05. DISTRIBUTION MANAGEMENT

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1 05. DISTRIBUTION MANAGEMENT What is a Distribution Channel It is a set of interdependent organizations, or intermediaries, involved in the process of making a product or a service available for use or consumption by the consumer or the business user. Different intermediaries perform different functions Wholesalers & Retailers buy, take title to & resell merchandise. They are Merchandisers Manufacturer s representatives, brokers, sales agents search for customers & may negotiate on behalf of the manufacturer, but do not take title to the goods. They are called Agents Transportation companies, independent warehouses, banks, ad agencies assist in the distribution process but do not take title to the goods & do not negotiate purchase or sale. They are called Facilitators Why are marketing channels used Marketing channels are used for their greater efficiency in making goods available to target markets because of their contacts, experience, specialization and scale of operations. They can offer the producer more than it can achieve on its own Channel intermediaries can provide economies. The use of channels implies fewer relationships to manage & hence intermediaries reduce the amount of work of producers & consumers Marketing intermediaries transform the assortment of products made by producers into assortments wanted by consumers Producers produce narrow assortments of products in large quantities, but consumers want broad assortment of products in small quantities The channel intermediaries buy moderately large quantities from many producers & break them down into smaller quantities & broader assortments, which are bought by consumers. Thus, channels play an important role in matching demand & supply Functions of distribution channels Information: Gathering & distributing info about producers offers to consumers, collecting market intelligence from consumers & providing them to producers for their planning & control Promotion: Persuading target consumers to buy products & services produced by the producers Contact: Locating & communicating with prospective buyers Matching: Shaping the offer to suit the buyers requirements Negotiating:Reaching a negotiated price & other terms of the offer so that ownership can be transferred Physical storage & distribution Financing: Funding the cost of channel work Risk taking: Bearing & sharing the risk of carrying out channel functions Different Channel Flows The different channel functions create different flows through the marketing channels: Physical Flow (Forward Flow) Title Flow (Forward Flow) Promotion Flow (Forward Flow) Information Flow (Forward & Backward Flow) Payment Flow (Backward Flow) Channel Levels A) Consumer Marketing Channels Zero level (Direct marketing channels): Manufacturer Consumer One level: Manufacturer Retailer Consumer Two level: Manufacturer Wholesaler Retailer Consumer Three-level: Manufacturer Wholesaler Jobber Retailer Consumer B) Industrial Marketing Channels Zero level: Manufacturer Industrial Consumer One level: Manufacturer Industrial Distributor Consumer Two level: Manufacturer Manufacturer s Rep Industrial Distributor Consumer

2 BBA404 Marketing Management 05 Distribution Management Page 2 of 8 Channel Design Decisions In designing channels, marketers look at what is ideal & what is practical A company may use different channels to reach different target markets Channels can evolve over time. However, channels once established, should have some stability. Channel structures cannot be changed as easily as product, price or promotion decisions Channel design calls for :Analyzing consumer service needs, Setting channel objectives & constraints, Identifying major channel alternatives and Evaluating channel alternatives Analyzing consumer service needs Involves finding out target customers expectations - Do customers want to buy from nearby locations? - Are they willing to travel some distance to buy? - Do they want to buy in person, or over phone, by using mail, or on the internet? - Would they prefer product variety or assortment breadth or would they like specialization? - Do they expect add-on services like delivery, credit, installation, repair, maintenance, exchange and buy-back? Setting Channel Objectives & Constraints Usually, a firm can identify different segments wanting different levels of channel service The firm should decide which segments to serve and the best channels to use to reach them In each chosen segment the firm should try to minimize the total channel cost of meeting customers expected channel service requirements Channel decisions are also influenced by the nature of the product. Perishable products require direct marketing. Bulky products (e.g. cement) require minimizing shipping distance and handling. Company sales forces sell custom-made products. Products that need installation or maintenance are sold & maintained by franchised dealers Channel decisions are made keeping in mind the competitors channels. A Company may want to compete in or near the same outlets that are used by competitors, or, it may consciously avoid those channels & look for more exclusive or innovative channels rather than fight for retail shelf-space with competitors Identifying Major Channel Alternatives types of intermediaries the no. of intermediaries & the responsibilities of each channel member Types of Intermediaries: Depending on the type of product & level of distribution channels to used, the firm needs to decide what type of intermediaries to use like Company sales force Wholesalers Retailers Brokers Industrial distributors Agents Telemarketing Direct Mail Internet Marketing, etc. be No. of intermediaries to be used: Intensive Distribution- Producers of convenient products use this strategy. They stock their products in as many outlets as possible. These products must be available when & where customers want them, e.g. toothpaste, soap, chewing gum, soft drinks, etc. Exclusive Distribution- Some producers severely restrict the no. of outlets that carry their products. Practiced by some auto manufacturers (Maruti), Jewellers (Tanishq), Apparel (Arrow shirts). Exclusive Distribution enhances company & product image, allows price premiums to be charged, secures stronger distributor service & promotion, gives more control on distribution Selective Distribution Lies between intensive and exclusive distribution. Involves selecting more than one but less than all of the intermediaries willing to carry the line. Most durables & appliances adopt this strategy

