WRITING HOMEWORK 2

Consider the following example. The final movement of a retail item occurred on March 6 at 10:47 A.M. when a customer brought home a garden hose that she had just purchased at a Walmart Supercenter in Amarillo, Texas. Thirteen months earlier, a sample of that hose had been in a Hong Kong showroom where a Walmart buyer ordered 200,000 hoses for the next year’s selling season from the showroom’s vendor. The buyer then hired a Chinese agent to represent Walmart after the buyer returned to Arkansas. This agent was to make sure that the factories met Walmart’s regulations regarding working conditions and that the hoses and parts met the retailer’s quality standards. Over the next nine months, the hoses were assembled in mainland China using nozzles made in Thailand. The hoses were then transported to a warehouse in El Paso’s free-trade zone. In late January, three truckloads of these hoses were shipped from El Paso to the Walmart distribution center in Plainview, Texas, for immediate shipment to the Amarillo Supercenter. In this example, manufacturing occurred in both China and Thailand, a Mexican warehouse stored the products for several months, and a Mexican motor carrier was used to transport the hoses by truck to the United States, where, after going through customs, the hoses were shipped to the free-trade zone. From there, either a U.S. or a Mexican trucking company took the hoses to Walmart’s Plainview distribution center. Within an hour of being received at the distribution center, Walmart’s own trucks were taking the hoses to Amarillo. Thus, before the final retail transaction could take place, several physical movements were needed that involved many firms other than the retailer. As the above example illustrates, retailers cannot properly. Perform their roles without the assistance of other firms. Retailers are part of a supply chain—a valuable component, but not the only one. In contrast to Walmart’s rather slow-moving supply chain, this chapter’s ‘‘Global Retailing’’ box describes how one Spanish apparel chain, Zara, has revolutionized the fashion world and become the world’s second-largest clothing retailer (in sales) by keeping a tight grip on every link in its supply chain. It is important to understand the retailer’s role in the larger supply chain. Retailers have used the term supply chain interchangeably with the term channel. Traditionally, this consisted of a set of institutions that moves goods from the point of production to the point of consumption. However, with increased concern about the physical environment or ecosystem, many retailers are beginning to view the supply chain as ‘‘dirt to dirt.’’ This broadened view traces all of the materials that go into manufacturing and then the institutions that bring the product to the retailer but then also includes what the consumer does to dispose of or recycle the product. Over the last decade, retailers became more aware of the need to expand their view of the supply chain due to harmful ingredients found in products such as lead used in paint for children’s toys or foreign substances used in pet food. Using the more traditional view, the supply chain or channel might include manufacturers, wholesalers, and retailers. For example, the manufacturer could sell directly to an individual for household usage, sell to a retailer for sale to the individual, or sell to a wholesaler for sale to the retailer, who then sells to the individual. Thus, supply chains consist of all the institutions and all the marketing activities (storage, financing, purchasing, transporting, etc.) that are spread over time and geographical space throughout the marketing process. If the retailer is a member of the supply chain that collectively does the best job, that retailer will have an advantage over other retailers. Why should the retailer view itself as part of a larger channel or supply chain? Why can’t it simply seek out the best assortment of goods for its customers, sell then goods, make a profit, go to the bank, and forget about the supply chain? In reality, the world of retailing is not that easy. Profits sufficient for survival and growth would be difficult, if not impossible, to achieve if the retailer ignored the supply chain. This does not mean that a channel should never be altered. Innovative retailers are always seeking to find a new method to change the existing supply chain and replace it with a better one. For example, discounters changed their relationships with vendors when they began to buy directly from manufacturers in large quantities, warehouse the merchandise in efficiently run distribution centers, and ship to their own stores as a means of obtaining lower prices. Prior to this change, discounters purchased smaller quantities from wholesalers only when the merchandise was needed. Similarly, as described in Chapter1’s ‘‘Retailing: The Inside Story,’’ airlines

restructured their supply chains to circumvent the need for travel agents by having customers purchase their own tickets directly from the airlines using the Internet. Prior to making changes in the overall channel structure, supply-chain members must understand that all channels are affected by five external forces: (1)consumer behavior, (2) competitor behavior, (3) the socioeconomic environment,(4) the technological environment, and(5) the legal and ethical environment. These external forces cannot be completely controlled by the retailer or any other institution in the supply chain, but they need to be taken into account when retailers make decisions. For example, a change in the minimum-wage law will usually increase the retailer’s cost of doing business. Similarly, a rapid rise or fall in fuel prices will result in a shift between using rail and motor carriers to deliver product. The retail strategic planning and operations management model (Exhibit 2.6) dramatizes the importance of these external forces in retail decision making. Supply-chain or channel structure also depends on the number of tasks or functions each member is willing to perform. Eight marketing functions must be performed by any supply chain or channel: buying, selling, storing, transporting, sorting, financing, information gathering, and risk taking. Most of these functions are self-explanatory; however, the concept of ‘‘sorting’’ requires some explanation. Sorting involves breaking down heterogeneous materials or product into more homogenous groups such as sorting oranges into those that are good for eating versus good for juice or other products. It also involves building up assortments of products that shoppers like to find together in a store—for example, orange juice with muffins, eggs, cereal, or bacon. Whether the economic system is capitalistic, socialistic, or somewhere in between, every supply chain must perform these eight marketing functions. They cannot be eliminated. They can, however, be shifted or divided in differing ways among the different institutions and the consumer in the supply chain. All forms of retailing were created by rearranging the marketing functions among institutions and consumers. For example, department stores were created specifically to build a larger assortment of goods. They capitalized on the opportunity to perform one or more functions better than the current competition. No longer was it necessary to travel to one store for a shirt and pants, another for shoes, and yet another for cookware; the necessary assortment was available in a single store. Supermarkets increased consumer participation by shifting more of the information gathering, buying, financing, and transporting functions to customers. Before supermarkets, consumers could have the corner grocer select items and deliver them and have them placed on a store credit account for payment every two weeks when the household received income, but with the introduction of super-markets came self-service and cash and carry. Consumers had to locate goods within the store, select them from an array of available products, pay for the goods, and transport them home. The airlines have now shifted the purchasing of tickets and the printing of boarding passes to the customer. By performing these marketing functions, the consumer is compensated with lower prices. It is important to note that a marketing function does not have to be shifted in its entirety to another institution or to the consumer; instead, it can be divided among several entities. For example, manufacturers that don’t want to perform the entire selling function could have the retailer perform part of the job through in-store promotions, local advertising, or promotions on the retailer’s website. At the same time, the manufacturer could assume some of the tasks using national advertising and by developing its own website to provide product information such as installation, cleaning directions, and the manufacturer’s warranty. No member of the channel would want or be able to perform all eight marketing functions entirely. For this reason, the retailer must view itself as being dependent on other supply-chain members. The institutions involved in performing the eight marketing functions are usually broken into two categories: primary and facilitating. Primary marketing institutions are supply-chain members that take title to the goods. Facilitating marketing institutions are those that do not actually take title but assist in the marketing process by specializing in the performance of certain functions. Exhibit 5.1 classifies the major institutions participating in the supply chain. Primary Marketing Institutions There are three types of primary marketing institutions: manufacturers, wholesalers, and retailers. Because manufacturers produce goods, we don’t often think of them as marketing institutions. But manufacturers cannot exist by only producing goods; they must also sell the goods produced. To produce those goods, the nation’s 400,000 manufacturers must purchase many raw materials, semi finish goods, and components. In addition, manufacturers often need the assistance of other institutions in performing the eight marketing functions. A second type of primary marketing institution is the wholesaler. Wholesalers generally buy merchandise from manufacturers and resell to retailers, other merchants, industrial institutions, and commercial users. An example of a wholesaler is Houston-based Sysco Corporation. Through its subsidiaries, Sysco engages in the distribution and marketing of food and related products primarily to the food- service industry in the United States and Canada. It distributes frozen foods, fully prepared entrees, fruits, vegetables, and desserts, as well as various nonfood items, including disposable napkins, plates, and cups; tableware; cleaning supplies; and restaurant and kitchen equipment to restaurants, hospitals, nursing homes, schools and colleges, hotels and motels. There are430,000 wholesalers in the United States, each performing some of the eight marketing functions.1 Just as it is important for retailers to continuously evaluate their own strategies, it is equally important for them to consider the strategies of the wholesalers in their supply chain. The third type of primary institution is the retailer. Today there are 1.1 million retail stores or institutions and more than 1.8 million service establishments in the United States.2 Retailers can perform portions of all eight marketing functions. It is possible that some firms, such as the membership warehouse clubs (Sam’s and Costco) can act as both a wholesaler selling to small businesses and a retailer selling to households. However, for statistical purposes, the Census Bureau con-siders all membership warehouse clubs to be wholesalers since the majority of their

