Marketing Channels: Delivering Customer Value (Chapter 12) PDF

12 OBJECTIVES OUTLINE Marketing Channels Delivering Customer Value OBJECTIVE 12-1 Explain why companies use marketing channels and discuss the functions these channels perform....

12 OBJECTIVES OUTLINE Marketing Channels Delivering Customer Value OBJECTIVE 12-1 Explain why companies use marketing channels and discuss the functions these channels perform. OBJECTIVE 12-2 Discuss how channel members interact and how they organize to perform the work of the channel. OBJECTIVE 12-3 Identify the major channel alternatives open to a company. OBJECTIVE 12-4 Explain how companies select, motivate, and evaluate channel members. ­OBJECTIVE 12-5 Discuss the nature and importance of marketing logistics and integrated supply chain management. CHAPTER We now look at the third marketing mix tool: We start by looking at Airbnb, a great example of a sig- distribution. Companies rarely work alone nificant distribution trend: distribution channel disruption. In PREVIEW in engaging customers, creating customer recent years, innovative companies in many industries have value, and building profitable customer relationships. Instead, disrupted traditional channels by finding new ways to bring most are only a link in a larger value delivery system. As such, a products and services to consumers. Amazon’s online selling firm’s success depends not only on how well it performs but also turned traditional store retailing on its head. Netflix’s mail-order on how well its entire marketing channel competes with competi- and video streaming channels put video rental stores out of tors’ channels. The first part of this chapter explores the nature of business and now even threaten movie theaters. iTunes and marketing channels and the marketer’s channel design and man- Spotify wiped out traditional music stores. And traditional taxi agement decisions. We then examine physical distribution—or and limo services have suffered at the hands of car hailing logistics—an area that has grown dramatically in importance and services like Uber and Lyft. In a similar way, Airbnb has radi- sophistication. In the next chapter, we’ll look more closely at two cally transformed the way hotel and hospitality services are major channel intermediaries: retailers and wholesalers. delivered. AIRBNB: Disrupting Traditional Distribution Channels N ot long ago, when you thought about traveling and when compared to the size of the world’s largest hotel chain— places to stay, you probably thought about standard 95-year-old Marriott International—with its 1.4 million rooms hotel or motel chains—Motel 6, Hampton Inn, or across 7,600 properties in 131 countries. In fact, Airbnb boasts maybe Marriott or Hilton. Airbnb has revolutionized more rooms than all global hotel groups combined. Airbnb isn’t your traditional hotel experience. It all started all of that. Without owning a single hotel, Airbnb is now the when Airbnb founders Brian Chesky and Joe Gebbia decided largest provider of rooms for overnight stays. to make some extra income to help pay the rent on their modest In little more than 14 years, the tech startup that popular- San Francisco loft apartment by renting out three air mattresses ized staying at the homes of strangers has built a global net- on the apartment’s floor at $40 a night each (hence the “air” in work of more than 7 million listings by 2.9 million hosts in 220 Airbnb). Chesky and Gebbia quickly realized that people who countries and regions throughout the world. That’s stunning booked their air mattresses got a lot more than just a cheap M12_KOTL9364_19_GE_C12.indd 362 17/02/23 12:47 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value 363 place to stay. They got an authentic “live-like-the-locals” ex- perience. The idea blossomed into Airbnb, an online lodgings marketplace that matches people who need a place to stay with people who have room to spare. The basic Airbnb model is simple. It starts with hosts— Airbnb’s official term for property owners with space to rent— who register and are vetted for legitimacy. Listings can include anything from a couch, a single room, a suite of rooms, or an apart- ment to moored yachts, entire houses, or even a castle. Some hosts even rent space in their yards for guests to pitch a tent. Each lo- cation is as unique as its owner. For guests, using Airbnb is like buying or booking almost anything else online. Registered users search by city, room type, price range, amenities, host language, and other options. Bookings are made through Airbnb, so money changes hands only through a secure interface. At first, Airbnb attracted mostly venturesome travel- Airbnb’s disruptive distribution model has shaken up the traditional ers looking for cheap and cool places to stay. Other potential hotel and hospitality industries, challenging many age-old principles. customers shied away, unwilling to accept the risk or discom- Whatever’s next, the company must continue to adapt and innovate. fort of staying with strangers. But the concept caught on, and Ink Drop/Shutterstock Airbnb grew rapidly. More than the cookie-cutter rooms and impersonal travel experiences offered by conventional hotels, people warmed to Airbnb’s authenticity and the unique expe- with hosts known for great reviews and attention to detail. For riences that Airbnb lodgings offered. the really discerning customer, Airbnb Luxe offers a level of Chesky and Gebbia came to realize that Airbnb provided premium luxury in extravagant homes with high-end options, much more than just spaces to rent. Exhaustive research with such as booking a butler or personal chef. And for business guests and hosts around the world found that the last thing travelers, Airbnb for Work offers rental properties that encour- guests wanted was to be tourists. Instead, Airbnb customers age businesses to “reimagine how your employees travel, con- wanted to be insiders—to engage with people and immerse nect, and collaborate.” themselves in local cultures. In addition to lodgings, Airbnb also offers Experiences, a According to the company, 86 percent of users picked platform that lets customers experience unique activities hosted Airbnb because they wanted to live more like a local. They by inspiring local experts. Guests can sing in a Harlem gospel wanted to belong. Accordingly, Airbnb’s mission is to help choir, make a from-scratch pasta meal with two chefs in Florence, people belong anywhere, to live in a place instead of just trav- or create a sterling-and-turquoise ring in Scottsdale, Arizona. eling to it. This mission inspired Airbnb’s tagline—“Belong For more immersive activities, there’s Airbnb Adventures, all- Anywhere”—and its brand symbol, the bélo. Carefully con- inclusive multiday trips led by local experts. Beyond the big ceived to contain the “A” in Airbnb, a heart, and a location cities in Morocco, for example, guests can book a four-day trek pin, Airbnb casts the bélo as the universal symbol of belong- through the country’s Atlas Mountains, which takes them to ing. “Belong Anywhere” drives everything Airbnb does, from guest houses in different villages where they take part in local its