Types and classification of channels - Marketing Management

Classification of Distribution Channels

Marketing channels can be characterized according to the number of channel levels. Each institution that works to bring the product to the point of consumption is included. The number of intermediaries involved in channel operation determines on how many levels it operates. There are four main types of channel level in consumer markets.

Channel relationships

Channel relationships

The first three levels (zero, one and two) are self explanatory. The three level channel includes a ‘jobber’, or merchant wholesaler who intervenes between the wholesaler and retailer. It is the jobber’s role to buy from wholesalers and sell to smaller retailers, who are not usually serviced by larger wholesalers. Within each channel, intermediaries are connected by three types of flow:

  1. Physical flow describes movement of goods from raw material that is processed in various stages of manufacture until it reaches the final consumer. In the case of a towel manufacturer raw material is cotton yarn which flows from the grower via transporters to the manufacturer’s warehouses and plants.
  2. Title flow is the passage of ownership from one channel institution to another; when manufacturing towels, title to raw materials passes from the supplier to the manufacturer. Ownership of finished towels passes from manufacturer to the wholesaler or retailer and then to the final consumer.
  3. Information flow involves the directed flow of influence from activities such as advertising, personal selling, sales promotion and publicity from one member to other members in the system. Manufacturers of towels direct promotion, and information flows to retailers or wholesalers, known as trade promotion. This type of activity may also be directed to end consumers, i.e. ‘end user’ promotion.

Conventional marketing channels comprise autonomous business units, each performing a defined set of marketing functions. Co-ordination among channel members is through the bargaining process. Membership of the channel is relatively easy, loyalty is low and this type of network tends to be unstable. Members rarely co-operate with each member working independently of others. Decision makers are more concerned with cost and investment relationships at a single stage of the marketing process and tend to be committed to established working practices. Most food grocery products in the European Union are marketed through conventional marketing channels; independent food and grocery producers are responsible for growing, rearing and manufacturing products and brands. These are sold through a series of wholesalers and retailers such as Sainsbury’s, Aldi, Lidl, Tesco or Carrefour each operating as independent businesses in the chain and selling to their own customers.

Vertical marketing systems are in contrast to conventional channels where members co-ordinate activities between different levels of the channel to reach a desired target market. The essential feature is that participants acknowledge and desire interdependence, and view it as being in their best longterm interests. For the channel to function as a vertical marketing system, one of the member firms must be acknowledged as the leader; typically the dominant firm, which can be expected to take a significant risk position and usually has the greatest relative power within the channel. An example of a vertical marketing system is that of franchising. The franchiser, usually on the basis of having a powerful brand or perhaps a patent/copyright, for a fee, allows franchisees to produce or distribute the product or service. The franchiser effectively controls the channel, including aspects such as product ingredients, advertising and marketing, pricing, etc. through formal and legally enforceable agreements. Franchising is an example of what are termed contractual vertical marketing systems which we consider again shortly.

Corporate vertical marketing is when a company owns two or more traditional levels of the channel. In many economies corporate vertical channels have arisen as a result of a desire for growth on the part of companies through vertical integration. Two types of vertical integration are possible with respect to the direction within which the vertical integration moves a company in the supply chain: when a manufacturer buys, say, a retail chain, this is referred to as forward integration with respect to the chain.

Backward integration is moving upstream in the supply chain, e.g. when a retailer invests in manufacturing or a manufacturer invests in a raw material source. Although the end result of such movements is a corporate vertical marketing channel, often the stimulus to such movement is less to do with channel economies and efficiencies, and more with control over access to supply or demand, entry into a profitable business or overall scale and operating economies. Much vertical integration activity which took place during the 1990s in many economies resulted in lower overall profitability levels, and in some cases, the demise of companies involved, as companies overextended themselves and/or moved into areas where they had little expertise. Because of this, many companies have now turned their attention towards contractual systems for achieving growth and more control through the vertical marketing system.

Many of the large oil companies are examples of corporate vertical mar keting. They prospect for oil, extract it, process it, distribute and retail it through their petrol stations. Other companies operate partial corporate vertical marketing systems in that they integrate only one way. Zara (the clothing retailer) is integrated vertically backward with manufacturing facilities. Firestone (the tyre manufacturer) on the other hand, is vertically integrated forward owning its own tyre retailers. Many companies formalize their obligations within channel networks by employing legitimate power as a means of control achieved by using contractual agreements. Nearly all transactions between businesses are covered by some form of contract, and as such the contractual agreement determines the marketing roles of each party within the contract. Indeed, the locus of authority usually lies with individual members. The most common form of contractual agreement are franchises and voluntary and co-operative groups.

