SUPPLY CHAIN PERFORMANCE: ACHIEVING STRATEGIC FIT AND SCOPE

COMPETITIVE AND SUPPLY CHAIN STRATEGIES

A company’s competitive strategy defines, relative to its competitors, the set of customer
needs that it seeks to satisfy through its products and services. For example, Wal-Mart
aims to provide high availability of a variety of products of reasonable quality at low
prices. Most products sold at Wal-Mart are commonplace (everything from home
appliances to clothing) and can be purchased elsewhere. What Wal-Mart provides is a low
price and product availability. McMaster-Carr sells maintenance, repair, and operations
(MRO) products. It offers more than 400,000 different products through both a catalog
and a Web site. Its competitive strategy is built around providing the customer with
convenience, availability, and responsiveness. With this focus on responsiveness,
McMaster does not compete based on low price. Clearly, the competitive strategy at Wal-
Mart is different from that at McMaster.

We can also contrast Dell, with its build-to-order model, with a firm like Gateway selling
eMachines PCs through retailers. Dell has stressed customization and variety at a
reasonable cost, with customers having to wait approximately one week to get their
product. In contrast, a customer can walk into a computer retailer, be helped by a
salesperson, and leave the same day with an eMachines computer. The amount of variety
and customization available at the retailer, however, is limited. In each case, the
competitive strategy is defined based on how the customer prioritizes product cost,
delivery time, variety, and quality. A McMaster-Carr customer places greater emphasis on
product variety and response time than on cost. A Wal-Mart customer, in contrast,
places greater emphasis on cost. A Dell customer, purchasing online, places great
emphasis on product variety and customization. A customer purchasing an eMachines PC
at a retailer is most concerned with price, fast response time, and help in product
selection. Thus, a firm’s competitive strategy will be defined based on its customers’
priorities. Competitive strategy targets one or more customer segments and aims to
provide products and services that satisfy these customers’ needs.
To see the relationship between competitive and supply chain strategies, we start with the
value chain for a typical organization.

The value chain begins with new product development, which creates specifications for
the product. Marketing and sales generate demand by publicizing the customer priorities
that the products and services will satisfy. Marketing also brings customer input back to
new product development. Using new product specifications, operations transforms
inputs to outputs to create the product. Distribution either takes the product to the
customer or brings the customer to the product. Service responds to customer requests
during or after the sale. These are core processes or functions that must be performed for
a successful sale. Finance, accounting, information technology, and human resources
support and facilitate the functioning of the value chain.
To execute a company’s competitive strategy, all these functions play a role, and each
must develop its own strategy. Here, strategy refers to what each process or function will
try to do particularly well.

A product development strategy specifies the portfolio of new products that a company
will try to develop. It also dictates whether the development effort will be made internally
or outsourced. A marketing and sales strategy specifies how the market will be segmented
and how the product will be positioned, priced, and promoted. A supply chain strategy
determines the nature of procurement of raw materials, transportation of materials to and
from the company, manufacture of the product or operation to provide the service, and
distribution of the product to the customer, along with any follow-up service and a
specification of whether these processes will be performed in-house or outsourced. Given
that firms are rarely completely vertically integrated, it is important to recognize that the
supply chain strategy defines not only what processes within the firm should do well but
also what the role played by each supply chain entity is. For example, Cisco’s supply
chain strategy calls for most component manufacturing and assembly to be outsourced. In
this case, Cisco’s supply chain strategy identifies not just what Cisco should do well but
also the role of each third party to which supply chain tasks are outsourced. Supply chain
strategy specifies what the operations, distribution, and service functions, whether
performed in-house or outsourced, should do particularly well. Because our focus here is
on supply chain strategy, we define- it in more detail. Supply chain strategy includes a
specification of the broad structure of the supply chain and what many traditionally call
“supplier strategy,”“operations strategy,” and “logistics strategy.” For example, Dell’s
decision to sell direct, Gateway’s decision to start selling PCs through resellers, and
Cisco’s decision to use contract manufacturers define the broad structure of their supply
chains and are all part of their supply chain strategies. Supply chain strategy also includes
design decisions regarding inventory, transportation, operating facilities, and information
flows. For example, Amazon’s decisions to build warehouses to stock some products and
to continue using distributors as a source of other products are part of its supply chain
strategy. Similarly, Toyota’s decision to have production facilities in each of its major
markets is part of its supply chain strategy.

The value chain emphasizes the close relationship between the functional strategies
within a company. Each function is crucial if a company is to satisfy customer needs
profitably. Thus, the various functional strategies cannot be formulated in isolation. They
are closely intertwined and must fit and support each other if a company is to succeed.

For example, Seven-Eleven Japan’s success can be related to the excellent fit among its
functional strategies. Marketing at Seven-Eleven has emphasized convenience in the
form of easy access to stores and availability of a wide range of products and services.
New product development at Seven-Eleven is constantly adding products and services,
such as bill payment services that draw customers in and exploit the excellent
information infrastructure and the fact that customers frequently visit Seven- Eleven.
Operations and distribution at Seven-Eleven have focused on having a high density of
stores, being very responsive, and providing an excellent information infrastructure. The
result is a virtuous cycle in which supply chain infrastructure is exploited to offer new
products and service that increase demand, and the increased demand in turn makes it
easier for operations to improve the density of stores, responsiveness in replenishment,
and the information infrastructure.

2.2 ACHIEVING STRATEGIC FIT

This chapter is built on the idea that for any company to be successful, its supply chain
strategy and competitive strategy must fit together. Strategic fit means that both the
competitive and supply chain strategies have aligned goals. It refers to consistency
between the customer priorities that the competitive strategy hopes to satisfy and the
supply chain capabilities that the supply chain strategy aims to build. The issue of
achieving strategic fit is a key consideration during the supply chain strategy or design
phase.

All processes and functions that are part of a company’s value chain contribute to its
success or failure. These processes and functions do not operate in isolation; no one
process or function can ensure the chain’s success. Failure at any one process or function,
however, may lead to failure of the overall chain. A company’s success or failure is thus
closely linked to the following keys:

1. The competitive strategy and all functional strategies must fit together to form a
coordinated overall strategy. Each functional strategy must support other
functional strategies and help a firm reach its competitive strategy goal.
2. The different functions in a company must appropriately structure their processes
and resources to be able to execute these strategies successfully.
3. The design of the overall supply chain and the role of each stage must be aligned
to support the supply chain strategy.

A company may fail either because of a lack of strategic fit or because its overall
supply chain design, processes, and resources do not provide the capabilities to
support the desired strategic fit.

Consider, for example, a situation in which marketing is publicizing a company’s

ability to provide a large variety of products very quickly; simultaneously,
distribution is targeting the lowest cost means of transportation. In this situation, it is
very likely that distribution will delay orders so it can get better transportation
economies by grouping orders together or using inexpensive but slow modes of
transportation. This action conflicts with marketing’s stated goal of providing variety
quickly. Similarly, consider a scenario where a retailer has decided to provide a high
level of variety while carrying low levels of inventory but has selected suppliers and
carriers based on their low price and not their responsiveness. In this case, the retailer
is likely to end up with unhappy customers because of poor product availability.

To elaborate on strategic fit, let us take the example of Dell Computer. Dell’s
competitive strategy is to provide a large variety of customizable products at a
reasonable price. Its customers can select from among thousands of possible PC
configurations. In terms of supply chain strategy, a PC manufacturer has a range of
options. At one extreme, a company can have an efficient supply chain with a focus
on the ability to produce low-cost PCs by limiting variety and exploiting economies
of scale. At the other extreme, a company can have a highly flexible and responsive
supply chain that is very good at producing a large variety of products. In this second
case, costs will be higher than in an efficient supply chain. Both supply chain
strategies are viable by themselves, but do not necessarily fit with Dell’s competitive
strategy. A supply chain strategy that emphasizes flexibility and responsiveness has a
better strategic fit with Dell’s competitive strategy of providing a large variety of
customizable products.

This notion of fit also extends to Dell’s other functional strategies. For instance, its
new product development strategy should emphasize designing products that are
easily customizable, which may include designing common platforms across several
products and the use of common components. Dell products use common components
and are designed to be assembled quickly. This feature allows Dell to assemble
customized PCs quickly in response to a customer order. The design of new products
at Dell supports the supply chain’s ability to assemble customized PCs in response to
customer orders. This capability, in turn, supports Dell’s strategic goal of offering
customization to its customers. Dell has clearly achieved strong strategic fit among its
different functional strategies and its competitive strategy. The notion of fit also
extends to other stages in the Dell supply chain. Given that Dell provides a high
degree of customization while operating with low levels of inventory, it is crucial that
its suppliers and carriers be responsive.

HOW IS STRATEGIC FIT ACHIEVED?

What does a company need to do to achieve that all-important strategic fit between
the supply chain and competitive strategies? A competitive strategy will specify,
either explicitly or implicitly, one or more customer segments that a company hopes
to satisfy. To achieve strategic fit, a company must ensure that its supply chain
capabilities support its ability to satisfy the targeted customer segments.