travel offerings to its marketing campaigns. Airbnb sees it- traditions. In South Africa, beyond the wild animal preserves, self not just as a rooms provider but as a curator of unique and guests can take a two-day “sleep under the stars” trip to explore authentic “belonging” experiences. The overriding rule for late Stone Age cave art. “These aren’t tours,” says Chesky, “You hosts: create belonging. Chesky tells hosts, “What’s special in immerse yourself; you join the local communities.” your world isn’t just the home you have. It’s your whole life.” Airbnb’s disruption has shaken up the staid and tra- Airbnb points out that “belonging” doesn’t have to be about ditional hotel and hospitality industry. Despite the threat, having tea and cookies with the host. Many hosts don’t live in however, traditional hotel chains have been slow to respond. the lodgings they share, and many guests don’t actually want Some have countered with new Airbnb-like home-sharing to meet the host. More broadly, belonging means hanging out in alternatives of their own. For example, Marriott pushed back someone else’s space and having a local experience “hosted” by with Marriott Homes & Villas, a luxury lodging service that that person, even if the host is not present. It means venturing tries to compete with Airbnb Plus. Marriott has also launched into local spots guests might not otherwise see and doing things new formats—such as Moxy Hotels—tech-forward, inexpen- they might not otherwise do. Unlike sive, experiential formats that a stay in a traditional hotel, Airbnb provide more of the convenience, sees the optimal “belonging” expe- Airbnb’s disruptive distribution model lower costs, and experiences that rience as a transformational journey. has shaken up the traditional hotel and many Airbnb buffs seek. But over- Airbnb offers an array of lodg- hospitality industries, challenging many all, such responses have been very ing experiences. For example, you few and very modest. age-old principles. Whatever’s next, the can rent a room, a cabin, an igloo, The COVID-19 pandemic hit or a castle. At the upper end, company must continue to adapt and the hotel industry especially hard. Airbnb Plus offers a selection of innovate. During the coronavirus travel high-quality, well-equipped homes lockdown, U.S. hotel occupancy M12_KOTL9364_19_GE_C12.indd 363 17/02/23 12:47 PM  364   PART 3 | Designing a Customer Value–Driven Strategy and Mix fell from an average of 66 percent to historic lows of less than by 25 percent. In contrast, the pandemic cut revenues in half 25 percent. The pandemic hit Airbnb hard, too—2020 revenues for Marriott International and Hilton Worldwide. And even as were down by 30 percent over the previous year. But even in Airbnb’s business reached record levels this past year, business that horrific environment, Airbnb continued to adapt and in- for the big chains is still down by an average of 35 percent com- novate. For example, it launched “Go Near,” a social media pared to pre-pandemic heights. campaign to promote safe, nearby, longer-term getaways. And What’s next in the hospitality industry? No one really it designed a new virtual travel concept, Online Experiences— knows. But Airbnb’s disruption has significantly reshaped virtual activities led by unique hosts that gave customers a get- the habits of many of the world’s vacation travelers, challeng- away experience without ever leaving home. With online access ing many age-old principles of the hotel and hospitality busi- to walking tours, cooking lessons, dancing lessons, and other nesses. Whatever’s coming, Airbnb must continue to adapt and unique experiences, Online Experiences was an immediate hit. innovate, focusing on the thing that makes the experience so These efforts helped Airbnb bounce back in 2021, nearly dou- special. With Airbnb, no matter the circumstances, you “Belong bling its 2020 r­evenues and exceeding pre-pandemic business Anywhere.”1 AS THE AIRBNB STORY SHOWS, good distribution strategies can contribute strongly to customer value and create competitive advantage for a firm. But firms cannot bring value to customers by themselves. Instead, they must work closely with other firms in a larger value delivery network. Author These are pretty hefty Comment terms for a really simple Supply Chains and the Value Delivery Network concept: A company can’t create OBJECTIVE 12-1 Explain why companies use marketing channels and discuss the customer value on its own. It must functions these channels perform. work within a broader network of partners to accomplish this task. Producing a product or service and making it available to buyers requires building relation- Individual companies and brands do ships not only with customers but also with key suppliers and resellers in the company’s s­ upply compete with each other but so do chain. This supply chain consists of upstream and downstream partners. Upstream from the their entire value delivery networks. company is the set of firms that supply the raw materials, components, parts, information, finances, and expertise needed to create a product or service. Marketers, however, have tradi- tionally focused on the downstream side of the supply chain—the marketing channels (or distri- Value delivery network bution channels) that look toward the customer. Downstream ­marketing channel partners, such A network composed of the company, suppliers, distributors, and, ultimately, as wholesalers and retailers, form a vital link between the firm and its customers. even customers—all of whom partner The term supply chain may be too limited, as it takes a make-and-sell view of the busi- together to improve the performance of ness. It suggests that raw materials, productive inputs, and factory capacity should serve the entire system in delivering customer as the starting point for market planning. A better term would be demand chain because it value and driving profits. suggests a sense-and-respond view of the market that is customer-centric. Under this view, planning starts by identifying the needs of target cus- tomers, to which the company responds by organizing a chain of resources and activities with the goal of creat- ing and delivering customer value. Yet even a demand chain view of a business may be too limited because, much like links in a chain, it takes a step-by-step, linear view of purchase-production-­ consumption activities. Instead, most large companies today are engaged in building and managing a com- plex, continuously evolving value delivery network. As defined in Chapter 2, a value delivery network is made up of the company, suppliers, distributors, and, ultimately, customers who “partner” with each other to improve the performance of the entire system. For ex- ample, Ford makes great trucks. But to make and market just one of its many lines—say, its best-selling F-150 truck model—Ford manages a huge network of people within the company, from marketing and sales people to folks in Value delivery network: In making and marketing its lines of trucks, finance and operations. It also coordinates the efforts of Ford manages a huge network of people within the company plus thousands of outside