business involves wholesale transactions. Facilitating Marketing Institutions many institutions facilitate the performance of the marketing functions. Most specialize in one or two functions; yet none of them takes title to the goods. Institutions that facilitate the buying and selling functions in the supply chain or channel include agents and brokers, who are independent businesspeople who receive a commission

or fee when they are able to bring a buyer and seller together to negotiate a trans-action. Seldom do agents or brokers take physical possession of the merchandise. One of the new breed of e-tailing brokers is Priceline.com, Inc. It pioneered the e-commerce pricing channel known as a demand collection channel, which allows it to act without holding any inventory. Priceline’s channel enables consumers to use the Internet to make bids on a wide range of products and services while enabling sellers to generate incremental revenue. Using its ‘‘Name Your Own Price’’ or ‘‘Negotiation’’ proposition, Priceline collects consumer demand in the form of individual customer offers, guaranteed by a credit card, for a particular product or service at a price set by the customer. Priceline then either communicates that demand directly to participating sellers or accesses participating sellers’ private databases to determine whether Priceline can fulfill the customer’s offer and earn its brokerage commission. Priceline’s business model can be applied to a broad range of products and services and is already being copied. Marketing communications agencies, or advertising agencies, also facilitate the selling process by designing effective advertisements and advising management o where and when to place these advertisements. Institutions that facilitate the transportation function are motor, rail, and air carriers and pipeline and shipping companies. Transporters can have a significant effect on how efficiently goods move through the supply chain. These firms offer differing advantages in terms of delivery, service, and cost. Generally, the quicker the delivery, the more costly it is. However, there is usually a trade-off because faster delivery enables the supply chain to have lower warehousing costs. The major facilitating institution involved in storage is the public warehouse, which stores goods for safekeeping in return for a fee. Fees are usually based on cubic feet used per time period (month or day). Frequently, retailers take advantage of special promotional buys from manufacturers but have no space for the goods in their stores or storage facilities. As a result, they find it necessary to use public warehouse. A variety of facilitating institutions also help provide information throughout the supply chain. For example, the role of computer specialists, referred to as channel integrators, in setting up computer channels for transmitting information is evident throughout the business world. Retailers can now order many types of merchandise online. In fact, many retail analysts believe that Walmart’s leap into the number-one spot in worldwide retail sales stems directly from Retail Link, a sophisticated electronics system used to manage its huge supply and distribution network. Retail Link (described in this chapter’s ‘‘What’s New?’’) enables the suppliers to work in tandem with Walmart as the retail environment shifts. Due to the success of Retail Link, most of today’s major retailers require that all their vendors be linked electronically to their computers, thereby permitting the vendors to automatically ship replacements without purchase orders and receive payment electronically. By saving on distribution costs, these retailers have been able to hold their selling prices constant despite a slight increase in merchandise costs. Other facilitating institutions aid in financing, such as commercial banks, merchant banks, factors, stock and commodity exchanges, and venture-capital firms. These institutions can provide, or help the retailer obtain, funds to finance marketing functions. For example, retailers frequently use factors for short-term loans to fund working-capital requirements (e.g., to finance the increased level of inventory needed for the Christmas selling season) while relying on banks for long-term loans to continue growth and expansion (adding new stores or remodeling). Venture-capital firms are primarily used by retailers starting a new operation or format. Finally, insurance firms can assume some of the risks in the channel, insuring inventories, buildings, trucks, equipment and fixtures, and other assets for the retailer and other primary marketing institutions. They can also insure against a variety of events such as employee and customer injuries, changes in interest rates, and the impact of terrorist activity. Having reviewed the various functions and institutions in the supply chain, we are now ready to examine how the primary marketing institutions are arranged into a supply chain. A direct supply chain or channel occurs when manufacturers sell their goods directly to the final consumer or end user. In these rare cases, the lack of involvement by other middle men pushes the manufacturer to perform most of the marketing functions (e.g., transporting is often performed by facilitating institutions or even the consumer). An example of such a supply chain is Firestone, which sells some of its tires through company-owned retail outlets to the consumer. The supply chain becomes indirect once independent members (or retailers. retailers) are added between the manufacturer and the consumer. Indirect supply chains, as shown in Exhibit 5.3, may include just a retailer or both a retailer and a wholesaler. Consider, for example, your neighborhood Avon or Mary Kay representative. This representative is an independent retailer who purchases cosmetic products from Avon or Mary Kay and then sells them to a consumer. This channel is described as being indirect because it goes from manufacturer to retailer to consumer. Similarly, when a local independent grocer purchases some Hunt’s ketchup from Super Value, a large food wholesaler that had already purchased the ketchup from its manufacturer, Con-Agra, the channel is also indirect, going from manufacturer to wholesaler to retailer to consumer. Sometimes the length of a supply chain is hard to determine. For example, when a consumer purchases cosmetics from a manufacturer’s website and that manufacturer mails the merchandise directly to the consumer, the chain is said to be a direct manufacturer-to-consumer channel. However, if the consumer makes a purchase from a different manufacturer’s website, such as Avon, and an Avon sales representative delivers the merchandise to the consumer from her own inventory, then the channel would actually be indirect—manufacturer to retailer (remember that the Avon lady is an independent businessperson) to consumer. The desired length is determined by many customer-based factors such as the size of the customer base, geographical dispersion, behavior patterns like purchase frequency and average purchase size, and the particular needs of customers. For example, if the consumer was concerned only about the price paid for merchandise, then he or she would probably drive to a farmer’s roadside stand to purchase a dozen eggs. However, as we pointed out in Chapter 4, factors other than price influence demand. In this case, the consumer might be willing to pay 20 percent to 30 percent more for the convenience of purchasing the eggs at the neighborhood grocer—saving the time and the cost of gas for an hour’s drive into the country. Therefore, it is important to remember that, in many cases, indirect channels are actually cheaper in terms of total costs involved. In addition, the nature of the product—such as its bulk and weight, perish-ability, value, and technical complexity—is important in determining supply-chain length. For example, expensive, highly technological items such as home entertainment systems will generally use short channels because of the high degree of technical support and liaison needed, which may only be available directly from the manufacturer. Length can also be affected by the size of the manufacturer, its financial capacity, and its desire for control. In general, larger and better-financed manufacturers have a greater capability to bypass intermediaries and use shorter channels. Manufacturers desiring to exercise a high degree of control over the distribution of their products are also more likely to use a shorter chain (e.g., Zara from this chapter’s ‘‘Global Retailing’’ box). Retailers, on the other hand, do not always have a lot of control over their channel length. For example, retailers entering Japan will find that their channel’s long length is to a great extent predetermined. Japan’s channel structure (often referred to as a multitier distribution channel) was formed in feudal times and is the accepted method of doing business in that country. Sometimes the retailer must learn to operate as efficiently as possible within an inefficient channel. Supply-Chain Width Supply-chain width or channel width, shown in Exhibit 5.4, is usually described in terms of intensive distribution, selective distribution, or exclusive distribution. Intensive distribution means that all possible retailers are used to reach the target market. Selective distribution means that a smaller number of retailers are used, while exclusive distribution means only one retailer is used in the trading area. Although there are many exceptions, as a rule, intensive distribution is associated with the distribution of convenience goods, which are products that are frequently purchased; those for which the consumer is not willing to expend a great deal of effort to purchase. Selective distribution is associated with shopping goods, items for which the consumer will make a price or value comparison before purchasing. Exclusive distribution is identified with specialty goods—usually high-prestige branded products that the consumer expressly seeks out. Thus, soft drinks, milk, and greeting cards (convenience goods) tend to be carried by a very large number of retailers; home appliances and apparel (shopping goods) are handled by relatively fewer retailers; and specialty goods, such as Rolex watches, are featured by only one dealer in a trading area. Some of these specialty goods are so exclusive, Rolls-Royce automobiles for example, that many trade areas may not have a retailer handling them.

