Chapter 9
Channel Management And Physical Distribution

This chapter focuses upon channel management and the related topic of physical distribution. The selection of distribution channels will impinge upon decisions about every other element of the marketing mix. Pricing decisions will be greatly affected by whether the company attempts to mass market through as many wholesale and/or retail outlets as possible, or purposively target a relatively small number of outlets offering its customers high service levels. The amount of promotional effort required of an organisation will be a function of how much, or little, of the selling effort is undertaken by the channels of distribution it uses. The product and/or its packaging may have to be designed to suit the storage and physical handling systems of the distributor.

Chapter Objectives

In this chapter an attempt is made to explain:

The purposes and forms of distribution channels

How intermediaries improve the effectiveness and efficiency of a marketing system

Sources of conflict in distribution channels

Considerations in developing a customer service policy

The behaviour of costs attached to physical distribution functions

The key elements of transport and warehouse management and

How vehicles can be routed in such a way as to control total transport costs whilst delivering an acceptable level of customer service.

Structure Of The Chapter

The chapter begins by explaining how distribution decisions relate to the overall marketing strategy. There then follows a discussion of the contribution which intermediaries can make to the efficiency and effectiveness of a marketing system and the key decisions to be made regarding the appointment of intermediaries. A description of the main types of intermediary is provided and this is followed by an explanation of what is necessary in order to market to middlemen. The topic of power and conflict in channels is given some consideration. Attention is subsequently focused upon the costs and functions involved in physical distribution. The key aspects of transport and warehouse management are discussed, as are vehicle scheduling models.

Channel decisions in relation to marketing strategy

Decisions relating to the channels of distribution for a product or service are part of the strategic marketing plan. In that plan, the target market will have been specified along with target levels of market share, market coverage, customer service and so on. The channels of distribution used by an organisation must be capable of assisting in reaching these targets. Moreover, the establishment of a distribution system can take a long time, perhaps several years, and so decisions about the channels of distribution cannot be taken lightly, and have to be taken with a view to the longer term since it is not usually that easy to switch between channels.

A distribution channel may be defined as:

“…the set of firms and individuals that take title, or assist in transferring title, to a good or service as it moves from the producer to the final consumer or industrial user.”¹

The importance of channel decisions has not always been recognised. For a long time, marketers only gave thought to appropriate channels of distribution after the product had been developed. However, Bennett² claims that:

“… in today's competitive and increasingly global marketplace, managers plan for product distribution as they plan their products.”

The same author goes on to state that:

“Modern distribution systems are based on strategic planning, adhere to the marketing concept, focus on target markets, and are consistent and flexible.”

Strategic planning: Distribution channels must be compatible with the strategic marketing plan. If, for instance, a skimming strategy has been adopted or the product requires technical sales support, then mass marketing is probably inappropriate. Alternatively, if large volume sales are required in order to achieve particular profit targets, then selective distribution would be inappropriate.

As new products are introduced, existing channels have to be reassessed since they may not be the right channels for the new product. In some cases, a company will decide not to launch a new product because it does not fit in with existing distribution channels and existing strategy. A few years ago Ciba, the Swiss chemicals company, was looking for new growth opportunities in the animal health market. Sales of its animal health and hygiene products for farm animals were beginning to plateau and the company considered diversifying into products for domesticated pets. The biggest barrier for Ciba was the differences in the distribution systems for the two markets. Ciba's strategy in the agricultural market was to deal with a small number of relatively large wholesalers, who then sold on to smaller wholesalers and agricultural merchants. This was a cost-effective distribution system for Ciba. However, the distribution system for health and hygiene products for pets is altogether more fragmented and would have involved dealing with very large numbers of very small independent stores. Ciba simply did not have the staffing levels to cope with a large number of accounts. Moreover, Ciba would have found the costs prohibitive since each store ordered very small quantities.

Another consideration is the stage of the product's life cycle. It can happen that as the product proceeds through its life cycle the appropriateness of the distribution channel can change. When developing the strategy, thought should be given to how the needs of the product might differ over its life span.

An organisation's distribution strategy is often interconnected with its promotional strategy. As figure 9.1 illustrates, the distribution system can be depicted as a channel through which products and services move from producer to end user. If the agribusiness concerned believes that its product(s) can be meaningfully differentiated from others on the market, then it may elect to direct the greater part of its promotional effort towards end users. This is termed a pull strategy, whereby the objective is to create such a strong preference for the product among end users that the resulting demand pulls the product through the channel of distribution. Where the product is perceived by end users to be a commodity (or one where there is little difference between brands) then the channel strategy of the agribusiness may be to target much of its promotional effort on intermediaries. If intermediaries can be persuaded to stock the product, in preference to those of competitors, then when customers visit a sales outlet and ask for a product by its generic name it is the product of the company which is supplied. This is termed a push strategy. In practice, the promotional strategies of most agribusinesses will be a combination of pulling and pushing the product through the channel of distribution, but there is likely to be more emphasis on one or the other.

Figure 9.1 Push and pull strategies

Adherence to the marketing concept: Agribusinesses which themselves have adopted the marketing concept often experience a problem when their products and services have to be delivered to the end user through intermediaries who are more sales than market-oriented. This should be one of the primary criteria when selecting distributors, i.e. the degree of market orientation. In many cases, the producer or supplier will find it difficult to find market oriented intermediaries and in these instances will have to embark on training and education programmes.