suppliers, dealers, and marketing service firms thousands of suppliers, dealers, and advertising agencies that work together to create and deliver value and the brand’s “Built Ford and other marketing service firms. The entire network must Tough” positioning. function together to create and deliver customer value and REUTERS/Rebecca Cook establish the brand’s “Built Ford Tough” positioning. M12_KOTL9364_19_GE_C12.indd 364 17/02/23 12:47 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value    365 This chapter focuses primarily on marketing channels—on the downstream side of the value delivery network. We examine four major questions concerning marketing channels: What is the nature of marketing channels, and why are they important? How do channel firms interact and organize to do the work of the channel? What problems do companies face in designing and managing their channels? What role do physical distribution and supply chain management play in attracting and satisfying customers? In the next chapter, we will look at marketing channel issues from the viewpoints of two important channel members—retailers and wholesalers. Author In this section, we look Comment at the downstream side The Nature and Importance of Marketing Channels of the value delivery network—the Few producers sell their goods directly to final users. Instead, most use intermediaries to marketing channel organizations bring their products to market. They try to forge a marketing channel (or distribution that connect the company and its channel)—a set of interdependent organizations that help make a product or service avail- customers. To understand their value, able for use or consumption by the consumer or business user. imagine life without retailers—say, without grocery stores, discount A company’s channel decisions directly affect every other marketing decision. Pricing stores, or online sellers like Amazon. depends on whether the company works with national discount chains, uses high-quality com. specialty stores, or sells directly to consumers online. The firm’s sales force and commu- nications decisions depend on how much persuasion, training, motivation, and support its channel partners need. Whether a company develops or acquires certain new products Marketing channel (distribution may depend on how well those products fit the capabilities of its channel members. channel) Companies often pay too little attention to their distribution channels—sometimes ­ set of interdependent organizations A with damaging results. In contrast, many companies have used imaginative distribu- that help make a product or service tion systems to gain a competitive advantage. Enterprise Rent-A-Car revolutionized the available for use or consumption by the ­car-rental business by setting up off-airport rental offices. Apple turned the retail music consumer or business user. business on its head by selling music via the internet on iTunes. FedEx’s creative and sprawling distribution system made it a leader in express package delivery. Uber and Airbnb, with their sharing models, have disrupted the taxi and hospitality businesses. And Amazon.com forever changed the face of retailing by selling anything and everything ­online without using physical stores. Distribution channel decisions often involve long-term commitments to other firms. For example, companies such as Ford, McDonald’s, or Nike can easily change their ­advertising, pricing, or promotion programs. They can scrap old products and introduce new ones as market tastes change. But when they set up distribution channels through contracts with franchisees, independent dealers, or large retailers, they cannot readily ­replace these channels with company-owned stores or online sites if the conditions change. Therefore, management must design its channels carefully, with an eye on not just today’s selling environment but also on tomorrow’s possibilities. How Channel Members Add Value Why do producers give some of the selling job to channel partners? After all, doing so means giving up some control over how and to whom they sell their products. Producers use intermediaries because they create greater efficiency in making goods available to target markets. Through their contacts, experience, specialization, and scale of operation, ­intermediaries usually offer the firm more than it can achieve on its own. Figure 12.1 shows how using intermediaries can provide economies. Figure 12.1A shows three manufacturers, each using direct marketing to reach three customers. This sys- tem requires nine different contacts. Figure 12.1B shows the three manufacturers working through one distributor, which contacts the three customers. This system requires only six contacts. In this way, intermediaries reduce the amount of work that must be done by both producers and consumers. From the economic system’s point of view, the role of marketing intermediaries is to transform the assortments of products made by producers into the assortments wanted by consumers. Producers make narrow assortments of products in large quantities, but consumers want broad assortments of products in small quantities. Marketing channel members buy large quantities from many producers and break them down into the smaller quantities and broader assortments desired by consumers. For example, Unilever makes millions of bars of Dove Beauty Bar soap each week. However, you most likely want to buy only a few bars at a time. Therefore, big food, drug, and discount retailers, such as Safeway, Walgreens, and Target, buy Dove by the truckload M12_KOTL9364_19_GE_C12.indd 365 17/02/23 12:47 PM  366 PART 3 | Designing a Customer Value–Driven Strategy and Mix FIGURE 12.1 How a Distributor Reduces the Number of Channel Transactions 1 Manufacturer Customer Manufacturer Customer 2 1 4 3 Marketing channel intermediaries make 4 buying a lot easier for 5 2 5 consumers. Again, Distributor Manufacturer Customer Manufacturer Customer think about life without grocery retailers. How would you go about 6 buying that 12-pack of 6 Coke or any of the 7 3 hundreds of other items 8 that you now routinely Manufacturer Customer Manufacturer Customer drop into your shopping 9 cart? A. Number of contacts without a distributor B. Number of contacts with a distributor and stock it on their stores’ shelves. In turn, you can buy a single bar of Dove along with a shopping cart full of small quantities of toothpaste, shampoo, and other related products as you need them. And on the next visit, you could buy another brand of soap from the same retailer. Thus, intermediaries play an important role in “breaking bulk” and match- ing supply and demand. In making products and services available to consumers, channel members add value by bridging the major time, place, and possession gaps that separate goods and services from those who use them. Members of the marketing channel perform many key func- tions. Some help to complete transactions: Information. Gathering and distributing information about consumers, producers, and other actors and forces in the marketing environment—information needed to make effective manufacturing and marketing decisions. Promotion. Developing