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Changing Channels: Distribution Strategies in the PC Industry
A new statistical model can help managers determine which distribution channel works best and evaluate the financial implications of changing the firm’s distribution strategy and channel-product line combinations.
 
In the study ‘Assessing the Economic Value of Distribution Channels’, I along with Junhong Chu of the business school at the National University of Singapore, and Naufel J. Vilcassim of London Business School examined manufacturers’ distribution channel and product line options in the PC industry.

The movement of products from manufacturer to consumer is referred to as a distribution channel, with agents en route to the consumer serving as intermediaries. Firms in industries selling multiple products and using multiple distribution channels such as the PC industry have to decide which distribution channels to use and which product to sell through which distribution channel. Distribution strategies are intertwined with a firm’s product line, market segmentation, and positioning & targeting strategies. Changes to these strategies affect a firm’s customer base and profits, as well as its relationships with intermediaries and other firms in the market.

It’s difficult to predict the result of changes in distribution channels, because existing relationships with intermediaries prevent firms from conducting actual experiments to test new strategies.

Gauging the outcomes of new distribution strategies is especially important because contracts between manufacturers and retailers are long-term relationships and cannot arbitrarily be broken. Modifying distribution channels is an expensive, timeconsuming task that leaves many people upset, notably intermediaries who might be dis-intermediated. In those contexts, a firm needs to have better guidance regarding the consequences of their actions.

A Changing Industry

There were two key triggers that changed distribution strategies in the PC industry. As Dell and direct sellers became more powerful and the Internet appeared in the mid-1990s, larger companies like HP and IBM began migrating to the direct channel. This shift enabled large manufacturers to sell and distribute their products directly to customers. The Internet provided a good catalyst for thinking about how to restructure distribution channels.

Traditional retail channel margins account for 20-30% of a product’s price. From a producer’s perspective, if they can sell as well as intermediaries, selling directly to consumers is much more profitable; the manufacturers will not have to give a share of profits to channel partners. Eliminating the retail markup via direct selling also benefits consumers in terms of lower costs.

To study the result of changing distribution strategies, we developed a structural model that simulates marketing policy changes. The model specifies the economic agents being studied – consumers, retailers, and manufacturers – and the nature of their interactions. The model is then used to predict the behavior of each set of agents in response to a manufacturer changing an element of its distribution strategy.

We used data from the PC industry to determine the parameters of the model, but eventually we needed the model to predict the effects of policy changes. Our statistical model characterizes the interactions between sales and prices of all products sold in all channels, allowing us to assess the economic value of each channel to each firm and its consumers. The structural model allowed us to conduct a “What if?” type of analysis that could be used as an input for marketing managers.

 
Data from the US PC market from 1995 to 1998 was used, including retail prices and unit sales at the manufacturer’s brand-model level across six different distribution channels. At the top of the channel are such manufacturers as Dell, Compaq, and Gateway. Each manufacturer has several brands, each of which has a series of PC models. Together, these models form a product line. For example, Dell has the Dimension brand, and multiple products within this brand compose the Dimension product line.

The six distribution channels evaluated in the study are: 1. Direct outbound sales by a manufacturer’s sales team; 2. Direct inbound telemarketing or catalog sales; 3. Dealer corporate account resellers and computer specialty dealers, usually focused on sales to large volume buyers; 4. Retail storefront businesses that sell to a large number of unrelated consumers; 5. Internet direct sales via manufacturer Web sites; 6. Other

Indirect channels (dealer and retail) accounted for the bulk of PC sales, with 35% of PCs sold via dealers and 31% sold in the retail channel. Internet sales accounted for less than 1% of total PC sales in 1998. All manufacturers used multiple channels to market their products, but different manufacturers focused on different channels. Each product line had one primary channel. These channel arrangements help firms match consumer preference for the product line with preference for the channel. This, in turn, helps reduce intra-brand competition across channels and better coordinates the manufacturer’s distribution strategy. For example, Compaq sold 90% of its Presario PCs via the retail channel, 85% of HiNote PCs via dealers, and 99% of ProSignia PCs via catalogs and its Web site.

Experimenting with Distribution Strategies

To assess the economic value of a distribution channel to a PC manufacturer, we dropped the distribution channel from a manufacturer’s distribution system and recalculated average prices and market shares under the new distribution system. We also recalculated changes in the manufacturer’s profits.

Distribution channels with high historical sales and profits were not necessarily the most economically valuable to firms. In addition, there were considerable differences in channel substitution patterns. For example, there was little substitution between direct and indirect distribution channels.

The removal of any distribution channel benefits rival PC manufacturers because it reduces competition. Removal of direct channels will benefit intermediaries, but removal of indirect channels will hurt them. In all cases, consumers are worse off when a channel is dropped.

Manufacturers usually incur losses when their product lines are dropped entirely from some channels. Rival manufacturers always benefit from the removal of a manufacturer’s product line because it lowers competition. Intermediaries benefit if a product line is dropped from a direct channel because some of the previous purchasers of the product line will switch to indirect channels, but intermediaries will be hurt if a product line is dropped from an indirect channel due to lost profits. Removal of a product line negatively impacts consumers because it decreases the amount of variety in the market. To study the effect of adding channels to a firm’s distribution systems, we simulated various strategies for Dell, Compaq, and Gateway.
          
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