Target marketing: Another important criteria on the selection of distribution channels is the extent to which these focus on the specific market segments that the producer or supplier wishes to penetrate. For example, Sri Lanka's Farm Service Centres distribute a wide range of agricultural inputs to smallholders but do very little business with plantations and estates. Therefore, Farm Service Centres would be the wrong type of outlet to handle, say, coconut or tea harvesting equipment since these crops are mainly grown on large estates or plantations.

Thus, it can be seen that channel decisions are central to the organisation's overall marketing strategy. Bennett² puts it succinctly when he makes the point that:

“Channels are interlocking, highly interdependent, and often complex. Effective distribution is not a patchwork quilt of randomly selected channel members; rather it requires a carefully planned network whose members have clearly assigned functions. The flow of products from manufacturer to wholesaler to retailer to the final buyer depends on systematic, strategic planning and management.”

The value of middlemen

There are many functions to be carried out in moving the product from producer to customer. Those functions each require funding and, often, specialist knowledge and expertise. Few producers have either the resources or the expertise to carry out all of the necessary functions to get a product/service to the ultimate user. A middleman's remuneration should depend upon the number of marketing functions he/she performs and, more especially, by the efficiency with which they are performed.

The advantages of using middlemen as opposed to marketing direct to end-users can be demonstrated very easily. The efficiency of most marketing systems is improved by the presence of effective intermediaries. This is illustrated in figures 9.2 a and b. These show that an intermediary between a number of producers and consumers reduces the number of transactions and thereby procurement and selling costs and time are all reduced.

Figure 9.2 A direct marketing system and a marketing system with intermediaries

A middleman's existence is justified just so long as he/she performs marketing functions which others cannot or will not, or can perform his/her marketing functions more efficiently than can the producer and/or alternative intermediaries. Gaedeke and Tootelian³ cite three additional reasons why middlemen are commonly employed by producers:

• intermediaries provide wider market exposure

• few producers have sufficient capital to market direct and

• producers can usually earn a higher return on investment by employing available capital in activities other than those of direct marketing.

All too often, in developing countries, middlemen are dismissed out of hand as parasites. The argument made is that it is the producer who, by the sweat of his labour, provides the physical commodity and it is he/she who deserves to gain most from marketing transactions in that product. When it is observed that marketing costs are sometimes four or five times the price paid to the farmer, a sense of injustice can arise. However, the value, if any, that the intermediary adds to the product, by virtue of the functions performed, must be taken into account. McVey⁴ states that:

“You can do away with the middleman but you cannot do away with his functions.”

In other words, those functions have to be carried out by someone and the expense and risk of doing so has to be met. The real question is not whether middlemen are needed but whether the middleman's remuneration is commensurate with the levels of risk carried and the services provided in the form of marketing functions performed. Furthermore, intermediaries can only be justified if they can perform these functions more efficiently and effectively than the other actual or potential market participants.

Key decisions in channel management

There are a number of key decision areas pertaining to the appointment of intermediaries. These include: price policy, terms and conditions of sale, territorial rights and the definition of responsibilities. In addition, a choice has to be made between extensive and intensive coverage of the market.

Price policy: List prices, wholesale/retail margins and a schedule of discounts have to be developed. These have to reflect the interests of the intermediary, as well as those of the producer/supplier if lasting alliances are to be formed with channel members.

Terms and conditions of sale: In addition to price schedules the producer/supplier must explicitly state payment terms, guarantees and any restrictions on where and how products are to be sold. If the product enjoys a sizeable demand then the producer/supplier may evaluate intermediaries on the basis of performance criteria such as the achievement of sales quota targets, inventory levels, customer delivery times, etc. Intermediaries whose performance is below target may have their right to handle the product withdrawn.

Territorial rights: In the case of certain products, distributors will be given exclusive rights to market a product within a specified territory. This happens, for example, with agricultural equipment. In deciding upon the boundaries of territories the manufacturer or supplier has to strike a balance between defining territories which are sufficiently large to provide good sales potential for distributors but small enough to allow distributors to adequately service the customers within the territory.

Definition of responsibilities: The respective duties and responsibilities of supplier and distributor have to be clearly defined. For instance, if a customer experiences a problem with a product and requires technical advice or a repair needs to be effected, then it should be immediately clear to both the supplier and the distributor as to which party is responsible for responding to the customer. In the same way, the agreement between the producer/supplier and the distributor should clearly specify which party is responsible for the cost of product training when new employees join the distributor or new products are introduced.

The intensity of distribution i.e. the total proportion of the market covered, will depend upon decisions made in the context of the overall marketing strategy. In simple terms there are two alternatives: skimming the market and market penetration. These strategies were described in the previous chapter. It will be remembered that a skimming strategy involves being highly selective in choosing target customers. Normally, these will be relatively affluent consumers willing and able to pay premium prices for better quality, sometimes highly differentiated, products. It will also be recalled that a penetration strategy is one where the decision has been made to mass market and the object is to make the product available to as many people as possible. The decision as to which of these is adopted as with immediate implications for distribution strategy. Three principal strategies these being; intensive, selective and exclusive distribution.

Extensive distribution: Those responsible for the marketing of commodities, and other low unit value products, are, typically, seek distribution, i.e. saturation coverage of the market. This is possible where the product is fairly well standardised and requires no particular expertise in its retailing. Mass marketing of this type will almost invariably involve a number of intermediaries because the costs of achieving extensive distribution are enormous. In developing countries, the decision to sell commodities nationwide has, in the past, been more often politically inspired than the result of commercial judgements. Many marketing boards, for example, have discovered just how great a financial burden pan territorial distribution can be and have found their role in basic food security incompatible with the objective of breaking even in their finances. In fact, except in social marketing of this nature, it is rare to find organisations which try for 100% distribution coverage. It is simply too expensive in most cases. Where commercial organisations do opt for extensive distribution, channels are usually long and involve several levels of wholesaling as well as other middlemen.