and spreading persuasive communications about an offer. Contact. Finding and engaging customers and prospective buyers. Matching. Shaping offers to meet the buyer’s needs, including activities such as downstream manufacturing and assembly, grading, assembling, and packaging. Negotiation. Reaching an agreement on price and other terms so that ownership or possession can be transferred. Others help fulfill the completed transactions: Physical distribution. Transporting and storing goods. Financing. Acquiring and using funds to cover the costs of the channel work. Risk taking. Assuming the risks of carrying out the channel work. The question is not whether these functions need to be performed—they must be—but rather who will perform them. To the extent that the manufacturer performs these func- tions, its costs go up; therefore, its prices must be higher. When some of these functions are shifted to intermediaries, the producer’s costs and prices may be lower, but the inter- mediaries must charge more to cover the costs of their work. In dividing the work of the channel, the various functions should be assigned to the channel members that can add the most value for the cost. Number of Channel Levels Companies can design their distribution channels to make products and services avail- able to customers in different ways. Each layer of marketing intermediaries that performs Channel level some work in bringing the product and its ownership closer to the final buyer is a channel A layer of intermediaries that performs level. Because both the producer and the final consumer perform some work, they are part some work in bringing the product and of every channel. its ownership closer to the final buyer. The number of intermediary levels indicates the length of a channel. Figure 12.2 shows both consumer and business channels of different lengths. Figure 12.2A shows several M12_KOTL9364_19_GE_C12.indd 366 17/02/23 12:47 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value 367 Direct marketing channel common consumer distribution channels. Channel 1, a direct marketing channel, has A marketing channel that has no no intermediary levels—the company sells directly to consumers. For example, Pampered intermediary levels, with the producer Chef, Mary Kay Cosmetics, and Amway sell their products through home and office sales selling directly to the consumer. parties and online websites and social media; companies ranging from GEICO insurance to Quicken Loans to Casper Mattress sell directly to customers via internet, mobile, and tele- Indirect marketing channel phone channels. The remaining channels in Figure 12.2A are indirect marketing channels, A marketing channel containing one or containing one or more intermediaries. Complex channels and international channels may more intermediary levels between the contain even more channel levels. producer and the consumer. Figure 12.2B shows some common business distribution channels. The business mar- keter can use its own sales force or the internet to sell directly to business customers. Or it can sell to various types of intermediaries, which in turn sell to these customers. Sometimes business marketing channels can have more levels, with intermediaries performing differ- ent tasks. For example, the business distributor might sell to the business customer as in Figure 12.2B, while a service agent is responsible for the product maintenance and perfor- mance after the sale. From the producer’s viewpoint, a greater number of intermediary levels means less control and greater channel complexity. Moreover, all the institutions in the channel are connected by several types of flows. These include the physical flow of products, the flow of ownership, the payment flow, the information flow, and the promotion flow. These flows can make even channels with only one or a few levels very complex. Ownership and control of these flows at different channel levels are an important issue between channel members. Author Channels are made Comment up of more than just boxes and arrows on paper. They Channel Behavior and Organization are behavioral systems consisting OBJECTIVE 12-2 Discuss how channel members interact and how they organize to of real companies and people who perform the work of the channel. interact to accomplish their individual and collective goals. Like groups of Distribution channels are more than simple collections of firms tied together by various people, sometimes they work well flows. They are complex behavioral systems in which people and companies interact to together and sometimes they don’t. accomplish individual, company, and channel goals. Some channel systems consist of only informal interactions among loosely organized firms. Others consist of formal interactions FIGURE 12.2 Consumer and Business Marketing Channels Using direct channels, a company sells directly to Using indirect channels, the company uses one or consumers (no surprise there!). more levels of intermediaries to help bring its products Examples: GEICO and Quicken to final buyers. Examples: most of the things you Loans. buy—everything from toothpaste to cameras to cars. Producer Producer Producer Producer Producer Producer Wholesaler Manufacturer’s representatives or sales branch Business Business Retailer Retailer distributor distributor Business Business Business Consumer Consumer Consumer customer customer customer Channel 1 Channel 2 Channel 3 Channel 1 Channel 2 Channel 3 A. Consumer marketing channels B. Business marketing channels M12_KOTL9364_19_GE_C12.indd 367 17/02/23 12:47 PM  368   PART 3 | Designing a Customer Value–Driven Strategy and Mix guided by strong organizational structures and contracts. Moreover, channel systems do not stand still—new types of intermediaries emerge and whole new channel systems evolve. Here we look at channel behavior and how members organize to do the work of the channel. Channel Behavior A marketing channel consists of firms that have partnered for their common good. Each channel member depends on the others. For example, a Ford dealer depends on Ford to design cars that meet customer needs. In turn, Ford depends on the dealer to engage cus- tomers, persuade them to buy Ford cars, and service the cars after the sale. Each Ford dealer also depends on other dealers to provide good sales and service that will uphold the brand’s reputation. In fact, the success of individual Ford dealers depends on how well the entire Ford marketing channel competes with the channels of Toyota, GM, Honda, and other auto manufacturers. Each channel member plays a specialized role in the channel. For example, Samsung’s role is to produce electronics products that consumers will covet and create demand through national advertising. Best Buy’s role is to display these Samsung products in con- venient locations, engage in local advertising, answer buyers’ questions, and complete sales. The channel will be most effective when each member assumes the tasks it can do best. Ideally, because the success of individual channel members depends on the overall channel’s success, all channel firms should work together smoothly. They should under- stand and accept their