GOING TO MARKET:

CHAPTER 8 -- "Managing Channels Conflict"

8· Managing Channels Conflict

In theory, direct salcsforccs, independent distributors, andcaptive distributors in a multichannels distribution system comple­ment one another. In fact, they are often in conflict. Why? First, itis di1Iicult to ddine their teSpeetive roles and product-marketboundaries explicitly. Having defined their roles, it is even moredi1Iicult for producers to ensure that intermediaries operate withinthose boundaries; Both inter- and intrachannel conflicts often re­sult. Accordingly, producers' major concerns are (1) maintainingand delineating product-market boundaries among channels and(2) resolving day-to-day channel conflict issues.

Adversarial channcls relationships are ofseveral sorts:• the direct salesforce versus resellers• captive versus independent distributor networks• mass merchandisers versus local full-service distributors• distributor versus. distributor within and across tetritorial

boundariesIn this chapter, we consider the nature of conflict in each of

these categories and the ways producers seek to resolve channelsfrictions.

DIRECT SALES AND RESALE CHANNElSCOMPETITION

A simplistic'delineation of selling teSponsibilities is that directsalespersons cover the large accounts, and resellers take the smallones. In theory, carving up the market in this way serves three pro­ducer objectives: achieving distribution cost efficiency, maintainingdirect sales relationships with large and important customers, andgetting broad market coverage. In practice, the large/small dichot-

149

150 CHANNELSOR~ZATION Managing Channels Conflict 151

omy is an ill-defined and fluid boundary, which intermediaries areseldom prone to observe.

Ftom the ptoducer's point of view, the problem has severalfacets. Reseller intrusion in accounts served by direct sales oftenleads to end-market pricing inconsistencies, confusion among user­customers, and salesforce demoralization. A manager for WrightLine, a computer accessories supplier, reported this experience:

We'd find, for example, that our sales rep would work for sixmonths to cultivate some large account, and then one day wouldfind that an office products dealer would call and tell the customerthat he could sell the same Wright Line products out of hisMediaLink catalog [WL's catalog] for less than our rep wasquoting.

Our sales reps complain that their customers see Wright Lineproducts in these catalogs at lower prices than what they are quot­ing. Every month there's at least one instance where one ofour repshas lost an order to a catalog account or whose credibility is beingquestioned by a customer who saw lower published prices for thesame products in someone else's catalog.

As these occurrences suggest, a major contributing factor ininterchannel competition lies in differential resale price structures.

. DiJferent channels obtain supplies of product at prices that maygive one channel a cost advantage over another. Generally, compa­nies that sell to different classes of buyets at different prices tty toensure that product sold at the lowest prices does not flow intochannels and market segments in which prevailing prices are higher.

One way that some companies have sought to reduce directsales reseller conflict is to set quantity discount schedules that en­able large user accounts to buy large quantities at prices equal to orlower than the prices charged to distributors fot like quantities. Forexample, the Lotus Development Corporation's price schedule forits software programs included the well-known Lotus 1-2-3 spread­sheet program, which became effective as of 1985. Exhibit 8.1shows the quantity price schedule for distributors that purchasedfrom Lotus and sold to retailers. Exhibit 8.2 is the schedule ofprices direct to large retail chains; to large OEMs such as IBM,DEC, and Wang; and to large software users. As a comparison ofthe two schedules indicates, "house accounts" buying direct inquantities as low as 2,000 units could purchase at 1% under thedistributor price; at 40,000 units and over, they had a 5% price

Exhibit 8.1 Lotus Distributors' Volume-Purchasing TermsDisoount Oft'

Annual Urn'" Purchased' Retail List ('If» Price"

50,000 and below 3650,001 to 100,000 37

100,001 to 150,000 38150,001 to 200,000 39200,001 and over 40

'A uni' means one 1-2-3, Symphony. 0' Jazz prognm. Othct Lotos programs, companiooprod\lCtll, DC opgndcs did not coon' towud discoun, volumes bot wm: pwdwed at the..... diJcowtt lcvds achieved throogh uni, pwehascs."lbcsc: diJcowtt lcvds became _ve in Sepl=bct 1985. Pri", to dw, they wen: each S'lbhigher.

Exhibit 8.2 Lotus House Account Volume-Purchasing TermsDiscount Oft'

Annual Urn'" Purchased Retail List ('If» Price

2,000 to 12,0ll0' 3712,001 to 20,000 3820,001 to 30,000 3930,001 to 40,000 4040,001 and over 41

"All house accounts had to commit to a minimum of 2,000 units. Since a majority of suchaccounts wen: large retail chains, there never was a problem getting this commitment.

advantage. Given these price relationships, there would be no roomfor resellers to underprice Lotus in selling to accounts able to buyin quantities of2,000 and above.

Prior to September 1985, however, distributor volume dis­counts had been 5% higher aCtoSS the board, giving distributors aprice advantage over large user-customers in all quantity brackets.The Lotus price revisions implemented an explicit decision to servelarge accounts through its direct salesfurce.

While some firms have utilized price schedules that discouragedistributors from selling to direct accounts, the inherent competi­tion between the direct salesforce and rescllers is more often fos­tered by producer pricing practices, which encourage rcsellers tocompete with the direct salesforce for large volume business.Deeper discounts for distributors than for user-eustomers in thesame quantity brackets allow distributors to quote to large custom­ers prices that are below producer list prices.

152 CHANNELSOR~ZATION MilnRtJing Channels Conflict 153

In some cases, the large customer may take a price-cutter role.A sigoificant disparity between the producer's list prices and themuch lower prices it quotes on competitive bids for large quantitiescan create arbitrage opportunities for user-customers that buy atlower price and move surplus supplies into market segments whereprodu= prices are higher.

