WHAT DEFINES AN EFFECTIVE CHANNEL AND CREATING A DISTRIBUTION STRATEGY

An effective distribution channel has several characteristics, which are discussed briefly below.

Inventory

At various points along the channel, inventory must be warehoused and ready to be shipped where needed, whether it is raw materials to the manufacturer, or finished goods to the customer. Entrepreneurs need to decide whether they want to hold inventory or outsource that capability to someone else in the channel. Holding the inventory for distribution gives the entrepreneur more control over what happens to products, but warehousing and distribution are competencies that the entrepreneur’s team may not have.

Ownership

It is important to distinguish ownership of the goods and possession of them. As goods move through the channel, ownership typically changes only at the point of purchase, but possession may change at various points. For example, when a fulfillment house agrees to warehouse and ship for a company, it takes possession of the goods but does not purchase them and therefore does not own them. Information, as an intangible product, presents some unique challenges with regards to ownership, and illegitimate channels may even be formed to move the product through the channel. This can be seen, for example, in the pirating of software and music.

Negotiation

Many channels that deal in expensive items, such as automobile or industrial equipment, function primarily as price negotiators.  Prices are set merely as a starting point for negotiation with the final customer, so for these channels to be effective, they must provide the ability to negotiate.

Gathering of Market Information

The internet has facilitated the gathering of market intelligence by companies and industries of all sizes. Because such information is critical to successful product development and business planning, gathering it has become a characteristic of a successful business channel.

Financing and Payment

Credit is an essential element of an effective channel because it smoothens out the fluctuations in cash on hand experienced by purchasers. Methods of collecting payments for purchases have been enhanced by technology.

Risk Management

 The movement of products through channels entails some level of risk for which third-party insurance is required.  Examples of such risk are product loss or breakage during shipping, product liability, and failure of the customer to pay for goods.  In addition, manufacturers take on responsibility via warranty programs and after-sale service agreements.

Member Power

Effective channels often produce channel members who gain the power to control aspects of the channel. A channel member gains power if (1) other members rely on it for their primary needs, (2) it controls financial resources, (3) it plays a critical role in the value chain, (4) it has no substitute, (5) it has information that reduces uncertainty.  For example, Wal-Mart is known for employing strong-arm tactics to exact the lowest possible prices from its suppliers. Because it is the world’s largest retailer, it is well aware that smaller suppliers cannot afford to lose such a huge customer. Strong retailers can also force manufacturers to adopt new systems as was in the case in the 1990s when retailers forced manufacturers to provide UPC symbols on packages so the retailers could scan them for inventory and sales tracking.

In an effective channel, strong members include other members in the decision-making process; they share information and often make concessions when a new policy or technology is costly to a member. 

CREATING A DISTRIBUTION STRATEGY

Distributors, retailers, and other outlets are one means through which manufacturers and other producers communicate with the customer, so they are very much partners with the organization, particularly in a virtual company. Their goal is to gather information from the customer so that the manufacturer or producer can revise and improve its offerings. Finding good, loyal outlets is competitively difficult. In fact, distribution, once a mundane, routine occupation, has become the glamor stock of the business world, and “channel surfer” entrepreneurs constantly seek the most productive channel. 

Before choosing a distribution strategy, the wise entrepreneur looks at the various distribution channels that similar companies are using. That provides an indication of customer expectation about time and place of delivery. It also helps reveal opportunity gaps – innovative distribution strategies that might allow the entrepreneur to capture a group of customers that is not currently being served.

Factors Affecting the Choice of Strategy

 In very broad terms, the choice of distribution strategy is a function of desirability (Will the customer be happy with it?), feasibility (Can the channel do what the entrepreneur wants it to be?), and profitability (Can the entrepreneur make money using this channel?). 

The following factors should be considered when one attempts to determine the most effective distribution strategy: costs, market coverage, level of control, speed and reliability, and type of intermediary.

Costs

Costs include all the various expenses related to marketing the product and distributing it to the customer or end-user. Consider the situation of a manufacturer producing a consumer product in the sporting goods industry. At each stage, the channel member adds value to the product by performing a service that increases the chances of the product’s reaching the intended customer.  The wholesaler seeks appropriate retail outlets, and the retailer advertises and promotes the product to the customers. The value created allows each channel member to increase the price of the product to the next channel member. 

For example, the manufacturer charges the wholesaler a price that covers the costs of producing the product, plus an amount for overhead and profit. The wholesaler, in turn, adds an amount to cover the cost of the goods purchased and his or her overhead and profit.  The retailer does the same and charges the final price to the customer. That price can typically be four to five times what it cost to manufacture the product (labor and materials).

Suppose the manufacturing entrepreneur decides to by-pass the wholesaler and sells directly to retailers:

                          Manufacturer → Retailer 

It appears on the surface that the final retail price could be substantially lower, perhaps even the rate at which the manufacturer sold to the wholesaler in the first example.  However, there is a flaw in this reasoning. The wholesaler performed a valuable service. He or she made it possible for the manufacturer to focus on producing the product and not to incur the cost of maintaining a large marketing department, a sales force, additional warehouses, and a more complex shipping department.  

All these activities now become a cost to the manufacturer of doing business with retailers and must be factored into the price charged to the customer as well as the decision to choose this distribution channel. This is not to say that it never makes sense for manufacturers to sell direct to retailers. However, it is important for the entrepreneur to consider all the costs, advantages, disadvantages, and consequences of choosing a particular market channel to reach the customer. Consider the following channel:

Manufacturer → Retailer

In this instance, it may be advantageous to locate the manufacturing plant near major transportation networks to hold down shipping costs. Now, consider the following channel:

                  Manufacturer → Wholesaler → Retailer → Customer

Here it is not important for the manufacturer to be located conveniently near the retailer. Having a location that maximizes shipping costs to the wholesaler becomes more relevant. If the entrepreneur is a retailer (or wholesaler), she or he looks at the distribution channel from both directions. The customer will be reached directly, but looking back down the distribution channel; the retailer must also be concerned with finding a good distributor who represents quality manufacturers. The cost of a distribution channel will directly affect the company’s ability to make profit.

Market Coverage

With a start-up company, it is often advantageous to use intermediaries, because doing so enables the entrepreneur to enter a larger market more quickly. Selling a product to just five distributors can provide access to hundreds of wholesale and retail outlets with increasing marketing efforts or sales staff. This is important because entrepreneurs typically have very limited resources.

Control of Distribution

The choice of distribution strategy affects the level of control an entrepreneur exerts over what happens to the product once it leaves the entrepreneur’s hands. If the product requires unique or unusual marketing tactics to entice the customer, the intermediary that is carrying competing lines or a variety of other products may not be a good choice; the entrepreneur’s s product might not get the attention it requires to achieve the target sales level. In this case, a direct channel may be more appropriate.

Speed and Reliability

The Internet creates the impression that business is moving much faster than before, and in some cases it is. Customers expect products and services to be available more quickly and they want instant access to information. If speed is essential to the successful distribution of a product or service, then any channel under consideration must meet that criterion. Likewise, if a reliable channel is essential to the distribution strategy, then many channels will be screened out of the selection process on that point alone. 

Having taken all of these considerations into account, and armed with a clear and compelling concept and business model, entrepreneurs are ready to conduct an effective market feasibility analysis.

If you find this article useful, please share and subscribe to our newsletter