roles, coordinate their activities, and cooperate to attain overall channel goals. However, individual channel members may not embrace such a broad view. Cooperating to achieve overall channel goals sometimes means giving up individual goals. Although channel members depend on one another, they often act alone in their own short-run best interests. They often disagree on who should do what and for what rewards. Channel conflict Such disagreements over goals, roles, and rewards generate channel conflict. Disagreements among marketing Horizontal channel conflict occurs among firms at the same level of the channel. For channel members on goals, roles, and instance, some Ford dealers in Chicago might complain that other dealers in the city steal rewards—who should do what and for sales from them by pricing too low or advertising outside their assigned territories. Or what rewards. Hampton Inn franchisees might complain about other Hampton Inn operators overcharg- ing guests or giving poor service, hurting the overall Hampton Inn image. Vertical channel conflict—conflict between different levels of the same channel—is even more common. ­ For example, with nearly 40,000 independently owned outlets, sandwich chain Subway is the world’s largest food franchise by number of outlets. In recent years, however, Subway has faced often-damaging con- flict with its franchisees:2 A group of more than 100 anonymous Subway franchisees recently published an open letter ­outlining a long list of issues with Subway’s man- agement, ranging from lack of autonomy in raising ingredient quality and choosing locations to unfair franchise agreements that Subway could change at will without notice. The most basic conflicts are financial. Subway makes its money from an 8 percent royalty on franchisee sales. In contrast, franchisees make money on margins—what’s left over after their costs. Thus, franchisees have long complained that Subway makes decisions that in- crease sales but squeeze franchisee profits. They assert that Subway forces them into money-losing decisions—like opening unneeded new locations right next to existing ones or offering unprofitable menu items. Channel conflict: A high level of franchisee discontent is worrisome Just one example of a long-running dispute for both Subway and its franchisees. There’s a huge connection between involves Subway’s famous on-again-off-again “$5 franchisee satisfaction and customer service. footlong” promotion. First introduced nationally in Kristoffer Tripplaar/Alamy Stock Photo 2008, the deal became a cultural phenomenon, and M12_KOTL9364_19_GE_C12.indd 368 17/02/23 12:47 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value 369 sales soared. And with 2008 labor and material costs at low levels, the $5 footlong was initially profitable for franchisees. But as costs inevitably rose, franchisee margins on the popular sand- wich eroded. So in 2012, Subway yielded and raised the price to $6. But the story doesn’t end there. In 2017, seeking sales growth, Subway reintroduced the $5 footlong. But by then, the costs of making the footlong had risen to $4.85, making it impossible for franchisees to make a mean- ingful profit. Facing franchisee disgruntlement, Subway again shelved the offer. The story’s still not over. In 2020, to spur sales slowed by the COVID-19 pandemic, over the objections of many franchisees, Subway launched a “ $10 for two footlongs” deal, causing yet another uproar. Such conflicts are worrisome for both Subway and its franchisees. Studies show that there’s a huge connection between franchisee satisfaction and customer service. Some channel conflict takes the form of healthy competition. Without some such com- petition, the channel could become passive and noninnovative. For example, Subway’s conflict with its franchisees might represent normal give-and-take over their respective rights. However, prolonged conflict can disrupt channel effectiveness and harm channel relationships. Subway should ensure that all company and franchisee interests are aligned in the long run. Vertical Marketing Systems Conventional distribution channel For the channel as a whole to perform well, each channel member’s role must be specified, A channel consisting of one or more and channel conflict must be managed. The channel will perform better if it includes a independent producers, wholesalers, firm, agency, or mechanism that provides leadership and has the power to assign roles and and retailers, each a separate business manage conflict. seeking to maximize its own profits, Historically, conventional distribution channels have lacked such leadership and perhaps even at the expense of profits power, often resulting in damaging conflict and poor performance. One of the big- for the system as a whole. gest channel developments over the years has been the emergence of vertical marketing systems that provide channel leadership. Figure 12.3 contrasts the two types of Vertical marketing system (VMS) channel arrangements. A channel structure in which producers, A conventional distribution channel consists of one or more independent produc- wholesalers, and retailers act as a unified ers, wholesalers, and retailers. Each is a separate business seeking to maximize its own system. One channel member owns profits, perhaps even at the expense of the system as a whole. No channel member has the others, has strong contracts with much control over the other members, and no formal means exists for assigning roles and them, or has so much power that they all resolving channel conflict. cooperate. In contrast, a vertical marketing system (VMS) consists of producers, wholesalers, and retailers acting as a unified system. One channel member owns the others, has strong FIGURE 12.3 Comparison of Conventional Distribution Channel with Vertical Marketing System Producer Producer Retailer Wholesaler Wholesaler Vertical marketing system—here’s Retailer another fancy term for a simple concept. It’s simply a channel in which members at different levels (hence, vertical) work together in a unified way (hence, system) to accomplish the work of the channel. Consumer Consumer Conventional Vertical marketing marketing channel system M12_KOTL9364_19_GE_C12.indd 369 17/02/23 12:47 PM  370   PART 3 | Designing a Customer Value–Driven Strategy and Mix contracts with them, or wields so much power that they must all cooperate. The VMS can be dominated by the producer, the wholesaler, or the retailer. We look now at three major types of VMSs: corporate, contractual, and administered. Each uses a different means for setting up leadership and power in the channel. Corporate VMS Corporate VMS A corporate VMS integrates successive stages of production and distribution under ­single A vertical marketing system that ownership. Coordination and conflict management are attained through regular organiza- combines successive stages of tional channels. For example, European eyewear maker EssilorLuxottica has a firm grip production and distribution under single on the global eyewear channel from producer to consumer. It produces many famous eye- ownership—channel leadership is wear brands—including its own