Control of the Supply Chain

The previous discussion was concerned with the length and width of a supply chain. However, a more pressing issue is who should control the supply chain. Many chains consist of independent business firms who, without the proper leadership, may look out solely for themselves, to the detriment of the other members. For this reason, experts agree that no supply chain will ever operate at a 100-percent efficiency level. Supply-chain members must have as their goal ‘‘to minimize the sub-optimization’’ of the supply chain. Supply chains follow one of two basic patterns: the conventional marketing channel and the vertical marketing channel. Exhibit 5.5 provides an illustration of these major channel patterns.

Conventional Marketing Channel

A conventional marketing channel is one in which each member of the supply chain is loosely aligned with the others and takes a short-term orientation. Predictably, each member’s orientation is toward the subsequent institution in the channel. The prevailing attitude is ‘‘what is happening today’’ as opposed to ‘‘what will happen in the future.’’ The manufacturer interacts with and focuses efforts on the wholesaler, the wholesaler is primarily concerned with the retailer, and the retailer focuses efforts on the final consumer. In short, all of the members focus on their immediate desire to close the sale or create a transaction. Thus, the conventional marketing channel consists of a series of pairs in which the members of each pair recognize each other but not necessarily the other components of the supply chain. The conventional marketing channel, which is historically predominant in the United States, is a sloppy and inefficient method of conducting business. It fosters intense negotiations with in each pair of institutions in the supply chain. In addition, members are unable to see the possibility of shifting or dividing the marketing functions among all the participants. Obviously, it is an unproductive method for marketing goods and has been on the decline in the United States since the early 1950s.

Vertical Marketing Channels

Vertical marketing channels are capital-intensive networks of several levels that are professionally managed and rely on centrally programmed systems to realize the technological, managerial, and promotional economies of long-term relationships. The basic premise of working as a system is to operate as close as possible to that elusive 100-percent efficiency level. This is achieved by eliminating the sub-optimization that exists in conventional channels and improving the channel’s performance by working together.3 Formerly adversarial relationships between retailers and their suppliers are now giving way to new vertical channel partnerships that minimize such inefficiencies.4 Because vertical channel members realize that it is impossible to offer consumers value without being a low-cost, high-efficiency supply chain, they have developed either quick response (QR) systems or efficient consumer response (ECR) systems. These systems, which are identical despite the differing names adopted by various retail industries, are designed to obtain real-time information on consumers’ actions by capturing stock-keeping unit (SKU) data at point-of-purchase terminals and then transmitting that information through the entire supply chain. This information is used to develop new or modified products, manage channel wide inventory levels, and lower total channel costs. The final section of this chapter discusses category management, which is accomplished when all the members (who would have acted independently in a conventional channel) work as team to apply the ECR concept to an entire category of merchandise. There are three types of vertical marketing channels: corporate, contractual, and administered. Each has grown significantly in the last half-century.