There are three basic steps to achieving this strategic fit, which we outline here and
then discuss in more detail:

1. Understanding the Customer and Supply Chain Uncertainty: First, a company must
understand the customer needs for each targeted segment and the uncertainty the
supply chain faces in satisfying these needs. These needs help the company define the
desired cost and service requirements. The supply chain uncertainty helps the
company identify the extent of the unpredictability of demand, disruption, and delay
that the supply chain must be prepared for.
2. Understanding the Supply Chain Capabilities: There are many types of supply
chains, each of which is designed to perform different tasks well. A company must
understand what its supply chain is designed to do well.

3 Achieving Strategic Fit: if a mismatch exists between what the supply chain does
particularly well and the desired customer needs, the company will either need to
restructure the supply chain to support the competitive strategy or alter its
competitive strategy.

Step 1: understanding the Customer and Supply Chain Uncertainty

To understand the customer, a company must identify the needs of the customer
segment being served. Let us compare Seven-Eleven Japan and a discounter such as
Sam’s Club (a part of Wal-Mart). When customers go to Seven-Eleven to purchase
detergent, they go there for the convenience of a nearby store and are not necessarily
looking for the lowest price. In contrast, low price is very important to a Sam’s Club
customer. This customer may be willing to tolerate less variety and even purchase
very large package sizes as long as the price is low. Even though customers purchase
detergent at both places, the demand varies along certain attributes. In the case of
Seven-Eleven, customers are in a hurry and want convenience. In the case of Sam’s
Club, they want a low price and are willing to spend time getting it. In general,
customer demand from different segments varies along several attributes as follows.

• The Quantity of the Product Needed in Each Lot: An emergency order for
material needed to repair a production line is likely to be small. An order for material
to construct a new production line is likely to be large.

• The Response Time that Customers are willing to Tolerate: The tolerable
response time for the emergency order is likely to be short, whereas the allowable
response time for the construction order is apt to be long.

• The Variety of Products Needed: A customer may place a high premium on the
availability of all parts of an emergency repair order from a single supplier. This may
not be the case for the construction order.

• The Service Level Required: A customer placing an emergency order expects a

high level of product availability. This customer may go elsewhere if all parts of the
order are not immediately available. This is not apt to happen in the case of the
construction order, for which a long lead time is likely.

• The Price of the Product: The customer placing the emergency order is apt to be
much less sensitive to price than the customer placing the construction order.

• The Desired Rate of Innovation in the Product: Customers at a high-end

department store expect a lot of innovation and new designs in the store’s apparel.
Customers at Wal-Mart may be less sensitive to new product innovation.
Implied Demand Uncertainty: At first glance, it may appear that each of the
customer need categories should be viewed differently, but in a very fundamental
sense, each customer need can be translated into the metric of implied demand
uncertainty. Implied demand uncertainty is demand uncertainty due to the portion of
demand that the supply chain is targeting, not the entire demand.

We make a distinction between demand uncertainty and implied demand uncertainty.

Demand uncertainty reflects the uncertainty of customer demand for a product.
Implied demand uncertainty, in contrast, is the resulting uncertainty for only the
portion of the demand that the supply chain plans to satisfy and the attributes the
customer desires. For example, a firm supplying only emergency orders for a product
will face a higher implied demand uncertainty than a firm that supplies the same
product with a long lead time, as the second firm has an opportunity to fulfill the
orders evenly over the long lead time.

Another illustration of the need for this distinction is the impact of service level. As a
supply chain raises its level of service, it must be able to meet a higher and higher
percentage of actual demand, forcing it to prepare for rare surges in demand. Thus,
raising the service level increases the implied demand uncertainty even though the
product’s underlying demand uncertainty does not change.
Both the product demand uncertainty and various customer needs that the supply
chain tries to fill affect implied demand uncertainty. Table 2-1 illustrates how various
customer needs affect implied demand uncertainty.

As each individual customer need contributes to the implied demand uncertainty, we

can use implied demand uncertainty as a common metric with which to distinguish
different types of demand.

Table: 2-1
Table: 2-2

Fisher (1997) pointed out that implied demand uncertainty is often correlated with
other characteristics of demand, as shown in Table 2-2. An explanation follows.

1. Products with uncertain demand are often less mature and have less direct
competition. As a result, margins tend to be high.

2. Forecasting is more accurate when demand has less uncertainty.

3. Increased implied demand uncertainty leads to increased difficulty in matching

supply with demand. For a given product, this dynamic can lead to either a stock- out
or an oversupply situation. Increased implied demand uncertainty thus leads to both
higher oversupply and a higher stockout rate.

4. Markdowns are high for products with high implied demand uncertainty because
oversupply often results.

First let us take an example of a product with low implied demand uncertainty— such
as rice. Rice has a very low margin, accurate demand forecasts, low stockout rates,
and virtually no markdowns. These characteristics match well with Fisher’s chart of
characteristics for products with highly certain demand.

On the other end of the spectrum, a new LCD TV has high implied demand
uncertainty. It will likely have a high margin, very inaccurate demand forecasts, high
stockout rates (if it is successful), and large markdowns (if it is a failure). This too
matches well with Table 2-2.

Another example is a circuit board supplier whose customers include two different
types of PC manufacturers. One of its customers is a build-to-order PC manufacturer
such as Dell that requires same-day lead times. In this case, the supplier might need to
build up inventory or have very flexible manufacturing to be prepared for whatever
demand Dell has that day. Forecast error and supplier inventories would be high;
because of these factors, margins would likely be higher. The supplier’s other
customer builds a small variety of PCs and specifies in advance the number and type
of PCs to be built. This information gives the supplier a longer lead time and reduces
the forecasting errors and inventories. Thus, the supplier would likely get smaller
margins from the latter PC manufacturer. These examples demonstrate that even with
the same product, different customer segments can have different implied demand
uncertainty given disparate service requirements.

Lee (2002) pointed out that, along with demand uncertainty, it is important to
consider uncertainty resulting from the capability of the supply chain. For example,
when a new component is introduced in the PC industry, the quality yields of the
production process tend to be low and breakdowns are frequent. As a result,
companies have difficulty delivering according to a well-defined schedule, resulting
in high supply uncertainty for PC manufacturers. As the production technology
matures and yields improve, companies are able to follow a fixed delivery schedule,
resulting in low supply uncertainty.

Table 2-3 illustrates how various characteristics of supply sources affect the supply
uncertainty.

Supply uncertainty is also strongly affected by the life-cycle position of the product.
New products being introduced have higher supply uncertainty because designs and
production processes are still evolving. In contrast, mature products have less supply
uncertainty.

A company introducing a brand-new cell phone based on entirely new components

and technology faces high implied demand uncertainty and high supply uncertainty.
As a result, the implied uncertainty faced by the supply chain is very high. In contrast,
a supermarket selling rice faces low implied demand uncertainty and low levels of
supply uncertainty, resulting in a low implied uncertainty. Many agricultural products
such as coffee are examples where supply chains face low levels of implied demand
uncertainty but significant supply uncertainty based on weather. The supply chain
thus has to face an intermediate level of implied uncertainty.
Figure: 2-2

Step 2: Understanding the Supply Chain Capabilities

After understanding the uncertainty that the company faces, the next question is: How
does the firm best meet demand in that uncertain environment? Creating strategic fit
is all about creating a supply chain strategy that best meets the demand a company
has targeted given the uncertainty it faces.

We now consider the characteristics of supply chains and categorize them. Similar to
the way we placed demand on a one-dimensional spectrum (the implied uncertainty
spectrum), we will also place each supply chain on a spectrum. Like customer needs,
supply chains have many different characteristics that influence their responsiveness
and efficiency.

First we provide some definitions. Supply chain responsiveness includes a supply

chain’s ability to do the following:

• Respond to wide ranges of quantities demanded

• Meet short lead times
• Handle a large variety of products
• Build highly innovative products
• Meet a high service level
• Handle supply uncertainty

These abilities are similar to many of the characteristics of demand and supply that
led to high implied uncertainty. The more of these abilities a supply chain has, the
more responsive it is.

Responsiveness, however, comes at a cost. For instance, to respond to a wider range

of quantities demanded, capacity must be increased, which increases costs. This
increase in cost leads to the second definition: Supply chain efficiency is the inverse
of the cost of making and delivering a product to the customer. Increases in cost lower
efficiency. For every strategic choice to increase responsiveness, there are additional
costs that lower efficiency.

The cost-responsiveness efficient frontier is the curve in Figure 2-3 showing the
lowest possible cost for a given level of responsiveness. Lowest cost is defined based
on existing technology; not every firm is able to operate on the efficient frontier. The
efficient frontier represents the cost-responsiveness performance of the best supply
chains.