Ray-Ban, Oakley, Persol, and Vogue Eyewear brands and established through common ownership. licensed brands such as Burberry, Chanel, Polo Ralph Lauren, Dolce & Gabbana, DKNY, Prada, Versace, and Michael Kors. It also produces and sells about 45 percent of the world’s prescription lenses. It then controls the distribution of these brands through some of the world’s largest optical chains—LensCrafters, Pearle Vision, Sunglass Hut, Target Optical, Sears Optical—which it also owns. In all, through vertical integration, EssilorLuxottica makes and sells close to 1 billion pairs of lenses and frames a year.3 A corporate VMS can give a company more channel control and flexibility. Consider Tesla. Unlike almost every other vehicle manufacturer, Tesla does not sell and service its cars through in- dependent franchise dealerships. Tesla reasoned that dealerships selling gas-powered vehicles profit substantially from ongoing servicing, but its all-electric vehicles require little to no ongoing service. Tesla also wanted to avoid the difficulties of complex franchisee agreements and the thicket of state-level regulations governing auto dealer- ships. So instead, Tesla sells its cars online and through a network of ­company-owned Tesla stores or “galleries,” where customers can see sample vehicles, get more information, and receive as- Corporate VMS: Unlike other auto companies, to gain more control over sistance in configuring and ordering their Teslas. its distribution channels, Tesla sells and services its cars online and through Customers can pick up purchased cars at the Tesla a network of company-owned Tesla stores or “galleries,” where customers location or have them delivered to their door- can see sample vehicles, get more information, and receive assistance in steps. In the rare instance that service is needed, configuring and ordering their Teslas. customers can coordinate service activities, costs, Chon Kit Leong/Alamy Stock Photo tracking, delivery, and pickup with a Tesla service center through the Tesla service app. With its corporate vertical marketing system (VMS), Tesla has challenged the channel distribution channel structure that has dominated the auto industry for more than a century.4 Contractual VMS Contractual VMS A contractual VMS consists of independent firms at different levels of production and A vertical marketing system in which distribution that join together through well-defined contracts to obtain more economies or independent firms at different levels of sales impact than each could achieve alone. Channel members coordinate their activities production and distribution join together and manage conflict through contractual agreements. through well-defined contracts. The franchise organization is the most common type of contractual relation- ship. In this system, a channel member called a franchisor links several stages in the Franchise organization ­production-distribution process. In the United States alone, some 753,700 franchise A contractual vertical marketing system outlets account for $670 billion of economic output and employ 7.5 million people.5 in which a channel member, called a Almost every kind of business has been franchised—from motels and fast-food restau- franchisor, links several stages in the rants to dental centers and dating services and from wedding consultants and repair production-distribution process. services to funeral homes, fitness centers, moving services, and hair salons. Franchising allows entrepreneurs with good business concepts to grow their businesses quickly M12_KOTL9364_19_GE_C12.indd 370 17/02/23 12:48 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value    371 and profitably. For example, consider Planet Fitness, which has grown rapidly by franchising its unique gym and fitness approach:6 Planet Fitness’s unique selling point is a low $10 monthly membership fee, which allows access to bright, clean, no-frills but well-equipped gyms with a non-intimidating, “you belong” workout environment—what it calls a “judgement free zone” in which anyone and everyone can be com- fortable. “No need to be gymtimidated,” says the company. Its value proposition is designed to ap- peal to a broad population, including occasional gym users and the approximately 85 percent of population who don’t have a gym membership. To make average ­gym-goers feel more comfortable, Planet Fitness’s purple-themed locations even have a “Lunk Alarm,” which sounds loudly when a member is overly exuberant in terms of grunt- ing, dropping heavy weights, and exhibiting other Franchising: Planet Fitness has grown rapidly to more than 2,250 locations by franchising its affordable “judgement free zone” gym and fitness formula. behaviors that you might find in gyms targeting more serious bodybuilders and committed ath- Lars Hagberg/Alamy Stock Photo; Bernard Weil/Toronto Star via Getty Images letes. Thanks to franchising, in less than 20 years, Planet Fitness has grown rapidly to more than 2,250 locations in all 50 states and the District of Columbia, Puerto Rico, Canada, Panama, Mexico, and Australia, with systemwide sales of $3.4 billion. There are three types of franchises. The first type is the manufacturer-sponsored retailer franchise system—for example, Ford and its network of independent franchised deal- ers. The second type is the manufacturer-sponsored wholesaler franchise system—Coca-Cola ­licenses bottlers (wholesalers) in various world markets that buy Coca-Cola syrup con- centrate and then bottle and sell the finished product to retailers locally. The third type is the service-firm-sponsored retailer franchise system—for example, Sonic Drive-In has more than 3,500 franchisee-operated restaurants in the United States. Other examples can be found in everything from auto rentals (Hertz, Avis), apparel retailers (The Athlete’s Foot, Plato’s Closet), and motels (Holiday Inn Express, Hampton Inn) to supplemental educa- tion (Huntington Learning Center, Kumon Math & Reading Centers) and personal services (Planet Fitness, Two Men and a Truck, Great Clips). The fact that most consumers cannot tell the difference between contractual and corporate VMSs shows how successfully the contractual organizations compete with corporate chains. The next chapter on retailing presents a fuller discussion of the various c­ ontractual VMSs. Administered VMS Administered VMS In an administered VMS, leadership is assumed not through common ownership or A vertical marketing system that contractual ties but through the size and power of one or a few dominant channel mem- coordinates successive stages of bers. Manufacturers of a top brand can obtain strong trade cooperation and support from production and distribution through the ­resellers. For example, P&G and Samsung can command unusual cooperation from many size and power of one of the parties. resellers regarding displays, shelf space, promotions, and price policies. In turn, large re- tailers such as Walmart, Home Depot, Kroger, Best Buy, and Walgreens can exert strong influence on the many manufacturers that supply the products they sell. For example, in the normal push and pull between Home Depot and its suppliers, giant Home Depot—the