MM – Instructor Manual

CHAPTER 9 – CHANNELS OF DISTRIBUTION AND

BUSINESS MARKETING NETWORKS AND LOGISTICS
KNOWLEDGE OBJECTIVES

1. Become Familiar with the Terms Channels of Distribution and Logistics

2. Understand Distribution/Channel Intensity
3. Acknowledge Channel Conflict and Resolution
4. Recognize the Impact of Channel Power on Channel Behavior
5. Stress the Importance of Retailing and Its Various Forms

CHAPTER OUTLINE

 What is a Distribution
 Distribution Design Decisions
 Channel Conflict and Channel Power
 Retailing
 Summary

1. Channels of Distribution Defined

Section relates to knowledge objective #1

Figure 9.1 Farmer’s Market

This figure applies to knowledge objectives #1

Figure provides a layout of the farmer’s market discussed in the opening vignette, identifying the
location of each of the vendors.

TEACHING NOTE: Among the earliest writings on marketing include A.W. Shaw, “Some
Problems in Market Distribution,” which discussed such issues as, “Analysis of the functions of the
middleman: sharing the risk, transporting the goods, financing the operations, assembling, assorting,
and re-shipping, and the advantages of direct selling in some industries.” The article appeared in The
Quarterly Journal of Economics in August 1912. So, the fundamental aspects of marketing &
channels of distribution have not radically changed in nearly 100 years. For what it’s worth,
many of the earliest writings discussed the marketing of farm product’s such as L.D.H Weld’s,
“Studies in the Marketing of Farm Products,” (1915), which also discussed distribution issues.

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Distributions channels are networks of interconnected firms that provide sellers a means to
introduce their goods in a marketplace and enable buyers to be able to more easily buy those
goods.

These interconnected firms can include: manufacturers, distributors, or wholesalers, retailers,

consumers, as well as others.

Basic functions that firms in a distribution channel include: ordering, handling and shipping,
storage and display, promotion, financing and breaking bulk.

TEACHING NOTE: A frequently used example of breaking bulk is small retail operators selling
a single cigarette. In many poorer locations people cannot afford an entire pack of cigarettes, so
merchants offer a single cigarette for sale. A less common, but similar example are “packaged
goods stores” the type of small “corner” retail establishment that sells liquor, selling individual
12 ounce cans of beer. 12 ounce cans are typically only available in 6-packs. However, some
owners recognize that some people may not have money for a 6-pack, but only have money for a
single can of beer. In order to make a sale, the liquor store owner will “break bulk” by breaking
one 6-pack into six singles and make six single sales rather than one six pack sale. The six single
sales typically earn more revenue than the single 6-pack sale.

Links between the firms in the distribution channel include: movement and ownership of goods,
flow of payment and information, and promotional assistance.

Logistics is the coordination of the flow of all of goods, services, and information between
channel members throughout the channel.

A critical business decision is whether to all of the logistical functions alone, or to have others do
some part (or parts) of the functions. The challenge is in dealing with other independent firms,
buy” decision and comes down to whether the other party can do it better (more cheaply),
thereby adding value.

Figure 9.2 Manufacturers Direct to Consumers

This figure applies to knowledge objective #1

Figure shows a direct to consumer system. In this case each manufacturers deals with all
customers that what its product. Each customer deals with each manufacturer. This results in a
total possible number of links to be 33 (number of manufacturers times the number of
customers).

Figure 9.3 Manufacturers through a Channel

This figure applies to knowledge objective #1

Figure shows the effect of adding a single intermediary reduces the total number of possible
links to 14. Assuming that the cost per contact is the same, the channel with the fewest links is
more efficient. The system in Figure 9.3 is more than the system illustrated in Figure 9.2

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TEACHING NOTE: One illustrative example of figures 9.2 and 9.3 is to assume that the
manufacturers are each at a different fixed location, customers wishing to buy the product that
each of the manufacturer supplies must travel to each manufacturer location. So each consumer
must make three trips. However, with the use of a channel member, consumers need only make
one trip and therefore save both time and money, as three trips would require more distance
traveled (increased fuel consumption) and greater time traveled.