Selective distribution: Suppliers who appoint a limited number of retailers, or other middlemen, are chosen to handle a product line, have a policy of selective distribution. Limiting the number of intermediaries can help contain the supplier's own marketing costs and at the same time enables the grower/producer to develop closer working relations with intermediaries. The distribution channel is usually relatively short with few or no intermediaries between the producer and the organisation which retails the product to the end user.

Selective distribution is common among new businesses with very limited resources. Their strategy is usually one of concentrating on gaining distribution in the larger cities and towns where the market potential can be exploited at an affordable level of marketing costs. As the company builds up its resource base, it is likely to steadily extend the range of its distribution up to the point where further increases in distribution intensity can no longer be economically justified.

Exclusive distribution: Exclusive distribution is an extreme form of selective distribution. That is, the producer grants exclusive right to a wholesaler or retailer to sell in a geographic region. This is not uncommon in the sale of more expensive and complex agricultural equipment like tractors. Caterpillar Tractor Company, for example, appoints a single dealer to distribute its products within a given geographical area.

Some market coverage may be lost through a policy of exclusive distribution, but this can be offset by the development and maintenance of the image of quality and prestige for the product and by the reduced marketing costs associated with a small number of accounts. In exclusive distribution producers and middlemen work closely in decisions concerning promotion, inventory to be carried by stockists and prices.

The details of an exclusivity agreement can have important ramifications for both producer and distributor. Some involve tied-agreements where an enterprise wishing to become the exclusive dealer for a given product must also carry others within that agribusiness's product line. For instance, a chemicals manufacturer could have a fast selling herbicide and will tie the exclusive distribution for such a product to a slower moving specialist product like a nematacide.

Agribusinesses which are considering becoming involved in exclusivity agreements need to be aware of their legality. In some markets, exclusivity agreements are either prohibited altogether or are restricted in some way because they are judged, by regulatory authorities, to lessen competition in the marketplace.

Types of distribution system

Figure 9.3 The principal types of distribution system

Direct marketing systems: Where distances between producers and consumers are short, direct transactions between the two groups can take place. Farmers who elect to market their products directly have to trade off the benefits of doing so against the time they are away from farming activities. In the case of industrial markets, direct transactions are common where there are a relatively small number of customers (e.g. equipment designed for abattoirs).

Retail institutions: The retail sector includes a wide range of outlets such as merchants, equipment dealers (in the case of farmers), department stores, supermarkets and smaller grocery stores. They are characterised by their dealing with the end user of the product or service.

Wholesalers: Wholesalers make marketing systems more efficient by buying a variety of products, in fairly large quantities, and selling these items on to other businesses who require relatively small quantities of a variety of goods. Wholesalers may service consumer and/or industrial retail outlets. For instance, fruit and vegetable wholesalers often sell to both grocery stores (consumer) and hotels, hospitals, schools, prisons, etc. (industrial). Some wholesalers offer a full-service i.e. they perform all the distribution functions such as selling, pre-delivery inspection (in the case of machinery), technical advice, extension of credit, storage, and delivery. Other wholesalers provide only a limited service. An example would be cash-and-carry wholesalers who require customers to collect the goods and to pay cash. Patrons of cash-and-carry wholesalers are usually compensated for the lower service levels by lower prices.

Sales agents and brokers: Sales agents and sales brokers are distinguished from the other types of channel member already described in that they do not take title to the goods. The role of agents and brokers is to facilitate distribution by bringing buyers and sellers together. Sales agents often have close relations with particular growers/processors/manufacturers and contract to sell on their behalf in return for a commission. Some agents negotiate sales for a number of non-competing clients, whilst others handle sales for only one client and usually have the exclusive right to do so, within a specified geographic area. In many respects the sales agent behaves as though he/she were an extension of the client's own sales organisation. Brokers, on the other hand, earn a commission for informing buyers of possible sellers and informing sellers of possible buyers. Clients use the services of a broker intermittently since their supply of the product to the market is intermittent.

Whilst figure 9.3 is helpful in structuring a discussion on the different types of distribution system, it is an oversimplification and this has to be recognised. For instance, whilst sales agents and wholesalers are categorised separately in this diagram, they often operate together. This is common in fruit and vegetable wholesale markets where sales agents sell produce, on a commission basis, on behalf of growers.