Minimizing direct sales-reseller competition becomes a mat­ter, first, of clearly defining their respective domains and, second,of coordinating pricing actions to reduce the rewards that may begained by moving goods from one class of buyer to another. How­ever, this may be easier said than done ifthe producer is to be pricecompetitive in segments that differ in bargaining power and in thepricing conventions (e.g., competitive bid, published list, dis­counted list) they observe. Pricing coordination, as an arbitragedeterrent, may be supplemented by tracking, to the extent possible,large shipments to the low-price user-customer, both direct andthrough distributors, to ensure that the quantities purchased arenot in excess of those which will be consumed by the purchaser.While tracking large shipments is frequently done by suppliers, thisaction, too, is never a panacea.

In the discussion that follows, we turn to defining the respec­tive roles of the direct salesforce and resellers.

Establishing Reseller-Direct Sales Boundaries

Why do producers want to draw lines between their directsalesforces and their independent distributors in moving theirproducts to market? There are several reasons. The first and mostimportant is profit maximization. Dealing directly with large ac­counts may entail lower expense-to-revenue ratios and higher netmargins than does selling through a distributor at wholesale prices.A second, and related, reason is that it may be important to controlthe large customer relationship rather than leave it in the hands ofan external intermediary. Third, each customer has needs that maybetter be served through one channel or another, and each productrequires its own level of sales and technical effort. There may beopportunities, then, to match product groups and customer sets totypes ofchannels and to optimize selling effectiveness.

Producers may draw the lines in at least three ways. The first

and probably the most common is to reserve certain specificallynamed accounts or classes of accounts for direct sales. The secondis to channel certain product categories through resellers and othersthrough the direct salesforce. The third method is to set some limitsexpressed in terms of order size or of customer annual purchasevolume that delineate the domains ofdirect sales and resellers.

r In choosing a way of drawing the lines, it is relevant to takeinto account the way user-customers buy. Further, any approach todefining channels turf should, of course, be implementable. In thediscussion that follows, we consider customer class, product class,and purchase amount as dimensions along which selling responsi­bilities may be allocated between a direct salesforce and an indepen­dent distributor network.

Demarcation by Customer. Reserving certain customersofclasses or accounts for direct selling is a long-established practice.Despite occasional challenge, it has survived the scrutiny of thecourts as being a legitimate exercise of the supplier's rights inchoosing to whom it will sell-as long as such exercise does nothave a detrimental effect on interbrand competition and is not anelement ofa conspiracy in restraint oftrade.1

As discussed previously, certain accounts may be reserved fordirect selling because direct sales expenditures will be less than thenet reduction in account revenues represented by the distributordiscount. In addition, suppliers may wish to have direct relation­ships with their large accounts for purposes of negotiating prices,providing technical support, and meeting the large customers'other service needs. A direct relationship may be important as wellifnegotiations'with large buyers tend to set market price levels.

With a long tradition of selling its lines of stationary air com­pressors through a direct salesforce only, Ingersoll-Rand's Station­ary Air Compressor Division (SACD) continued to reserve certaindesignated accounts and classes ofcustomers for direct selling afterthe division began building an independent channels network in1960. Its policies in this regard were explicitly laid out in its salesmanual as follows:

, For legal reference, ...DtmtIUlB. Ria Tire Co. v. MidJelin r... Cotp., 638 F2d IS (4th Or)ccrt deni<d, 454 US 864 (1981), andR"D~S"PPly,1m. v. Liplid CRrl10nk Cotp., 637F2d 1001 (5th Or), cert deni<d, 454 US 827 (1981).

154 CHANNELS ORGANIZATION Managing Channels Conflia 155

Exhibit 8.3 Allocation ofSales Responsibility fur StationaryAir Compressors by 1YPe and Size to Sales Channels for1960, 1973, and 1984

neling product through direct sales, there were significant revenuesto be obtained from aftermarket service and spare parts sales.

Delineation by PnHlfla Classifkation. Some companiesdistinguish between reseller and direct sales roles in tenus of theproducts given to each channel to sell. Again, SACD is a case inpoint. In addition to class-of-customer boundaries, SACD differ­entiated between its direct salesforce and resellers in tenus of prod­uct size and type. However, an increasing number of SACD prod­ucts were being reclassified to the distributor domain. Exhibit 8.3indicates the buildup in the list of distributor-class products be­tween 1960 and 1984.

Product-class distinctions between channels implicidy assumethat potential CUStomers can be sorted out by the category ofprod­uct they buy (in this case, large, medium, or small air compressors)and the channels through which they typically source. But as notedin the Wright Line example the same customers often wish to buythrough different channels at different points of time, dependingon the purchase order size, urgency ofneed, and desire fur purchaseconvenience. Furthermore, they are typically customers fur the fullproduct line range.

Direct Salesforcc Rccips 50 hp andover

Rotaries ISO hpand over

1. It is the policy of Ingersoll-Rand Company to sell directlyto all users those items of equipment not specifically de­scribed in the selling agreement. Inasmuch as Ingersoll­Rand calls on these customers direct to sell engineeredproducts, we also reserve the right to sell all products on adirect basis to accounts which are designated as "SpecialAccounts."

2. It is the marketing policy of Ingersoll-Rand Company tosell our equipment direct to Original Equipment Manufac­turers and N ationa! Accounts, where this best serves theinterest of the customer.

3. It is the policy of Ingersoll-Rand Company to encourageand assist established and officially designated distributorsto sell equipment of the type described in the SellingAgreement to state, county and city governments. How­ever, Ingersoll-Rand reserves the right to sell to local gov­ernments direct if the distributor is not properly represent­ing us or is unable or unwilling to handle the sale.