A firm that is not on the efficient frontier can improve both its responsiveness and its
cost performance by moving toward the efficient frontier. In contrast, a firm on the
efficient frontier can improve its responsiveness only by increasing cost and
becoming less efficient. Such a firm must then make a trade-off between efficiency
and responsiveness. Of course, firms on the efficient frontier are also continuously
improving their processes and changing technology to shift the efficient frontier itself.
Given the tradeoff between cost and responsiveness, a key strategic choice for any
supply chain is the level of responsiveness it seeks to provide.

Supply chains range from those that focus solely on being responsive to those that
focus on a goal of producing and supplying at the lowest possible cost

The more capabilities constituting responsiveness a supply chain has, the more
responsive it is. Seven-Eleven Japan replenishes its stores with breakfast items in the
morning, lunch items in the afternoon, and dinner items at night. As a result, the
available product variety changes by time of day. Seven-Eleven responds very
quickly to orders, with Store managers placing replenishment orders less than 12
hours before they are supplied. This practice makes the Seven-Eleven supply chain
very responsive. The Dell supply chain allows a customer to customize any of several
thousand PC configurations. Dell then delivers the appropriate PC to the customer
within days. The Dell supply chain is also considered very responsive. Another
example of a responsive supply chain is WW. Grainger. The company faces both
demand and supply uncertainty; therefore, the supply chain has been designed to deal
effectively with both. An efficient supply chain, in contrast, lowers cost by
eliminating some of its responsive capabilities. For example, Sam’s Club sells a
limited variety of products in large package sizes. The supply chain is capable of low
costs, and the focus of this supply chain is clearly on efficiency.

Step 3: Achieving Strategic Fit

After mapping the level of implied uncertainty and understanding the supply chain
position on the responsiveness spectrum, the third and final step is to ensure that the
degree of supply chain responsiveness is consistent with the implied uncertainty. The
goal is to target high responsiveness for a supply chain facing high implied
uncertainty, and efficiency for a supply chain facing low implied uncertainty.

From the preceding discussion, it follows that increasing implied uncertainty from
customers and supply sources is best served by increasing responsiveness from the
supply chain. This relationship is represented by the “zone of strategic fit” illustrated
in Figure 2-5. For a high level of performance, companies should move their
competitive strategy (and resulting implied uncertainty) and supply chain strategy
(and resulting responsiveness) toward the zone of strategic fit.

The first step in achieving strategic fit is to assign roles to different stages of the
supply chain that ensure the appropriate level of responsiveness. It is important to
understand that the desired level of responsiveness required across the supply chain
may be attained by assigning different levels of responsiveness and efficiency to each
stage of the supply chain.
In contrast, another approach for responsiveness may involve the retailer holding very
little inventory. In this case, the retailer does not contribute significantly to supply
chain responsiveness and most of the implied demand uncertainty is passed on to the
manufacturer. For the supply chain to be responsive, the manufacturer now needs to
be flexible and have low response times.

The preceding discussion illustrates that the supply chain can achieve a given level of
responsiveness by adjusting the roles of each stage of the supply chain. Making one
stage more responsive allows other stages to focus on becoming more efficient. The
best combination of roles depends on the efficiency and flexibility available at each
stage. The notion of achieving a given level of responsiveness by assigning different
roles and level of uncertainty to different stages of the supply chain is illustrated in
Figure 2-6. The figure shows two supply chains that face the same implied
uncertainty but achieve the desired level of responsiveness with different allocations
of uncertainty and responsiveness across the supply chain.
Figure: 2-6
Supply Chain I has a very responsive retailer who absorbs most of the uncertainty,
allowing (actually requiring) the manufacturer and supplier to be efficient. Supply
Chain II, in contrast, has a very responsive manufacturer who absorbs most of the
uncertainty, thus allowing the other stages to focus on efficiency.

To achieve complete strategic fit, a firm must also ensure that all its functions
maintain consistent strategies that support the competitive strategy, as shown in
Figure 2-7. All functional strategies must support the goals of the competitive
strategy. All sub-strategies within the supply chain—such as manufacturing,
inventory, and purchasing—must also be consistent with the supply chain’s level of
responsiveness.

Thus, firms with different locations along the responsiveness spectrum must have
different supply chain designs and different functional strategies that support their
responsiveness.

Table 2-4 lists some of the major differences in functional strategy between supply
chains that are efficient and those that are responsive.

Changing the strategies to achieve strategic fit may sound easy enough to do, but
in reality it can be quite difficult. In later chapters, we will discuss many of the
obstacles

to achieving this fit. Right now, the important points to remember from this
discussion are the following.

1. There is no supply chain strategy that is always right.

2. There is a right supply chain strategy for a given competitive strategy.
The drive for strategic fit should come from the highest levels of the organization. In
many companies, different groups devise competitive and functional strategies.
Without proper communication between the groups and coordination by high-level
management such as the CEO, these strategies are not likely to achieve strategic fit.
For many firms, the failure to achieve strategic fit is a key reason for their inability to
succeed.

OTHER ISSUES AFFECTING STRATEGIC FIT

Our previous discussion focused on achieving strategic fit when a firm serves a single
market segment and the result is a well-defined strategic position. We now consider
how multiple products, multiple customer segments, and product life cycle affect
strategic fit.

Multiple Products and Customer Segments

Most companies produce and sell multiple products to multiple customer segments,
each with different characteristics. A department store may sell seasonal products
with high implied demand uncertainty, such as ski jackets, along with products with
low implied demand uncertainty, such as black socks. The demand in each case maps
to a different part of the uncertainty spectrum. W.W. Grainger sells MRO products to
both large firms, such as Ford and Boeing, and small manufacturers and contractors.
The customer needs in the two cases are very different. A large firm is much more
likely to be concerned with price, given the large volumes they generate from W.W.
Grainger, whereas a smaller company is apt to go to W.W. Grainger because it is
responsive. The two segments that are served map to different positions along the
implied uncertainty spectrum. Another example is Levi Strauss, which sells both
customized and standard-sized jeans. Demand for standard-sized jeans has a much
lower demand uncertainty than demand for customized jeans.

In each of the aforementioned examples, the products sold and the customer segments
served have different implied demand uncertainty. When devising supply chain
strategy in these cases, the key issue for a company is to design a supply chain that
balances efficiency and responsiveness given its portfolio of products, customer
segments, and supply sources.

There are several possible routes a company can take to achieve this balance. One is
to set up independent supply chains for each different product or customer segment.
This strategy is feasible if each segment is large enough to support a dedicated supply
chain. It fails, however, to take advantage of any economies of scope that often exist
among a company’s different products. Therefore, a preferable strategy is to tailor the
supply chain to best meet the needs of each product’s demand.
Tailoring the supply chain requires sharing some links in the supply chain with some
products, while having separate operations for other links. The links are shared to
achieve maximum possible efficiency while providing the appropriate level of
responsiveness to each segment. For instance, all products may be made on the same
line in a plant, but products requiring a high level of responsiveness may be shipped
using a fast mode of transportation such as FedEx. Those products that do not have
high responsiveness needs may be shipped by slower and less expensive means such
as truck, rail, or even ship. In other instances, products requiring high responsiveness
may be manufactured using a very flexible process, whereas products requiring less
responsiveness may be manufactured using a less responsive but more efficient
process. The mode of transportation used in both cases, however, may be the same. In
other cases, some products may be held at regional warehouses close to the customer
whereas others may be held in a centralized warehouse far from the customer. WW.
Grainger holds fast-moving items in its decentralized locations close to the customer.
It holds slow-moving items with higher implied demand uncertainty in a centralized
warehouse. Appropriate tailoring of the supply chain helps a firm achieve varying
levels of responsiveness for a low overall cost. The level of responsiveness is tailored
to each product or customer segment.

Product Life Cycle

As products go through their life cycle, the demand characteristics and the needs of
the customer segments being served change. Supply characteristics also change as the
product and production technologies mature. High-tech products are particularly
prone to these life-cycle swings over a very short time span. A product goes through
its life cycle from the introductory phase, when only the leading edge of customers is
interested and supply is uncertain, all the way to the point at which the product
becomes a commodity, the market is saturated, and supply is predictable. Thus, if a
company is to maintain strategic fit, its supply chain strategy must evolve as its
products enter different phases.

Let us consider changes in demand and supply characteristics over the life cycle of a
product. Toward the beginning stages of a product’s life cycle:

1. Demand is very uncertain and supply may be unpredictable.

2. Margins are often high, and time is crucial to gaining sales.
3. Product availability is crucial to capturing the market.
4. Cost is often a secondary consideration.

Consider a pharmaceutical firm introducing a new drug. Initial demand for the drug is
highly uncertain, margins are typically very high, and product availability is the key
to capturing market share. The introductory phase of a product’s life cycle
corresponds to high implied uncertainty given the high demand uncertainty and the
need for a high level of product availability. In such a situation, responsiveness is the
most important characteristic of the supply chain.

As the product becomes a commodity product later in its life cycle, the demand and
supply characteristics change. At this stage it is typically the case that:

1. Demand has become more certain and supply is predictable.

2. Margins are lower due to an increase in competitive pressure.
3. Price becomes a significant factor in customer choice.