3 BBA404 Marketing Management 05 Distribution Management Page 3 of 8 Responsibilities of each channel member The producer & the intermediaries need to agree on i) Price Policies: The Producer has to establish a list price & a fair set of discounts for the intermediaries ii) Conditions of sale: Refer to payment terms & producer guarantees iii) Distributors territorial rights: The producer has to clearly spell out the distributor s territory & it should be careful in placing new resellers iv) Mutual services & duties: to be clearly spelt out in terms of promotional support, training support, record-keeping, technical assistance, physical facilities, manpower, information exchange etc. Evaluating channel Alternatives: Channel alternatives need to be evaluated against the following criteria Economic Criteria Companies try to replace high cost channels with low-cost channels Companies believe that for smaller expected volumes, agencies are cheaper. So, many new companies use agencies or large companies use agents for low potential markets For higher volumes, it is believed that the sales force is more effective i) they have better product knowledge ii) they are more aggressive iii) they are more motivated to sell as their future depends on it. iv) they would provide better service and collect better market information The fixed cost of engaging a sales force is higher compared to engaging an agency which earns only a commission Control Criteria A company has less control on independent channel members than on its own sales force Channel members being independent businesses, concentrate on buyers that buy more, not on the company s products Channel members cannot be expected to master the company s product or be as motivated to sell the company s line as would the company s salespeople Flexibility Criteria Setting up channels means a long-term commitment from both sides. Yet, to adapt to changing market conditions, the company might need more flexibility in its distribution A company s sales force is more flexible while a channel structure is more inflexible Channel Management Decisions Selecting channel members Training channel members Motivating channel members Evaluating channel members Modifying channel arrangements Selecting Channel Members In order to select channel members, the company needs to evaluate each member s - years in business - other product lines carried - growth and profit history - cooperativeness - reputation - size and quality of sales people - location - market covered - nature of customers - future growth potential Big and reputed companies manufacturing well-known & heavily advertised brands have little difficulty in attracting channel members Some producers manufacturing new products with little advertising back-up find it very difficult to attract channel members.

4 BBA404 Marketing Management 05 Distribution Management Page 4 of 8 Training Channel Members Companies need to train the sales & service personnel of the channel members as they are viewed as the company by the end-users e.g. Microsoft carries out training for third-party service engineers who are required to take certification exams. Those who pass are formally recognized as Microsoft-certified professionals. This helps them to promote their business Motivating Channel Members The Company must sell not only through channel intermediaries but to them. They are the company s first-line customers To motivate them, the Company at times offers motivators like higher margins, special deal premiums, display allowances, sales contents, etc. At times, the Company uses de-motivators like reduced margins, slower delivery, etc. Companies should look upon channel members as working partners. It should carefully study the needs & wants of the channel members & also clearly state what is expected out of them by way of market coverage, inventory levels, market feedback & services, etc. Evaluating Channel Members The Company should periodically review each channel member s performance against mutually agreed standards like sales quota, average inventory levels, treatment of damaged and lost goods, co-operation in company promotion & training, service etc. Performing channel members need to be rewarded & recognized Under-performing intermediaries need to be assisted, motivated, guided or replaced LOGISTICS MANAGEMENT Logistics management is conventionally defined as the process that has the responsibility to ensure the delivery of the right product at the right place at the right time in right quantities. The logistical network is involved in the actual transportation of the goods and services from the place of manufacture to the place of consumption. Normally, when logistics management is talked about, the entire supply chain is considered, from the raw material procurement stage to the delivery of finished goods to the customers. The Council of Logistics Management defines logistics in the following manner: Logistics is the process of planning, implementing, and controlling the efficient, cost-effective flow and storage of raw materials, in-process inventory, finished