4. It is the policy of Ingersoll-Rand Company to sell directlyall of its products to the United States Government and allof its agencies, including the Armed Forces.

5. It is the policy of Ingersoll-Rand to sell distributor prod­ucts through privately owned distributors. However, whenthe privately owned distributors are not growing or show­ing sufficient market penetration or where we cannot findprivate capital or expertise, Ingersoll-Rand reserves theright to operate company-owned Distributor stores.

At least in the early days of multichannel distribution forSACD, one reason fur preserving direct sales relationships with"special accounts" and certain classes of customers was the level oftechnical expertise and service that these accounts required. It islikely that SACD's management regarded their technical resourcesas being better than their new distributors'.

Equally important, the economics of direct selling to this classof customer would clearly be more attractive than serving itthrough indirect channels. Beyond the cost effectiveness of chan-

Distributon

Air Centers

Manufacturers'Reps

1960

R':&;,under

1973

Rccips ISO hpandover

Rotaries 450 hpandover

All ccntrifugals

Rccips under150hp

Rotaries Wlder150hp

Rccips Wlder150hp

Rotaries under150hp

1984

~~Ohp

All ccntrifugals

R.ecipsunder250hp

Rotaries under450hp

Rccips WJder250hp

Rotaries Wlder450hp

~.k5hpand

156 CHANNELS ORGANIZATION MllnRging Chllnnels Conflict 157

Thus, product-class distinctions for purposes ofdelineating di­rect sales and reseller domains are useful only when, as in the caseof Ingersoll-Rand, broad customer categories can be linked withparticular product groups and channels.

Account PotentW lind Size-oj'-QrIIer BoundRries. Asnoted earlier, many manufacturers act on the premise that the roleof resellers is to serve the smaller accounts. When accounts grow tosome predetermined size, the direct salesforce may then take themover. There are, of course, two problems with moving customersfrom a reseller to a direct sales relationship. One is that the cus­tomer itself may have some preference for buying from local dis­tributors rather than sourcing direct. The other is that such a prac­tice hardly builds goodwill with the resale channels network.

Size-of-account guidelines served, for example, at Control Da­ta's Peripheral Products (PPCo) business unit to distinguish directcustomers from those which would be reached through distribu­tors. The following comment from one ofPPCo's distributors sug­gests the reseller's concern about losing large accounts to its sup-

plier:PPCo has probably the largest salesforce ofany company sell­

ing disk drives, and their order quantities for the direct versus dis­tributor cutoffpoint tend to be somewhat lower than the industrynorm. The result is that we may develop a small account into onethat now orders at least a thousand units annually, but the fruits ofthat work go to the manufacturer. That's of course a generic issue inany manufacturer-distributor relationship. But my point is that wecan keep an account "our account" longer with some other manu­facturers because of their pricing policies.Bounding resale and direct market segments by size of order

may be an even less desirable method of categorization. Thismethod means sorting out, day-to-day, those sales leads to be ap­proached by direct salespersons and those to be turned over to re­sellers. First, it is often difficult, ifnot impossible, to know how biga business opportunity might be in terms of immediate potentialrevenue anellor follow-on sales. Second, serious difficulties oftenarise in persuading direct sales reps to turn over leads to resellersand vice versa, regardless of revenue potential. Companies attemptto resolve this difficulty by offering lead referral bonuses calculated,usually, as a percentage of the dollar amount of a consummated

:~'

sale. Such incentives, however, seem often to be ineffective becausethey fall short of what the referring agent, either reseller or directsales rep, could earn by making the sale itself.

At Honeywell Information Systems Division (ISD), field salesmanagers were instructed to channel all sales opportunities under$150,000 through resellers (in this case, VARs) and, above thatamount, to the direct sales reps. Going to market through multiplechannels, however, sometimes led to questions of which channelwould best serve lSD's competitive positioning in any particularinstance. A headquarters marketing manager commented,

Usually a direct sales rep doesn't want to have competitionfrom the indirect sales channel and often will not give a referral tothe VAR reseller on his own initiative until it looks like he is notgoing to be able to ger the business anyhow. In one instance re­cendy, in a large account, a piece of business involving 200 sysremsfor large dollars was out for bids. When the Honeywell direct salesrep realized that he was losing the business, he wanted to call in aVAR reseller because it was a specialized application, but it was toolate. The winner turned out to be a large compurer supplier whohad teamed up with a systems house. What we would like to say tothe branch manager is "Put Honeywell's best foot forward to makesure that we win the business with the best solution, and we willreward you no matter where the business comes from."The marketing manager's example suggests another weakness

in drawing lines based on size-of-order or account potential: Sucha guideline gives no consideration to which channel type in a mul­tichaimel system is best equipped to secure the order and to provideaccount service.

lSD's general manager spoke of two other concerns in turningleads over to resellers:

Our biggest VAR account also carries a competitor's line. IfanISD rep puts in a lot of rime helping it to get an order, it's rimewasted ifthe VAR doesn't supply DPS-6 systems but sells competi­tive equipment instead.

& a practical matter, too, it may be difficult to know in anyindividual instance on which side of the line the sale should fall.Let's say, for example, Harvard puts out a bid for a small system,and maybe a VAR dealer who is a specialist and has a Jot ofexperi­ence has agood solution to what Harvard wants. Maybe the busi­ness is ouly potentially halfa million dollars, and our direct sales repshouldn't spin his wheels going after it. But on the other hand,

156 CHANNELSORG~ZATION Mllnaging Chllnnels Conflict 157

Thus, product-class distinctions for purposes ofdelineating di­rect sales and reseller domains are useful only when, as in the caseof Ingersoll-Rand, broad customer categories can be linked withparticular product groups and channels.

