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DTM Chapter 2 Page 1 of 14

Chapter 2

Distribution Channels

2.1 What is a Channel of Distribution?

A channel of distribution is a collection of organizational units, institutions, or

agencies within or external to the manufacturer, which performs the functions

that support product marketing. The marketing functions include buying,

selling, transporting, storing, financing, bearing market risk and providing

marketing information. Any organizational unit, institution or agency that

performs one or more of these marketing functions is a member of a channel

of distribution.

The structure of a distribution channel is determined by the marketing

functions that a specific organization performs. The specific structure depends

to a large extent on the nature of the product and the firm’s target market.

Management must determine channel structure within the framework of the

firm’s corporate and marketing objectives, its operating philosophy, its

strengths and weaknesses, and its infrastructure of manufacturing facilities

and warehouses. Channel structure affects (1) control over the performance

of functions, (2) the speed of delivery and communication and (3) the cost of

operations.

2.2 Channel Intermediaries

In the olden days a company or person made a product and the consumer

bought it direct from the manufacturer. However, this is rarely the case today.

The manufacturer or producer and the consumer may be geographically

separated. The consumer does not want to visit many different manufacturers

or producers in order to buy their goods and the producers do not want to

deliver to all the outlets stocking their products. The use of a middleman, or a

channel intermediary, contributes to efficiency, which is illustrated Figure 2–1.

In the situation without a middleman, a total of twelve contacts or transactions

are required for each producer to service each customer. On the other hand,

with the introduction of a middleman, only seven transactions or contacts are

required. The introduction of the middleman contributes to cost-effectiveness.

In summary, the advantage of a channel intermediary is in reducing the

number of contacts or transactions, thereby reducing the total cost to the

customer.

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Figure 2-1 Comparison between Distribution Channel with and without

Intermediary

2.3 The Functions of Channel Intermediaries

The emergence of channels of distribution has shortened the time in the

process of exchange of goods from the manufacturers to the customers. Their

functions can be classified into the following six main areas.

(a) Channel intermediaries reduce market contact

Marketing channels develop because intermediaries (e.g. wholesalers and

retailers) make the marketing process more efficient by reducing the number

of market contact. This is illustrated in Figure 2-1. Specialization in production

creates efficiency and the advantage of an intermediary is greater as the

number of specialized producers increases. Moreover, a manufacturer selling

to low-volume customers could reduce selling and logistics costs substantially

by using an intermediary.

(b) Channel intermediaries provide possession, time, and place utility

Channel intermediaries create possession utility through the process of

exchange, the result of the buying and selling functions. They provide time

utility by holding inventory available for sale. And they provide place utility by

physically moving goods to the market.

(c) Channel intermediaries enable the adjustment of the discrepancy

of assortment by performing the function of sorting and assorting

The assortment of goods and services held by a producer and the

assortments demanded by the customer often differ. The primary function of

Distribution channel with an intermediary

Direct distribution channel with no intermediary

Producer 1

Producer 2

Customer 1

Producer 3

Customer 2

Customer 3

Customer 4

Producer 1

Producer 2

Producer 3

Customer 1

Customer 2

Customer 3

Customer 4

Channel intermediary

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channel intermediaries is to adjust this discrepancy by performing the

following “sorting” process.

• Sorting out

This sorts a heterogeneous supply of products into stocks that are

homogeneous.

• Accumulating

This brings together similar stocks from different sources.

• Allocating

This breaks a homogeneous supply into smaller lots.

• Assorting

This builds up assortments of goods for resale, usually to retail

customers.

Customers may demand a much broader assortment of goods and services

than that provided by a single manufacturer. Specialization develops in the

exchange process to reduce distribution costs. Hence, the customer’s desire

for discrepancy of assortment drives the producer to use intermediaries to

reach the customer, leading to improved distribution efficiency.

(d) Channel intermediaries provide routinization of transactions

The cost of distribution can be minimized if transactions are routine. Marketing

agency form channel intermediaries to make routinization possible. Channel

cooperation and efficiency are improved by the routine handling of

transactions. Logistics operations can be made more efficient by using the

same processes. They may be even more efficient if third parties are utilized.

(e) Channel intermediaries facilitate the searching process by

customers

Buyers and sellers engage in a process in which consumers try to satisfy their

consumption needs and producers attempt to predict those needs. Channel

intermediaries facilitate the process of searching when institutions are

organized by separate lines of trade and provide information to their markets.

If the searching process is successful, allocation and assorting will take place,

resulting in benefits to both customer and producer.

(f) Channel intermediaries reduce costs

The use of a channel intermediary reduces some or all of the following costs:

• Selling costs (because fewer market contacts are required).

• Transportation costs (the use of intermediaries may result in fewer but

larger volume shipments).

• Inventory carrying costs (if the intermediary takes ownership).

• Storage costs.

• Order processing costs.

• Customer service costs.

2.4 Types of Channel Intermediaries

Channel intermediaries provide a variety of services, for example, providing

variety for the consumer, breaking down bulk purchases into more easily

manageable quantities, assisting with promotional activities and enabling a

much wider geographic dispersion.

There are three main types of channel intermediaries: agents, wholesalers

and retailers.

• Agents

Agents are used extensively in export markets, especially when the producing

company does not have a detailed knowledge of the export market, when the

producer’s ambitions are limited or when the level of sales does not make the

cost of a full-time team worthwhile.

Agents usually work in one of the following two ways: –

(a) They obtain orders from customers, pass these to the producer and

then take a commission on the agreed price. In this case, the contract

is between the producer and the customer. No stock-holding.

(b) They purchase goods from the producer and sell them directly to