Franchises are where the parent company grants an individual person or relatively small company the right or privilege to do business in a prescribed manner over a certain time period in a specified place. The parent company is referred to as the franchiser (or franchisor) and may occupy any position in the channel network. The franchise retailer is termed the franchisee. There are four basic types of franchise system:

  • Manufacturer/retailer franchise, e.g. service stations where most of the garage petrol stations such as Shell and Esso are franchisees of the large oil exploration and refining companies. n Manufacturer/wholesaler franchise: e.g. Coca-Cola sell drinks they manufacture to franchised wholesalers, who in turn bottle and distribute soft drinks to retailers. This type of arrangement is common in the food and drinks markets with many of the large companies franchising part of their manufacturing and or wholesaling activities to others.
  • The wholesaler/retailer franchise. Many retail chains are franchisees of large wholesalers. These wholesalers saw the value of securing a measure of control, and of course a share of the retail profits, from marketing their products and brands. The most notable example is ‘Spar’ which advertises itself as ‘Spar, your 8.00 till late shop’, and of course all retail members must abide by this promise.
  • The service/sponsor retailer franchise e.g. McDonald’s, Kentucky Fried Chicken, Subway, Car Rental companies like Avis and Hertz and services like DynoRod and Prontaprint. This is the best known and certainly most ubiquitous of franchising arrangements and it has enabled many organizations to rapidly expand their global operations.

There are different types of franchise arrangement, e.g. McDonald’s insists that franchisees purchase from official suppliers; they provide building and design specifications, help locate finance for franchisees and impose quality standards to which each unit must adhere in order to hold its franchise. Rigorous inspection through ‘secret shoppers’ ensures franchise ‘rules’ are being obeyed.

Franchises share a set of common features and operating procedures:

  1. A franchise essentially sells a nationally, or internationally, recognized trade name, process, or business format to the franchisee.
  2. The franchiser normally offers expert advice e.g. location selection, capitalization, operation and marketing.
  3. Most franchises operate a central purchasing system at national or international level to enable cost savings to be made at the individual franchise level.
  4. The franchise is subject to a contract binding both parties that normally requires the franchisee to pay a franchise fee and royalty fees to the franchiser, but the franchisee owns the business as opposed to being employed.
  5. The franchiser often provides initial and continuous training to the franchisee.

Contractual vertical marketing systems like franchising have been one of the fastest growing areas of marketing and distribution. Substantial advantages derive from the franchising system. From a system that essentially involves two independent parties voluntarily agreeing to contract with each other, advantages accrue to both the franchisee and franchiser. Advantages to the franchisee are:

  • The franchisee gains the benefit of being able to sell a well-known product or service which has been market tested and known to work.
  • The franchisee enjoys access to the knowledge, experience, reputation and image of the franchiser. Because of this the franchisee is able to enter a business much more easily than setting up from scratch. The learning curve is shortened, expensive mistakes can be avoided, and there is less chance of business failure.
  • Although the franchisee has the backing of what is often the large organization of the franchiser, the franchisee is still essentially an independent business with all that this implies for motivation to succeed.
  • The franchisee is often helped by national or international advertising and promotion by the franchiser which would be beyond the means of a small independent business.
  • The franchisee enjoys the use of the franchiser’s trademark, continuous research and development and market information.
  • The franchiser will normally provide a system of management controls such as accountancy, sales and stock control procedures.

Advantages to the franchiser are:
Finding and recruiting a network of franchisees enables rapid growth as wider distribution can be achieved with less capital.

  • The individual franchisee is more motivated than a hired manager might be.
  • The franchiser secures captive outlets for products or services, especially in the case of trade name franchising and private labels.
  • Franchise and royalty fees provide a regular stream of income for the franchiser.
  • The terms of the franchise contract normally give the franchiser substantial control over how the franchise is operated and normally the franchiser can terminate a contract should the relationship turn out to be unsatisfactory. The costs of such terminations are likely to be less than if the franchiser was operating a corporate owned facility with staff on the payroll.

Normally, terms and restrictions on location and sale of the business by the franchisee ensure that the franchiser is able to maintain territorial exclusivity for its franchisees. There are disadvantages, but the franchise relationship combines the strengths of both small and large scale businesses. The franchisee is the small business person who is able to respond to local market conditions and offer personal services to customers. The franchiser passes on economies of scale in national advertising and bulk purchasing. For a franchise to be successful both parties need to work towards a common goal and avoid conflicts which requires frequent and open communication between partners if the system is to meet changing market conditions while maintaining its integrity.