In the case of a pharmaceutical company, these changes occur when a drug’s patent
expires and generic drugs are introduced. At this stage, demand for the drug stabilizes
and margins shrink. Customers make their selections from the various choices based
on price. Production technologies are well developed and supply is predictable. This
stage corresponds to a low level of implied uncertainty. As a result, the supply chain
needs to change. In such a situation, efficiency is the most important characteristic of
the supply chain.

This discussion illustrates that as products mature, the corresponding supply chain
strategy should, in general, move from being responsive to being efficient, as
illustrated in Figure 2-8.

To illustrate these ideas, consider the example of Intel Corporation. Each time intel
introduces a new computer processor, there is great uncertainty with respect to
demand for this new product, as it depends on the sales of new high-end PCs.
Typically there is high uncertainty retarding how the market will receive these PCs
and what the demand will be. Supply is unpredictable because yield is low and
variable. At this stage, the Intel supply chain must be very responsive so it can react if
demand is very high.

As the Intel processor becomes more mainstream, demand begins to stabilize, and
yield from the production process is higher and more predictable. At this point
demand and supply normally display lower implied uncertainty and price becomes a
greater determinant of sales. Now it is important for Intel to have an efficient supply
chain in place for producing processors.

All PC manufacturers are subject to the cycle described earlier. When a new model is
introduced, margins are high, but demand is highly uncertain. In such a situation, a
responsive supply chain best serves the PC manufacturer. As the model matures,
demand stabilizes and margins shrink. At this stage it is important that the
manufacturer have an efficient supply chain. Apple Computer is an example of a firm
that has had difficulty during product introduction. When it introduced the G4 in
1999, demand for the machine far exceeded the available supply of processors,
resulting in significant lost sales. The supply chain in this case did not display
sufficient responsiveness during the product’s introductory phase.

The key point here is that demand and supply characteristics change over a product’s
life cycle. Because demand and supply characteristics change, the supply chain
strategy must also change over the product life cycle if a company is to continue
achieving strategic fit.

Globalization and Competitive Changes over Time

A final dimension to consider when matching supply chain and competitive strategy
is the change in competitor behavior resulting from changes in the marketplace or
increased globalization. Like product life cycles, competitors can change the
landscape, thereby requiring a change in the firm’s competitive strategy. An example
is the growth of mass customization in various industries since the last decade of the
twentieth century. As competitors flood the marketplace with product variety,
customers are becoming accustomed to having their individual needs satisfied. Thus,
the competitive focus today is on producing sufficient variety at a reasonable price.
As more firms increase the level of variety offered, supply chains have been forced to
develop the ability to support a wider range of products. Another big change is the
increase in global sourcing of products. The availability of a Chinese-made leather
recliner at Wal-Mart for $199 has put pressure on U.S. manufacturers to become
much more responsive than they were in the past. Successful furniture manufacturers
in the United States have responded by offering, enough variety to make choice an
advantage, while bringing down response time and keeping prices in check. Similar
pressures of globalization are being felt in the apparel sector with the end of quotas,
and local firms in developed countries are forced to respond. As the competitive
landscape changes, a firm is forced to alter its competitive strategy. With the change
in competitive strategy, a firm must also change its supply chain strategy to maintain
strategic fit.
Managing Channel Behavior
INTRODUCTION

Channel design is the starting point for channel management but the actual task of
channel management is much more complex than designing the customer-oriented
channel. The task of channel management starts with the channel design. In its
essence, channel management involves maintaining mutually profitable relationships
with the members of the channel so that the activities of the channel are performed
smoothly by the interlinked entities in a sustainable manner.

Channel management in its day-to-day manifestations would not be limited to just

logistics management or activity planning. In fact, the major part of the channel
management function involves the management of the channel constituents in
directing their behaviour towards the effective and efficient achievement of the
overall objectives of the channel.

A logistics network, however perfect be its design, cannot completely achieve its
potential unless the constituent members work in tandem and do not indulge in
opportunistic activities that may bring them short-term profit but hurt the interests of
the channel in the long run. To give a simple example, assume that a company
increases the discounts to distributors so that it can be transferred to the retailers, but
later discovers that the discounts are not being transferred and instead the extra profits
are being pocketed by the distributors. In this scenario, the distributors will gain in the
short-term but in the long-term if the competitors are giving a better deal to the
retailers, the company’s market share will suffer, ultimately leaving the distributors
with much reduced quantum of sales.

Further, the trust of the manufacturer in the distributor would have been severely
eroded with this behaviour, limiting future avenues for cooperation. Preventing such
opportunistic behaviour and pulling together the channel members so that the ultimate
goal of customer satisfaction is achieved is not an easy task. This is because the
orientations and the motivations of the channel members vary and might not always
tally with those of the manufacturer. Also, the channel members will always have a
propensity to seek autonomy in major decisions. It is well acknowledged among
marketing theorists that marketing channels are not merely economic entities but are
also social systems characterized by the dual elements of cooperation and conflict.
The autonomy-seeking propensity is a reflection of this fact. The task of the channel
manager is thus complex and requires the effective use of persuasion and conflict
resolution techniques.

The design of the commercial network should ensure that the commercial
arrangements between the channel members should be fair and just without in any
way leading to perceived injustice. The actual functioning of the channel should also
not allow a feeling of injustice to creep in at any stage. However, if the design of the
commercial network and the system of sharing the revenue itself lacks equilibrium
and fails to instill a feeling of equity among the channel members, it is difficult to
ensure a smooth functioning of the channel subsequently since the relationship
between the individual members will be bereft of trust and commitment. Therefore, it
is important to design the commercial network component of the channel carefully so
that it does not have any inherent flaws which can affect the morale of the channel
members.

CHANNEL RELATIONSHIPS

Since the members of a channel interact continuously with each other in the course of
achieving the common organizational as well as individual goals, relationships are
invariably formed both at the organizational level and between individuals who
interact on behalf of the organizations. These relationships are defined in terms of
interrelated concepts such as perceptions of organizational power, dependence,
control, trust, commitment, cooperation, etc. The nature of these relationships
ultimately impacts the effectiveness of channel functions. This is because in a
channel, system-wide activities can be effectively carried out only when all the
members of the system perform their roles with sincerity.

In the absence of motivation for carrying out programmes at the extended channel
level, even well-conceived programmes will not be implemented smoothly. For
instance, a large firm in the switchgear industry in India wanted to implement
enterprise resources planning systems at its dealer level. However, the move was
initially met with a lot of resistance since the dealers did not want to share some of
their business information with the company. This was mainly due to the erosion of
trust among the dealers for the company. Another famous instance is the mass boycott
of FMCG companies by the distributors and retailers of Kerala in the late 1 990s.
These instances highlight the extreme levels to which relationships between channel
partners could deteriorate.

However, often the relationships may not aggravate to these extremes, but can lead to
numerous other obstacles and subsequent sub-optimal deployment of resources. A
channel partner might unnecessarily delay the implementation of an organization-
wide programme without any valid reason and then when hard pressed, night
implement so reluctantly that the whole purpose of the programme is eventually lost.
Maintaining a strong and sustainable relationship with the channel partners is thus an
important part of the channel management function. The relationship should ideally
enable a manufacturer or a channel leader to effectively undertake and accomplish
programmes and strategies throughout the system. Here, a channel leader is the
organization which takes the lead in setting channel- wide objectives and has the
responsibility of marshalling the resources of the channel in order to achieve these
objectives. Usually, it is the manufacturer who becomes the channel leader, but often
when a large distributor sources products from several small manufacturers and sells
it through a network of retailers it becomes incumbent on the distributor to lead the
channel.
In many developed countries large retail networks like Wal-Mart and K-Mart are the
channel leaders and not the manufacturers who supply to the channel. It is of course
very important to have a channel leader otherwise the activities of the channel will
never be coordinated. Usually, the largest player in the channel in terms of sales or
other assets will automatically assume the leadership of the channel by virtue of its
size. Henceforth in our discussion we will be using the words channel leader or
channel principal to denote the largest organization in the network that is responsible
for coordinating the activities of the channel. Defining a channel leader or principal is
very important in the discussion on channel relationships because the relationship
always revolves around the channel principal. The channel principal is also entrusted
with the coordination of the entire channel. Unless the channel principal’s status is
well recognized, the channel will never exist as a coordinated chain of interlinked
organizations since without coordination all the members of the channel will seek
complete autonomy and hence will strive to maximize their own benefits without
considering the channel goal. This is explained in terms of the various types of
relationship behaviour as witnessed among distribution channels. Figure 16.1 shows
the continuum of relationship types.

The first type of relationship is a transaction-specific relationship where both the

parties to the relationship do not have any commitment to another. These types of
relationships are also called discrete relationships. While it is difficult to illustrate a
totally discrete relationship, generally relationships limited to just one transaction can
be included in this category.