Case 9.1 Marketing Small Ruminants In Indonesia
    The village collector is a key figure in the marketing system since 50% of the animals are handled by him. He usually lives in the locality and provides several services vital to the effective operation of the marketing system. He bears at least part, and often all, of the risks inherent in trading by taking legal title to the animals. If an animal cannot be sold on a particular day or has to be sold at a low price then these costs are borne by the village collector. He also helps finance trade by paying the farmer 50% of the agreed price immediately and the balance after the next market day. The village collector also meets the transport costs. He increases the efficiency of the marketing system since unit transport costs are lower when several animals are transported to market. In Indonesia, most ruminants are farmed by smallholders who usually have a single animal to sell at a given time. Sometimes the village collector performs a storage function too by holding animals until market prices are acceptable.
    Smallholders have alternatives to selling to the village collector. There is usually more than one village collector and also sedentary and itinerant “blantiks” or livestock traders who intercept farmers enroute to the market and strike a deal. Sedentary traders work a single market whilst itinerant traders trade in several markets. Neither the sedentary nor the itinerant trader is as familiar to the farmer as the village collector.
    Another player in the marketing system is the “makelar” or broker. There are 2 types of brokers; the commission broker and the floor-price broker. Commission brokers charge a fixed selling fee. If the animal remains unsold then the farmer pays nothing to the commission broker. Floor-price brokers agree a price for the animal with the farmer. The broker then attempts to sell the animal above this price. If successful, he keeps the difference between the floor-price and the actual price as his margin. Unsold animals remain the property of the farmer.
    The system serves producers well. Smallholders' supplies are erratic in that they send animals usually one at a time at irregular intervals to the market. However, since 1 in 5 rural households keeps sheep and/or goats there is, in aggregate, a stable supply to the market. The market itself is stable in that demand is fairly constant throughout the year except during periodic religious feasts when demand and prices can increase substantially. Thus the village collector makes an important contribution to the marketing system for small ruminants. He buys, taking title and, of course he sells. He also helps perform other marketing functions, including assembling, finance, transportation, storage and risk bearing. In addition when he fattens the animals he adds value to the product.
    Itinerant and sedentary traders represent an alternative marketing channel for smallholders. The itinerant traders perform a similar range of marketing functions to those undertaken by the village collector. Their only disadvantage is that they are not generally as well known to smallholders as the village collector. Sedentary traders actually have more in common with brokers than with either village or itinerant traders in that they act more as an agent than a buyer. The sedentary trader offers fewer services to the farmers and therefore his margin tends to be lower than that of other types of trader. Arguably, brokers perform only two functions, i.e. selling and market intelligence. However, their existence does extend the level of competition in the system. The low level of services offered by brokers perhaps explains why 80% of the farmer's trade in small ruminants is through traders⁵.

Auctions: Auctions are frequently used to transfer ownership of agricultural commodities. The system involves bringing prospective buyers and sellers together under the auspices of an independent auctioneer. The auctioneer is an employee of the organisation managing the auction market. Neither the auctioneer nor his/her employer participates in buying or selling the commodity on their own account. The auction company makes its profits from facilitating the purchase and sale of the commodity. The auctioneer invites bids for specific lots with the produce being sold to the highest bidder. Two distinct methods of auctioning may be employed: upward bidding and the Dutch method (or clock auction). The upward bidding method is where the auctioneer declares a starting price for the lot and prospective purchasers offer increasing amounts until a point is reached where no further bids are received because no one is willing to go beyond the value of the last bid. The Dutch method traditionally makes use of a clock that moves in a downward direction. The auctioneer displays an opening price on the clock and invites bids. If no bids are forthcoming then the auctioneer causes the clock hand to display decreasing prices. At the moment a bid is made the clock is stopped and the sale is made.

Auction selling makes prices transparent since all of the buyers and sellers present hear the bids and are therefore aware of prevailing price levels.

Vertical marketing systems: This is a system in which the producer(s), wholesaler(s) and retailer(s) act as a unified system. Usually one channel member owns the others, or has contracts with them, or has franchises with others in the channel. The argument for vertically integrated marketing systems is based upon increased efficiency of the system by the removal of duplicated services. They also achieve economies through size, bargaining power and reductions in potential conflicts of interest. In some instances there is a physical coming together of operations and enterprises such as when an abattoir and packhouse physically integrate to provide slaughter, processing, packing and cold store services within a single enterprise. On other occasions the integration has no physical dimension. Examples include:

Franchisers operate by vertically linking several levels of the marketing system. Thus Coca Cola ‘wholesales’ its syrup concentrate (product) to franchisees who carbonate and bottle and distribute the brand (processing, packaging and physical distribution) to consumers who have been targetted by Coca Cola's heavy advertising (promotion).

In many parts of the world agricultural equipment manufacturers supply machinery (product) to appointed distributors who are given exclusive rights to sell and maintain their whole goods and parts (physical distribution and service) within a specified geographical area. The manufacturer will often provide sales support (promotion) to authorised dealers. In return, these independent distributors agree to abide by the manufacturer's decisions regarding pricing, service levels, stockholding policy and a wide range of other terms and conditions.

Small scale retailers have responded to the competitive advantage of supermarkets by voluntarily integrating their buying and/or wholesaling and marketing operations. This has enabled them to achieve lower operating costs and to offer consumers lower prices than they otherwise could. Some of these organisations, such as SPAR enjoy a high profile among consumers across a large number of countries around the world.

Horizontal marketing systems: Channels can also develop into horizontal marketing systems in which two or more companies, at the same channel level, cooperate to pursue marketing opportunities. The basis of the marriage is that in combining resources and expertise the partners can achieve some goal that individually they could not. Thus, for example, a seed company and a grain merchant might set up a joint venture to offer farmers a complete package where he buys certified seed from the new enterprise which guarantees to buy his/her grain crop at prevailing market prices.

Strategic alliances of this type are likely to increase in the future. In newly liberalised markets they can be especially useful in protecting local agribusinesses whose low level of capitalisation, outdated technology and inexperience of operating within a competitive marketplace makes them vulnerable when foreign competitors with better resources enter their market.

Marketing to middlemen

No matter how well a product meets the needs of customers, without effective and efficient distribution it is unlikely to succeed in the marketplace. However, it would be misleading to suggest that producers or suppliers were entirely free to choose which organisations should form the channel for their product (s). In reality, the distribution strategy adopted by most producers more often reflects what is possible rather than what is ideally desired. McVey⁴ underlines the point when he states that:

“The middleman is not a hired link in a chain forged by a manufacturer, but rather an independent market, the focus of a large group of customers for whom he buys.”