Figure 9.4 Forms of Distribution Channels

This figure applies to knowledge objectives #1

Figure shows three types of distribution channels: Manufacturer direct to Consumer,

Manufacturer to Retailer to Consumer, and Manufacturer to Wholesaler to Retailer to Consumer.

Figure 9.5 Channels and Supply Chains

This figure applies to knowledge objectives #1

Figure provides an example manufacturer to wholesale to retailer to consumer design. The

direction of manufacturer to wholesale to retailer to consumer is referred to as downstream and a
channel. The reverse direction (consumer to retailer to wholesaler to manufacturer) is referred to
as upstream and referred to as a supply chain.

2. Channel Design

Section relates to knowledge objectives #1 and #2

Channels are based upon efficiency, economies of scale, and consistency in positioning. In order
to design a proper system, firms need to consider level of intensity and properly aligning
partners’ motives.

A. Distribution Intensity refers to the number of intermediaries involved in distributing

the product to end consumers. Intensive distribution means that the product is made
widely available. Selective distribution means that the intensity is not as great, fewer
outlets or intermediaries are used. Exclusive distribution is an extreme case of
selective distribution in that single outlet/intermediary is used.

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TEACHING NOTE: Intensity does not necessarily relate to length. Length refers to the number
of intermediaries involved in a single channel between manufacturer and consumer in sequence.
Intensity means the number of intermediaries involved and there can be multiple intermediaries
of a given type. For example, a manufacturer can have its product sold directly through many
different retailers, which could be intensive but still be a relatively short system of manufacturer
to retailer to consumer.

If goods are simple, inexpensive and easily transported they are typically intensively
distributed. Consumer packaged goods are typically intensively distributed.
However, if goods are relatively expensive and complex so that some assistance (such
as knowledgeable sales staff) in purchasing may be needed, the goods are more likely
to be distributed selectively. Selective distribution benefits from having fewer
intermediary relationships to manage and more control.

Channel design needs to be consistent with the other marketing mix elements. Wide
distribution usually goes with heavy promotion, lower prices and average or lesser
quality products.

B. Push and Pull Strategies

Customers pull goods through the channel, while intermediaries push the goods to
consumers from the manufacturer. Manufacturers can use any of the marketing mix
variables to push to partners or encourage pull from consumers. The hope is that by
offering intermediaries incentives, they will get behind the product and push them to
the final consumer.

Figure 9.6 Push vs. Pull Strategies

This figure applies to knowledge objectives #2 and #4

Figure a manufacturer, wholesaler, retailer, consumer channel and some corresponding

promotional strategies associated with both push and pull strategies. Some push oriented
activities include: price discounts, quantity discounts, financing typically directed at the
intermediary. Examples of pull oriented activities include: consumer directed advertising,
coupons, rebates, loyalty points, and free samples. Note that some activities can be both push
and pull.

C. Conflict and Power

Disagree between channel members can occur. Various reasons for disagreement
include: sellers thinking the price is too low and downstream members thinking the
price too high, or difference in levels of support with sellers thinking the product
should receive more support and downstream members thinking they are giving
adequate support or having to provide to much support. A primary concern is that
independent organizations within the channel will act in their own best interest (self
interest) and potentially act opportunistically.

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Transaction Cost Analysis (TCA) is a model that considers channel member’s

production and governance costs. Using intermediaries often reduces costs of
producing and bring products to market due to economies of scope and scale.
Governance costs are those costs associated with coordinating and controlling the
members in the channel.

