Channel Policy and Physical Distribution

Key Terms: physical distribution, total cost approach to physical distribution, indirect marketing channel, direct distribution, indirect distribution, multichannel distribution systems (multiple distribution), channel conflict, forward buying, vertical marketing system (VMS), corporate VMS, contractual VMS, administered VMS, franchise, intensive distribution, selective distribution, exclusive distribution, and partnering.

Physical Distribution:

Physical distribution (logistics) deals with the efficient movement of a company’s product through the channel of distribution. A firm can manufacture a great product, but if it takes 10 months for the product to get from the manufacturer to the retailer (or consumer), the firm will find itself in serious trouble. Do you know that an average grocery product spends about 84 days in the channel? This means that grocery foods are not as fresh as we may think they are. Making the physical distribution process work more efficiently is important to marketing. Physical distribution makes up about 10% to 15% of the total cost of a product.

Physical distribution consists of the following tasks:
Warehousing, Materials Handling, Inventory Management, Order Processing, and Transportation.

Firms must take a total cost approach to physical distribution (PD). This means that firms should work to minimize the total cost of physical distribution and not try to minimize each of the five tasks separately. It does not make sense to consider the costs of storing and handling inventory and transportation separately. For example, a firm might be considering two different approaches to PD:
Approach A: They will have one warehouse in the center of the United States and will use computerized order processing and ship via air.
Approach B: They will have six warehouses throughout the United States and ship via truck.

The question is which approach is cheaper overall. Approach A may be very costly as far as shipping (shipping by air is very expensive) but the savings in inventory and warehousing may outweigh the extra expense of shipping by air. Approach B has much lower shipping expenses but the warehousing and inventory expenses are much higher.

The brilliance of Dell Computers when it entered the computer business was in realizing that it would be cheaper to allow consumers to configure a computer on the Dell website and order it online, rather than selling them in stores.   After the order was received by Dell, the computer was assembled and shipped.   This saved the company a huge amount of money on warehousing, inventory management, and order processing.  Other companies were selling computers using traditional channels of distribution -- manufacturer to wholesaler to retailer -- in which consumers bought them in stores.  This meant that a large number of computers were stored in warehouses. The life cycle of a computer is short and once a computer is a year or two old, it has very little value.  Whoever is stuck with the old inventory, is going to lose a lot of money.  On the other hand, when a company makes a product "on demand" there is no inventory. 

The Marines are learning to improve their supply chains by emulating the private sector (see Business Week, "The Marines Learn New Tactics--From Wal-Mart" December 24, 2001, p. 74). Several years ago, when a soldier needed a spare part it took a week to get it--even if the part was on the other side of the military base. Moreover, the Marine Corps policy that required a 60-day supply of every article was very cost-ineffective and resulted in the overstocking of too many items. During the Gulf war, tons of supplies were stockpiled in the desert near the battlefield. One problem: no one was able to keep track of all the ordnance and therefore much of it went unused. After hiring a consulting firm, things began to change and the Marines started using the approach used by the private sector. Handheld scanners are now being used to keep track of inventory and 60-day inventory supplies are no longer necessary. If supplies are ordered, e.g., jeeps, they will be shipped from the nearest supply point. A great deal of money is saved by improving logistics. The Marine Corps now needs less inventory (improved inventory management), warehouses perform the sorting and retrieving tasks more efficiently and at reduced cost (warehousing), and technology has been greatly simplified by the use of fewer computer systems (order processing).

Marketing Channel Decisions:

Indirect distribution vs. direct distribution:
Indirect distribution means that intermediaries will be used. One common channel of distribution is:
Manufacturer  => Wholesaler => Retailer => Consumer 
Note that two intermediaries are being used (a wholesaler and a retailer).

With direct distribution, no intermediaries are used. Some examples:
Manufacturer sells to consumers by using (a) its own retail outlets (e.g., Gateway sells computers through its own outlets) (b) door-to-door salespeople (c) the Web (Electronic Commerce) (d) direct mail (e) catalogs (f) telephone (telemarketing) (g) direct response radio advertising (h) direct response television adverting (i) direct response magazine advertising (j) direct response newspaper advertising.

Direct response ads are advertisements that attempt to elicit a response from the consumer. In the above cases, the ads attempt to get you to order the product by calling the 800 telephone number in the ad (or mailing something in). Many late-night television commercials are direct response TV ads that attempt to get consumers to call an 800 telephone number and order music, exercise equipment, beds, mattresses, education, etc.

Note: Do not confuse direct marketing and direct distribution. Direct distribution means that no intermediaries are used. Selling through manufacturer-owned retail outlets or door-to-door salespeople is direct distribution, but is not direct marketing. You will learn more about direct marketing in the section dealing with retailing and direct marketing.