Account Potentitd lind Size-uf-Drder Boundtwies. Asnoted earlier, many manufacturers act on the premise that the roleof resellers is to serve the smaller aCcounts. When accounts grow tosome predetermined size, the direct salesforce may then take themover. There are, of course, two problems with moving customersfrom a reseller to a direct sales relationship. One is that the cus­tomer itself may have some preference for buying from local dis­tributors rather than sourcing direct. The other is that such a prac­tice hardly builds goodwill with the resale channels network.

Size-of-account guidelines served, for example, at Control Da­ta's Peripheral Products (PPCO) business unit to distinguish directcustomers from those which would be reached through distribu­tors. The following comment from one ofPPCo's distributors sug­gests the reseller's concern about losing large accounts to its sup­plier:

PPCo has probably the largest salesforce ofany company sell­ing disk drives, and their order quantities for the direct versus dis­tributor cutoffpoint tend to be somewhat lower than the industrynorm. The result is that we may develop a small account into onethat now orders at least a thousand units annually, but the fruits ofthat work go to the manufacturer. That's ufcourse a generic issue inany manufacturer-distributor relationship. But my point is that weean keep an account "our account" longet with some other manu­facturers because of their pricing policies.

Bounding resale and direct market segments by size of ordermay be an even less desirable method of categorization. Thismethod means sorting out, day-to-day, those sales leads to be ap­proached by direct salespersons and those to be turned over to re­sellers. First, it is often difficult, ifnot impossible, to know bow biga business opportunity might be in terms of immediate potentialrevenue and/or follow-on sales. Second, serious difficulties oftenarise in persuading direct sales reps to turn over leads to resellersand vice versa, regardless of revenue potential. Companies attemptto resolve this difficulty by offering lead referral bonuses calculated,usually, as a percentage of the dollar amount of a consummated

sale. Such incentives, however, seem often to be ineffective becausethey fall short of what the referring agent, either reseller or directsales rep, could earn by making the sale itself.

At Honeywelllnformation Systems Division (ISO), field salesmanagers were instructed to channel all sales opportunities under$150,000 through resellers (in this case, VARs) and, above thatamount, to the direct sales reps. Going to market through multiplechannels, however, sometimes led to questions of which channelwould best serve ISO's competitive positioning in any particularinstance. A headquarters marketing manager commented,

Usually a direct sales rep doesn't want to have competitionfrom the indirect sales channel and often will not give a referral tothe VAR reseller on his own initiative until it looks like he is notgoing to be able to get the business anyhow. In one instance re­cently, in a large account, a piece uf business involving 200 systemsfur large dollars was out fur bids. When the Honeywell direct salesrep realized that he was losing the business, he wanted to call in aVAR reseller because it was a specialized application, but it was toolate. The wirmer turned out to be a large computer supplier whohad teamed up with a systems house. What we would like to say tothe branch manager is "Put Honeywell's best foot forward to makesure that we win the business with the best solution, and we willreward you no matter where the business comes from."The marketing manager's example suggests another weakness

in drawing lines based on size-of-order or account potential: Sucha guideline gives no consideration to which channel type in a mul­tiChannel system is best equipped to secure the order and to provideaccount service.

ISO's gener:i.l manager spoke of two other concerns in turningleads over to resellers:

Our biggest VAR account also carries a competitor's line. If anISD rep puts in a lot of time helping it to get an order, it's timewasted if the VAR doesn't supply DPS-6 systems but sells competi.tive equipment instead.

As a practical matter, too, it may be difficult to know in anyindividual instance on which side of the line the sale should fall.Let's say, for example, Harvard puts out a bid fur a small system,and maybe a VAR dealer who is a specialist and has a lot ofexperi­ence has agood solution to what Harvard wants. Maybe the busi·ness is only potentially halfa million dollars, and our direct sales repshouldn't spin his wheels going after it. But on the other hand,

RESELLER RIVALRY: INDEPENDENTDISTRIBUTORS VERSUS CAPTIVE BRANCHES

"IfGESCO puts a captive branch in New Bedford, I'm drop­ping my GE lines!" exclaimed the owner ofone multilocation elec-

maybe the job requires a lot of networking where Honcywcll isstrong, and it will mean a foot in the door at Harvard and we cansell a lot more equipment later on, such as LANs and control sys­tems. But ifwe don't have the best solution and it's a specific appli­cation that doesn't have any follow-on opportunities, then maybeit's best that that piece of business be picked up by one ofourVARs. In general, I don't want my direct sales reps going after thesmallicads and being diverrcd from the $1 million opportunities.In summary, producers attempt to minimize direct sales-re-

seUer contentions in several ways. One way is by using differentchannels for different product sets. If market segments can be dif­ferentiated in terms of the products they buy and the channels theyuse, this strategy may be effective. It is not effective, however, ifcustomers tend to buy from several channels sources, either concur­rently or at different points in time, along a wide range ofproducts.

Another approach is to segregate direct and resale market seg­ments by size ofaccount. The drawback here is the inevitable strainin supplier-rcseller relationships that results when resale accountsgrow in size and are taken over as "house" accounts. Further, shift­ing a customer from reseUer to producer roles may not be in accordwith the customer's wishes.

Delineating direct and reseUer markets by size of potential or­der is often impractical to enforce because salespeople are inher­ently reluctant to turn over leads. In addition, size of order indi­cates neither future revenue potential nor the relative advantages ofproducer and reseUer reps in serving the account.

Probably the most workable scheme is to specify, at the timeofgranting the franchise, that the franchisee may sell to all custom­ers and classes of trade except those specifically reserved for directselling. In establishing account and class-of-trade restrictions, theproducer sets explicit boundaries that arc relatively simple to ad­minister, are consistent with customer buying behavior, and willserve to maximize sales margins. However, in any case boundariesbetween direct sales and resellers arc difficult to draw, as a practicalmatter, with any assurance of restricting each to its intended d0­main.

