Supply-Chain Mgmt Notes

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, butin 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

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

Zone OfAcceptance Supplier Authority

Pay-offFunction

Tolerance Function

Distributors’Profit earned

A

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 Conflictbehaviour, 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.