In these transactions both the parties aim to maximize their individual profits since
there is no expectation of a long-term relationship which could bring a sustained
profit in the long run. In such kind of relationships there is no concept of a channel
principal or a channel leader. This is because the parties to the relationship are only
interested in their individual goals they are not aware of a common goal nor are they
motivated to work towards achieving a common goal.

At the other end of the continuum is a relationship characterized by relational

exchange. In this relationship category, the parties to the exchange are so attached to
each other in their desire to achieving a common goal that they willingly sacrifice
their individual goals in the short term. Here, the level of commitment towards the
relationship is very high and the expectation for a long-term relationship is very high.
To achieve this state both the parties should benefit equally from the relationship. In
this context it is important to note the indispensability of each party to the
relationship. There should also be a perfect convergence of individual and common
goals. Again, in practice, it is difficult to point out an absolute case of relational
exchange.

The most important point is that a relational exchange takes place over a longer
period of time in the sense that transactions are not just limited to one transaction.
Instead, the parties to the transaction anticipate more mutual transactions and also
most often there is a history of transaction between the contracting parties. Hence,
there is a basis for future collaboration which is often supported by implicit and
explicit assumptions, trust, and planning. Also relational exchange participants can be
expected to derive complex, personal, non-economic satisfaction and engage in social
exchange.

In reality most of the exchange relationships fall somewhere in between a relational

exchange and a discrete relationship. Thus, every relationship situation will have a
common goal and individual goals for the parties interlocked in the relationship. A
channel principal emerges to coordinate the activities of the individual players so that
the activities are always oriented towards the common goal. The role of the channel
principal is accepted and based on the extent to which the common goal is important
to all the members and the extent to which the individual members are motivated to
achieve the common goal. The channel principal succeeds in steering the activities of
the channel members to the common goal on the basis of the control wielded by it
over the channel members. In a situation where there exists no channel principal, it is
actually an instance where no channel member is in a position to enforce its control
over the others. Channel control is an important concept because it is associated with
channel power.

CHANNEL CONTROL

The need for channel control is based on the fact that improved coordination of
activities within the channel is a necessary condition for future channel survival and
success. This is because a loosely controlled channel system cannot optimize the
deployment of resources. Assume that the reorder point and economic order quantity
has been calculated for a distributor in a channel set-up. However, if due to lack of
control the distributor is not made to stick to this ordering scheme, then the system-
wide logistics cost will be high, as the inventory carrying cost will shoot up as well as
the stockout probability. In order to avoid this situation, it is important that all the
distributors are made to follow the ordering scheme. This can be done through several
means like imposing specific penalty, personal intervention, etc. For instance, in most
pharmaceutical companies there are specific dates after which the C&F agents
appointed by the company do not accept any order from the stockists every month. So
if the stockist has to place an order, it has to be communicated before this specific
date. This arrangement is a deterrent against placing orders of small quantities as well
as ordering indiscriminately which can put pressure on the inventory position as well
as the production process. However, to enforce this, the manufacturer needs to have
sufficient clout in the market. Thus, the controlling member must possess some
authority over the members whose actions are controlled.

Authority exists only when a spirit of compliance exists. According to Barnard

(1950), the source of authority originates with the interests of those who are to be
controlled. ‘Authority is based directly on the willingness to comply to those to whom
orders are given.’ This takes us to the concept of what is usually called a ‘zone of
indifference’. According to Barnard, there exists a zone of indifference in each
individual within which orders are acceptable without conscious questioning of their
authority. Further, the zone of indifference will be wider or narrower depending upon
the degree to which the inducements exceed the burdens and sacrifices, which
determine the individual’s adhesion to the organization. This means that if the
perceived inducements of adherence are very narrow or not significant, the zone of
indifference will also be narrow. That authority is proportional to the ability to impart
inducements. Bucklin (1973) extended Barnard’s the theory of authority and proposed
a unique theory of channel control. The theory is conceptualized in Figure 16.2 and
16.3

Distributors’
Profit earned Tolerance
Function

Pay-off
Function

A
Zone Of
Acceptance Supplier Authority

Figure 16.2 Theory of channel control

In Figure 16.2, the vertical axis represents the profits obtained by the channel member
from doing business with the channel principal. The horizontal axis denotes the
authority or control of the channel principal where authority increases from left to
right. This authority gradually increases as the channel member is increasingly forced
to operate based on the direction of the channel principal. It can be imagined as the
number of decisions of the channel member being totally influenced by the decisions
of the channel principal. At one extreme it could be nil, where the channel principal
does not have any influence on the decisions of the channel member and then slowly
as we proceed towards the right, more and more decisions like pricing, inventory
management, investment decision, staffing etc. come under the directions of the
channel principal. The other extreme is when the channel principal vertically
integrates so that the channel member is just an extension of the channel principal’s
organization. The two functions employed in the model are the pay-off function and
the tolerance function. The pay-off function expresses the change in the profits of the
individual member as the channel member subjects itself more and more to the
authority of the channel principal. As the figure indicates, the pay-off function

begins at a particular height which is indicative of the profits earned by the channel
member with the least channel control. As the authority or control over the channel
member increases, the pay-off for the channel member shows a declining trend. This
is because as the channel principal subjects the channel member under its control, the
decisions will be increasingly influenced by the goals of the channel principal and
less on the goals of the channel member. For example, if the manufacturer controls
the inventory decisions of the distributor completely, the channel member may be
asked to stock more which will lead to greater relief on the working capital front for
the manufacturer while it will be detrimental for the distributor as its working capital
outlay will be higher.

The tolerance function, on the other hand, reflects the perception of the burden and
sacrifice by the channel member by increasingly subjecting itself to the control of the
channel principal. As the channel member submits to the control of the principal, it
has to sacrifice a lot of its opportunities. As the control increases, the perceived value
of these sacrificed opportunities increases. For instance, when the channel is
subjected to limited control, most of the opportunities available of the channel
principal will he comparable to that within the channel. However as the control
increases, the opportunities outside will be perceived as more attractive. The tolerance
function is the reflection of these lost opportunities as the channel becomes
increasingly subjected to control by the channel principal. If, however the channel
principal offers greater profits, the perceptions of opportunities lost will not be felt till
the control becomes very overbearing. Thus if the profits offered through the
association with the channel principal is high the tolerance function will start at a
lower level. The slope of the tolerance function on the other hand reflects the
autonomy- seeking propensity of the channel member. Since a channel member is not
just an economic entity its social tendency to seek autonomy should also be
considered. If the authority is increasingly perceived as affecting the freedom to make
decisions, the tolerance curve will have a steep slope.

As Figure 16.2 indicates, as long as the tolerance function is below the pay-off curve,
the control falls under the acceptance region or the zone of indifference. However
when the tolerance function goes above the pay-off function, the channel member will
no longer be happy to submit to the authority of the principal. In this region, the
channel member will perceive the pay-off due to compliance to be not adequately
compensating the suffering— both economical and social—that has to be tolerated
and hence will be less willing to submit to the control of the principal. Thus, if the
channel member is earning high levels of profit the zone of acceptance will be larger
since the pay-off function will start from a high point in the vertical axis as well as the
tolerance function will start at a relatively lower point in the vertical axis. As far as
the tolerance function is concerned, the vertical axis is not the profits earned by the
middlemen; rather it is the relative attractiveness of the alternate offers.

Figure 16.3 extends the theory of channel control by looking at the approaches to
control the activities of the channel member based on the specific situations
encountered during the channel management process. In Figure 16.3, till the point A,
the pay-off function of the channel member witnesses a gradual increase with greater
control. This is probably because, due to greater control, the overall efficiency of the
system increases due to several reasons like better management of resources, greater
marketing effectiveness, etc. In this region, the tolerance curve is also well below the
pay-off curve which implies that the attractiveness of alternate options outside of the
existing relationship is not very high. Controlling members in this phase is relatively
easy as persuasion is all that is needed to influence the decisions of the channel
member. Once this phase is over, the pay-off functions slopes down as the marginal
compliance to the channel principal’s authority does not lead to an increase in
additional pay-off. However, the tolerance curve is still below the pay-off curve. In
this phase, the control process requires moderate imposition of authority in the form
of formal communications and instructions. These steps may however sow the seeds
of future conflicts as the channel member will increasingly perceiving efforts at
control as exploitative in nature. Increasing use of authoritarian approaches will also
increase the slope of the tolerance curve as the relative attractiveness of the options
outside of the existing relationships increases. This phase where authority has to be
used to control will extend till the point B, when the tolerance curve will meet the
pay-off function and the sense of sacrifice in compliance is equal to the pay-off from
compliance. Any further compliance to control from the channel principal will be
strongly resisted as the pay-offs of compliance is less than the perceived
attractiveness of options that are sacrificed to remain in the relationship. This phase
requires actual use of coercive tactics to achieve compliance. This will be counter-
productive as it will inevitably lead to greater conflict between the principal and the
channel member. It is, of course, not desirable to control through coercive tactics.
Coercion involves wanton punishments, strongly worded communications, threats,
etc. that undermines the freedom of the channel member. In these circumstances, the
channel member will naturally try to either retaliate or decide to break the
relationship.

