Unit L.03 – Using Channels of Distribution

What you’ll learn to do: explain what channels of distribution are and why organizations use them

Monster Energy drink is a dominant player in the growing market for drinks enhanced with stimulants to give consumers extra energy. Monster promises to deliver “a big, bad buzz.” The company sponsors the X Games and a broad range of high-adrenaline sports. The company boasts that it puts all its marketing dollars into supporting the scenes that energy-drink buyers love. In 2014, the company found itself closing in on Red Bull, the market leader that launched the original energy drink in 1997.^[1]

In deciding how to best capture the top position in the market, Monster forged an important strategic partnership with Coca-Cola. The press release that announced this partnership stressed the benefit to Monster of Coca-Cola’s global distribution network—the most powerful distribution network in the global beverage industry:

The Coca-Cola Company and Monster Beverage Corporation announced today that they have entered into definitive agreements for a long-term strategic partnership that is expected to accelerate growth for both companies in the fast-growing, global energy-drink category.  The new, innovative partnership leverages the respective strengths of the Coca-Cola Company and Monster to create compelling value for both companies and their share owners.

Importantly, the partnership strategically aligns both companies for the long-term by combining the strength of the Coca-Cola Company’s worldwide bottling system with Monster’s dedicated focus and expertise as a leading energy player globally.^[2]

The terms of the agreement also included Coca-Cola transferring all of its energy drinks to Monster, and Monster transferring all of its non-energy beverages to Coca-Cola, with Coca-Cola purchasing 16.7 percent of Monster Beverage Corporation.

Between June 2014 and December 2015, Monster Beverage Company’s stock price rose by 115 percent. The company has clearly benefited from access to Coca-Cola’s distribution infrastructure, and will continue to do so. However, it still lags behind Red Bull, which has the largest market share.

This example illustrates the power of distribution channels, which we’ve been calling “place” in the four Ps. Up next, you’ll learn what these are and why companies use them.

Evolution of Channels of Distribution

As consumers, we take for granted that when we go to a supermarket the shelves will be filled with the products we want; when we are thirsty there will be a Coke machine or bar around the corner, and we count on being able to get online and find any product available for purchase and quick delivery. Of course, if we give it some thought, we realize that this magic is not a given and that hundreds of thousands of people plan, organize, and labor long hours to make this convenience available. It has not always been this way, and it is still not this way in many other parts of the world.

Looking back over time, the channel structure in primitive culture was virtually nonexistent. The family or tribal group was almost entirely self-sufficient. The group was composed of individuals who were both communal producers and consumers of whatever goods and services could be made available. As economies evolved, people began to specialize in some aspect of economic activity. They engaged in farming, hunting, or fishing, or some other basic craft. Eventually this specialized skill produced excess products, which they exchanged or traded for needed goods that had been produced by others. This exchange process or barter marked the beginning of formal channels of distribution. These early channels involved a series of exchanges between two parties who were producers of one product and consumers of the other.

With the growth of specialization, particularly industrial specialization, and with improvements in methods of transportation and communication, channels of distribution have become longer and more complex. Thus, corn grown in Illinois may be processed into corn chips in West Texas, which are then distributed throughout the United States. Or, turkeys raised in Virginia are sent to New York so that they can be shipped to supermarkets in Virginia. Channels do not always make sense.

The channel mechanism also operates for service products. In the case of medical care, the channel mechanism may consist of a local physician, specialists, hospitals, ambulances, laboratories, insurance companies, physical therapists, home care professionals, and so on. All of these individuals are interdependent and could not operate successfully without the cooperation and capabilities of all the others.

Based on this relationship, we define a channel of distribution, also called a marketing channel,  as sets of interdependent organizations involved in the process of making a product or service available for use or consumption, as well as providing a payment mechanism for the provider.

This definition implies several important characteristics of the channel. First, the channel consists of organizations, some under the control of the producer and some outside the producer’s control. Yet all must be recognized, selected, and integrated into an efficient channel arrangement.

Second, the channel management process is continuous and requires continuous monitoring and reappraisal. The channel operates twenty-four hours a day and exists in an environment where change is the norm.

Finally, channels should have certain distribution objectives guiding their activities. The structure and management of the marketing channel is thus, in part, a function of a firm’s distribution objective. It’s also a part of the marketing objectives, especially the need to make an acceptable profit. Channels usually represent the largest costs in marketing a product.