Case 9.2 Dealer Relations At Caterpillar
    Caterpillar Tractor Company has 230 dealers in over 140 countries handling its range of agricultural, construction and marine machines and engines. Having this extensive and high quality distributive system recognised both by the company, and the end-users of its products, as giving Caterpillar a strong competitive advantage.
    Caterpillar pursues a dealer policy with the twin objectives of assisting in strengthening the profit performance of these independent businesses and enabling them to deliver an outstanding level of service to their customers. The implementation of this policy is evident in the terms and conditions applied to the sale of parts and equipment, the heavy investment in the parts supply system, the commitment to product training and the encouragement given to dealers to diversify their businesses. Terms and conditions of sale: Caterpillar operates a sale-or-return policy for all products and parts. This encourages dealers to carry the full product line and to enhance customer service levels by holding a very large number of parts in stock. Parts supply system, the heavy investment which Caterpillar has made in both computerising its inventory management system and in maintaining extensive parts inventories helps further improve customer service levels. Caterpillar dealers around the world are able to give fast parts delivery to their customers on any item. Almost all dealers in North America, Latin America, Europe and the Middle East can directly access Caterpillar's computerised inventory management systems and those of other dealers.
    When launching new products, Caterpillar first establishes a two month parts supply within its dealerships. Dealers never find themselves in a position where they are unable to service a new machine. Product training: Caterpillar recognises that the dealer's personnel have to understand customer needs well enough to supply the right product. Accordingly the company sponsors a large number of training programmes for staff from its dealerships. Sometimes these programmes involve sending large numbers of dealer personnel to different countries and continents to attend courses or demonstrations and the financial outlay is considerable. The company is equally committed to keeping its own staff updated on product developments. Dealer diversification: Caterpillar positively encourages its dealers to diversify into other related businesses including the renovation of parts, which makes Caterpillar's machines cheaper to repair for customers. Dealer diversification also strengthens the financial base of those dealerships.
    Competitors seeking to either penetrate Caterpillar's markets or attract its dealers face a difficult task. The Caterpillar dealer network is committed to marketing Caterpillar products. In part, this commitment is explained by the support dealers receive from Caterpillar, in the form of computerised stock systems, sale-or-return agreements, product training and the assistance given towards business diversification, but it is also a product of the company's basic attitude towards dealers, which is summed up in the words of its chairman, Lee Morgan. “We approach our dealers as partners in the enterprise, not as agents or middlemen.”⁶

Thus, we are advised by McVey to see all members of the channel we wish to use as customers and we must market to them not through them. To successfully market to middlemen we must:-

Power and conflict in distribution channels

Within a distribution channel there is usually a balance of power, and the characteristics of the channel are shaped by the manner in which power is exercised. Sometimes the balance of power in a channel lies with the producer/manufacturer and in other it lies with the intermediary. Moreover, there is always the potential for conflict between channel members.

Case 9.3 Changing Tanzanian Distribution Systems For Lake Victoria Fish
    Rosson suggests that the planners of development projects pay too little attention to the need for reform of traditional distribution systems when they seek to modernise agricultural production systems. His concern, in particular, is that power imbalances between producers and intermediaries are often the major constraint to attempts to improve production systems. He cites the case of the modernisation of Tanzania's Lake Victoria fisheries. The production system was backward, with the fishermen working from traditional canoes and relying on paddles for power and gill nets to make their catches. The government was interested in both improving the economic lot of its fishermen and increasing the supply of this high protein food for its consumers. The key to the situation proved not to be the modern fishing technology which the government was willing to finance, but the entrenched interests of the middlemen who provided a ready market for the catch, broke the catch down into small lots for individual consumers and helped finance the fishermen by supplying capital for equipment and cash advances during the seasonal troughs. The fisherman often had to pledge future catches to the lender as repayment for the loans.
    Thus fishermen were locked into a system which new technology alone would not break open. If the intermediaries chose to they could consider the addit,ional volumes of fish caught, as a result of the fishermen having access to more modern technology, as a ‘glut’, and pay reduced prices. The fisherman would have little alternative but to accept what he was offered because of his debt to the middleman and the distances between Lake Victoria and the major fish markets.
    For as long as fishermen were forced to continue selling their fish into the traditional distribution system, mechanising Lake Victoria fisheries was likely to have only a limited effect on the incomes of the fishermen and the supply of this source of protein to consumers. Rosson's experience was shared by McHenry⁸ on a similar project to develop fisheries on Lake Tanganyika and by Lawson⁹ when he studied an attempt to change the fish distribution system in Ghana⁷.

Conflict between channel members can arise for one or more of the following reasons:

Incompatibility of goals: Organisations can have conflicting goals. A grower may want to grade the produce in order to achieve a price premium for the top quality produce or to develop a brand image, but the wholesaler may only be interested in selling large volumes of undifferentiated produce.

Confusion over roles and rights: For example, a grower may sell part of the produce through local agents and part direct to supermarkets. This may cause conflict because the local agent believes that all sales should go through him/her.

Differences in perceptions: Among the many potential differences in perceptions, which can result in conflict, are: who the customer is; what the market wants; the objectives of other channel members in participating in the market; and the role which other channel members play in helping the organisation achieve its own objectives.