CHANNEL POWER

In social exchange situations, whether it be the exchange between a subordinate and

superior in an office or between a large organizational buyer rand a set of small
vendors or between channel members and channel principals, the concept of power is
an important dimension. This is because power or authority critically determines the
outcomes of such exchange relationships. A subordinate emboldened by support from
a powerful employees union will not be suppliant to a boss since the subordinate
considers himself to have acquired power through his or her association with the
employees union. The situation would have been different if there were no employee
union in the organization. A similar situation ran be witnessed in the negotiation
between a buyer and the vendors. If the buyer is a large organization with a large
purchase budget and most of the vendors are small organization, the buyer will be in
an advantageous position to bargain for greater discounts from the small vendors. The
social exchange situations normally witnessed in a distribution channel is no
different. The nature of power has been highlighted greatly by the contributions of a
number of authors, particularly Emerson (1962) and French and Raven (1959).
Emerson emphasizes on the relationship between power and dependence in his
definition of power:

The power of A over B is equal to and based upon, the dependence of B upon A. The
dependence of actor B upon actor A is (i) directly proportional to B’s motivational
investment in goals mediated by A, and (ii) inversely proportional to the availability
of those goals to B outside of the A—B relation.’

Emerson’s definition of power, considered to be one of the most popular in social

exchange theory links the existence of power entirely on the dependence of one
organization on other. This seems to be quite logical when channel relationships are
analysed. A channel principal is in a position to exert its power over its channel
members only to the extent to which it can mediate the goals of its channel members.
CHANNEL INFLUENCE STRATEGIES

The channel offering thus serves to provide the foundation for channel principal to
influence the channel members to achieve the system-wide goals. Influence strategies
are the methods through which the authority of the channel principal is applied. The
channel principal acquires power through various sources that are part of the channel
offering. But these sources provide only the authority or power to control the
behaviour of the channel members, effectively operationalizing the power sources is
another major task for the channel principal. Power is exercised when there is a need
to align the activities of a channel member to common goals. For instance, if the
manufacturer wants to ensure that all orders from the distributor should reach the
branch offices before the 25th of the preceding month, then for effective achievement
of this programme, the manufacturer has to ensure that there is complete compliance.
If certain members are not cooperating, then the manufacturer has to exercise its
power to make them abide by the programme. This can be achieved by adopting
different types of strategies based on the relationship between the manufacturer and
the errant distributors. For instance, at one extreme, the distributor can be threatened
with a break of relationship, to the other extreme the manufacturer can choose to do
nothing and hope that the distributors will abide by the command in the next month.
An influence strategy is thus an approach to enforce control in the distribution set-up.
The choice of influence strategies is crucial in achieving the desired results. This is
because certain types of influence strategies work well only in certain types of
situations. The channel manager’s competence lies in assessing the situation properly
and picking the correct influence strategy that will work well in that particular
situation. After considerable research into types of influence strategies that are
normally applied in the context of channel management, Frazier and Summers (1984)
had tried to develop a comprehensive typology of influence strategies. These
strategies were grouped into three classes based on the type of their impact. Table
16.1 lists down the influence strategies.
As the table shows, there are direct, indirect, mediated, unmediated influence
strategies as also strategies where a plain reward or punishment is used. In indirect
strategies, like information exchange, information control or modelling, the attempt is
to indirectly use information to influence a channel member. If a channel member is
required to stock more, the channel principal just gives information on the stockout
situation that can result from inadequate stock as well as the stockout costs. The need
for actually increasing the stock position is not however indicated. In information
control strategies, the flow of information is controlled by the channel member in
such a way that the channel member ends up taking the required action without any
direct influence attempt. For example, to increase the stock position, the channel
principal sends periodic reports to the channel members that indicate an increase in
sales for the product in other markets or the impending increase in demand due to
some market factors. The expectation is that the channel member in its own interest
after taking cognizance of the information will take the appropriate action. In
modelling, the channel principal, along with the channel member, tries to model an
impending event with a greater sharing of information so that the channel member is
in the end convinced of following a particular course of action. n none of these
strategies the channel member is directly asked to follow a particular activity. The
indirect influence strategies are normally employed when the channel principal does
not want to create the impression among the channel members that their decision
making domain is being encroached upon by the channel principal. In these strategies
even what decision has to be taken is not spelt out by the channel principal and the
expectation is that the channel member after being fed with the proper information
will automatically take the decision that the channel principal will desire.

In direct unmediated strategies, the effort is to be more direct and specific in terms of
conveying what the channel member is expected to do. However, the channel member
is still not told in any form that the channel principal may initiate any action in favour
of or against the channel member for complying or not complying with the decision.
Instead, the channel member is informed about the consequences of complying or not
complying based on the reaction from the external market environment. The effort is
still not to give an impression that something is forced on the channel member. In the
recommendation strategy, for instance, the channel member is told that the decision if
adopted will lead to greater gain. For example, if the channel member is expected to
increase the number of salespeople devoted to the product line, the channel member is
asked to increase the number since it will generate more orders and not because the
channel principal will take any action against the channel member for not complying.

In warning strategy, the channel member is similarly told about the negative
consequences because of non complying. In positive and negative normative strategy
the channel member is impressed upon that complying with a particular decision is a
norm in the channel. The line of argument in the case of salesperson appointment will
be like ‘for all the other dealers have a dedicated salesperson for this product only in
this dealership no one is there.’ In direct unmediated strategy the domain of decision
making is still not completely portrayed as being usurped by the channel principal.
However, unlike the indirect strategy the exact decision to be taken is directly
conveyed albeit without mentioning any action from the part of the principal for
compliance.

In reward and punishment strategy the channel principal directly imparts rewards or
punishments to the channel members for complying with or refusing to comply with
the decisions. Rewards and punishments can be both economic as well as non-
economic. A special discount for supporting new products, usually given by
pharmaceutical companies, is an example of the economic reward strategy while an
appreciation letter from the president of the channel principal is an example of non-
economic reward. Reward and punishment strategy impacts the channel member’s
general inclination to cooperate with the channel principal. As such, they just serve to
reinforce the channel member’s need to comply with the dictates of the channel
principal. For a reward and punishment strategy to be effective, the channel members
should adequately value it. Further excessive use of economic reward could actually
lead to the gradual erosion of its utility.

The request strategy is unique in that the channel member is conveyed directly the
channel principal’s desire about complying with a particular decision. The request is
made directly with the channel principal specifying what the channel member is
expected to do in clear unambiguous terms. However, there is absolutely no mention
about the consequences of compliance. It is different from a strategy like
recommendation since the request strategy involves directly asking the channel
member to abide by the decisions that it can be construed by the channel member as a
blatant encroachment of their freedom to take decisions. In case of recommendation
strategy; while the requisite decision to be taken by the channel member is specified,
it is not conveyed as if the channel principal would like the channel member to abide
by it. A request strategy can be very effective if the channel principal is known by the
channel members to indulge in reward strategy often.

In direct mediated strategies like promise, threat, and legalistic plea, etc., the channel
principal not only communicates the decision to be complied by the channel members
in forthright terms but also spells out the consequent actions on the part of the
channel principal. These strategies thus seriously affect the sense of freedom enjoyed
by the channel members to take decisions on matters concerning their activities.
Hence, excessive use of these strategies prompts the channel members to look for
other alternatives since they may find it difficult to tolerate further. In the personal
plea strategy; the personnel from the channel principal appeals to the personal
relationships with the channel member’s organization to turn the decision in favour of
the channel member.

CHANNEL CONFLICT

Channel members being independent organizations with individual goals and

orientations, it is quite natural that, often there occurs conflict of interests among the
constituents of the channel. In fact there is a stream of thought that encourages
functional conflict since only when there is functional conflict will the channel be
able to operate effectively in a sustainable manner. This stream believes that
operational conflict brings out the simmering disagreements that can be then resolved
rather than suppressing disagreements and allowing the conflict to simmer till it
erupts into a major crisis.

Channel conflict is defined as a situation where one channel member perceives the
behaviour of another channel member to be impeding the attainment of its goals or its
effective functioning. It is of course impossible to imagine a situation where all the
component members of the channel think alike and act in complete unison so that
there is no conflict. However, it is important that disagreements and diversions from
expected behaviour do not lead to a reduction in the performance of the channel.

Channel conflict is often observed to be progressing through distinct stages. In fact,

conflict is often portrayed as comprising a sequence of episodes like in a movie where
one incident leads to another. The conflict process may ultimately result in conflict
resolution wherein the parties concerned work out a satisfactory solution or it may
lead to a complete breakdown of relationships.