goods and related information from the point of origin to the point of consumption for the purpose of conforming to customer requirements. However, since we are limiting our focus to the logistical activities concerned with the distribution channels, we will only be concentrating on the second part of the chain viz. the delivery of the finished goods and services to the customers from the manufacturers' end. This part of the logistical activities of a firm is called the outbound logistics of the company. The outbound logistics is a critical activity in any firm as it directly links the company to its consumer and comprises a set of activities that complements the marketing function of the firm. Logistics Planning Logistics planning tackles four major problem areas: (i) customer service levels (ii) facility planning (iii) inventory management, and (iv) transportation decisions. The customer service demand is however very critical for the logistics planning process since it is instrumental in providing the central objective for the logistical planning function. The entire plan revolves around this aspect. Thus, the logistics planning process is often considered as a triangle of logistics decision- making. As the figure illustrates, the three major components of the logistical plan in effect attempts to fulfill the objective set under the customer service goals. This is because the level of logistical activity and consequently, the cost of providing the logistical support are totally dependent on the level of customer service envisaged in the strategic plan of the firm. The level of service provided also affect the design of the logistical system. If a higher level of customer service is planned to be provided the system would require more facilities like warehouses, transportation, etc. Conversely, as the cost of logistics is reduced, the ability of a firm to provide greater service levels is also reduced.

5 BBA404 Marketing Management 05 Distribution Management Page 5 of 8 Inventory Management Inventory levels Deployment of inventories Control methods Customer service goals Transportation decisions Modes of transport Carrier routing/scheduling Shipment size/consolidation The triangle of logistical decision making Location decisions Number, size and location of facilities Assignments of stocking points to sourcing points Assignment of demand to stocking points LOCATION DECISIONS A logistical system would normally require some permanent facilities for storing and supplying the products to the end consumers. Warehouses are locations where the inventory is received, stored, and shipped out according to the demand. Warehouses are usually secure well-protected buildings with special facilities to prevent any damage to the goods that are stored. Modern warehouses are equipped with sophisticated material-handling equipment that enable easier handling of inventory. Since the primary purpose of a warehouse is to handle inventory, the need for a warehouse would exist whenever a system has some amount of inventory. Main Functions of Warehousing Operations The main function of a warehouse is to store inventory or perform the critical functions of accumulation, storage, and allocation. The warehousing function performs several specific activities as part of integrated logistics system so as to enable the system to function perfectly with the maximum level of efficiency. These activities can be basically classified into three main types: movement, storage, and information transfer. The movement function itself consists of several activities such as (i) receiving (ii) transferring (iii) order picking/ selection, and (iv) shipping. The receiving activity involves all the activities that are required when product shipments are received from the sender. The main activities at this stage involve the unloading of the goods, updating of the inventory records, inspection of damage, and verification of the merchandise count against the orders and shipping records. The transfer activity involves transferring the shipment received to locations within the warehouse specifically meant for the storage of that category of inventory to enable easy access whenever required. The order picking or selection activity takes place whenever the warehouse gets an order from the downstream recipient for the goods stored. Once the order is received, the order is picked and packed to be shipped after selecting the mode of transport, after adjusting the inventory records. The storage function may be performed on a temporary or a semi-permanent basis. Goods can be stored in a warehouse temporarily awaiting an order from the downstream intermediary or else, mainly in the case of seasonal products, goods can be stored for a reasonably long period either to offset the seasonal demand or on the basis of speculation or forward buying. The information transfer function of warehousing occurs simultaneously with the movement and storage functions. Information on inventory levels, throughout levels (i.e., the amount of product moving through the warehouse), stock keeping locations, inbound and outbound shipments, facility space utilization, order fulfillment data, etc. are the type of information that a firm expects a warehouse to provide. Information technology is increasingly being used to make it easier to capture these kinds of data and transfer it online to decision makers. INVENTORY MANAGEMENT DECISIONS Managing the inventory in the distribution system is probably the most critical activity in the logistics management process. Inventory levels directly influence the profitability of a company since building up inventories lead to greater costs. Strategic orientation is therefore needed to maintain the most optimum level of inventory so that the customer service standards are met with the minimum level of inventory.