Case 9.4 Sri Lanka's Rice Transplanter
    Around 40% of the rice grown in Sri Lanka is transplanted as seedlings with the remainder of the crop directly broadcast. The work of transplanting is mainly carried out by women. It is an arduous and time-consuming task. The government-funded Farm Machinery Research Institute (FMRC), in association with the German development agency, GTZ, designed a mechanical 6-row rice transplanter. Once the machine was at the prototype stage a number of local agricultural machinery manufacturers were encouraged to adopt the design and take it on to production.
    Almost all of the field research and testing for this machine was carried out in the vicinity of the research station. FMRC is located in the north of the country where the rural population density is low and, since there is relatively little pressure on the land, plant spacings are twice that of the much more densely populated southern provinces. The machine specifications were adequate for northern transplanting conditions but in the south the life span of the times proved extremely short. Further R&D was quickly undertaken and an improved Mark II version was soon launched on to the market.
    None of the manufacturers who had been involved in the production of the Mark I transplanter could participate in the relaunch because so much of their capital was tied up in stocks of the Mark I model whose sales were very slow due to the adverse publicity given to that machine. FMRC went ahead and contracted a separate group of agricultural machinery manufacturers to produce the Mark II transplanter. The Mark I was made obsolete and sales of that model ceased altogether. The group of manufacturers who were left with stocks of the Mark I felt betrayed by an organisation which they had supported in bringing one of its innovations to market. Not surprisingly, FMRC has found it difficult to persuade this group of companies to engage in the production of any of its subsequent machinery developments. Since the firms are Sri Lanka's largest agricultural machinery manufacturers FMRC's mission to introduce improved and affordable machines and implements to Sri Lanka's farmers has been greatly handicapped.
    The case of Sri Lanka's rice transplanter illustrates how conflict can arise though goal incompatibility. FMRC's exclusive concern was for the farmers whom it considered to be its target beneficiaries. It did not recognise that the manufacturers were also legitimate stakeholders since FMRC's mission could not be achieved without a thriving and vibrant domestic agricultural machinery manufacturing sector. The case also serves to demonstrate the dire consequences of confusion over rights and responsibilities. Whilst FMRC could argue that it had no legal obligations to the manufacturers of the Mark I transplanter, it would appear that it did have a moral obligation to avoid actions which would exacerbate the financial difficulties of companies that had entered into the production of the machine in good faith. The level of interdependence between FMRC and the agricultural machinery manufacturers was high and so the probability of conflict was also high. FMRC has R&D facilities but no mass production capability and so relies entirely upon manufacturers being persuaded to take up its innovations and developments. Like manufacturers in most developing countries, Sri Lanka's agricultural machinery companies have very limited R&D resources and so there is a measure of dependence on institutions like FMRC for new products. Lastly, and possibly most important of all, the transplanter case highlights the problems which can arise from differing perceptions. FMRC perceived itself to be a farmer-oriented development institute with no direct interest in profitability. FMRC did not perceive itself to be part of the channel of distribution for agricultural equipment. The truth is that FMRC's mission could only be fulfilled if the machines it developed could be commercially successful. This being the case, FMRC had to be interested in the commercial viability of the machines it was developing and that of the companies which would have to manufacture them if they were to reach the farmer. This was clearly the perception held by the manufacturers who engaged in the production of the Mark I rice transplanter.

Members of a distribution channel can also differ in how they perceive themselves. There is an argument as to whether the ‘distribution channel’ is more than an abstract academic concept. Whilst manufacturers and producers may think in terms of a distribution system, intermediaries do not necessarily see themselves as part of some other party's ‘system’, but instead consider themselves as independent operators. If intermediaries do lack a systems orientation, then there are additional prospects of conflict since they will be, naturally, reluctant to compromise their own interests in deference to those of the distribution system as a whole.

Degree of interdependence: The greater the degree of interdependence between two members of the distribution channel, the greater the potential for conflict. This is because the actions of one directly impinge upon the performance of the other.

Physical Distribution

Gaedeke and Tootelian¹⁰ define physical distribution as:

“…all activities involved in planning, implementing, and controlling the physical flow of raw materials, in-process inventory, and finished goods from point-of-origin to point-of-consumption. The main activities include customer service, inventory control, material handling, transportation, warehousing and storage.”

Case 9.5 Physical Distribution: A Leader, Or Just a Supporter?
    Bowersox et al.,¹¹ provide an interesting perspective on the relationship between marketing strategy and physical distribution practices. These authors relate the story of the development of the cut flower market in the USA.
    Cut flowers have to be distributed very quickly. Even if they are treated with a preservative, such as silver nitrate, their shelf-life is fairly limited. Californian growers were among the first to develop special containers which helped slow the rate of deterioration in cut flowers. These containers precooled freshly cut flowers in the field, held flowers in different quantities, were designed to fit aircraft hold dimensions and were easy to handle.
    The traditional marketing channel for cut flowers was flower shops. These were considered inappropriate when the objective was to expand demand for cut flowers. Market research suggested that only 2.5 percent of households regularly purchased cut flowers but that there were opportunities to induce the public to buy more flowers and more often. Flower shops, however, were oriented towards special occasions such as weddings, funerals, gift days etc. Growers wanted to mass market their produce and so department stores and food chains were targeted because these outlets enjoyed much higher levels of customer traffic.
    Research also revealed that many consumers considered the unit price too high for them to purchase cut flowers regularly. The grower's response was to abandon the convention of selling in packs of a dozen stems. They brought down the unit price by packaging in smaller bundles. Roses, for instance, were marketed in lots of three. Having decided on the size of the sales units, flowers were packed in the field accordingly.
    To persuade retailers to stock cut flowers margins had to be competitive with those of other products competing for the limited floor space available. Growers invested in the design of a merchandising unit which minimised the floor space required and maximised the impact on prospective purchasers. In addition, because research showed flowers to be an impulse purchase and more likely to take place at the end of a store visit than at the beginning, growers encouraged retailers to position the merchandising units at the checkout counters. These tactics served to increase the profitability of cut flowers to retailers.
    This case illustrates how physical distribution and marketing tend to interact. The changes in physical distribution practices required a change in marketing strategy in order to be effective, and vice versa.¹¹

Thus, it is suggested that physical distribution has two components: materials management and marketing logistics. Materials management is concerned with physical supply operations such as procurement and the storage and movement of raw materials to and through processing into a finished product. Marketing logistics deals with the transfer of finished goods to intermediaries, final buyers and end-users.