Channel Flows

One traditional framework that has been used to express the channel mechanism is the concept of flow. These flows reflect the many linkages that tie channel members and other agencies together in the distribution of goods and services. From the perspective of the channel manager, there are five important flows.

1. Product flow: the movement of the physical product from the manufacturer through all the parties who take physical possession of the product until it reaches the ultimate consumer
2. Negotiation flow: the institutions that are associated with the actual exchange processes
3. Ownership flow: the movement of title through the channel
4. Information flow: the individuals who participate in the flow of information either up or down the channel
5. Promotion flow: the flow of persuasive communication in the form of advertising, personal selling, sales promotion, and public relations

Monster Channel Flow

The figure below maps the channel flows for the Monster Energy drink (and many other energy drink brands). Why is Monster’s relationship with Coca-Cola so valuable? Every single flow passes through bottlers and distributors in order to arrive in supermarkets where the product will be available to consumers.

Coca-Cola explains the importance of the bottlers in the distribution network:

While many view our Company as simply “Coca-Cola,” our system operates through multiple local channels. Our Company manufactures and sells concentrates, beverage bases and syrups to bottling operations, owns the brands and is responsible for consumer brand marketing initiatives. Our bottling partners manufacture, package, merchandise and distribute the final branded beverages to our customers and vending partners, who then sell our products to consumers.

All bottling partners work closely with customers — grocery stores, restaurants, street vendors, convenience stores, movie theaters and amusement parks, among many others — to execute localized strategies developed in partnership with our Company. Customers then sell our products to consumers at a rate of more than 1.9 billion servings a day.^[3]

Revisiting the channel flows we find that the bottlers and distributors play a role in each flow. Examples of the flows are listed below. Remember, while the consumer is the individual who eventually consumes the drink, the supermarkets, restaurants, and other outlets are Coca-Cola’s customers.

• Product flow: the bottlers receive and process the bases and syrups
• Negotiation flow: the bottlers buy concentrate, sell product and collect revenue from customers
• Ownership flow: distributors acquire the title of the syrups and own the product until it’s sold to supermarkets
• Information flow: bottlers communicate product options to customers and communicate demand and needs to Coca-Cola
• Promotion flow: bottlers communicate benefits and provide promotional materials to customers

Distribution Objectives

The distribution strategy supports company-level objectives, as well as marketing objectives. Typically, distribution approaches support company-level objectives related to growth, as in the example of Monster Energy, or profitability, since distribution can improve company efficiencies.

Think about your perspective as a buyer. When you need food, you most likely shop at a grocery store. You could purchase bread from a bakery, milk and eggs from a dairy, fruit and vegetables directly from a farm, but most people don’t. They appreciate the convenience of purchasing many different types of items from a single store. We call this contact efficiency, because the buyer is able to make contact with many different product types in a more efficient way.

Distribution channels provide efficiencies in a number of areas: product form, time, place, and exchange. Remember the example of the Coca-Cola bottlers: The bottlers purchase a concentrate that is condensed and easy to distribute all around the world. Once the concentrate is mixed with carbonated water and bottled or canned, it’s larger and heavier—and more difficult to distribute. For that reason, this process happens in the local markets, where final distribution to customers is easier. The bottlers provide efficiency in product form. Likewise, grocery retailers provide efficiency in time and place by offering many different products in a single shopping experience. Similarly, the groceries are purchased in a single cash or credit card transaction, even though they are coming from many different producers.

These efficiencies benefit both consumers and businesses. Early in this course we looked at the success of the Chobani yogurt company, which has grown through a national and now global distribution network. An effective distribution network enables the company to get its product in front of consumers far from its headquarters in Norwich, New York, and it means that a consumer in Norwalk, California, can buy Chobani’s greek yogurt in a local supermarket without ever thinking about the time and effort it required to get it there.

The primary purpose of any channel of distribution is to efficiently bridge the gap between the producer of a product and the user of it, whether the parties are located in the same community or in different countries thousands of miles apart.