6 BBA404 Marketing Management 05 Distribution Management Page 6 of 8 Why do we Need Inventories? Several reasons are responsible for the existence of inventories in a distribution channel. Some of the most important ones are: Improves Customer Service Production facilities, which have to be programmed in advance for producing at specific capacities, cannot respond to fluctuating demands instantaneously. However, demand is normally very stochastic in the short term. This means that the exact level of demand cannot be accurately predicted in the short term. Hence, inventory is required to service the possible increase in demand that might occur defying the forecasts. Smoothens the Operations of the Logistics System Much of the inventory is actually carried out as a buffer to service unpredictable demand during the lead time after passing the order for replenishment to the production facility. Any logistics system will have a lead time between the order transmission and the order receipt. Reduces Costs While inventory pile up usually leads to higher costs, some cost-saving is also effected due to inventory management. For instance, the capability to carry inventory in the system enables a production facility to avail of quantity discounts from its raw material suppliers. Objectives of Inventory Management Inventory management aims to achieve the perfect balance between achieving customer service targets and reducing inventory costs. The customer service demands are expressed in terms of product availability. The term used to express the service level is fill rate (FR). Fill Rate is defined as the ratio of the number of orders completely serviced to the total number of orders received during a particular time period. Fill Rate Expression The expression fill rate is actually used to express two different perspectives to indicate the service level of the logistics system. These two measures are line fill rate (LFR) and order fill rate (OFR). Both the measures are used to denote the extent to which the warehouse or the inventory management system has been able to fulfill the orders placed in the expected lead time. It is in reality an indication of the system's ability to anticipate the demand from the retailers or customers downstream. (Total number of units received) Line fill rate = (Total number of units ordered) To illustrate, the two measures are calculated for a single order from a distributor to a warehouse. The composite consists of orders for five different SKUs. Scenario-I Scenario-II SKU Order quantity Receipt SKU Order quantity Receipt A A B B C C D D E E Total Total Line fill rate = 95% Line fill rate = 76% Order fill rate = 0% Order fill rate = 80% (Total SKU categories for which 100% of units ordered were received) Order fill rate = (Total No of SKU categories ordered) As can be seen from the above example, the OFR is a more exacting measure of inventory management service levels. It is possible to have a high line fill rate with abysmal order fill rate. When the logistics system is planned, a specific fill rate figure is always kept in mind as a target. Further, different systems can be compared on the basis of the fill rates and the corresponding inventory level that is used to achieve those fill rates. If an inventory is high, the fill rate will consequently be high. However, the efficiency of a system is to achieve the same fill rate figure with fewer inventories. Costs Associated with Inventory The costs associated with inventory can broadly be classified into three: (i) inventory procurement costs, (ii) stock-out costs, and (iii) inventory carrying costs. If the inventory carrying cost is reduced by ordering lesser quantities of inventory each time, both the procurement and the stock-out costs will increase.

7 BBA404 Marketing Management 05 Distribution Management Page 7 of 8 Inventory Procurement Cost The inventory procurement costs are normally considered as the ordering costs for the inventory. These are fixed costs which have to be incurred in setting up the machinery, procurement of related materials, transportation, order processing, etc. Hence, when the order quantity is large, the procurement costs will come down. Stock-Out Costs Out of stock costs are incurred when an order is placed but cannot be filled from the inventory to which the order is normally assigned. The two types of out of stock costs are (i) cost of lost sales and (ii) back order costs. The cost of lost sales occurs when the customer withdraws the purchase order in case the product is not supplied within the tolerable waiting time. Back order costs occur when the purchase is delayed and not lost. Back orders create additional burden on the system with greater clerical time and associated costs in order processing and delivery. Inventory Carrying Cost Inventory carrying costs can be classified into four basic categories. (i) Capital costs (ii) Inventory service costs (iii) Storage space costs (iv) Inventory risk costs Capital costs Inventory investments Inventory carrying costs Inventory service costs Storage space costs Insurance and taxes Warehouse rent, Maintenance charges Inventory carrying costs Components of the inventory carrying costs Obsolescence Damage and pilferage Shrinkage Relocation costs Capital Costs To build up inventory sufficient capital has to be tied up for a considerable length of time. The capital cost of inventory is the cost of the capital tied up in the inventory. It is estimated that on an average this constitutes about 80% of the entire inventory carrying costs. Inventory Service Costs Inventory service costs mostly consist of insurance and taxes. Storage Space Costs These costs relate to the charges for the warehouse including the rent, maintenance charges, etc. Inventory Risk Costs Often inventory stored for a longer period of time might lose its value because of shrinkage, obsolescence, deterioration, etc. In the case of perishable items, the time period involved is very short. It is often necessary that someone bears this cost. Often the owner of the inventory bears this cost. However, the manufacturer takes responsibility for the expired stock from the retailers. TRANSPORTATION DECISIONS The transportation activity moves products to markets that are geographically disparate and provides added value to the customers when the products arrive on time, undamaged, and in quantities required. The utility provided by the transportation function is called place utility, while time utility is created by the storage function. However, without transportation function, the delivery of time utility will not be complete since transportation function decides how fast and how consistently a product moves from one point to another. Transportation is thus a critical logistics activity. It has been found that apart from the cost of goods sold, which is reflected in the inventory carrying costs, the transportation cost is the largest component of the logistical costs. The major decision areas in transportation include (i) mode selection, (ii) vehicle routing and scheduling, and (iii) shipment consolidation.