There are many ways to overcome conflict or the potential for conflict, reduce
transaction costs, and to enhance value.
While there are many forms of power including, coercive, legitimate, and reward
power, the use of power can be ineffective and potentially create resentment. One
way to foster good channel relationships is through communication as communication
has been shown to facilitate trust and satisfaction. Trust is the willingness and ability
to deliver on promises. Exchanging personnel is another way to strengthen
relationships. Other conflict prevention or resolution methods include negotiation
and mediation.

D. Revenue Sharing
In a direct channel the manufacturer’s profit is a function of the customer’s price, the
manufacturing and selling (retailing) costs, and demand. Using an intermediary, there
is a second markup when the retailer makes the product available to the consumer.
Double marginalization is the problem associated with determining what is a proper
profit for the manufacturer and retailer, without increasing the price paid by the
consumer to the point where demand drops. A simple way to work on the problem is
to consider a direct to consumer channel and consider the profit the manufacturer
would make to be total channel profit and allocate the total channel profit among the
manufacturer and intermediaries. This way the price to the customer does not
increase.

Figure 9.7 Double Marginalization: The Problem

This figure applies to knowledge objectives #3 and #4

Figure provides an example of the double marginalization problem showing two distribution
channels a direct to consumer channel and a manufacturer to retailer to consumer channel. In the
direct to consumer case, the manufacturer has a manufacturing cost of $50 and a retailing cost of
$50. The manufacturer uses a markup of $100 so that the selling price to the consumer is $200.
In the second design, the manufacturer still has a $50 manufacturing cost and retains the $100
markup, so that the selling price to the retailer is $150. The retailer has a $50 retailing cost and a
markup of $50. This results in a $250 selling price to the consumer as manufacturer ($50 cost +
$100 markup+ retailer ($50 cost + $50 markup = $250. This is a $50 increase over the $200
consumer price in the direct channel instance.

Figure 9.8 Double Marginalization: Solutions

This figure applies to knowledge objectives #3 and #4

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Figure details two solutions to the double marginalization problem illustrated in figure 9.7. In
the first case, the manufacturer has a cost of $50 with a markup of $67 for a price to the retailer
of $117. The retailer has a cost of $50 and a markup of $33 for a total of $83. The total price to
the consumer is $117 + $83 = $200 with a margin split 2:1 ($67 to $33) manufacturer to retailer
split. In the second, the costs to the manufacturer and retailer remain the same, however the
margin is now 100% of cost for both the manufacturer and retailer, so that both the manufacturer
and retailer have the same margin of $50 each. So the total cost to the consumer remains the
same. The figure suggests that in figuring out a solution, start with the price to the consumer and
then figure out how to split the margin among all of the channel members.

E. Integration
Integration refers to the back or buy decision that firms face when determining
whether to do a distribution function or to have someone else undertake the activity.
Firms typically review the issue on a regular basis. Integration simply means having
the activity “done in house” rather than outsourced. Firms may forward integrate
meaning doing an activity that is “downstream” a function closer to the end consumer
or backward integrate meaning doing an activity “upstream” a function further away
from the customer than the company is currently doing. Examples used in the text:
Barnes and Nobles backward integrating by warehousing, as well as publishing
(moving backwards from retailing). Sony and Apple are both given as examples of
forward integration as both companies are manufacturers, but have also opened retail
stores. Many retailers have backward integrated setting up private labels. Private
labels offer several advantages: provide negotiating power when dealing with
manufacturers, potential for higher margins, allow retailer to distinguish itself as the
only place offering the brand.

TEACHING NOTE: Other examples not in the textbook: Under Armour, New Balance, Bose,
Nike are all manufacturers that sell through various retailers but also have retail stores. Loblaw a
Canadian food distributor also manufacturers as well as distributes and is also a retailer.

Integration can create other forms of competition. Through integration horizontal,

which is competition at the same level of the distribution channel can occur and there
can also be vertical competition which is competition occurring at different levels of
the channel. So, it possible for a firm to compete with a firm in one channel, yet
cooperate with it in another.