Channel Partners That Support Objectives

The channel is composed of different institutions that facilitate the transaction and the physical exchange. Institutions in channels fall into one of the following three categories:

1. The producer of the product: a craftsman, manufacturer, farmer, or other producer
2. The user of the product: an individual, household, business buyer, institution, or government
3. Middlemen at the wholesale and/or retail level

Not all channel members perform the same function. Channel partners perform the following three important functions:

1. Transactional functions: buying, selling, and risk assumption
2. Logistical functions: assembly, storage, sorting, and transportation
3. Facilitating functions: post-purchase service and maintenance, financing, information dissemination, and channel coordination or leadership

These functions are necessary for the effective flow of product and title to the customer and payment back to the producer. Certain characteristics are implied in every channel. First, although you can eliminate or substitute channel institutions, the functions performed by these institutions cannot be eliminated. Typically, if a wholesaler or a retailer is removed from the channel, the function they perform will either be shifted forward to a retailer or to the consumer, or shifted backward to a wholesaler or to the manufacturer. For example, a producer of custom hunting knives might decide to sell through direct mail instead of retail outlets. The producer absorbs the sorting, storage, and risk functions; the post office absorbs the transportation function; and the consumer assumes more risk in not being able to touch or try the product before purchase.

Second, all channel institution members are part of many channel transactions at any given point. As a result, the complexity may be quite overwhelming. Consider for the moment how many different products you purchase in a single year and the vast number of channel mechanisms you use.

Third, the fact that you are able to complete all these transactions to your satisfaction, as well as to the satisfaction of the other channel members, is due to the routinization benefits provided through the channel. Routinization means that the right products are most always found in the places where the consumer expects to find them, comparisons are possible, prices are marked, and methods of payment are available. Routinization aids the producer as well as the consumer, in that the producer knows what to make, when to make it, and how many units to make.

Fourth, there are instances when the best channel arrangement is direct—from the producer to the ultimate user. This is particularly true when the producer feels he can perform the tasks best or when no competent middlemen are available. It may be important for the producer to maintain direct contact with customers so that quick and accurate adjustments can be made. Direct-to-user channels are common in B2B settings where personal sales are a more common tactic. Indirect channels are more typical and prevalent, though, because producers are not able to perform the tasks provided by middlemen as efficiently or with as broad of a reach.

Channel Structures

While channels can be very complex, there is a common set of channel structures that can be identified in most transactions. Each channel structure includes different organizations. Generally, the organizations that collectively support the distribution channel are referred to as channel partners.

The direct channel is the simplest channel. In this case, the producer sells directly to the consumer. The most straightforward examples are producers who sell in small quantities. If you visit a farmer’s market, you can purchase goods directly from the farmer or craftsman. There are also examples of very large corporations who use the direct channel effectively, especially for B2B transactions. Services may also be sold through direct channels, and the same principle applies: an individual buys a service directly from the provider who delivers the service.

Examples of the direct channel include:

• Etsy.com online marketplace
• Farmer’s markets
• Oracle’s personal sales team that sells software systems to businesses
• A bake sale

Retailers are companies in the channel that focuses on selling directly to consumers. You are likely to participate in the retail channel almost every day. The retail channel is different from the direct channel in that the retailer doesn’t produce the product. The retailer markets and sells the goods on behalf of the producer. For consumers, retailers provide tremendous contact efficiency by creating one location where many products can be purchased. Retailers may sell products in a store, online, in a kiosk, or on your doorstep. The emphasis is not the specific location but on selling directly to the consumer.

Examples of retailers include:

• Walmart discount stores
• Amazon online store
• Nordstrom department store
• Dairy Queen restaurant

From a consumer’s perspective, the wholesale channel looks very similar to the retail channel, but it also involves a wholesaler. A wholesaler is primarily engaged in buying and usually storing and physically handling goods in large quantities, which are then resold (usually in smaller quantities) to retailers or to industrial or business users. The vast majority of goods produced in an advanced economy have wholesaling involved in their distribution. Wholesale channels also include manufacturers who operate sales offices to perform wholesale functions, and retailers who operate warehouses or otherwise engage in wholesale activities.

Examples of wholesalers include:

• Christmas-tree wholesalers who buy from growers and sell to retail outlets
• Restaurant food suppliers
• Clothing wholesalers who sell to retailers

The agent or broker channel includes one additional intermediary. Agents and brokers are different from wholesalers in that they do not take title to the merchandise. In other words, they do not own the merchandise because they neither buy nor sell. Instead, brokers bring buyers and sellers together and negotiate the terms of the transaction: agents represent either the buyer or seller, usually on a permanent basis; brokers bring parties together on a temporary basis. Think about a real-estate agent. They do not buy your home and sell it to someone else; they market and arrange the sale of the home. Agents and brokers match up buyers and sellers, or add expertise to create a more efficient channel.

