Chapter 9 Vertical Integration in Distribution

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Chapter 9Vertical Integration in Distribution
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FIGURE 8.1 CONTINUUM OF DEGREES OF VERTICAL
INTEGRATION
Classical Market Contracting
Quasi-Vertical Integration (Relational Governance)
Vertical Integration
How does the the work get done
Third Party Does it (for a price)
You do it
The costs
You and third party share costs and benefits
Their operation (control) Their gain or loss
Your operation (control) Your gain or loss
The benefits
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The Continuum of Interfirm Exchange Format
Franchise Systems
Hierarchy (within firm)
Buying Groups
Market Setting (outside firm)
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TABLE 8.2 EXAMPLES OF INSTITUTIONS PERFORMING
SOME CHANNEL FLOWS
Classical Market Contracting
Quasi-vertical Integration
Function
Vertical Integration
1) Selling (only) Manufacturers Captive or
Exclusive Producer Sales Representatives Sale
s Agency Force (direct sales
force) 2) Wholesale Independent Distri
bution Distribution Distribution Wholesaler
Joint Venture Arm of Producer 3) Retail Indepe
ndent Franchise Company Distribution (3rd
party) Store Store
Operationally, a sales agency deriving more
than 50 of its revenues from one principal
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Distribution Objectives
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• Economic Theories of Vertical Integration
• Transaction Cost Analaysis
• Control Rights Theory

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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

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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

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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

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FG 7.2 HOW ENVIRONMENTAL UNCERTAINTY IMPACTS
VERTICAL INTEGRATION
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FIGURE 7.4 ROAD MAP TO THE VERTICAL INTEGRATION
DECISION
Presume outsourcing is more attractive than
vertical integration
GO!
Start here
NO
Is potential business major or substantial?
Outsourcing preferable
YES
Examine how function will develop
(Take both roads and see where they go)
Will substantial company-specific investments
accrue?
Will performance ambiguity be high?
NO
NO
Outsourcing remains attractive
YES
YES

Volatile, uncertain environment (accelerates
effect of company-specific investments)
Consider overturning outsource
presumption Vertical Integration, increasingly
attractive
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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
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Chapter 8Strategic Alliances in Distribution ?
Skip!
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• Motivating the Channel Members

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Major Topics for Motivating Channel Members

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• General Discussion
• Finding out Channel Member Needs
• Three Types of Programs that Motivate Channel
  Members
• Another Approach on Channel Member Motivation

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Motivation Management
Motivation Management
The actions taken by the manufacturers to foster
channel member cooperation in implementing the
manufacturers distribution objectives
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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.

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Supporting Channel Members
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3 Types of Channel Trade Programs

• Cooperative
• Arrangements

2. Partnership or strategic alliance
3. Distribution programming
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1. Cooperative Arrangements
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Focuses on channel member needs problems
Simple straightforward
Conveys a clear sense of mutual benefit
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Cooperative Arrangements
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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?

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2. Partnerships Strategic Alliances
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Focus on a continuing and mutually supportive
relationship between the manufacturer and its
channel members
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Partnerships Strategic Alliances
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Three basic phases

• Manufacturer should make explicit statement of
• policies in areas such as product
  availability,
• technical support, pricing, etc.

• 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
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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

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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

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3. Distribution Programming
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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
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Distribution Programming
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• Steps for developing a program
• Analysis of marketing objectives the kinds of
  levels of support needed from channel members
• Ascertains channel members needs
• problem areas
• 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

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Relationship Differences
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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
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Another Approach on Motivating Channel Members

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• Theoretical foundation Agency theory
• Before you begin
• Screening and Qualification
• Selection
• As you begin
• Role Specification
• Joint Planning

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Another Approach (Contd)

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• 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?