1 & discussed earlier, captive distribution systeIl1S arc organized lUi business units in indus­trial manufacturing companies and serve as wholesale channels through which the producingdivisions may move their products to market, in addition, typically, to going through inde­pendent rcsdlers. Like any independent chain, the captive network consists of a complex ofsales branches that stock and sdL a wide range of itemS sourced not only from sister depart­ments but from O1Jtside suppliers as well.

159

trical distributor in the Greater Boston area. Feelings run strongamong distributors carrying the lines of suppliers that sell throughcaptive distribution operations> in their territories. The complaintsof the independents tend to be based on a sometimes ill-foundedperception that the producer favors captive branches in its pricingpractices, in allocating product supplies, and in providing a rangeof support services. Ironically, captives often perceive independentsas the favored channel. Franchisees' appeals for support in theircompetition with captive branches go to their suppliers' productdepartment managers and sales representatives, wbo are dependenton them in making their sales quotas. Product department manag­ers will in turn tend to distance themselves from the captive distri­bution operation and exert their influence internally to contain itsgrowth and market power. Thus, independent distributors may ele­vate the interchannel rivalry to another level by working to exacer­bate the product department-sales department relationships, andoften with considerable effect. Their weight may be felt to an evengreater extent if they speak through an organized distributor advis­ory council.

Two principles may usefully be observed if the two channelsare to coexist: sales program stabiliry and market segment differ­entiation. Program instability-a pattern of opening and closingcaptive sales branches in different market areas, a changing mix ofproducts going through these branches, or inconsistent price andpromotion policies-is almost certain to escalate the level of con­flict. To the extent that the role of the captive operation is knownand understood in the market and remains relatively constant, in­dependent resellers may develop their own market positions withsome degree oflong-term security.

In addition, to the extent that the captive operation is focusedon different product-market segments than the independents, thesense of unfair competition and local market rivalry may be less­ened. We have, in fact, observed a tendeney for each channel todifferentiate itself in terms of customer groups. For example, cap­tive distributors in the electrical equipment industries, such asGESCO and WESCO, seem to focus on the large construction

Managing Channels ConflictCHANNELS ORGANIZATION158

160 CHANNELS ORGANIZATION Managing Channels Conflict 161

market segment, leaving residential construction to independents.The reason for this focus may be to build on the strength of theirengineering competence. Nevertheless, by targeting those dasses ofaccounts not served by small, local independents, the producer­owned distribution network may cool the emotional reactions ofthe independent reseller, which perceives its single most formidablecompetitors to be its suppliers. An appendix to this chaprer consid­ers, in greater depth, the role of captive distribution in the corpo­rate environment. In many large industrial product firms, boththose with and those without a captive distribution system, thereseems to be considerable uncertainty about its relative benefits andmission.

THE SPECTER OF THE DISCOUNT CHAINIndependent resellers perceive themselves as competing, on

the one hand, against captive distributor branches and, on theother, against large national chains-chains such as W. W. Graingerin the electrical supplies industry, and retail mass merchandisers,such as Grossman's, True Value and K mart-selling through cata­logs and through muhiple branch locations. While these channelsoften do not compete directly for the same customer sets as theindependents, they are nonetheless threatening to the small, localindustrial distributor. Traditional independents typically react bypressing their suppliers not to franchise the large chains, and maythreaten to drop their suppliers' lines if they do.

Producers can respond to this form of interchannel rivalry inone of three ways. The first is to give up one channel as the priceof retaining the support and cooperation of the other. For example,Square D entered consumer retail channels in 1981 by franchisinglarge mass-merchandising chains to carry selected lines of electricalproducts that would appeal to do-it-yourself customers as well asto tradespersons engaged in electrical contracting and small con­struction. It discontinued this facet of its distribution program fiveyears later, in part because of concerns about interchannel compe­tition. Some Square D distributors were already selling to retailoutlets, and Square D's managers did not want to be in the ambi­valent position of supplier and competitor. Nor did the managersthink it desirable to have consumer retail outlets competing withSquare D industrial distributors for the business of the small elec­trical contractors. There was also some concern that the low pricesof the retail chains would serve to undercut the business of the

small electrical contractors engaged in home remodeling. In thiscase, the response was to forgo incremental sales revenues thatmight have been realized through mass merchandisers in favor ofsupporting the independent industrial distribution channels.

Interchannel rivalry such as that experienced by Square Dwould seem diflicult to contain without the producer sacrificing thesupport ofone channel or another. As in the case ofSquare D, then,one option is to be highly selective in the types of channels thatmake up the distribution system so as to avoid interchannel rivalry.

The second way that the producer may elect to ease interchan­nel conflict is by developing different brands or by supplying a pri­vate brand to the mass merchandiser. Again, the cost may be someloss of revenue as compared with marketing under a single, widelyaccepted brand name. A third option, ofcourse, is to accept somelevel of conflict and reseller resentment in the interest of gainingfull market access through a range ofchannels.

The answer clearly depends on an assessment of channel reve­nue potential, the value among users ofthe producer's brand name,and the strength of the producer's field salesforce both at the dis­tributor and the user levels. The greater the producer's power inthe end-market, the more tolerance it may have for interchannelcompetition without risking the disaffection of its local distributornetwork, and the greater its freedom in going to market through avariety ofchannels.

TERRITORIAL COMPETITIONWITHIN CHANNELS

On the one hand, producers often find it essential to have mul­tiple representation in a trading area; on the other, they may wishto constrain the extent of price competition among distributorsboth within and across territorial boundaries. Intensive intrabrandprice competition at the resale level may discourage resellers fromstocking and actively promoting the supplier's line. It will certainlysuppress distributor value-added services, which increase the resell­er's costs and lower its margins. Finally, intensive intrabrand pricecompetition among resellers may escalate into intensified inter­brand price competition at the producer level, as producers lowerprices to resellers, enabling the latrer to reduce their prices in tum.