Channel Conflict as a Process

In practice, it is not very easy to detect conflicts till they erupt into disruptive
behaviour on the part of aggrieved parties. In fact, it will be better to state that
different conflicts exist at different stages of accentuation, at all levels in a channel of
distribution. Often, the conflict is latent and does not affect the normal functioning of
the channel. Only when the conflict degenerates into destructive behaviour will it
really get noticed and considered seriously. This is, however, a reactive approach to
conflict which is not desirable in the long run since channel members will be
encouraged to indulge in destructive activities even for small reasons just to get
noticed. It is therefore important to understand and comprehend an impending
conflict in its initial stages itself. This thinking is based on the observation that inter-
channel conflict is not a one-off incident but a process which might culminate in a
destructive act. It is therefore important to understand the conflict process if it has to
be controlled before it leads to irreparable acts of destruction.

While several authors use different notation, it is generally agreed that channel
conflict progresses through roughly four distinct stages unless they are resolved at
each stage. Figure 16.5 illustrates the process of channel conflict through its sequence
of steps.

The first stage is the latent conflict stage where the seeds of conflict start germinating
Inter-channel conflicts normally arise from some latent causes that were left
unattended for a long while by the channel principal. These causes could be anything
from a perceived injustice in the agreement to personal relationships. Etgar (1979)
classifies these conflict causes into two classes (i) attitudinal causes and (ii) structural
causes.

Attitudinal Causes of Conflict

Attitudinal causes are explained as those causes which are associated with
disagreements about channel roles, expectations, perceptions, and channel
communications. These are therefore not very easy to detect. Channel roles are
defined as a set of prescriptions defining what the behaviour of a member should be
in a particular position. For instance, if the retailer is expected to ensure that the
stocks are neatly arranged and maintained throughout the time it is stocked, the other
members will expect all retailers to perform that role perfectly. If certain retailers do
not perform well, then the distributor might feel that the role expectation goals are not
being properly met and any consequent reduction in the sale may be construed as
being the result of the reluctance to perform the assigned roles by the retailers.

Role-based conflict could also be due to the lack of proper definition of roles. If roles
are not well defined and properly communicated, each channel member might expect
the other to perform roles which he considers to be difficult and not profitable. The
result will be total chaos in the system. Thus, it is very important to take care of these
aspects at the channel design stage itself since it is during the channel design stage
that most of the roles are specified. It is quite possible due to a new circumstance or
due to market developments that certain new roles are required to be performed. It is
necessary that such new roles ‘are properly assigned with an associated increase in
the margin for the concerned channel member.

Attitudinal conflict could also arise due to differences in expectations about what
might happen in the future. Expectations are mostly beliefs about what is going to
happen in the future. For instance, the manufacturer might expect that a new product
could capture significant market share based on the consumer research that was
conducted, but the retailers may not share these expectations since they are not aware
of this study or are incapable of interpreting the results. Differences of opinion on
what could happen in the future might lead to lack of motivation or inadequate
allocation of resources in the programmes of the channel.

While the expectations are about the future state of affairs, perceptions are about the
present state of affairs. Inter-channel conflict could arise due to the differing
perceptions of reality also. Managing perceptions is thus a major task in channel
management. Mostly differing perceptions are caused clue to a difference in
perspective. Large manufacturers often will have a larger, global perspective and
would take decisions that encompass variables across all the markets in which it
operates. Distributors or retailers however will have a narrower perspective and hence
may not always be in a position to appreciate the reasons why a particular decision
was taken. Further, a particular retailer may be dealing with a particular segment of
customers while the manufacturer will be dealing with a much larger population of
customers comprising several segments.

Lack of communication could also lead to inter-channel conflict since communication

affects other attitudinal factors like expectations, perceptions, role clarity etc.
Communication between channel members in order to be effective must be bilateral
and should not be limited to just formal modes like memos and orders. This is
because only when bilateral communication is encouraged, channel members can
expresses their problems and concerns properly. In the absence of an avenue for
bilateral communication, it is difficult to understand the perceptions and expectations
of the channel members.

Structural Causes of Conflict

The structural causes of conflict are easier to understand and detect since they are
often based on tangible and well-articulated causes. Three main causes of structural
conflict are (i) divergence in goals, (ii) drives for autonomy, and (iii) fights over
scarce resources.

Divergence in goals is a common reason for conflict. Manufacturers might, for

instance, desire to extend their market share by introducing new products. For the
distributors, however, dealing in new products is quite risky since it involves
investing in an unknown commodity. This is a classic example of a conflict caused
due to divergence in goals. ‘The manufacturer would thus be inclined to consider the
distributors as a hindrance to the attainment of his goals. The distributor’s goal is to
ensure reasonable profits in a sustainable manner with the minimum of risk and
additional investment. Goal divergence conflicts are quite common if distributors are
not chosen with proper care.

All channel members seek to exert their autonomy in making decisions that directly
concern them. When the channel principal or other channel members are perceived to
be infringing on this autonomy, there will be a natural resentment against such acts of
control. For instance, the manufacturers could insist that the distributors deposit blank
cheques with them so that any of the orders placed can be immediately encashed. The
distributors, on the other hand, could consider this as a major interference in their
freedom to manage their cash, as they are now unable to rotate their cash assets.
Practical Insight 16.3 illustrates an instance of how the drive for autonomy leads to a
major conflict.

Conflicts caused due to the competition for scarce resources occur mostly between
channel members at the same level in a distribution set-up. These conflicts are
otherwise called horizontal conflicts. Such conflicts are very common when a
manufacturer indulges in a strategy of intensive distribution. When a manufacturer
appoints more dealers in a particular market, there will be an ensuing competition
between the dealers for customers. This will result in intense competition and
subsequent conflict. The personal computer sector in India is a prime example where
this type of conflict is quite common. The conflict between dealers could lead to such
situations where undercutting could lead to a lot of erosion of brand value. These
types of conflicts, though not very problematic for the manufacturers in the short run
could actually lead to unhealthy practices among channel members that could
eventually harm the interests of the product in the long run.

Felt Conflict

The causes of conflict are only the seeds for the eventual conflict behaviour. If left
unattended to, the conflict could fester into a spiral of disruptive activities where each
member will try to outsmart each other. Once the seeds of conflict are sown, the
conflict normally proceeds to an affective conflict stage. This stage is also called the
felt conflict stage. At this stage, the members really feel the conflict in terms of
frustrations, disappointments, or negative feelings towards the relationship. Some
authors identify another stage to precede the felt conflict stage where conflict is
perceived but not felt. This is because, often, channel members may choose an
attitude of ‘agree to disagree’ without giving further thought to it. Felt conflict stage
occurs when the level of disagreement crosses a particular level and affects the
emotions of the individuals concerned. Still, the members do not indulge in any
disruptive behaviour that could derail the normal functioning of the channel.
However, whenever they are presented with an opportunity, the channel members
vent these frustrations openly so as to draw the attention of the channel members. At
this stage, most of the channel principals take note of the conflict and initiate some
measures for resolution. If, however, the conflict is not satisfactorily resolved at this
stage, the conflict deteriorates into the manifest conflict stage.

The manifest conflict stage is characterized by destructive actions like a boycott or

total breakdown of communication, etc. where some expressed behaviour is involved.
It is inadvisable to allow matters to drift to such a state where the members of the
channel resort to such manifest behaviour. Once the conflict manifests itself in such
external.

Manifest Conflict
behaviour, it is difficult to come back to the former relationship stage since the trust
would have broken down between the two parties.
At least at this stage some resolution methods are thought about and implemented.
This could affect the conflict process by halting the manifestation of the conflict or, if
it fails, in a total destruction of the chain. It is often seen that when the channel
principals decide to discontinue their relationships with certain dealers by annulling
the contract with the dealer or even cancelling the relationships with an entire group
of intermediaries. If, however, the resolution method succeeds. then the relationship
will survive but the experience of the conflict would linger and could effect the
attitudinal or structural causes for new conflicts as well as it could impact the
affective state of the channel members. This is because the painful incidents that
occurred during and after the conflict manifestation will always remain in the
memory of the channel members and could affect the future interactions. It could
create perceptions of unfairness; the outcomes in fact could involve alterations in the
design of the channel or alterations in the roles and responsibilities. Each of these
transformations that had happened could in fact permanently alter the chemistry of
the channel. The relationships could never be the same again. Once conflict of a
major type occurs and manifests in serious disruptive acts, any further action by the
channel principal or other members could be construed in a negative way due to lack
of trust. Thus, conflict breeds more conflict.

Conflict Management Methods

Conflict management is one of the primary tasks of the channel manager. It is also
one of the most difficult tasks. Conflict management is different from conflict
resolution in the sense that conflict management tries to prevent disagreements and
other problems to reach the stage of manifest conflict. The emphasis is to detect latent
conflict in the initial stages and work out modalities to reduce differences that might
lead to destructive behaviour. It is only when conflict reaches a manifest State, the
resolution methods are adopted. Conflicts are normally resolved at two stages: (i) at
the initial stage before the conflict degenerates into a felt or manifest conflict or
failing which (ii) the conflicts can be resolved after their manifestation. Figure 16.6
illustrates the various conflict management methods used at various stages of the
conflict. It is, of course, always desirable that the conflicts are resolved at the initial
stage. However, such a strategy requires the channel principal to take proactive steps
that help in detecting possible channel conflict causes.