Corporate Channels

Corporate vertical marketing channels typically consist of either a manufacturer that has integrated vertically forward to reach the consumer or a retailer that has integrated vertically backward to create a self-supply network. The first type includes manufacturers such as Dell, Sherwin Williams, Polo Ralph Lauren, and Coach, which have created their own warehousing and retail outlets or Internet selling sites. An example of the second type includes Holiday Inns, which for years was vertically integrated to control a carpet mill, furniture manufacturer, and numerous other suppliers needed to build and operate its motels. To illustrate this point, consider that Holiday Inn had to conduct extensive research to overcome manufacturing problems encountered with the production of cinnamon rolls, the trademark of its Holiday Inn Express units. Incorporate channels, it is not difficult to program the channel for productivity and profit goals since a well-established authority structure already exists. Independent retailers that have aligned themselves in a conventional marketing channel are at a significant disadvantage when competing against a corporate vertical marketing channel. Contractual Channels Contractual vertical marketing channels, which include wholesaler-sponsored voluntary groups, retailer-owned cooperatives, and franchised retail programs, are supply chains that use a contract to govern the working relationship between the members. Each of these variations allows for a more coordinated, system wide perspective than conventional marketing channels. However, they are more difficult to manage than corporate vertical marketing channels because the authority and power structures are not as well defined. Supply-chain members must give up some autonomy to gain economies of scale and greater market impact. Wholesaler-Sponsored Voluntary Groups. Wholesaler-sponsored voluntary groups are created when a wholesaler brings together a group of independently owned retailers (independent retailers is a term embracing anything from a single mom-and-pop store to a small local chain)—grocers, for example—and offers them a coordinated merchandising program (store design and layout, store site and location analysis, inventory management channels, accounting and bookkeeping channels, insurance services, pension plans, trade area studies, advertising and promotion assistance, employee-training programs) as well as a buying program that will provide these smaller retailers with economies similar to those obtained by their chain store rivals. In return, the independent retailers agree to concentrate their purchases with that wholesaler. It is a voluntary relationship; that is, there are no membership or franchise fees. The independent retailer may terminate the relationship whenever it desires, so it is to the wholesaler’s advantage to build competitive merchandise assortments and offer services that will keep the voluntary group satisfied. In the past, local food wholesalers got practically all of their business from independent grocers. Recently, however, as transportation costs have risen, major chains operating over a wide geographic area have also started using local or regional wholesalers. While welcoming this new business, wholesalers have attempted to keep their independents happy (since they still account for more than 40 percent of their business) by offering them additional services. Wholesaler-sponsored voluntary groups have been a major force in marketing channels since the mid-1960s. They are now prevalent in many lines of trade. Independent Grocers’ Alliance (IGA) and National Auto Parts Association (NAPA) are both examples of wholesaler-sponsored voluntary groups. Retailer-Owned Cooperatives. Another common type of contractual vertical marketing channel is retailer-owned cooperatives, which are wholesale operations organized and owned by retailers; these are most common in hardware retailing. They include such familiar names as True Value (which was highlighted in Exhibit 2.3), Ace, and Handy Hard-ware, and they offer scale economies and services to member retailers, allowing their members to compete with larger chain-buying organizations. It should be pointed out that, in theory, whole- sale-sponsored groups should be easier to manage since they have only one leader, the wholesaler, versus the many owners of the retailer-owned group. One would assume that in retailer-owned cooperatives, individual members would desire to keep their autonomy and be less dependent on their supplier partner for support and direction. In reality, however, Just the opposite has been true. A possible explanation is that retailers belonging to a wholesale co-op may make greater transaction-specific investments in the form of stock ownership, vested supplier-based store identity, and end-of-year rebates on purchases that combine to erect significant exit barriers from the cooperative. Franchises. The third type of contractual vertical marketing channel is the franchise. A franchise is a form of licensing by which the owner of a trademark, service mark, trade name, advertising symbol, or method (the franchisor) obtains distribution through affiliated dealers (franchisees). Each franchisee is authorized by the franchisor to sell its goods or services in either a retail space or a designated geographical area. The franchise governs the method of conducting business between the two parties. Generally, a franchisee sells goods or services supplied by the franchisor or that meet the franchisor’s quality standards. This relationship is regulated by Federal Trade Commission laws. In many cases, the franchise operation resembles a large chain store. It operates with standardized logos, uniforms, signage, equipment, storefronts, services, products, and practices—all as outlined in the franchise agreement. The consumer might never know that each location is independently owned. Franchising is a convenient and economic means of fulfilling an individual’s desire for independence with a minimum amount of risk and investment but maximum opportunities for success. This is possible through the utilization of a proven product or service and marketing method. Consider that one of the benefits of franchising is that it permits a franchisee to select a location in a somewhat sophisticated manner based on the various professional forecasting models that use data from earlier units. Another advantage is in the purchasing of key items. Holiday Inn, for example, knows more about how to buy mattresses and furniture than most of its franchisees. However, a franchisee–franchisor relationship requires an ongoing commitment, with each party expected to uphold its end of the contract though active communication, solidarity, and mutual trust. In those cases where a franchisee–franchisor relationship does not work, it is usually the result of a franchisee misunderstanding the franchising model and the franchisor failing to set expectations or the franchisee not understanding them at the outset. Remember that a franchisee gives up some freedom in business decisions that the owner of a non-franchised business would retain. The most common franchise mistakes result from a franchisee’s incorrect perception of him- or herself as a traditional entrepreneur. In order to maintain uniformity of service and to ensure that the operations of each outlet will reflect favorably on the organization as a whole, the franchisor must exercise some degree of control over the operations of franchisees, requiring them to meet stipulated standards of product and service quality and operating procedures. There are some 1,200 franchisors in the United States today, and they can be found at any position in the marketing channel; about 60 percent of them have startup costs of less than $300,000. The franchisor could be a manufacturer such as Chevrolet or Midas Mufflers; a service specialist such as Sylvan Learning, Stanley Steemer, AAMCO Transmissions, H&R Block, Lawn Doctor, Merry Maids, Mr. Handyman, Supercuts, or Century 21 Real Estate; a retailer such as Gingiss Formalwear; or a fast-food retailer such as McDonald’s, Dunkin’ Donuts, Subway, Domino’s Pizza, or KFC. It should be noted that franchising isn’t all about food anymore. Consumer service providers such as fitness centers, lawn-care specialists, dance studios, and pet hotels have not opened the most outlets recently, but they have been the best performing.6 A more complete list can be found at the Inter-national Franchise Association website (www.franchise.org).7 Another advantage of being a franchisee was illustrated during the recent economic crisis when many financial institutions cut or reduced their loans to the franchisees. Such actions, for example, made it harder for fast-food franchises to remodel existing locations and buy or open new restaurants.8 However, while most franchisors normally don’t provide financial assistance to existing franchisees, they made an exception during the recent recession. This was because the franchisors were able to get the financing partly because of their historically low default rate on previous loans as well as their current balance sheets. By securing these loans, a franchisor provided capital to be used by the franchisee for expansions, acquisitions, debt consolidation, and refinancing for new and current obligations.9 Finally, although only a third of U.S. franchisors are currently operating in foreign countries, another third are looking to expand internationally within the next five years. After all, why compete in overcrowded U.S. markets when many foreign markets are available? Although franchising is seen as an economic-development tool for poor countries, the most widely considered foreign markets are the most prosperous markets of Canada, Japan, Mexico, Germany, the United Kingdom, and, more recently, Southeast Asia—Philippines, Thailand, Taiwan, Singapore, and Indonesia.

