chapter 9 vertical integration in distribution. classical market contracting quasi-vertical...
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Chapter 9Vertical Integration in
Distribution
Classical MarketContracting
Quasi-VerticalIntegration
(Relational Governance)
VerticalIntegration
Buy Make
Third Party Does it(for a price)
You do itHow does the the work get done
Their operation (control)Their gain or loss
Your operation (control)Your gain or loss
The benefits
The costs
You and third partyshare costs and
benefits
Their peopleTheir money
Their riskTheir responsibility
Your peopleYour money
Your riskYour responsibility
FIGURE 8.1: CONTINUUM OF DEGREES OF VERTICAL INTEGRATION
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The Continuum of Interfirm Exchange Format*
Hierarchy(within firm)
Franchise Systems
BuyingGroups
Market Setting(outside firm)
Classical MarketContracting
Quasi-verticalIntegration
VerticalIntegrationFunction
1) Selling (only) Manufacturers’ “Captive” or Exclusive Producer SalesRepresentatives Sales Agency * Force (direct
sales force)
2) Wholesale Independent Distribution Distribution Distribution Wholesaler Joint Venture Arm of Producer
3) Retail Independent Franchise CompanyDistribution (3rd party) Store Store
* Operationally, a sales agency deriving more than 50% of its revenues from one principal
TABLE 8.2: EXAMPLES OF INSTITUTIONS PERFORMING SOME CHANNEL FLOWS
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Distribution ObjectivesDistribution Objectives
Economic Theories of Vertical Integration
1.Transaction Cost Analaysis
2.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
Low Specificity High Specificity
Highly Volatile Market
Outsource Distributionto Retain FlexibilityUntil Uncertainty Is
Reduced
Highly PromisingMarket
Less PromisingMarket
Vertically Integrateto Gain Control OverEmployees And Avoid
Small-Numbers BargainingIn Changing Circumstances
Do Not Enter
FG 7.2: HOW ENVIRONMENTAL UNCERTAINTY IMPACTS VERTICAL INTEGRATION
Consider overturning outsource presumption:
Vertical Integration,increasingly attractive
Presume outsourcing is more attractive than vertical integration
Examine how function will develop
Outsourcing remains attractive
Will substantial company-specific
investments accrue?
Volatile, uncertain environment(accelerates effect of company-
specific investments)
GO!
Outsourcingpreferable
Is potential business major or substantial?
Will performance ambiguity be high?
Start here
(Take both roads and see where they go)
NO
YES
NO NO
YESYES
FIGURE 7.4: ROAD MAP TO THE VERTICAL INTEGRATION DECISION
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 8Strategic Alliances in Distribution Skip!
Motivating the Channel Members
99Major Topics for Motivating Major Topics for Motivating
Channel MembersChannel Members
1. General Discussion2. Finding out Channel Member
Needs 3. Three Types of Programs that
Motivate Channel Members*4. Another Approach on Channel
Member Motivation*
Motivation Management:
Motivation ManagementMotivation Management
The actions taken by the manufacturers tofoster channel member cooperation inimplementing the manufacturer’s distribution objectives
Motivating Channel Motivating Channel MembersMembers
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*Supporting Channel Members*99
3 Types of
ChannelTrade
Programs
2. Partnership or strategic alliance
3. Distribution programming
1. Cooperative Arrangements
991. Cooperative Arrangements1. Cooperative Arrangements
Focuses on channel member needs & problems
Simple & straightforward
Conveys a clear sense of mutual benefit
99Cooperative ArrangementsCooperative Arrangements
Typical types of cooperative programsprovided 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?
992. Partnerships & Strategic 2. Partnerships & Strategic AlliancesAlliances
Focus on a continuing and mutuallysupportive relationship between themanufacturer and its channel members
Partnerships & Strategic Partnerships & Strategic AlliancesAlliances
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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
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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
3. Distribution Programming3. Distribution Programming 99
A comprehensive set of policies for the promotionof a product through the channel
Developed as a joint effort between the manufacturer and the channel members
to incorporate the needs of both
Distribution ProgrammingDistribution Programming 99
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
Relationship DifferencesRelationship Differences99
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
99Another Approach on Motivating
Channel Members*Theoretical foundation: Agency
theory1. Before you begin…
1. Screening and Qualification2. Selection
2. As you begin…1. Role Specification2. Joint Planning
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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?