TEACHING NOTE: The problems of competition mentioned above are related to the issue
referred to as “dual distribution” in which a firm uses two or more channels in which to sell the
same product. The most common instance of dual distribution is when a manufacturer sells
through a retailer, yet also sells directly to the consumer through its own website. Examples
would include any other the firms mentioned earlier such as Under Armour or New Balance, not
only does Under Armour and New Balance compete against such sporting goods retailers as
Dick’s and Sports Authority through the use of its website, it also competes with its own Under
Armour or New Balance retail stores as well.

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Figure 9.9 Channel Network

This figure applies to knowledge objective #4

Figure shows some of the component suppliers for a commercial jet aircraft. General Electric,
Rolls Royce and Pratt & Whitney supply engines and related items. Goodrich supplies the
landing gear, Northrop provides some subassemblies, while Northrop and Raytheon supply radar
equipment and Lockheed Martin oversees the final assembly.

3. Retailing

Section relates to knowledge objective #5

Retailing is often the most visible element of the channel and can impact image, positioning and
brand equity. Retailers have gained increased power in the distribution channel. Retail outlets
can be classified in a variety of ways including level of service, ownership (independent, branded
chains, and franchises). Stores can also be classified along product lines. Specialty stores carry
depth, but not breadth. General merchandise retailers carry more breadth, but are typically not
deep in any given line.

A trained, competent, motivated and enthusiastic sales staff is vital to retail success. There is a
strong positive relationship between employee satisfaction and customer satisfaction. Service
design is critical and typically divided between backstage and frontstage. Frontstage are those
activities visible to the customer, while backstage is not. IT can play are critical role in
streamlining through for example self-service.

While location remains critical for brick and mortar retail establishments, site selection models
help predict the likelihood of success. Site selection models predict sales as a function of
population density and proportions of target demographic presence in potential site areas.

Retail growth can come through the offering of additional services, reaching out to additional
segments of customers, or through the opening of additional stores, and international expansion.

A. Franchising
Franchising is a form of multi-site expansion that allows the company to retain some
control without complete ownership of capital expenditure.

Figure 9.10 Benefits of Franchising

This figure applies to knowledge objective #4

Figure shows benefits to the franchisor and franchisee. For the franchisor benefits include:
capital, efficiencies and economies of scale, committed people, reduced investment risk, ability
to focus on core functions (e.g. product development). For the franchisee benefits include: well
known brand, market awareness, supplier relationships, training and support.

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There are two main types of franchises: product franchising and business format
franchising. In the first, a supplier authorizes a distributor some territory to carry its
products, use its name, and benefits of its advertising. Examples include: automobile
dealerships, and franchised gas stations. Business format franchises offer a system in
which to conduct business, a brand name, and advertising. Examples include:
McDonald’s and most other fast-food outlets, and 7-Eleven convenience stores.

Franchisees pay an up front fee and a royalty typically based on sales.

Figure 9.11 Franchise Chains

This figure applies to knowledge objective #4

Figure uses H&R Block, Anytime Fitness, Senior Helpers, Dunkin’ Donuts, Subway and
ServiceMASTER Clean to note that much of what I franchisee is buying is intangible. What the
franchisee is buying is brand equity and that there is a positive relationship between financial
measures of intangibility and the proportion of franchises.

B. E-Commerce
The Internet is an important channel representing $30 billion in sales, growing at
about 4% per quarter and representing 3% of all sales. Almost anything can and has
been sold over the internet. One of the big advantages of e-commerce is its low costs.

Figure 9.12 Top Internet Penetration Numbers

This figure applies to knowledge objective #4

Figure provides a bar graph of 9 countries and their corresponding penetration number.

Figure 9.13 Internet Picture for China and India

This figure applies to knowledge objective #4

Figure provides a bar graph of China and India’s population and internet penetration numbers
and clearly indicates the tremendous growth potential for each country.