nation’s sixth-biggest retailer and largest home-improvement merchant— usually gets its way. Take specialty coatings and sealants supplier RPM International, for instance. You may never have heard of RPM International, but you’ve probably used one or more of its many familiar do-it-yourself brands—such as R ­ ust-Oleum paints, Plastic Wood and Dap fillers, Watco finishes, and Testors hobby cements and paints—all of which you can buy at your local Home Depot store. The Home Depot is a very important customer to RPM, accounting for a significant share of its consumer sales. However, The Home Depot’s sales of close to $130 billion are more than 20 times RPM’s sales of $6.1 billion. As a result, the giant retailer can, and often does, use this power to gain channel cooperation and sup- port from RPM and thousands of other smaller suppliers.7 M12_KOTL9364_19_GE_C12.indd 371 17/02/23 12:48 PM  372   PART 3 | Designing a Customer Value–Driven Strategy and Mix Horizontal Marketing Systems Horizontal marketing system Another channel development is the horizontal marketing system, in which two or A channel arrangement in which two more companies at one level join together to follow a new marketing opportunity. By work- or more companies at one level join ing together, companies can combine their financial, production, or marketing resources to together to follow a new marketing accomplish more than any one company could alone. opportunity. Companies might join forces with competitors or noncompetitors. They might work with each other on a temporary or permanent basis, or they may create a separate company. For example, Target partners with CVS Health, which operates CVS phar- macies and Minute Clinics in Target stores through a store-within-a-store format. The partnership gives CVS Health more than nearly 1,700 pharmacies and 1,100 clinics at prime locations inside Target stores. At the same time, it frees up Target to focus on its core merchandising and marketing strengths while still offering customers the expert pharmacy and h ­ ealth-care services they want. Best Buy partners with key retail com- petitor Amazon by creating store-within-store areas featuring Amazon’s Alexa/Echo, FireTV, and other home electronics products. The arrangement boosts Best Buy’s smart- home product sales while giving Amazon a broader and more effective physical store presence for its devices. And ride-sharing service Uber now teams up with taxi compa- nies in New York City as well as in many over- seas locations to make the taxi cabs available to riders through its app. The cab companies gain access to Uber’s huge customer base and Uber supercharges the size of its fleet. Partnering with taxi fleets also helps Uber to smooth relation- ships with legislators and policy makers in those locations.8 Horizontal channel arrangements also work well globally. For example, Finnair partners with British Airways, American Airlines, and Iberia to provide customers with more choices, better connections, and better pricing on transat- lantic routes. This makes the global travel experi- ence for the customer easier and more rewarding. British Airways is part of the One World Alliance, allowing for many connecting flights. Thus, the airlines that are part of the alliance can increase passenger volume through travel agents. The Horizontal marketing systems: Finnair partners with British Airways, premise for the alliance is that the travel agent American Airlines, and Iberia to their mutual benefit, as they provide their who books passengers on one airline will more customers with more choices and better connections. likely book passengers on connecting airlines TRISTAR PHOTOS/Alamy Stock Photo within the alliance.9 Multichannel Distribution Systems In the past, many companies used a single channel to sell to a single market or market seg- ment. Today, with the proliferation of customer segments and channel possibilities, more Multichannel distribution system and more companies have adopted multichannel distribution systems. Such multi- A distribution system in which a single channel marketing occurs when a single firm sets up two or more marketing channels to firm sets up two or more marketing reach one or more customer segments. channels to reach one or more customer ­Figure 12.4 shows a multichannel marketing system. In the figure, the producer segments, coordinating channel sells directly to consumer segment 1 using catalogs, online, social media, and mobile chan- strategies to maximize total profits nels and reaches consumer segment 2 through retailers. It sells indirectly to business seg- across all the channels. ment 1 through distributors and dealers and to business segment 2 through its own sales force. Multichannel marketing calls for the producer to coordinate its channel strategies to maximize total profits across all the channels. These days, almost every large company and many small ones distribute through multiple channels. For example, John Deere sells its familiar green-and-yellow lawn and garden tractors, mowers, and outdoor power products to consumers and commercial M12_KOTL9364_19_GE_C12.indd 372 17/02/23 12:48 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value 373 FIGURE 12.4 Multichannel Distribution System Producer Most large companies distribute through multiple channels. For example, Distributors you could buy a familiar green-and-yellow John Deere lawn tractor from a neighborhood John Deere dealer or from Lowe’s. A large farm or forestry business would buy larger Catalogs, Sales John Deere equipment from a premium online, full-service John Deere dealer and its Retailers Dealers force social media, sales force. and mobile Consumer Consumer Business Business segment 1 segment 2 segment 1 segment 2 users through several channels, including John Deere retailers, Lowe’s home improvement stores, and online. It sells and services its tractors, combines, planters, and other agricul- tural equipment through its premium John Deere dealer network. And it sells large con- struction and forestry equipment through selected large, full-service John Deere dealers and their sales forces. Multichannel distribution systems offer many advantages to companies facing large and complex markets. With each new channel, the company expands its sales and market coverage and gains opportunities to tailor its products and services to the specific needs of diverse customer segments. But such multichannel systems are harder to control, and they can generate conflict as more channels compete for cus- tomers and sales. For example, when John Deere first began selling selected consumer products through Lowe’s home improvement stores, many of its independent dealers complained loudly. To avoid such conflicts in its online marketing channels, the com- pany routes all of its online sales to John Deere dealers. Today, firms must align chan- nel goals, roles, and incentives so that all of the company’s channels work in harmony to maximize total profits. Changing Channel Organization Changes in technology and the explosive growth of direct and online marketing have had a profound impact on the nature and design of marketing channels. One major