Administered Channels

The final type of vertical marketing channel is the administered channel. Administered vertical marketing channels are similar to conventional marketing channels, yet one of the members stakes the initiative to lead the channel by applying the principles of effective inter-organizational management, which is the management of relationships between the various organizations in the supply chain. Administered channels, although not new in concept, have grown substantially in recent years. Frequently, administered channels are initiated by manufacturers because channel members have historically relied on manufacturers’ administrative expertise to coordinate the retailers’ marketing efforts. Suppliers with dominant brands have predictably experienced the least difficulty in securing strong support from retailers and wholesalers. However, many manufacturers with ‘‘fringe’’ items have been able to elicit such cooperation only through the use of liberal distribution policies that take the form of attractive discounts (or discount substitutes), financial assistance, and various types of concessions that protect resellers from one or more of the risks of doing business.10 Some of the concessions manufacturers offer retailers are liberal return policies, display materials for in-store use, advertising allowances, extra time for merchandise payment, employee-training programs, assistance with store layout and design, inventory maintenance, computer support, and even free merchandise. Manufacturers that use their administrative powers to lead channels include Coca-Cola, Sealy (with its Posture pedic line of mattresses), Villager (with its dresses and sportswear lines), Scott (with its lawn-care products), Norwalk (with its upholstered furniture), Keepsake (with diamonds), and Stanley (with hand tools). Retailers can also dominate the channel relationship. For example, Walmart, besides using its Retail Link, was one of the earliest adopters of ECR systems and today administers the relationship with almost all of its suppliers by asking that all money designated for advertising allowances, end-display fees, and so forth be taken off the price of goods instead. By doing this, the giant retailer believes that its supply chains are managed in the most efficient and effective way possible. Retailers that are not part of a contractual channel or corporate channel will probably participate in different channels since they will need to acquire merchandise from many suppliers. Predictably, these channels will be either conventional or administered. If retailers want to improve their performance in these channels, then they must understand the principal concepts of inter-organizational management. In this case, retailers must strategically manage their relations with or retailers manufacturers. What are the basic concepts of inter-organizational management that a retailer needs to understand? They are dependency, power, and conflict.

Dependency

As we mentioned earlier, every supply chain needs to perform eight marketing functions. None of the respective institutions can isolate itself; each depends on the others to do an effective job in order for the channel to be successful. Retailer A is dependency on suppliers X, Y, and Z to make sure that goods are delivered on time and in the right quantities. Conversely, suppliers X, Y, and Z depend on retailer A to put a strong selling effort behind their goods, displaying them properly, and maybe even helping to finance consumer purchases. If retailer A does a poor job, then each supplier can be adversely affected; if even one supplier does a poor job, then retailer A can be adversely affected. In all these alignments, each party depends on the others to do a good job. This concept was recently illustrated when several giant retailers worked with detergent manufactures to develop a concentrated product that would shrink the package size in half. In return, the retailers would help convince the consumer to pay the same price for a package that was half the size because it provided the same cleaning power. This was a win–win (collaboration) situation for both parties because retailers were able to use less shelf space and manufacturers saved on production costs. However, each party was dependent on the other to achieve these goals. When each party is dependent on the others, we say that they are interdependent. While this interdependency is at the root of the collaboration found in today’s supply chains, it is also the major cause of the conflict found in supply chains. To better comprehend this interdependency, an understanding of power is necessary.

Power

We can use the concept of dependency to explain power, but first we must define power. Power is the ability of one member to influence the behavior of the other supply chain members. The more dependent the supplier is on the retailer, the more power the retailer has over the supplier and vice versa. For example, a small manufacturer of grocery products would be very dependent on a large supermarket chain if it wanted to reach the most consumers. In this instance, the supermarket has power over the small manufacturer. Likewise, many suppliers are very dependent on Walmart because it is their biggest customer. For example, today Walmart accounts for 15 percent of Procter & Gamble’s (P&G’s) total revenue, more than the total of many foreign countries.11 Yet this dependence is not specific to domestic manufacturers. In fact, the Wall Street Journal recently ran the following headline across the top of its Marketplace section: ‘‘Walmart Sneezes, China Catches Cold’’ to illustrate the significant dependence so many have on Walmart.12 Thus, the power one member has over another supply-chain member is a function of how dependent the second member is on the first member to achieve its own goals.

There are six types of power:

1. Reward power is based on the ability of A to provide rewards to B. For instance, a retailer may offer a manufacturer a prominent end cap display in exchange for additional advertising monies and promotional support. Yet liquidity problems due to the recent economic slowdown resulted in the use of a different form of reward power: merchandise. Because of the sharp falloff in consumer spending, manufacturers were forced to unload excess inventory to anyone with the means to pay. This resulted in off-price retailers such as T.J. Maxx, Stein Mart, Ross Stores, and Overstock.com receiving some of the best selections of apparel, accessories, and electronic goods, items they would normally not get, at great prices.13

2. Expertise power is based on B’s perception that A has some special knowledge or superior ability. For example, Midas Muffler (a franchisor) has developed an excellent training program for store managers. As a result, franchisees view Midas as an expert in training effective store managers. Seeking the best managers possible, franchisees give up some of their control in order to gain access to this training program.