Resale price competition may result from the practice of fran­chising a large number of distributors in a trading area. It may be

SUMMARY

Designed to reach a range ofmarket segments in cost-effective ways,multichannel distribution systems nevertheless generate inter- and intra­channcl rivalries. Generally, it is in the producer's interest to contain intra­brand competition among different classes of reseIlers for the business ofparticular classes ofaccounts and to discourage intensive intrabrand resaleprice competition.

Mitigating competitive rivalry among and within channels is consid-

fueled as well by producers' quantity discount schedules that en­courage distributors to order in amounts larger than they need toserve existing customers. Excess inventories may then be movedeither by competing for other distributors' user accounts or byshipping to user-customers or resellers in other sales territories.Further, distributors may divert, to other end-users or resellers,parts ofshipments purchased at substantial discounts and intendedto fulfill producer contracts with large end-users.

Depending on the conditions that lie behind intensive resellerprice rivalry, possible ameliorative actions include (1) reducing theintensity of distribution-although this action may decrease salesrevenues, (2) adjusting quantity discount schedules if it appearsthat distributors are "dumping" at low prices, and (3) withholdingvarious forms of producer support from those resellers which arechronic price cutters. As one marketing manager explained, some­times a producer can discipline a distributor quite effectively:

Distributor Xwas hell-bent upon reducing our prices in themarket. Repeared requests didn't seem to help. Luckily, Neil, oursales rep, controlled the four largest customers in that territory. Hesimply routed the following quarter's order through our other dis­tributor, who had a more disciplined approach to the market.Frankly, the customer didn't care about prices; Neil's support andrelationship were more important.All of this presumes that tight control of prices at the resale

level is in the best interests of the producer. It may be, however,that price competitiveness at the resale level is necessary to preservethe producer's market share, particularly if its suggested list pricesare relatively high. Accordingly, any measures that the producermay take to secure conformance to any suggesred pricing scheduleshould be informed by a knowledge of price competition at localmarket levels.

163

APPENDIXA NOTE ON CAPTIVE DISTRIBUTION SYSTEMS

The conflicts that develop in the independent distributor-<:ap­rive distributor rivalry are reflected, as well, inside the producer's

erably facilitated if the producer has widely accepted product 1ines and astrong end-market presence. Such presence is needed, first, to obtain rel­evant market information fur purposes of furmulating tactical plans and,second, to work with distributors in influencing their sales programs.Strong field sales operations are also important in monitoring, to the ex­tent possible, the flow ofgoods through distributors to users, particularlyunder producer-negotiated contracts.

The extent of con1liet in multichannel systems depends also on thestructure of the system. Producers may have to make some choices amongchannels that are inherently in con1liet-such as small, local industrial dis­tributors and large, national discount chains-and between more or lessintensive distribution. In addition, effective channcls management re­quires that any boundaries drawn among channels in a multichannel net­work be enforceable. That is, the delineation of selling responsibilitiesought to be consistent with the way user-customers buy, and ought toreflect the natural capabilities, market segment orientations, and strategiesofdifferent types ofintermediaries. In other words, the strategy should beimpiementable at the field level.

This discussion has stressed the significance ofpricing inconsistenciesas a prime source ofinter- and intrachanncl price rivalries. Clearly, acentralelement in any program to constrain price contention at the resale levelmust closely integrate distributor quantity/price schedules, suggesred re­sale prices, and prices arrived at through producer negotiations. In prac­tice, however, inconsistent pricing tactics often result from the needs ofmanufacturing plants to maintain steady levels ofproduction and to moveinventories into the channels.

Finally, constructive channels relationships are built on the clarityand stability of the producer's distribution strategy and practices. Themost successful firms have consistent marketing policies, coherent distri­butinn systems struetures, and a strong market presence. In addition, theyseem carefully to avoid preferential treatment among channels in the in­terest ofenlisting the full cooperation ofeach.

In the next chapter, we treat still another category of interchannelcon1lict: authorized versus unauthorized channels competition and the re­sulting emergence of so-called gray markets, in which goods may be pur­chased at prices substantially below manufacturers' suggesred list prices.

Managing Channels ConflictCHANNELS ORGANIZATION162

164 CHANNELS ORGANIZATION ManRging Channels Conflict 165

organization as different internal constituencies support one chan­nel or the other. In fact, captive distribution business units typicallyhave an unclear mission, with their dual objectives-maximizingsales, profits, and return on investment; and maximizing the salesrevenues of their sister product departments-often at odds withstrategic and operating decisions.

Given these conflicting performance measures, the captivesales organization's contribution to corporate profits relative to itsuse of corporate assets is often questioned by product departmentmanagers. On the other hand, captive distributor managers oftenexpress the view that the strength they derive from the parent­company affiliation may be more than offset by the competitiveconstraints imposed on them by operating in this larger corporatecontext. The fullowing discussion focuses on WESCO, one of thelargest and best-known captive distribution systems in the world,to illustrate the issues often encountered in supporting a captivedistribution operation, developing and implementing its strategy,and assessing its perfurmance.

In 1985, with 243 branches in the Unired States, 37 in Can­ada, 4 in Saudi Arabia, and 1 in Singapore, WESCO was believedby industry observers to be the second largest of fuur full-line na­tional electrical distributor chains in the United States. The otherthree were Graybar, with 1985 sales of approximately $1.6 billion;General Electric Supply Company (GESCO), with sales estimatedat about $.94 billion; and Consolidated Electrical Distributors(CED), with 1985 sales estimated at $.69 billion. GESCO, likeWESCO, was also a captive distribution system.