Examples of brokers include:

• An insurance broker, who sells insurance products from many companies to businesses and individuals
• A literary agent, who represents writers and their written works to publishers, theatrical producers, and film producers
• An export broker, who negotiates and manages transportation requirements, shipping, and customs clearance on behalf of a purchaser or producer

It’s important to note that the larger and more complex the flow of materials from the initial design through purchase, the more likely it is that multiple channel partners may be involved, because each channel partner will bring unique expertise that increases the efficiency of the process. If an intermediary is not adding value, they will likely be removed over time, because the cost of managing and coordinating with each intermediary is significant.

The Role of Intermediaries

While the retail channel is most familiar to students, wholesalers play an important role as intermediaries. Intermediaries act as a link in the distribution process, but the roles they fill are broader than simply connecting the different channel partners. Wholesalers, often called “merchant wholesalers,” help move goods between producers and retailers.

For example, McLane Company Inc. is among the largest wholesalers in the United States. The breadth of its operations is described on the company Web site:

McLane Foodservice and wholly owned subsidiary, Meadowbrook Meat Company, Inc., operates 80 distribution centers across the U.S. and one of the nation’s largest private fleets.  The company buys, sells, and delivers more than 50,000 different consumer products to nearly 90,000 locations across the U.S. In addition, McLane provides alcoholic beverage distribution through its wholly owned subsidiary, Empire Distributors, Inc. McLane is a wholly owned unit of Berkshire Hathaway Inc. and employs more than 20,000 teammates.^[4]

Let’s look at each of the functions that a merchant wholesaler fulfills.

Purchasing

Wholesalers purchase very large quantities of goods directly from producers or from other wholesalers. By purchasing large quantities or volumes, wholesalers are able to secure significantly lower prices.

Imagine a situation in which a farmer grows a very large crop of potatoes. If he sells all of the potatoes to a single wholesaler, he will negotiate one price and make one sale. Because this is an efficient process that allows him to focus on farming (rather than searching for additional buyers), he will likely be willing to negotiate a lower price. Even more important, because the wholesaler has such strong buying power, the wholesaler is able to force a lower price on every farmer who is selling potatoes.

The same is true for almost all mass-produced goods. When a producer creates a large quantity of goods, it is most efficient to sell all of them to one wholesaler, rather than negotiating prices and making sales with many retailers or an even larger number of consumers. Also, the bigger the wholesaler is, the more likely it will have significant power to set attractive prices.

Warehousing and Transportation

Once the wholesaler has purchased a mass quantity of goods, it needs to get them to a place where they can be purchased by consumers. This is a complex and expensive process. McLane Company operates eighty distribution centers around the country. Its distribution center in Northfield, Missouri, is 560,000 square feet big and is outfitted with a state-of-the art inventory tracking system that allows it to manage the diverse products that move through the center. ^[5] It relies on its own vast trucking fleet to handle the transportation.

Grading and Packaging

Wholesalers buy a very large quantity of goods and then break that quantity down into smaller lots. The process of breaking large quantities into smaller lots that will be resold is called bulk breaking. Often this includes physically sorting, grading, and assembling the goods. Returning to our potato example, the wholesaler would determine which potatoes are of a size and quality to sell individually and which are to be packaged for sale in five-pound bags.^[6]

Risk Bearing

Wholesalers either take title to the goods they purchase, or they own the goods they purchase. There are two primary consequences of this, both of which are both very important to the distribution channel. First, it means that the wholesaler finances the purchase of the goods and carries the cost of the goods in inventory until they are sold. Because this is a tremendous expense, it drives wholesalers to be accurate and efficient in their purchasing, warehousing, and transportation processes.

Second, wholesalers also bear the risk for the products until they are delivered. If goods are damaged in transport and cannot be sold, then the wholesaler is left with the goods and the cost. If there is a significant change in the value of the products between the time of the purchase from the producer and the sale to the retailer, the wholesaler will absorb that profit or loss.