3. Referent power is based on B’s desire to be identified or associated with A. Examples of this are auto dealers that want to handle BMWs or Mercedes because of the cars’ status, or a manufacturer that wants to have its product sold in Neiman Marcus because of the image that retailer projects. Yet referent power is not always positive. In 2007, tainted pet food led to the deaths of more than a dozen dogs and cats and the illnesses of a thousand more. The food was produced by one manufacturer and sold using 101 different brand names. As a result, the differences in the selling price between the various brands were reflective of the company associated with the brand name used.14

4. Coercive power is based on B’s belief that A has the capacity to punish or harm B if B does not do what A wants. For example, franchisors like Burger King have the right to cancel a franchisee’s contract if it fails to maintain franchise standards such as restaurant cleanliness, food menu, hours of operation, and employee dress or uniforms. 5. Legitimate power is based on A’s right to influence B or on B’s belief that B should accept A’s influence. The presence of legitimate power is most easily seen in contractual marketing channels. A manufacturer may, for example, threaten to cut off a retailer’s supply if the retailer fails to meet certain standards. For example, Deere & Company recently terminated some if its smaller dealerships after years of selling the company’s equipment. Deere and Co. stated that many of these smaller dealers simply neglected to run their businesses as needed by the manufacturer; they neglected to develop new revenue streams (customers) while failing to assist the manufacturer in managing inventory costs. Now the company says that dealers must meet established profit and customer-loyalty targets or fear being merged with other dealers.15 This chapter’s ‘‘Service Retailing’’ box describes a similar fate for the retailers that sell and service America’s automobiles. Also, if the retailer accepts co-op advertising dollars, the manufacturer may control the minimum retail price, since this subject is usually covered in the agreement. Absent such an agreement, the retailer is free to set the selling price. To do otherwise would be a violation of certain federal antitrust laws, which we discuss in the next chapter.

6. Informational power is based on A’s ability to provide B with factual data. Not to be confused with expertise power, informational power occurs when the factual data is provided independently of the relationship between A and B. An example of this power would be a small retail store sharing scanner data with a vendor. Retailers and suppliers that use reward, expertise, referent, and informational power can foster a healthy working relationship. On the other hand, the use of coercive and legitimate power tends to elicit conflict and destroy cooperation in the supply chain.

Conflict

Conflict is inevitable in every supply-chain relationship because retailers and suppliers are interdependent. In other words, every channel member is dependent on every other member to perform some specific task. Interdependency has been identified as the root cause of all conflict in marketing channels. There are three major sources of conflict between retailers and their suppliers: perceptual incongruity, goal incompatibility, and domain disagreement. Perceptual incongruity occurs when the retailer and supplier have different perceptions of reality. A retailer may perceive that the economy isn’t coming out of recession and therefore may want to continue to keep a low level of inventory investments, while the supplier may believe that the economy is recovering and, therefore, that inventory investments should be maintained or possibly increased. Other areas where the retailer and supplier might perceive things differently include the quality of the supplier’s merchandise, the potential demand for the supplier’s merchandise, the consumer appeal of the supplier’s advertising, and the best shelf position for the supplier’s merchandise. A second source of conflict is goal incompatibility, a situation in which achieving the goals of either the supplier or the retailer would hamper the performance of the other. For example, Nike and Foot Locker have fought over the retailer’s goal of gaining sales with its liberal use of ‘‘BOGOs’’—industry jargon for ‘‘buy one, get one at half-off’’ sales. Such sales encourage consumers to buy two pairs on a single shopping trip, thereby reducing the chance the consumer would buy the second pair elsewhere.16 similarly, and some manufacturers don’t want their products sold at big-box stores or discounters for fear of cheapening the brand image. That is why Stihl advertises that its power tools ‘‘are not sold at Lowe’s or Home Depot.’’ Another example of incompatibility between retailer and supplier goals is a situation known as dual distribution. Dual distribution occurs when a manufacturer sells to independent retailers while simultaneously selling directly to the final consumer through its own retail outlets or through an Internet site. (This chapter’s

‘‘Retailing: The Inside Story’’ points out some of the problems that a manufacturer must consider when setting up an Internet site.) Thus, the manufacturer manages a corporately owned, vertical marketing channel that competes directly with independent retailers that it supplies through a conventional, administered, or contractual marketing channel. Retailers tend to become upset about dual distribution when the two channels compete at the retail level in the same geographic area. Remember the case at the end of Chapter 4 where it was pointed out that Trek Bicycles not only sold its bikes through a local independent retailer, but also through its own stores nearby? However, as consolidation continues among department stores, some manufacturers, such as Liz Claiborne, have opened stores selling their ‘‘power brands’’—Juicy Couture, Lucky, Sigrid Olsen, and Mexx. This practice has angered traditional retailers that buy from these manufacturers and can have an adverse effect on manufacturer–retailer relationships. Other manufacturers, such as Oakley and Tommy Bahama, believe that their stores help build brand awareness and thereby sales for the traditional establishments. The fear of upsetting current sales reps caused Tupperware to pull its products out of Target’s 1,200 stores. The attempt at dual distribution was meant to reach shoppers too busy to attend sales parties or deal with door-to-door salespeople. However, the easy availability of Tupperware products in the giant retailer’s stores had a ‘‘detrimental effect’’ on Tupperware parties.17 When Walmart sold its McLane’s wholesaling subsidiary to Warren Buffett’s Berkshire Hathaway Inc., many retailing experts felt that this action would ultimately enable Walmart to expand into the convenience store market. If the giant retailer had entered the convenience store market without selling McLane’s, the nation’s largest wholesaler serving convenience stores, it would have established a dual-distribution network whereby Walmart would operate its own retail outlets in competition with its McLane’s division wholesale customers. In such a case, the convenience store operators likely would have dropped McLane. Why would they want to financially support a competitor? The problem of goal incompatibility is not necessarily one of profit versus image goals. Even if the retailer and supplier both have a return on investment (ROI) goal, they can still be incompatible, because what is good for the retailer’s ROI may not be good for the supplier’s ROI. Consider the price element in the transaction between the supplier and the retailer. If the supplier obtains a higher price, then its ROI will be higher but the ROI of the retailer will be lower. Similarly, other key elements in the transaction between the retailer and supplier, such as advertising allowances, cash discounts, order quantity, and freight charges, can result in conflict. A third source of conflict is domain disagreements. Domain refers to the decision variables that each member of the marketing channel feels it should be able to control. When the members of the marketing channel agree on who should make which decisions, domain consensus exists. When there is disagreement about who should make decisions, domain disagreement exists. Consider the situation mentioned earlier where manufacturers were reluctantly forced to sell their upscale wares to off-price retailers. Many of the major department store chains that initially helped the manufacturer position those items as high-image brand names in the mind of the consumer felt betrayed. Another controversial domain disagreement practice in today’s retail marketing channels occurs when retailers sell merchandise purchased from the vendor to discounters that the manufacturer does not want selling its products. A diverter is an unauthorized member of a channel that buys and sells excess merchandise to and from authorized channel members. For instance, suppose a retailer could buy a name-brand appliance intended to retail for $389 at $185 if it purchases 100 units. However, if the retailer orders 200 units it can purchase the item at $158. What does the retailer do? Some retailers will purchase 200 units even though they need only100. They in turn sell the 100 extra units at as light loss, say $155, to a discount store that may retail the item for $219. The net result is the retailer loses $3 a unit on 100 units or $300; however, it bought the remaining 100 units at $27 a unit less, for a savings of $2,700.As a result of this price arbitrage, the retailer is $2,400 ahead on the transaction. However, the manufacturer is likely to be upset because the appliance has been diverted into a retail channel it did not intend and over which it has no direct control. Several manufacturers claim it is because of diverting that Target has been able to offer high-end beauty products from such labels as Kiehl’s, Origins, and Bare Escentuals in its stores.19 Similar to diverting is a practice known as gray marketing, whereby genuinely branded merchandise flows through unauthorized channels that cross national boundaries. Gray market channels develop when global conditions are conducive to profits. For example, consider the retailing of prescription drugs. Since Americans pay 67 percent more on average than Canadians for these drugs, the gray market, especially from Canada, has increased substantially. Diverting and gray marketing can lead to another supply-chain problem: free riding. Free riding occurs when consumers seek product information and usage instructions about products, ranging from computers to home appliances, from a full-service specialty store. Then, armed with the brand’s model number, consumers purchase the product from a limited-service discounter or over the Internet. Not all conflict in a channel is bad. Low levels of conflict will probably not affect any channel member’s behavior and may not even be noticed. A moderate level of conflict might even cause the members to improve their efficiency, much the same as happens with some of your classmates when you are working on a team project. However, high levels of conflict will probably be dysfunctional to the channel and lead to inefficiencies and channel restructuring. Although all supply chains experience some degree of conflict, the dominant behavior in successful supply chains is collaboration. Collaboration, where both parties seek to solve all problems with a win–win attitude, is necessary and beneficial because of the interdependency of retailers and suppliers. Retailers and suppliers must develop a partnership if they want to deal with each other on a long-term and continuing basis. As a result, many supply-chain members have begun to follow a set of best practices as listed in Exhibit 5.7. This vendor partnership is often a critical factor for the retailer who does not want to confuse the final consumer with constant adjustments in product offerings resulting from constant changes in suppliers.