WES~O began operations in 1922 when George Westing­~use a9wred seven baIikrupt independent distributors to main­tain Westingh?use's market access in these particular trading areas.~~CO connnued to grow by acquiring other financially troubleddis!Dbutors and by developing its own branches in some other 10­canons. As of 1985, about one-third ofWESCO's sales were oftheproducts of its Westinghouse sister divisions; two-thirds consistedofthe noncompeting lines ofover 600 electrical manufacturers. Cenain role constraints in this corporate context areexp~m these comments from one WESCO manager:

First, part ofour mission is to sell Westinghouse products andWI: ..wy carry competing lines. Westinghouse produet5 are highquality and well respected but not always the best, in price or per_

fonnance terms, in a given product area. But unlike an independentdistributor, we can't shop around for another supplier.

Second, unlike an independent, WI: can't threaten to go else­where ifa product division doesn't meet our requirements on pay­ment terms or stocking levels. That decreases our negotiating lever­age with the product divisions in comparison with independentdistributors.In addition, certain practices tended to impact WESCO's fi­

nancial perfurmance. One WESCO manager noted,I feel we incur what you might call "good samaritan" costs as a

captive distributot For example, for many product divisions WI:

gear our purchases to complement their manufacturing cycles, notmarket conditions. Therefore, WI: carry a higher average inventoryon many Westinghouse lines in comparison with the independent,who can source more opportunistically from a number ofsuppliers.We, however, are tied to the manufacturing cycle ofthe product di­vision, which hurts our inventory levels even as it helps the productdivision's throughput.

I also believe some product divisions tend to take WESCO forgranted and give us less service support than they give to their inde­pendents. We provide more functions for the product division thanthe average independent distributor does.

Further, corporate policies affected WESCO. According toone WESCO manager,

Our employees are covered by the Westinghouse benefits pack­age, which is more generous than the benefits offered by most inde­pendent distributors. In rum, the WESCO branch pays for the ben­efits. Up-front salary, howeva; is better at many independentdistributors than at WESCO. We lose some yoWJgC! reps, who arc

generaUy more concerned with the cash compensacion than withlonger-term benefits.

. Finally, aWestinghouse corporate executive suggested the fol-lowmg:

. WestingJtouse;'s investment in WESCO is largely investment inmventory and receivables. As a result, our investment in WESCO ismore fluid than in~estments made in manufacturing divisions.

Overall, I believe the ~evant numbers and ctiteria for judgingWESCO's perfurmance are different than the criteria usually em­ploYe<! to judge the perfurmance ofour manufacturing units. There~ "hidden econonues" embedded in a captive distribution opera­tIon, an mtricate mingling ofcosts and benefits. And any specific

164 CHANNELS ORGANIZATION Managing Channels Conflict 165

organization as different internal constituencies support one chan­nel or the other. In fact, captive distribution business units typicallyhave an unclear mission, with their dual objectives-maximizingsales, profits, and return on investment; and maximizing the salesrevenues of their sister product departments-often at odds withstrategic and operating decisions.

Given these conflicting performance measures, the captivesales organization's contribution to corporate profits relative to itsuse of corporate assets is often questioned by product departmentmanagers. On the other hand, captive distributor managers oftenexpress the view that the strength they derive from the parent­company affiliation may be more than offset by the competitiveconstraints imposed on them by operating in this larger corporatecontext. The following discussion focuses on WESCO, one of thelargest and best-known captive distribution systems in the world,to illustrate the issues often encountered in supporting a captivedistribution operation, developing and implementing its strategy,and assessing its performance.

In 1985, with 243 branches in the United States, 37 in Can­ada, 4 in Saudi Arabia, and 1 in Singapore, WESCO was believedby industry observers to be the second largest of four full-line na­tional electrical distributor chains in the United States. The otherthree were Graybar, with 1985 sales of approximately $1.6 billion;General Electric Supply Company (GESCO), with sales estimatedat about $.94 billion; and Consolidated Electrical Distributors(CED), with 1985 sales estimated at $.69 billion. GESCO, likeWESCO, was also a captive distribution system.

WESCO began operations in 1922 when George Westing­house acquired seven barikrupt independent distributors to main­tain Westinghouse's market access in these particular trading areas.WESCO continued to grow by acquiring other financially troubleddistributors and by developing its own branches in some other lo­cations. As of 1985, about one-third ofWESCO's sales were of theproducts of its Westinghouse sister divisions; two-thirds consistedof the noncompeting lines ofover 600 electrical manufacturers.

Certain role constraints in this corporate context are expressedin these comments from one WESCO manager:

First, part ofour mission is to sell Westinghouse products, andwe rarely cany competing lines. Westinghouse products are highquality and well respected but not always the best, in price or per-

furmance terms, in a given product area. But unlike an independentdistributor, we can't shop around for another supplier.

Second, unlike an independent, we can't threaten to go else­where ifa product division doesn't meet our requirements on pay­ment terms or srocking levels. TItat decreases our negotiating lever­age with the product divisions in comparison with independentdistributors.

In addition, certain practices tended to impact WESCO's fi­nancial performance. One WESCO manager noted,

I feel we incur what you might call "good samaritan" costs as acaptive distributor. For example, for many product divisions wegear our purchases to complement their manufacturing cycles, notmarket conditions. Therefote, we cany a higher average inventoryon many Westinghouse lines in comparison with the independent,who can source more opportunistically from a number ofsuppliers.We, however, are tied to the manufacturing cycle ofthe product di­vision, which hurts our inventory levels even as it helps the productdivision's throughput.