Conflict Resolution Mechanisms

Two basic methodologies can be identified for conflict management in the first stage
of the conflict: (i) institutional mechanisms that focus on structural changes such as
joint membership in trade organizations, executive exchanges, co-optation, distributor
councils, a development of superordinate goals, (ii’) interpersonal and third party
mechanisms, such arbitration and mediation. In the institutional mechanisms, specific
institutions are created for detection and resolution of channel conflicts.

These are formal institutional set-ups with a well-established framework of operation.

The institutional mechanisms are mostly capable of detecting conflict in its initial
stage and prevent it from escalating to its manifest stage. For instance, manufacturers
could consider joint memberships in the trade organizations with distributors so that
issues of dispute can get an immediate and direct redressal. Many organizations also
have formal practices of exchanging executives where qualified personnel from the
dealer organization are posted with the manufacturer for a period of time and also
executives from the manufacturer’s side are inducted into the dealer’s organization
for a short period of time. This leads to greater understanding of the goals and
constraints of the respective organizations. These executives later become
ambassadors of the organizations in which they worked. In cooptation, the
manufacturer enlists the support of distributors for designing and implementing
marketing programmes and promotional strategies. The channel members are
involved in the initial stage and are given considerable leeway in the development of
the strategy. This transfers the responsibility of successfully implementing such
programmes on the distributors who were part of designing it. This will also make the
distributors more closely linked to the channel principal’s organization along with
satisfying the channel member’s drive for autonomy.

Sometimes the channel principals take the initiative to constitute a council for the
channel members so that it provides a forum for the channel members to come
together and discuss issues of mutual interest with the channel principal. Such a
council will have a permanent set-up with office bearers and a regular meeting
schedule. Many organizations in India have these dealer councils which provide links
for the channel principal to directly interact with a section of the channel partners.
These dealer councils also help in developing super- ordinate goals which are
developed jointly for the purpose of furthering the cause of the channel members.
These goals could be set for operating parameters like inventory control or line fill
rate. It could also be set for larger aspects of the business like market share
achievement or sales growth.

Third party mechanisms like mediation or arbitration, the service of a third party
uninvolved or external to the organization is used before the conflict reaches a
destructive phase. In mediation, the parties concerned are persuaded to maintain their
communication without escalating their conflict to destructive behaviour. The
mediator helps in bringing together the two parties to share each other’s complaints
and point of view and distils facts from opinion. The mediator does not take a
decision, but helps the two contending parties to come to a mutually satisfactory
decision. In the absence of a mediator, who is perceived by both the parties to be
neutral, the two parties might not enter into a fruitful discussion due to mutual distrust
or lack of empathy. In arbitration, the third party takes a decision, which either
voluntarily or compulsorily is abided by the parties. Third party mechanisms are the
last resort before either of the parties actually takes to drastic action. These
mechanisms are thus employed when all the other institutionalized mechanisms
become ineffective and one party or the other is contemplating some destructive
behaviour.

Negotiation as a Mechanism for Resolving Conflict

When a conflict brims over and manifests itself in some form of overt behaviour, the
institutional mechanisms or third party mechanisms become irrelevant. It is then that
conflict negotiation becomes very important. Negotiation as a solution to reduce any
 variety of conflict is a time tested and popular approach. Negotiation is a process
where the parties to the dispute set down mutual rules of engagement and work within
these rules to achieve competitive advantage over the other party. During negotiation,
the parties to the dispute exchange views and revise their stands based on the
proposals provided by the other party. Hence, it is important to understand that
negotiations cannot take place without the two parties agreeing to negotiate. Further,
there are two or more parties to the negotiation and each party works out its own sets
of interests. These interests may not necessarily be economic in nature, although
economic interests normally predominate. Often, it is really difficult to comprehend
what are the real interests of the parties to the dispute. This is because the apparent
interests may not always be the real interests. It is seldom that the negotiating parties
reveal their real interests. Negotiations can be very formal with a detailed agenda and
well laid down code of conduct. Negotiations can also be quite informal with the two
sides talking to each other very informally without any particular agenda. Also,
negotiations vary on the basis of the time spent and the scope. Parties at the
negotiating table adopt different strategies to get what they want through the process.
While it is often argued that negotiation strategies cannot be predicted and come
naturally, it is always possible to identify patterns and explain different types of
strategies.

Negotiation strategies

Negotiation strategies are patterns of behaviour used by parties during the negotiation
process to resolve conflicts. Five types of negotiation strategies can be observed: (i)
competing or aggressive, (ii) collaborative or problem solving, (iii) compromising, (iv)
avoiding, and (v) accommodating. The five strategies can be explained by imaging a two-
dimensional plain with the dimensions being (a) concern for own interests and (ii)
concern for the other parties’ interests. Figure 16.7 illustrates this aspect. As is evident
from the figure, negotiating strategies can range from a competitive or aggressive
strategy where only self interests are considered without giving any attention whatsoever
to that of the opponent, to an accommodation strategy where self-interests are least
considered but the other’s interests are given the maximum importance. In avoidance
strategy, one gives in to all the demands of the opponent without putting up any demand
from one’s own side. This may be done purposefully to maintain the relationship or may
be because of some imminent external contingency. For example, if a manufacturer
anticipates an imminent entry of the competitor with superior goods and does not want to
lose support of its channel partners, the manufacturer would want to maintain the
relationships in the same state somehow. If the channel principal indulges in an
accommodation strategy very often, it would raise doubts about the power of the channel
principal to control the channel. In contrast, the aggressive strategy involves not giving
any room to the opponent and strongly pushing for one’s own cause. Here, the issues
involved are considered to be very important to give anything away. Adoption of an
aggressive strategy would naturally lead to a permanent strain in the relationship with the
channel partners. Further, it will be difficult to resolve a conflict if both the parties take
an aggressive stand on all the points of dispute.
At the other dimension, there are three strategies ranging from avoidance, where both
self interests as well as interests of the other party are given very low consideration,
to a collaborative strategy where the interest of both the parties are given high levels
of consideration. In avoidance strategy, the idea is to prolong the negotiation by
skirting real issues and discuss unimportant issues that are of no consequence. The
motive behind adopting such a strategy is to exhaust the other party’s resources, to
buy time, or to maintain status quo. This type of strategy could of course enrage the
opponents and they might even consider negotiation as a useless method of resolving
conflicts in the future.

In collaborative strategy, which is considered to he the most advisable strategy to

ensure long-term relationships, the parties to the dispute sit together and openly share
information so as to work out a solution which benefits both. The attempt is to
develop a solution that integrates the requirement of both the parties. This strategy
entails searching for alternate solutions and assessing the outcomes of each
alternative for both the parties. There is an earnest effort to consider each other’s
goals as well to work towards a win-win solution. The strategy however requires
sharing of substantial levels of information. This aspect discourages many channel
principals to adopt this strategy especially when they fear that such information may
be used by the opponent against the channel principal in the future.

Another strategy that is widely used is the compromise strategy. In this strategy the
parties decide to scale down their interests to a reasonable level so that the final
solution is acceptable to both the parties. This is different from collaborative strategy
as it involves a satisfying solution and not a completely satisfactory solution that is
beneficial to both the parties. Further, the level of information sharing that occurs is
much less than what is witnessed in the collaborative strategy.

Factors affecting the adoption of negotiation strategy. While in a practical situation

parties would select a broad approach, it is possible to identify these strategies if they
are subjected to an in depth analysis. The selection of a particular approach depends
on several factors associated with the issue of dispute, such as relative power of each
party long-term or short- term orientation of the parties, personal characteristics,
history of interaction between the parties, etc. For instance, if a channel principal is
very powerful and the channel members are dependent on the channel principal, the
channel principal will be tempted to resort to aggressive strategies for conflict
resolution. On the other hand, if the power relationship between the channel principal
and the channel members is symmetric, with both the parties needing each other
equally strategies like compromise and problem solving might be employed.

Avoidance strategy is usually employed by a party which is quite powerful and does
not want to alter the status quo. It is mostly used when the negotiation is carried out at
the other end by a sensitive individual who will be quite infuriated if aggressive
strategies are employed against him. The nature of issues also affect the selection of a
negotiation strategy If the issue under dispute is very important or has the potential to
set a precedent, then, a powerful channel member can be expected to indulge in
aggressive, competitive strategies. On the other hand, if issue is quite unimportant,
channel members will not have any problem in adopting n accommodation strategy

Further, if the channel principal has a long-term orientation which implies that there
is a desire to maintain the relationship for a long period with the channel members,
then, aggressive or avoidance strategies are usually not employed even if the channel
principal is powerful enough to adopt any of these strategies.