Facilitating Supply-Chain Collaboration

Collaboration in channel, or supply-chain, relations is facilitated by three important types of behavior and attitude. These are mutual trust, two-way communication, and solidarity.

Mutual Trust

Mutual trust occurs when the retailer trusts the supplier, and the supplier trusts the retailer. In continuing relations between retailers and suppliers, mutual trust, which is built on past and present performance between members, is critical. This trust allows short-term inequities to exist. If mutual trust is present, both parties will tolerate inequities because they know in the long term they will be fairly treated.20 For example, a vendor suggests that a retailer purchase a certain product. The retailer does not believe that the product will be successful in its market. However, the vendor insists that many buyers in other markets are purchasing that particular item and even agrees to ‘‘make it good’’ if the product does not sell. In this instance, the buyer will probably buy the merchandise knowing that the supplier can be trusted to make an appropriate adjustment on the invoice amount, provide markdown money, or make up this inequity in some other way in the future if the product does not sell. Without mutual trust, retail supply chains would disintegrate. On the other hand, when trust exists, it is contagious and allows the channel to grow and prosper. This occurs because of reciprocity. If a retailer trusts a supplier to do the right thing and the supplier treats the retailer fairly, then the retailer develops more trust and the process of mutual trust continues to build. In fact, during the past recession, many smaller or retailers were able to cut costs by renegotiating contract terms with manufacturers to match deals that the high-volume chains obtained. Here the manufacturers and smaller operators knew that they would need each other, further enhancing the trust between parties and allowing economic recovery to take place. Two-Way Communication As noted earlier, conflict is inevitable in retail supply chains. Consequently, two-way communication becomes the pathway for resolving disputes and allowing the channel relationship to continue. Two-way communication occurs when both parties openly communicate their ideas, concerns, and plans. Because of the interdependency of the retailer and supplier, two-way communication is necessary to coordinate actions. For example, when Jockey decides to run a national promotion on its underwear, it needs to coordinate this promotion with its retail supply chains so that when customers enter stores to shop for the nationally advertised items, they will find them displayed and in stock. Two-way communication is critical to accomplishing this coordination. Communication is not independent of trust. Disputes can be resolved by good two-way communication, and this improves trust. Furthermore, trust facilitates open two-way communication. The process is circular and builds over time. For example, Walmart is not only phasing in energy-efficiency requirements with its suppliers but also pushing gold miners to adopt strict environmental and social standards, verified by independent third parties. With allies Tiffany’s and Richline Group, the world’s biggest manufacturer of gold jewelry, the retail giant is upsetting miners. However, since mining enough gold to make a typical 18-carat wedding ring leaves behind 20 tons of waste, it appears that two-way communication will demonstrate the benefits of such standards to all parties.21 Solidarity Solidarity exists when a high value is placed on the relationship between a supplier and a retailer.22 Solidarity is an attitude and thus is hard to explicitly create. Essentially, as trust and two-way communication increase, a higher degree of solidarity develops. Solidarity results in flexible dealings where adaptations are made as circumstances change. When solidarity exists, each party will come to the rescue of the other in times of trouble. For example, several years ago, Walmart had a problem with shoplifting. It discovered that several Procter & Gamble products were easy to steal. Because of the relationship that existed between the retailer and supplier, P&G soon altered the packaging of the vulnerable products. Among the changes it made were enlarging and adding an extra layer of plastic to the Crest Whitestrips package and using a clamshell, a flat piece of cardboard covered with plastic, on its Oil of Olay products.23 another example of supply-chain partners working together to the benefit of each other recently occurred in the book-publishing industry. Here an industry practice dating from the 1930s allowed retailers to return unsold titles, which amounted to more than a third of all titles shipped, to publishers for full credit and without incurring shipping costs. Later these books were sent back to the same bookstore chains, where they are sold for a substantial discount on the list price. The idea of taking back inventory and then returning it wasn’t a good idea for anybody. Meanwhile, as mentioned in Chapter 2, Borders Books was facing financial issues. Thus, as a sign of the industry’s solidarity, the retailer agreed to accept books on a nonreturnable basis in return for a lower price. Experts were quoted as saying that the economic downturn has made publishers and booksellers more open to departing from tradition and willing to experiment with models that might decrease waste and increase profits for all parties.24 Nowhere is this collaboration in today’s channels exhibited more clearly than in the shift toward category management. Category Management25 Category management involves the simultaneous management of price, shelf-space, merchandising strategy, promotional efforts, and other elements of the retail mix within the merchandise category based on the firm’s goals, the changing environment, and consumer behavior. The task of category management is accomplished by members of a supply chain working as a team, not acting independently, to apply the ECR concept to an entire category of merchandise such as all hand tools, and not just a particular brand such as Stanley. The manager’s goal is to enable the retailer to meet specific business goals such as profitability, sales volume, or inventory levels. Retailers designate a category manager from among their employees for each category sold. The retailer begins the process by defining specific business goals for each category. The category manager then leverages detailed knowledge of the consumer and consumer trends, detailed point-of-sale (POS) information, and specific analysis provided by each supplier to the category. With this information, the category manager creates specific modular’s that may have different facings for different stores as the retailer tailors its offerings to the specific needs of each market. In addition, category managers work with suppliers to plan promotions throughout the year to achieve the designated business goals for the category. In cases where the solidarity of the channel partners is high, a supplier may serve as the retailer’s category manager. In this case, the chosen supplier takes on the designation