Today, many manufacturers use several channels – multiple distribution (multichannel distribution systems) – to distribute their product. This may be necessary to reach everyone in your target market. For instance, not every student wants to buy music from a specialty store. Some students would rather download it directly into their computers. Others might prefer purchasing music from direct response television ads on late night television. Many companies are finding that they have to use several channels of distribution in order to ensure that everyone in their target market is reached. A new channel of distribution for automobiles is the World Wide Web. Quite a few cars are ordered via the Web. Check out Microsoft’s Web site ( ) or ( ).

Another reason for using multiple distribution is to reach new market segments, i.e., market development. These are segments you have not reached in the past. For instance, some colleges are using distance learning to reach American soldiers stationed overseas. The classroom courses are for students living in the area.

Use of multiple distribution can cause friction in the channel of distribution. In particular, retailers get very upset when suppliers start selling directly to customers using the Web.

Channel Captain
The informal leader of the channel of distribution is the channel captain. In the early days of the PC, IBM became the channel captain. They set standards and everyone followed. For example, IBM decided on DOS as their operating system and this became the operating system of most desktop computers. Later on, they switched to Windows and this became the default operating system. Today, the channel captain seems to be Microsoft.

For many years, automobile manufacturers were the channel captains. A shift occurred a while back. The rise of the superdealer (or megadealer) such as Potamkin – a firm that sells numerous makes of car – caused a shift. The superdealers are becoming the channel captain. The Web may change things again. Companies selling cars on the Web might become the next channel captains of the industry.

Conflict in the Channel
Quite often there is conflict in the channel. As noted above, multiple distribution can cause strife. Sometimes manufacturers put pressure on intermediaries to carry too much inventory. Intermediaries might place pressure on manufacturers to reduce prices or provide more promotional allowances. In general, retailers do not like EDLP (Everyday Low Pricing) and they want specials. They take advantage of the specials and stock up. In fact, they do enough "forward buying" (also called trade loading) so that they have enough merchandise for several months. Of course, the product is sold at the special price for only a week or two, even if the supermarket purchased enough product for three months.

Vertical Marketing System (VMS)
Vertical marketing systems are coordinated and integrated channels. There are three types:

Corporate VMS – One way of getting a channel to work better is by having one company own several levels of the channel If a manufacturer takes over a retailer, you have a corporate VMS. In some industries, the channel of distribution is fully (vertically) integrated. One company owns all the stages of production and distribution.

Administered VMS – A very strong channel captain (e.g., a company with the incredible resources of a Microsoft) can use their power to make the channel function well and obtain economies.

Contractual VMS – A franchise is an example of a contractual VMS. The franchisee signs an agreement with the franchisor and has to agree to various stipulations. The franchisee, however, gets training and the right to use the name. Many of the well-known fast food restaurants (Burger King, MacDonald’s, Kentucky Fried Chicken) are franchises.

Some manufacturers are linking their computers with their retailers (e.g., Procter and Gamble is doing this with Wal Mart and K-Mart). The manufacturer then has the ability to observe when inventories are low for a particular product and make recommendations that the retailer restock, or even just make a shipment. This process may be tied into the retailer’s inventory system and automated. The manufacturer can recommend which products to stock altogether and how much inventory to carry for each brand. The manufacturer can also inform the retailer which promotions are most likely to be effective at a particular location. Working together results in lower inventory costs for both the manufacturer and retailer and enables the manufacturer to even out the production schedules.

Film Distribution

The film industry is an interesting one to examine.  According to Adam Leipzig (New York Times, 1/16/2005, p. AR 9), about 450 movies are released per year in the United States by approximately 30 distributors.  Making a film is quite easy today--all you need is a computer with editing software and a digital video camera.  Indeed, more than 2,600 films were submitted to the Sundance Film Festival in 2004, the major portal for independent films.  Unfortunately, only 120 of those films (120/2600) were shown, and only 10 of the 120 were selected for distribution.  

The trick is not in making a film but in getting distribution.  Even if you get distribution, very few films released by independent distributors make any money.  Studio-released films account for about 90% of box office receipts; this leaves very little for the films released by independent distributors.  A similar problem exists with new products.  A great product will not succeed if it does not get shelf space.  

The traditional model of film distribution:  theaters, then pay-per-view, then home video, then pay cable networks such as HBO, and finally broadcast television.  The time from beginning to end used to be 6 months, now it is about 4 months.  This traditional model is being challenged by film producers who are testing a simultaneous release (this is known as "day-and-date releases or omni debuts). Advantage of this is that homebodies who do not like to go out can watch the film immediately.  The film producers save a great deal of money on advertising with day-and-date releases.  (By the way, a typical film earns 50% of its revenue from home video about double what is earns from theaters.)  Theater owners are very concerned about this new distribution strategy and fear it will destroy their business.  As you can see, there are numerous ways to get films to the public; theaters are only one channel of distribution.  The big question is how big is the channel using theaters?  Is it an obsolete channel? 




(c) 2010 H.H. Friedman