Figure 9.14 Internet Penetration % in Asia: Countries with 30mm+ Populace

This figure applies to knowledge objective #4

Figure shows the country population and online presence for countries with a population of at
least 30,000,000. Shows that the Japan and S. Korea have the highest penetration rates, while
India, Indonesia and Pakistan have the lowest.

C. Catalog Sales

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Despite the presence and growth of the internet, catalog sales remain solid with 83 of
the top 100 catalog merchants experiencing growth. While the internet is well suited
for search, catalogs are preferred for browsing. Catalogs and e-commerce
complement each other as catalogs serve as a prompt, motivating customers to go
online more frequently. Catalogs can serve the same purpose for brick and mortar
retailing as well. Catalogs can be customized so that product offerings can be tailored
to a specific segment. The same ability to customize extends to promotional
incentives.

Figure 9.15 Top Catalogers

This figure applies to knowledge objective #4

Figure identifies the top 10 catalog merchants in terms of sales. There are from 1 to 10: Dell $52
billion, Thermo Fisher Scientific $11 billion, IBM, Staples, CDW, Henry Schein, Wesco
International, United Stationers, OfficeMax, and Office Depot, and all having between $9 and $4
billion in sales.

D. Sales Force
For many companies the sales force is a critical element. This is especially so in the
business to business area. For more undifferentiated products, the quality of the sales
force is often the single most important means of differentiation. Key sales force
issues are sales force size and compensation issues. Size is typically determined
through expected workload, typically considering how many customers are served,
the frequency of contact and the average duration of the contact. Compensation is
usually salary and bonus with the key issue the proportion. Three biggest complaints
by buyers about a salesperson are: 1. the salesperson isn’t following my company’s
buying process, 2. the salesperson doesn’t listen to my needs, and 3. the salesperson
didn’t bother to follow up.

E. Integrated Marketing Channels

As the number of channels increases, problems with coordination and integration of
the activities, data, customer contact points present challenges. Companies must
grapple with understanding customer behavior and understand what is important in
each channel and how all of these issues impact loyalty. There are many strategic
issues such as allocation of resources, the effect of adding additional channels, should
advertising and pricing be held constant across various channels or varied.

4. Summary

Distributions channels are networks of interconnected firms whose activities enable products to
be sold and consumers to have easier access to those products. Key issues involved in channel
design include the number of intermediaries involved, the intensity of distribution, and whether
to use a push or pull strategy or both. Compensation is another key issue. Understanding power

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structure, and handling conflict are important to channel success. Communication and trust are
critical to channel success. Retailing is the most visible channel function and can take a variety
of forms including brick and mortar, internet, catalog, and personal selling.

SUGGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. Would you feel equally comfortable buying socks, shoes, jeans, CDs, DVDs, books, an
all-inclusive travel package, a used car, a new car, and an apartment online versus
making the purchase IRL? Why or why not? What is it about these purchase categories,
and what is it about the online versus real life contribute to your opinions on these
matters?

All of the above items have been successfully purchased online. Some issues that may
dictate whether or not a purchase is made online could include: individual factors -
some people are simply still rather risk averse when it comes to purchasing online and
so, expensive items, or those requiring a long term commitment would seem less
conducive to being purchased online these include cars and an apartment. Another
critical factor that would possibly sway an individual is trust in the seller. How
confident are you that the merchandise is as advertised? Guarantees in the form of
return policies can help, the online auction ebay helps alleviate buyer’s fear through
feedback, ability to obtain history reports and the like. However, again this is an
individual process and even a pair of jeans may be determined to be too risky to be
purchased without being tried on first prior to purchase. Again, liberal return policies
could help.

2. If you were an entrepreneur starting from scratch, how would you design a channel to get
your high-end luxury goods to your target consumers?