of category advisor. Walmart, for example, uses this strategy wherein the category advisor works closely with the Walmart buyer to ensure that the category achieves peak performance in all stores. Normally, a supplier is chosen to become a category advisor because it is a trend leader in the specific category and can contribute merchandising and market analysis. Often, but not always, this supplier is also the dominant provider within the specific category. As each buyer has responsibility for several related product categories, each category may have a separate category advisor, depending on need. Further, while a supplier may be recognized as a trend leader in one category, a different supplier may be recognized as the trend leader in another. At one point, category advisers were called category captains. While the responsibilities have not changed, retailers have adopted the new terminology (category advisors) to avoid speculation and confusion about who is responsible for making decisions. Also, to ensure fairness, the individual fulfilling the category advisor position is not supposed to have any sales relationships with Walmart. In fact, this person is not supposed to report to anyone with selling responsibility for Walmart. The category advisor receives access to the sales information for all items and suppliers in the designated category. To keep business confidentiality, advisors do not receive access to data on profitability. Also, they are not allowed to share the information with anyone in their company. Given these boundaries, the question arises, why would a vendor want to pay for the category advisor? Most companies would agree that the ability to better understand the retailer’s merchandise direction (or thinking and strategy) is enough of a benefit to justify the cost. If you consider, for example, that Walmart purchases $200 million in greeting cards annually from Hallmark, you quickly see the economic logic of investing in a category advisor. The category captain or category advisor, working closely with the retail buyer, must make sure that the retailer has the best assortment for each store in order to achieve the greatest sales possible. This includes carrying the competition’s merchandise. As a result, the supplier’s role as the category captain or category advisor has changed greatly in recent years. Whereas in the past the supplier sought to get as many of its items into the retailer’s store as possible, today that supplier has to understand how its products help the retailer achieve its objectives, even if this means selecting a competitor’s product over its own. For retailers using a single advisor, a yearly review and possible reassignment of the advisor’s role to another supplier helps to keep the category advisor’s recommendations objective. To survive strong competition from other retailers, advising suppliers must stay ahead of consumer trends and meet the ever-changing tastes of the consumer. To Aid the supplier who serves as a category advisor, the retailer provides the same POS information (except the competition’s prices) that it would give its own employee serving as the category manager. Category managers must be ready to constantly adjust the space given to each item so that the right merchandise is in the right stores, at the right time, and in the right amount. Over the last decade, category management has enabled retailers to do a better job of staying in stock on the best-selling items and avoid being over-stocked on merchandise with a lower turnover rate. The category manager must be able to recognize what critical items need to remain in stock at all times to make the assortment complete. In addition, as will be explained in Chapter 13, the category manager tries to create a shelf layout based on how the consumer shops. Retailers, however, are far from passive when it comes to accepting a supplier’s recommendation. They usually run the supplier’s category plan by a second supplier known as the validator. Thus, Unilever, for example, could run a reality check for supermarkets using Procter & Gamble as their category advisor or captain. Even more important, retailers must insist that category advisors adhere to the retailer’s strategy with regard to pricing, promotions, and so on. Category management is now standard practice at nearly every U.S. supermarket, convenience store, mass merchant, and drug chain. Its use is growing because the results of this collaboration benefit both retailer and supplier. Retailers using category management report an increase in sales for both parties, a decrease in markdowns, better in-stock percentages on key items for the retailer, an increase in turnover rates and a decrease in average inventory for both retailers and wholesalers, and an increase in both members’ ROI and profit. However, when all retailers begin to use the same category management approach to optimize each store’s layout and maximize the gross margin dollars produced per unit of space, many times stores end up looking just like their competitors. This is why Walmart replaced the ‘‘captain’’ with ‘‘advisors’’ so that they could gain the benefits of different approaches.

WRITING AND SPEAKING EXERCISE

Diva’s is a 55-store upscale women’s shoe chain targeting businesswomen and college students. Most of its stores are located in regional malls in the Southeast and Southwest. The chain has enjoyed rapid growth over the last decade, and its annual sales volume last year was $167 million. Profitability has kept pace with the rapid rise in sales volume. Diva’s prices most of its shoes between $39.95 and $109.95. The top-selling shoes are sold using the chain’s private label, Avalanche. A primary reason for the success of Diva’s has been its vertical marketing channel. The chain has eliminated most suppliers and relies almost entirely on its own production capabilities. Diva’s staff designs most of the shoes and has them made to specification by manufacturers in Mexico. As a result, the chain’s shoes are priced approximately 20 percent lower than competitors’ shoes of a similar quality. In addition, the chain has a higher markup than stores that buy from manufacturers and wholesalers. Besides these advantages, vertical integration minimizes potential sources of conflict. This strategy does have its weaknesses, though. Diva’s needs a large amount of capital. Money is needed to purchase raw materials and to defray other costs incurred during manufacture. In addition, since orders are placed approximately nine months to a year in advance of shoe sales, predicting sales is difficult. If orders are placed with manufacturers and business slows down, orders cannot be reduced or canceled. Because they control production, orders cannot be changed. Finally slow-moving merchandise cannot be returned to vendors. If something does not sell, it has to be marked down in hopes that it will. Using this strategy, how would the retailer’s need for capital affect its ROI during an economic slowdown? (The student might want to refer to the strategic profit model discussed in Chapter 2.) In view of your answer, should the chain change its merchandise mix by adding more well-known national brands?