Figure 9.4 The elements of business logistics

Physical distribution is often viewed as a necessary support system for the organisation's marketing programme. However, there is an alternative, and more creative perspective which can be taken and that is to see an efficient physical distribution system as a potent marketing tool in its own right, and one which is capable of creating a competitive advantage for the organisation. An organisation which is able, for instance, to supply a wide variety of products speedily at specified times helps reduce the inventory holding costs of the intermediaries being served. Thus the level of interest in the way physical distribution is managed is explained by its potential as a powerful marketing instrument, the opportunity to realise significant savings in marketing costs and by the importance of physical distribution to customer service levels.

Customer service levels

The level of customer service provided by a company is part of the marketing mix. In some instances, a company offers an exceptionally high level of customer service as the principal means of differentiating itself from competitors. Customer service levels are as pertinent to the intermediaries which the agribusiness serves.

For many customers the level of customer service provided by the agribusiness enterprise is as important as any other attribute which it may possess, including the excellence of its products. There are aspects of customer service which have little to do with physical distribution, such as the after-sales service, warranties and the handling of customer complaints, but a large part of customer service is effected through the physical distribution function. A wide range of criteria may be used in evaluating the service level offered by an agribusiness but these are likely to include:

• timeliness of delivery

• order size and assortment constraints

• order cycle time, i.e. time interval between order placement and delivery

• percentage of items out of stock

• percentage of times an item cannot be supplied from stock (or within a prescribed number of days from order placement)

• percentage of orders filled accurately

• percentage of orders arriving in good condition,

• ease and flexibility of order placemen, and

• competitors' service levels.

Maintaining high levels of customer service carries heavy costs and can only be justified when doing so results in marketing opportunities which otherwise would not be realised. At the same time, the logistics manager must monitor the effects of operating a given level of customer service on profitability. As figure 9.5 seeks to illustrate, as the customer service level gets nearer to 100 percent, the costs of doing so rise sharply. This means considering the trade-offs between the costs involved and the service level offered. It is possible, after all, to provide a level of service above that required or appreciated by the customer. There is likely to be no discernible difference in the service levels of two suppliers, one of whom is able to immediately supply a spare part from stock on 99 of 100 occasions and another who is able to supply from stock on 97 of 100 occasions.

Figure 9.5 The relationship between customer service level and cost

Developing a customer service policy

Given the need to deliver a level of customer service which is acceptable to the market and the level of cost which can be incurred in doing so, it is important to approach the establishment of a customer service policy in a systematic way. A six-step procedure is recommended as follows:

Case 9.6 International Harvester Goes POP!
    Concerned over an increasing number of complaints, from around the world, about product defects, both from farmers and agricultural machinery dealers distributing International Harvester's equipment, IH introduced the POP programme into its factories. POP, or Pride-Of-Performance, sought to reduce the number of defective products leaving the factory to as near zero as possible. This involved making changes to the methods of production, plant layout, quality inspection procedures and bonus schemes for production workers. What proved an important aspect of POP was the practice of, each week, publicly displaying the percentage of products which had emerged from the manufacturing process entirely without defect. Figures were also displayed for each stage of production and for each working shift. For example, as a tractor was built up along the production line quality inspectors checked it at discrete points before giving it permission to proceed to the next stage in production. In this way, the figures could be broken down so that the performance of each working shift and each group of workers (e.g. those responsible for engine assembly, gear box assembly, chassis construction, etc.) could be seen by everyone in the factory. The scheme was designed to encourage personnel to take a pride in the quality of the product (and sub-assembly) they contributed towards producing.
    POP was widely regarded to be a success both within the company and among its various customer groups. Although POP was initially focused upon production activities, it was later successfully extended into other company operations, including distribution departments. A little later POP was also extended into the pre-delivery inspection and service work of IH's independent dealerships.

The total distribution concept

The total distribution concept and the total cost approach are widely applied by managers of physical distribution. They are based on the notion that all elements of physical distribution are so interdependent that a decision made about one element will impact on some or all of the others. Thus, for example, the decision to reduce the number of depots operated by a grain merchant may well reduce costs associated with staffing, wastage, and inventory levels but will also increase transportation costs. The real question is whether the savings in one area match, exceed or fall short of the increased costs in another.

Since, in general, physical distribution managers appreciate that their challenge is to minimise the total costs of the distribution system, rather than the costs of a particular element, they tend to employ the total cost concept. To this end, management must calculate the trade-offs between three categories of cost: transportation costs, order processing costs and stockholding costs. Figure 9.6 shows the general relationship between these different categories of cost.

Figure 9.6 The components of the total costs attached to physical distribution

Storage costs: Because of economies of scale a large warehouse can be operated at a lower cost than can several smaller warehouses. These economies include the fact that larger warehouses are often better able to achieve better utilisation of space and equipment, overheads incurred in a large warehouse can be spread over a higher throughput of stock items and the amount of money tied up in stock tends to be less for a large depot than for several smaller warehouses¹¹. In addition, each separate site will require its own management team and this increases distribution costs further. At some point, however, diseconomies of scale set in and the single central warehouse becomes less attractive in financial terms. This happens, for instance, when depots reach a size where they are difficult to manage and the distances between the warehouse and many of the organisation's customers is so great that transport costs rise to unacceptable levels and the level of service to the customer is adversely affected.