I also believe some product divisions tend to take WESCO forgranted and give us less service support than thcy give to their inde­pendents. We provide more functions fur the product division thanthe average independent distributor does.

Further, corporate policies affected WESCO. According toone WESCO manager,

Our employees are covered by the Westinghouse benefits pack­age, which is more generous than the benefits offered by most inde­pendent distributors. In turn, the WESCO branch pays fur the ben­efits. Up-front salary, however, is bertet at many independentdistributors than at WESCO. We lost some younger reps, who aregenerally more concerned with the cash compensation than withlonger-term benefits.

Finally, a Westinghouse corporate executive suggested the ful­lowing:

Westinghouse's investment in WESCO is largely investment ininventory and receivables. As a result, our investment in WESCO ismore fluid than investments made in manufacturing divisions.

Overall, I believe the relevant numbers and criteria fur judgingWESCO's petfurmance are different than the criteria usually em­ployed to judge the perfurmance ofour manufacturing units. Thereare "hidden economies" embedded in a captive distribution opera­tion, an intricate mingling ofcosts and benefits. And any specific

166 CHANNELS ORGANIZATION MlUlIIging Channels Conflia 167

decision affecting the relationship between WESCO and the prod­uct divisions must be made within this context.In effect, this last comment suggests that evaluating the per­

formance of a captive sales operation against that of an individualprofit-centered product department is like "comparing apples andoranges." While corporate managements must assess the profit per­furmance of all business units, it is useful as well to take account,on the one hand, of the relative benefits of having a captive distri­bution arm and, on the other, of how the corporate context mayboth strengthen and constrain this operation in competing againstindependent resellers.

From the parent company's point of view, perhaps the singlegreatest benefit the captive network offers is that it is a significantdistribution channel from which competing products are essentiallyexcluded. Also to be counted as an important benefit is marketfeedback. In addition, the captive branches may provide valuableexperience for managers destined for product department and cor­porate responsibilities, and fur those charged with managing distri­bution networks. Over time, the captive system may serve as wellto set perfurmance standards fur independent resellers and to be atesting ground for resale marketing programs. Finally, it may helpto ensure market access if the independent reseller network in sometrading area fails to secure the producer's market share and/or theindependents are being acquired by competing producers to formtheir own captive distribution systems.

In a company that is also heavily reliant on independent resell­ers, however, the existence of a captive distribution arm that is per­ceived as competition by the independents is often a bone of con­tention. The independents allege that the captive reseller receivesfavored treatment on supply allocation, service support, market in­formation, and prices. Managers in the captive distribution busi­ness unit believe, on the other hand, that the product departmentsare more often biased in favor of external channels, since the inter­nal network can always be counted on as a market outlet.

From the captive branch's point of view, there are certain off­setting benefits. In holding its own competitively against its inde­pendent counterparts, the captive branch may count as an advan­tage its access to the financial and technical resources of the parentcorporation. It often operates as well under the aegis of a well-

known brand name. In addition, simply because of its scale, thecaptive unit may have opportunities fur distribution efficienciesthat are not available to the smaller independent, such as the com­puterization of its inventory management and order receipt andprocessing systems.

On the whole, however, sales branches in captive sales organi­zations face significant competitive disadvantages. First, since theymay well have come into the captive network as financially troubledprivate businesses or as new sales locations in "uncharted" tradingareas, they are frequently not located in prime market areas.

Second, the relations of the captive sales organization with itsexternal suppliers are often strained. The latter are concerned aboutthe captive's access to proprietary infurmation of competitive sig­nificance, which may find its way to the captive's sister productdivisions.

Another weakness of the captive is that, in building customerrelationships in local trading areas, the management suffers frombeing considerably more transient than its counterpart in the inde­pendent business. Often the career paths ofcaptive distributor per­sonnel are such that their tours ofduty in field branch locations arerelatively short. Meanwhile the managers of the independent re­seller firms and their families are closely identified with the com­munity and benefit from any propensity on the part of the cus­tomer enviro~tto favor local enterprise.

Managers in captive systems often feel constrained, as well, byperceived limits on their ability to sct prices and even to secure salesthrough extensive customer entertainment. The parent corporationmay impose restrictions on both counts out ofconcern for avoidinglegal charges ofprice discrimination and also to maintain the integ­rity of its pricing practices thtoughout the system. According toone WESCO manager, "The independent also has more pricingflexibility than WESCO branch managers do. WESCO manage­ment sets margin guidelines. The independent can go after lower­price business on a loss-leader basis, where the WESCO branchcan't."

In the captive distribution systems that we have observed, thecaptive distributor's response to the conditions imposed by the cor­porate context seems to be to orient its local marketing strategiestoward segments in which its constraints are less disadvantageous

168 CHANNELS ORGANIZATION

and its strengths have particular value. These are often segments inwhich customers tend to be larger in size, require technical assist­ance, and buy through competitive-bidding procedures. In thesecircumstances, the priority of priceJvalue considerations in the pur­chasing decision and of technical support may weigh more heavilythan personal relationships with vendor personnel Such an orien­tation may better serve the purposes of parent companies' productdepartments if they may, at the same time, count on their indepen­dent distribution to cover their other market segments.

Thus, captive distribution systems may be sources of internalcontention over such issues as business objectives, responsibility forresults, performance, and measurement. Yet they may contributeimportantly to the corporation's overall marketing e1fectiveness.

In companies that have captive distribution business units,howeVer, the conflict issues may not be well defined, much less re­solved. Line managers are then left with little to guide their day-to­day actions in mediating the differing interests of product depart­ments, captive sales organizations, and external reseller channels.This suggests the need at the corporate level for being explicitabout the strategic roles and objectives of captive sales operationsand about the measures against which their respective performanceswill be assessed.