Marketing

Often, the wholesaler will fill a role in the promotion of the products that it distributes. This might include creating displays for the wholesaler’s products and providing the display to retailers to increase sales. The wholesaler may advertise its products that are carried by many retailers.

Wholesalers also influence which products the retailer offers. For example, McLane Company was a winner of the 2016 Convenience Store News Category Captains, in recognition for its innovations in providing the right products to its customers. McLane created unique packaging and products featuring movie themes, college football themes, and other special occasion branding that were designed to appeal to impulse buyers. They also shifted the transportation and delivery strategy to get the right products in front of consumers at the time they were most likely to buy. Its convenience store customers are seeing sales growth, as is the wholesaler.^[7]

Distribution

As distribution channels have evolved, some retailers, such as Walmart and Target, have grown so large that they have taken over aspects of the wholesale function. Still, it is unlikely that wholesalers will ever go away. Most retailers rely on wholesalers to fulfill the functions that we have discussed, and they simply do not have the capability or expertise to manage the full distribution process. Plus, many of the functions that wholesalers fill are performed most efficiently at scale. Wholesalers are able to focus on creating efficiencies for their retail channel partners that are very difficult to replicate on a small scale.

What Is a Supply Chain?

We have discussed the channel partners, the roles they fill, and the structures they create. Marketers have long recognized the importance of managing distribution channel partners. As channels have become more complex and the flow of business has become more global, organizations have recognized that they need to manage more than just the channel partners. They need to manage the full chain of organizations and transactions from raw materials through final delivery to the customer— in other words, the supply chain.

The supply chain is a system of organizations, people, activities, information, and resources involved in moving a product or service from supplier to customer. Supply chain activities involve the transformation of natural resources, raw materials, and components into a finished product that is delivered to the end customer.^[8]

The marketing channel generally focuses on how to increase value to the customer by having the right product in the right place at the right price at the moment the customer wants to buy. The emphasis is on the providing value to the customer, and the marketing objectives usually focus on what is needed to delivery that value.

Supply chain management takes a different approach. The Council of Supply Chain Management Professionals (CSCMP) defines supply chain management as follows:

Supply Chain Management encompasses the planning and management of all activities involved in sourcing and procurement, conversion, and all logistics management activities. Importantly, it also includes coordination and collaboration with channel partners, which can be suppliers, intermediaries, third-party service providers, and customers. In essence, supply chain management integrates supply and demand management within and across companies. Supply Chain Management is an integrating function with primary responsibility for linking major business functions and business processes within and across companies into a cohesive and high-performing business model. It includes all of the logistics management activities noted above, as well as manufacturing operations, and it drives coordination of processes and activities with and across marketing, sales, product design, finance and information technology.^[9]

Supply Chain and Marketing Channels

The supply chain and marketing channels can be differentiated in the following ways:

1. The supply chain is broader than marketing channels. It begins with raw materials and delves deeply into production processes and inventory management. Marketing channels are focused on bringing together the partners who can most efficiently deliver the right marketing mix to the customer in order to maximize value. Marketing channels provide a more narrow focus within the supply chain.
2. Marketing channels are purely customer facing. Supply chain management seeks to optimize how products are supplied, which adds a number of financial and efficiency objectives that are more internally focused. Marketing channels emphasize a stronger market view of the customer expectations and competitive dynamics in the marketplace.
3. Marketing channels are part of the marketing mix. Supply chain professionals are specialists in the delivery of goods. Marketers view distribution as one element of the marketing mix, in conjunction with product, price, and promotion. Supply chain management is more likely to identify the most efficient delivery partner. A marketer is more likely to balance the merits of a channel partner against the value offered to the customer. For instance, it might make sense to keep a channel partner who is less efficient but provides important benefit in the promotional strategy.

Successful organizations develop effective, respectful partnerships between the marketing and supply chain teams. When the supply chain team understands the market dynamics and the points of flexibility in product and pricing, they are better able to optimize the distribution process. When marketing has the benefit of effective supply chain management—which is analyzing and optimizing distribution within and beyond the marketing channels—greater value is delivered to customers. If the supply chain team came to you (the marketer) and told you that, based on their analysis,  you should add a lean warehousing, just-in-time inventory approach for your product, you should definitely listen.

Try It

Play the simulation below multiple times to see how different choices lead to different outcomes. All simulations allow unlimited attempts so that you can gain experience applying the concepts.

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