Students are likely to recognize that in the case of a high-end luxury item the channel is
likely to be selective or even exclusive with respect to intensity. In fact, IF one elects to
use an intermediary, as an unknown an exclusive arrangement may need to be made in
order to have the (or any) intermediary carry the product. Depending upon the
complexity of the item, it may require a more direct sales method so that a manufacturer
to retailer to customer channel may be in order. It may be that due to lack of personal
selling ability, the entrepreneur may have to use a representative (an independent sales
person) to try to find a retailer(s) to carry the product. An enterprising entrepreneur
may attempt to go an alternative route and eschew the brick and mortar retail setting
and instead try to develop a website or have the product carried by a cataloger. Of
course, the entrepreneur being an entrepreneur may decide to go direct to the consumer
through e-commerce or infomercials. The options are many and there is no best way,
other than to recognize that a high end item will NOT be mass distributed.

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3. If you worked at a big company with an extended product portfolio, and you were
responsible for launching a brand extension, how would you activate a channel of
distribution? If you worked at this company and you were launching a product that was
new to the world and new for your company, how would you activate a channel?

Students will need to consider just how different the extension is from the existing brand.
Is it in the same category, or in an entirely new category with which the firm has little
experience? The issue to consider is can the company use the existing channel, so that it
is simply a matter of convincing intermediaries and retailers to carry an additional
product in the company’s line? If this is the case, the company’s track record, brand
image, and brand equity position will go a long way towards activating a channel.
However, if it is the case that these things do not apply, then it is more likely that deal
making and incentives will need to be used in order to get intermediaries and retailers to
carry the product. Inform students however, that the type of incentive (generous
margins) can have long term implications. Snapple is frequently used as an example in
which deals made early in the brands life, have had a lasting effect on distribution
decisions nearly 40 years later.

4. If your channel partner wasn’t doing what you wanted, what would you do? What would
you do if you were big? small? If it was a supplier (upstream) or distributor
(downstream)?

This question is addressing the issues of power and conflict. Have students review the
section on power and conflict. Types of power in question: coercive (willing to take
away benefits or inflict punishment), legitimate (size or expertise), referent (cooperation,
affiliation-wanting to be like the other party), reward (providing incentives for good
behavior). Also have students consider the industry dynamics. Are there other options
available in terms of suppliers or distributors? The industry concept of competition
acknowledges that number of alternatives in the form of number of suppliers versus
number of buyers has an implication for bargaining power. If there are multiple
suppliers, the firm has options and is in a better position to negotiate. If it does not, then
it at best can used for a of reward power by offering the channel partner incentives for
doing what you want. This should hold irrespective of the channel partner being a
supplier or distributor.

5. How would you apportion your business across retail stores, the Internet, a catalog, or a
sales force? How would that answer depend on whether you sold a new CPG, fashion,
OTCs, or business machines?

As noted in the second portion of the question, student responses are likely to be
somewhat “contextual” depending on the type of product. Although Dell Computer has
been extremely successful with a direct to consumer channel, most companies dealing
with business machines will rely heavily on a sales force and likely have two channels –
one business to business and another dealing with retailers for the consumer market.
For consumer products, over the counter pharmaceuticals, or fashion casual
investigation that virtually any type of channel design can be used. Although fashion is

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typically considered to be a brick and mortar type of good, company’s like Land’s End
and J. Crew have been quite successful as catalog merchandisers, with the internet only
helping sales. So, student responses should consider issues or risk (upfront versus long
term costs) revenue potential, potential for interchannel conflict and control.

6. Go online to investigate and report the range of fee structures for franchise systems in an
industry of your choice (you might try franchise.org, or whichfranchise.com). For
example, people can get very rich by being a franchisor for only a single McDonald’s
store, but how much money must you have to get into the system? What are the cheapest
three franchises you can buy into? Why do you suppose they’re so inexpensive?