trend is Disintermediation (or channel toward disintermediation or channel disruption—big terms with a clear message and disruption) important consequences. Disintermediation and channel disruption occur when product The cutting out of marketing channel or service producers cut out intermediaries and go directly to final buyers or when radi- intermediaries by product or service cally new types of channel intermediaries displace traditional ones. producers or the displacement of Thus, in many industries, traditional intermediaries are dropping by the wayside, as is traditional resellers by radical new types the case with online marketers taking business from traditional brick-and-mortar retailers. of intermediaries. For example, online music download services such as iTunes and Amazon pretty much put traditional music-store retailers out of business. In turn, however, streaming music services such as Spotify, Amazon Prime Music, and Apple Music are now disintermediating digital download services. Streaming, both subscription based and ad supported, now accounts for 80 percent of the music revenues. Worldwide, more than 500 million people pay for digital music services.10 Disintermediation and disruption present both opportunities and problems for producers and resellers. Channel innovators who find new ways to add value in the channel can displace traditional resellers and reap the rewards. For exam- ple, app-based ride-hailing services Lyft and Uber stormed onto the scene, rapidly M12_KOTL9364_19_GE_C12.indd 373 17/02/23 12:48 PM  374   PART 3 | Designing a Customer Value–Driven Strategy and Mix disintermediating traditional taxi and car-for-hire services by offering better cus- tomer experiences at lower fares. In Southeast Asia, Grab is rapidly disintermediat- ing conventional taxicab and car-for-hire services (see Real Marketing 12.1). In an example from another industry, consider Anghami: Founded in 2012, Anghami (“my tunes” in Arabic) is the first music-streaming platform in the Middle East and rivals global brands such as Spotify and Deezer. Before it launched, music lovers used traditional intermediaries such as radio channels, brick-and-mortar music retailers like Virgin Megastores, and iTunes. With the coming of Anghami, the music business went mobile. Offering more than 57 million Arabic and international songs and with around 70 million registered users, Anghami generates approximately 10 billion streams a year. In 2021, Anghami became the first technology company from the region to list on the Nasdaq, with a valuation of up to $230 million. High mobile penetra- tion, the availability of cheaper smartphones, and high- speed connectivity infrastructures in the GCC helped Anghami—which initially launched as a mobile app— to grow its adoption and consumption. As global play- ers started entering the market, Anghami not only had to maintain market leadership but also scale up. One of the challenges at this growth stage was convincing peo- ple to pay for music by subscribing. As credit card pen- etration was low, Anghami partnered with local telecom companies to encourage subscription through direct mobile billing. Through its knowledge of the local Arab ecosystem, Anghami was able to withstand competition from international companies, and by offering an Arab music catalog that none of the international streaming applications could match, Anghami became a hub for all things Arabic. Lovers of Arabic music could now search for, download, and stream their music without resort- ing to illegal sites or apps littered with ads that offered no revenue to the artists. Anghami’s Live Radios feature allows users to host online public and private listening Disintermediation and disruption: Anghami and other innovative app-based sessions, promoting a unique Arab community feel. music services are rapidly disintermediating conventional music distribution Anghami’s algorithms create automated customized channels. playlists based on user preferences, but they also pro- Timon Schneider/Alamy Stock Photo mote local talent to users.11 History brims with examples of companies that failed to recognize and respond to channel disruptions and paid the price. For example, Toys“R”Us pioneered the superstore format that once made it the go-to place for buying toys and baby products, driving most small independent toy stores out of business. But in later years, Toys“R”Us failed to adapt to major shifts in toy market sales, first toward big discounters such as Walmart and Target and then toward online merchants like Amazon. Last year, an estimated 45 percent of toy and baby product purchases were made online. Amazon leads in online toys sales, with Walmart hot on its digital heels. As a result, Toys“R”Us ended up declaring bankruptcy and shuttering its website and stores. A new owner has recently reignited the brand, focus- ing on a more interactive model that allows customers to experience toys before buying them. It’s new 20,000-square-foot flagship store in New Jersey’s American Dream mega- mall features 10,000 toys, an ice-cream parlor, a café, and a two-story slide. However, despite its iconic brand, reestablishing itself in today’s omni-channel retail environment will present substantial challenges.12 The recent decade has seen the rapid rise of a new type of channel disrupter: Direct-to-consumer (DTC) brands d ­ irect-to-consumer (DTC) brands. Rather than competing head-to-head with estab- Brands that avoid direct competition with lished competitors in retail stores, DTC brands sell and ship directly to consumers through established traditional brands by selling online and mobile channels. DTC brands have found success in categories ranging from and shipping to consumers only through beauty and personal care, apparel, and food to pet care, home furnishings, and fitness. To online and mobile channels. compete with this disruptive competitive threat, many established brands have developed their own DTC channels. Like resellers, to remain competitive, product and service producers must develop new channel opportunities, such as the internet, mobile, and other direct channels. Going direct to consumers, however, often brings brands into direct competition with their established channels, resulting in conflict. To ease this problem, companies often look for ways to make going direct a plus for the entire channel. For example, Stanley Black & Decker knows that M12_KOTL9364_19_GE_C12.indd 374 17/02/23 12:48 PM  CHAPTER 12 | Marketing Channels: Delivering Customer Value    375 Real Marketing 12.1 How to Grab and Shake Things Up Before it became possible to be on your way Grab. Originating in 2012 as Grab Taxi, oper- They also launched Grab Bike in cities such as to a destination after little more than a few ating in Malaysia, Grab is now considered one Jakarta, Manilla, Bangkok, and Ho Chi Minh swipes and taps on a phone, transport was an of Southeast Asia’s most important tech uni- to leverage the fact that many of the densely industry ripe for disruption. Many local and re- corns, having reached a valuation of $6 billion populated Asian cities suffered from regular gional companies operated in limited radii,