What constitutes the main disadvantages of franchising depends from whose perspective we are looking; the franchisee or the franchiser. The main disadvantages of franchising from each perspective are:

Disadvantages to franchiser:

  • The franchiser loses some control over the provision and marketing of the brand. Poor service on the part of the franchisee can result in problems for brand image.
  • Ideas and techniques can be copied even if seemingly well protected by patents and copyright arrangements.
  • Some proportion of profit has to be foregone.
  • There may be less commitment and enthusiasm from the franchisee.
  • Often franchisees lack business skills or experience.

Disadvantages to the franchisee:

  • lack of support from franchiser;
  • franchiser may go out of business;
  • lack of flexibility/scope to use initiative;
  • close control from franchiser.

Franchising is not solely confined to consumer products like fast food. It is used for a wide range of products and services in both consumer and industrial markets.

Voluntary and co-operative groups emerged in the 1930s as a response to competition from chain stores. The scope of co-operative effort has expanded from concentrated buying power to the development of programmes involving centralized consumer advertising and promotion, store location and layout, financing, accounting and a package of support services. Generally, wholesale sponsored voluntary groups have been more effective competitors than retail sponsored co-operative groups.

Primarily this is because of the difference in channel organization between the two. In the former, a wholesaler can provide strong leadership, because it represents the locus of power within the voluntary system and this is normally supported by a brand name like ‘Spar’. In the latter, power is diffused throughout the retail membership and role specification and allocation of resources are more difficult to accomplish. The principal purpose here is in bulk purchasing. In voluntary groups, retail members have relinquished some of their autonomy by making themselves highly dependent on specific wholesalers for expertise. In retail co-operative chains, individuals retain more autonomy and this tends to depend much less strongly on the supply unit for assistance and direction.

This type of organization is not to be confused with the Co-operative movement that was founded in 1844 by the Rochdale, Lancashire, Society of Equitable Pioneers who were a group of 28 weavers and other workers. As mechanization of the Industrial Revolution pushed more and more skilled workers into poverty, tradesmen banded together to open their own store selling items they could not otherwise afford. Over four months they pooled together £28 of capital. They opened their store with a basic selection of dry goods and foodstuffs and quickly moved into higher quality unadulterated produce. They devised the internationally famous Rochdale Principles:

  1. open membership;
  2. democratic control (one person, one vote);
  3. distribution of surplus in proportion to trade;
  4. payment of limited interest on capital;
  5. political and religious neutrality;
  6. cash trading (no credit);
  7. promotion of education.

Administered vertical marketing systems (VMS) do not have the formal arrangements of a contractual system or the clarity of power dependence of a corporate system. It is a co-ordinated system of distribution channel organization in which the flow of products from the producer to the end user is controlled by the power and size of one member of the channel system rather than by common ownership or contractual ties. Member organizations acknowledge the existence of dependence and adhere to the leadership of the dominant firm, which may operate at any level in the channel. Large retail organizations like Marks & Spencer typify this system. In administered systems like Marks & Spencer, units can exist with disparate goals, but there is informal collaboration on inclusive goals.

Decision making occurs by virtue of interaction between channel members in the absence of a formal inclusive structure. However, the locus of authority still remains with individual channel members. As in conventional channels commitment is selforiented and there is a minimum amount of system-wide orientation among the members. As McCammon1 observes:

Manufacturing organizations . . . have historically relied on administrative expertise to coordinate reseller marketing efforts. Suppliers with dominant brands have predictably experienced the least difficulty in securing strong trade support, but many manufacturers with ‘fringe’ items have been able to elicit reseller co-operation through the use of liberal distribution policies that take the form of attractive discounts, financial assistance, and various types of concessions that protect resellers from one or more of the risks of doing business. An example of a successful administered VMS in is that of the furniture/lifestyle retailer, IKEA who has developed close working relationships with its suppliers. Acting as the channel co-ordinator, IKEA is committed to cost-effective supply and their suppliers benefit from the channel leadership of an effective and marketing-oriented retailer.

Administered VMS are one step removed from conventional marketing channels. In an administered system, co-ordination of marketing activities is achieved by the use of programmes developed by one or a limited number of firms. Successful administered systems are conventional channels in which the principles of effective inter-organizational management have been correctly applied. Before we discuss how such marketing channels are co-ordinated, it is important that we discuss their structure.

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