For most franchising opportunities the standard fee structure is an upfront fee plus
royalty. The size of the upfront fee (as well as royalty) is a function of two elements: the
franchise’s brand reputation and infrastructure (building and equipment) cost. Fees can
range from under $50,000 to in excess of $500,000. Royalty rates can range from under
5% to as much as 15% of sales. One key item not mentioned in the textbook is that most
franchise opportunities as require the prospective franchisee to have a minimum net
worth not including real estate. These amounts can be from $100,000 to in excess of
$1,000,000. Janitorial services/cleaning services are typically among the cheapest as
there is little “brand name” recognition to such franchises.

7. If you were to take your company global, which three countries would be your first
targets and why? What kinds of strategies and products fit with those countries’ segments
of customers?

Assuming that the company was a U.S. based firm, a likely first choice would be Canada
due to geographic proximity and language (although eastern portions of Canada speak
French). Due the U.S. having an increasingly large Spanish speaking population
packaging and instructions are likely to currently be in both English and Spanish, so
Mexico could very well be a likely choice as well. NAFTA could also come into play for
selecting these two countries as well. Language continues to be a consideration and IF
marketing to Mexico why not continue with Spanish speaking countries and market the
product throughout Central and South America?

Alternatively, depending on product (for example a consumer apparel product or status

product) one might decide to market to Asia (Japan, China, etc.) due to population size,
(rising) income levels and an occasional predisposition to adopt U.S. products.

Lastly, one could consider first marketing to India given the country’s rising standard of
living, large population and large English speaking population.

SUGGESTED ANSWERS TO MARKETING PLAN QUESTIONS

Place/Distribution:
Design distribution system to be extensive or selective: Place1

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Intensity will likely be determined by 2 key issues: first is it a luxury item or convenience
item? Second, is the company an existing company with an established distribution
system? IF the company is a small startup, even if the item is a convenience item the
company because it is unknown and likely to have a small amount of capital will most
likely have to start out with a selective distribution system. For an energy drink, if the
product is existing then more than likely the desired system will be in place and the
considerations will be, is more support needed? Should/can intensity be expanded, or
should it be decreased? For a new product, the issue is in what outlets can we get the
product into? Can we get it into supermarkets and other large format retailers or will
we need to go to “mom and pop” independent convenience style stores?

Integrate with promotions as push or pull: Place2

Most manufacturers will be incorporating both push and pull strategies. The key is the
coordination between the two and what promotional and communication incentives to
use. Is this a launch, re-launch, or status quo situation?

Any conflicts needed to be resolve? Communication, contract, profit-share: Place3

Students should review the different forms of power, possible reasons for conflict and
address how any such conflicts would be resolved/addressed or prevented. Examination
of profit-sharing scenarios would help. Students might be asked to assume different
channel structures (number of intermediaries), e-commerce or catalog outlets and
consider how to handle inter-channel issues through incentives and compensation.

SUGGESTED ANSWERS TO MINI-CASE: SNOWBOARD RENTAL

There’s a snowboard rental guy at a ski resort in Wyoming who looks suspiciously like
Bruce Willis (so we’ll call him Bruce). He’s an amiable, chatty soul, and he asked a visiting B-
school student for some advice.
Bruce has to balance his needs to have an extensive inventory (for customer availability)
with the fact that snowboards cost $200 each. Further, they get scuffed up and broken, so each
month during winter (from December to March), he outlays some 4x20x$200=$16,000. The 20
snowboards available at any given time get rented every day during each of those four months;
i.e., 20 boards x 30 days a month x 4 winter months = 2,400 uses. The rental fee is $20 for the
day, so he racks up $20x2400=$48,000 (over the 4 months, of course). If he kept all the revenue,
his profit would be 48,000-16,000=$32,000. The manufacturer from whom he buys the
snowboards makes the $16,000 Bruce paid to get them, but it makes no money on Bruce’s
rentals.
So the B-school student suggested “revenue sharing.” Bruce naturally asked why—he’s
currently getting 100% of the rental fee.

