels than business travelers. Based on the firm's
competitive position in each segment, one may decide to accelerate the migration,
as easyJet does by offering discounts to customers who book on the Web, or
decelerate by refusing to accommodate the new channel.
In contrast, complementary effects compel companies to move certain types of
transactions and customers to the new channel of distribution. New channels add to
the existing value network without lowering the value of existing distribution outlets.
Marketers must communicate these economics to distribution members. Sharing
independent market research demonstrating the complementary effects works well in
reducing channel member anxiety.
turning core capabilities into core rigidities
The emergence of a new type of distribution channel usually generates considerable
excitement as companies see the potential for increased coverage, lowered costs,
and/or greater control. Unfortunately, innovative new distribution channels also
aggravate industry incumbents. Established companies often fear radically new
distribution channels will harm them by obsolescing competences, devaluing their
distribution network assets, ossifying their core capabilities, and eroding their
industry leadership positions. To illustrate these repercussions, let us examine the
channel transitions in the PC industry.
channel migration in the pc industry
In 1981, almost 80% of personal computer sales were through a combination of a
direct sales force serving the large accounts and full service PC dealers reaching the
rest. Currently, direct sales and PC dealer account for less than 40% of the industry
sales with the remainder flowing through a multiplicity of channels including value
added resellers (VARs), direct response pioneered by Dell, mass merchandisers
dominated by Wal-Mart, warehouse clubs like Price Club/Costco, consumer electronic
superstores populated by Best Buy and Circuit City, computer superstores led by
CompUSA, and office product superstores such as Staples. In addition, there are
numerous Internet operations of brick-and mortar and pure play retailers. During the
intervening years, channel transitions have played a major role in determining the
changing fortunes of PC manufacturers such as Compaq, Dell, and IBM.
compaq versus dell
Today, the worldwide PC market leaders are Compaq and Dell. However, the
business models of the two companies differ significantly. Compaq has a value
network typical of branded products: relatively high R&D expenditures; low cost, low
variety, large run manufacturing systems; one month finished products inventory;
and third-party resellers. In the early 1990s when IBM, with its large direct sales
force, was ambivalent about third party resellers, Compaq dedicated itself to PC
sales through resellers whose subsequent push catapulted Compaq into market
leadership in 1992.
Dell primarily targeted corporate accounts but with built to order, customized PCs at
reasonable prices. It invented a radically different value network combining minimal
R&D expenditures, made-to-order, flexible manufacturing systems one week parts
inventory, and an efficient direct distribution system. In the early 1990s, this
distribution system took orders through toll free telephone numbers and delivered
through various courier services.
dell's retail experience
As the value curves in Figure 02 indicate, the value proposition of serving customers
through Dell Direct differs from that through retail stores. In 1991, to reach those
small business customers and individual consumers who preferred to shop at retail
outlets, Dell decided to expand its distribution to retailers such as Business Depot in
Canada; CompUSA, Sam's Club, and Staples in the US and Mexico; and PC World in
the UK. However, unlike the customization option available through the Dell Direct
channel, since selling through retail stores required Dell to build for inventory, only a
limited number of preset PC configurations could be offered in the indirect channel.
Despite this limitation, channel expansion to retail stores brought immediate and
impressive sales gains for Dell and revenues rose to more than $2.8bn in 1993.
Unfortunately, the sales gains through the retail channels did not result in additional
profits. Dell's internal cost of selling fell from 14% in the direct channel to 10% in
the indirect channel as retailers took responsibility for some channel functions.
However, this did not fully offset the 12% margin that retailers had to be given for
their sales efforts. As a result, it was 8% percent more expensive for Dell to sell
through indirect channels. Given that its operating income was only 5% in the Dell
Direct channel, it was losing 3% in the indirect channels. And the more volume Dell
pushed through the retail channels, the more money it lost. In 1993, Dell posted its
first loss of $36mn. By mid-1994, Dell decided to exit the retail channel and
concentrate on direct distribution. This decision turned profits around to $149mn in
1994.
Beyond the economics, Dell sidelined many of its core capabilities and advantages
when sales went through retail. Michael Dell explained, "Our direct model turns
inventory twelve times, while our competitors who sell through retail only turn their
inventory six times. Even though customization increases our costs by 5%, we get a
15% price premium because of the upgrades and added features. But for the
standard configurations we offered through retail, we (could not) get any premium in
the market."
New channels may help some companies leverage their core competences and
distribution assets, while it hinders other companies within the same industry. How
competences and assets are affected depends on how a company competes within
an industry. But the need to develop new capabilities usually generates considerable
internal resistance as it devalues the power of those within the organization who run
the existing value network.
Abstract from Marketing As Strategy written by Nirmalya Kumar