8 BBA404 Marketing Management 05 Distribution Management Page 8 of 8 Mode selection Generally, five modes of transportation are used in moving goods from one point to the other, viz., air, rail, road, water, and through pipeline. In reality, however, intermodal combinations are always resorted to. Vehicle Routing and Scheduling While one of the major objectives of logistics is to reduce the inventory storage time, the transportation efficiency also plays a major part in achieving this objective. Vehicle routing tries to find out the best path a vehicle should travel through a network of roads, rail lines, shipping lines, etc. so that the time and distance traveled is minimized to the maximum. The methods of routing a vehicle through a network has been solved by methods designed specifically for it. Most of these methods are highly analytical in nature and require powerful computers to solve practical problems. Vehicle scheduling problems are extensions of vehicle routing problems. In vehicle scheduling more realistic restrictions are included like restrictions on the number of stops on the route where goods have to be picked up/or delivered, the use of multiple vehicles with different capacity limitations of both weight and volume, restrictions on maximum driving time, etc. Freight Consolidation Freight consolidation activity is mainly intended to reduce the cost of transportation through bringing together smaller quantities of inventory in order to create a bigger quantity for transportation. This principle ensures the optimum sharing of fixed costs of transportation. Consolidation is achieved by: (i) consolidating the inventories which involves grouping different items together so that these items are transported together and not one or a few items together, (ii) vehicle consolidation where vehicles with less than truckload inventory are not allowed and consolidation of inventory into full truckload is preferred, (ill) warehouse consolidation where warehouses are located in such a way that large quantities of inventory are transported through large distances and smaller quantities are transported through smaller distances, or (iv) temporal consolidation where orders from the downstream are held so that larger orders are accumulated for transportation. Factors affecting Transportation costs Transportation costs are affected by a variety of factors. These factors can be divided into product-related factors and market-related factors. The product related factors include: (i) the density of the product, (ii) stow ability, (iii) the ease or difficulty in handling, and (iv) liability. The weight to volume ratio or density has a major part to play in deciding the transportation costs. Products which are heavy will usually require costlier transportation alternatives. The stow ability refers to the extent to which a product can fill in the available area. For instance, liquids like petroleum or food grains can completely fill the volume of the area available while machinery or automobiles will not fill the area to that extent. Products with greater stow ability will thus require relatively less transportation space. Ease or difficulty in handling is also associated with stow ability. Products that are uniform in their physical characteristics or that can be manipulated with material handling equipment require less handling expenses and are therefore less costly to transport. Often, products which have high value to weight, like electronic gadgets, crockery, etc. are easily damaged and cost more for transport. Some of the market-related factors that affect transportation costs are: degree of intermode or intramode competition, location of the markets, balance or imbalance of infreight traffic in and out of the market, seasonability of the product movements, etc. If the degree of competition between two types of transportation modes or between operators of the same mode is higher, it is possible to get transportation services at a lesser price. Location of the market will greatly affect transportation costs, as far-flung locations will usually incur greater transportation costs. In any geographical location there will be some freight being transported in and some freight being transported out. The freight being transported in is used for consumption while the freight transported out is for sale outside the geographical region. If the freight is transported in is more than that transported out, trucks or other transport vehicles will have to return back empty, which is inherently inefficient and will affect the transportation cost. Instead, if the vehicles can go back fully loaded, the costs of transportation will come down. If there is high seasonal variation in the demand and the consequent product movement, the transportation cost will be reduced since the bulk of the demand will be transported in fewer trips.