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 MM – Instructor Manual

1. Can you illustrate the B-school student’s point? Say the manufacturer agrees to drop their
price to Bruce to $50 and he buys 40 during each of the winter months rather than only
20. Start with an offer of a 3:1 (75%:25%) split of the rental fees.

Assuming that Bruce has in effect double the demand than he is currently supplying (40
rentals per day rather than 20), his total outlay at current prices would be $32,000
(4x40x$200=$32,000). So, whatever deal he proposes to the ski board manufacturer
has to at least meet $32,000 to the manufacturer. With his new offer of 40 boards a
month at $50, the total provided to the manufacturer is $8,000 (4x40x$50). So, Bruce has
to at least come up with another $24,000 to make it worth the manufacturer’s interest.

Revenue Sharing

Sale Price 50 50 50 50
Qty 40 40 40 40
2000 2000 2000 2000 8000

Qty 40 40 40 40
Days 30 30 30 30
Rental Fee 20 20 20 20
Total Rental 24000 24000 24000 24000 96000
-8000
88000

So, Bruce has $88,000 to work with. Subtracting the $24,000 needed to make the
manufacturer “whole” (in the same position as if the manufacturer sold Bruce 40 boards
a month at $200). This leaves Bruce with $64,000. This is the exact same amount that
Bruce would earn if he paid the manufacturer $200 per board for 40 boards each month.
The advantage for Bruce is that doesn’t have to pay $200 for each board up front, but
rather $50 (an up front savings of $2000 each month) and the advantage to the
manufacturer is they are now receiving $8000 each month rather than $4000 per month.
The difference for the manufacturer is that they are now receiving two payments per
month (one at the beginning and one at the end) rather than one payment at the start of
the month). The question is how comfortable Bruce absorbing the fixed cost? Solution
does not take into account time value of money for the revenue being received later (at
the end of the month rather than the beginning).

2. Do you have a better suggestion?

Bruce has a couple of alternatives. If his concern is the monthly upfront expenditure he
must make and concern that he will not cover his costs due to demand fluctuations (due
to unseasonably warm weather), Bruce could simply offer the manufacturer a straight
percentage of his rentals in return for his not taking ownership of the boards. In this
case, the manufacturer does not sell the boards to Bruce who then rents them, but rather
Bruce acts an agent for the manufacturer. The two split the rental fees so that the

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 MM – Instructor Manual

manufacturer keeps the same profits ($4000/month). This may be acceptable. The
advantage for Bruce is that he has no upfront costs (no fixed cost). A second alternative,
is not strictly related to determination of channel margins, but recognizes that Bruce has
a fixed number of days with which to operate. Bruce could institute a segmentation
based pricing scheme in which he charges different rates for different times during the
week. Ski resorts typically have weekday and weekend lift ticket prices, so Bruce could
charge $20 Monday through Friday and $25 (or more) for Saturday and Sunday.

VIDEO OVERVIEW & DISCUSSION QUESTIONS

American Apparel (6:54)

Distribution channels consist of inter-connected firms that make products available to end
consumers. American Apparel is an independent clothing manufacturer which has had success
competing against national apparel manufacturers, such as Hanes and Fruit of the Loom.
American Apparel is the largest garment manufacturer located in the United States. It processes
raw yarn into garments and then sells these garments not only through traditional retail channels
but also through its website and company-owned brick and mortar retail shops. Vertical
integration allows it to be very efficient and flexible. It is able to respond quicker than its
competitors to customer requests and well as changes in the market.

Discussion Questions
1. Discuss how American Apparel’s vertical integration may allow it to save on
transportation costs. How could this efficiency impact its bottom line?

2. Consider consumer buying behavior when purchasing apparel. Would you recommend
an intensive, selective or exclusive distribution strategy for American?

3. Assume that American Apparel’s only operation was to sew fabric together. How could
it integrate backward? Forward?

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