As figure 9.6 shows, increasing the number of warehouses will, almost invariably, increase storage costs but this may be necessary to meet customer expectations with a minimum standard of service.

Figure 9.7 The effect of increasing the number of warehouses upon total storage costs

Transportation costs: As can be seen in figure 9.7, the increase in storage costs may be offset, either in whole or in part, by savings made in transportation costs As the number of warehouses increases, unit transport costs decline due to lower mileages being travelled by delivery vehicles.

Figure 9.8 The effect of increasing the number of warehouses on total transport costs

For most manufacturers and producers transportation is the major physical distribution cost.

Inventory carrying costs: The cost of maintaining sufficient stocks to meet any level of demand is usually prohibitive. Instead, the firm seeks to reach a balance between inventory carrying costs and an acceptable level of customer service.

Among the chief determinants of inventory carrying costs are:

• the greater the number of locations at which stock is held, the greater the level of stocks and carrying costs.
• longer order cycles result in higher stocks, and vice versa and
• as the product portfolio increases so does the amount invested in stocks

With respect to the effect of increasing the number of warehouses located in various areas, this would be, as was said earlier, to increase stock holding costs.

Figure 9.9 The effect of the increasing the number of depots on total inventory carrying costs

System Costs: The last category of the costs are those termed system costs. These include costs attached to order processing activities, the maintenance of information systems and communications between sites. The total cost of these services will, as figure 9.10 suggests, increase with number of sites.

Figure 9.10 The effect of increasing the number of warehouses on total system costs

Total distribution cost: At the outset of this chapter, it was emphasised that changes in one element of the distribution system can have a dramatic, and often unexpected effect on other elements of the system and upon the system as a whole. Hence the need to view the physical distribution system as a whole. Total distribution costs analysis can be used to this end. By bringing together the various types of distribution cost, the effects of proposed changes in one area of distribution can be assessed in terms of their impact on other individual elements and upon the system as a whole.

Direct product profitability: The conventional approach to assessing the profitability of products has been to average costs over the entire product range. DPP, or direct product profitability, is a process involving the allocation of all distribution costs, including space, to specific products and so arriving at a figure for the direct product costs (DPCs) then subtracting these from the gross margin of the products. McGoldrick's¹² explanation of DPP emphasises that distribution costs are a major component of direct product costs.

“The DPP of an item is therefore the gross margin, after adjustments, minus direct product costs (DPCs). These direct product costs arise at the warehouse, in transport, in the store and in the head office functions. The largest single element of DPC is likely to be incurred in the store. Here a cost is allocated, possibly using work-study techniques, for the labour involved in receiving, sorting, moving, price-marking, shelf-loading and checking out the item. A space cost is a allocated, being a function of the square or cubic footage occupied and the rate of the stockturn of the item.”

Thus, DPP seeks to monitor the actual costs and profits involved in distributing a product. The adoption of DPP is motivated by the desire to identify and eradicate inefficiencies within the distribution system. In addition, since DPP has the potential to pinpoint the costs of delivering specific products to specific customers, it also has the potential to help in devising cost-effective marketing strategies. Some of the other areas of decision-making in which managers in manufacturing and retailing are applying DPP are:

• Shelf space allocation
• types of display to be used
• retail pricing
• types and level of promotion
• methods of delivery
• selection of new products
• product design, and
• packaging design.

DPP is a useful measure for manufacturers or producers, wholesalers and retailers but it does require a sound management information system in order to be able to perform the detailed calculations. It probably also requires access to a computer, although this need only be an inexpensive personal computer.

Just-in-time: The purpose of JIT is to eliminate all production activities which do not directly add value to the product. The just-in-time (JIT) concept was developed with manufacturing in mind but it has implications for distribution. Whilst the organisations that have implemented this system tend to be large enterprises, the system also has implications for the smaller and middle-sized firms who may be their competitors, suppliers or customers.

JIT has four specific objectives¹³

• the production of goods that the customer wants
• the production of goods when the customer wants them
• the production of perfect quality of goods and
• the elimination of waste (in labour, inventory movement, space, etc.).

JIT ensures, for example, that components and raw materials arrive at the manufacturer's or processor's factory at the precise time they are required for production or processing. For JIT to work, there has to be good coordination of production schedules between suppliers and manufacturers/processors so that both parties can satisfy demand whilst carrying mini stocks.

The implementation of a JIT programme usually has a number of complementary elements. The most common are:

Organisations marketing to enterprises which have adopted JIT will find that new opportunities and challenges are created. The most likely effects of JIT are:

Materials requirement planning: The materials requirement planning system (MRP) most commonly found in modern manufacturing or processing concerns is based on the Japanese Kanban system. MRP is a computerised inventory control system intended to minimise the investment in manufacturing/processing materials and components, consistent with matching production levels to current demand.

The word Kanban translates as ‘visible record’ which may be a ticket, job or route card, or a computer code. A computer is used to plan production over several periods and using the Kanban system automatically triggers the production or purchase of components or materials at the time they are required for the manufacturing or processing of the finished product.

All materials or components are lodged in specially designed containers which have two Kanban cards attached to them. Those responsible for the production or supply of the material or the component will make use of the P-Kanban whereas the users of those materials or components will use the C-Kanban (C = conveyance). Each container is conveyed between the work areas of the materials/parts producers and users with one kanban being exchanged for another along the way. The production of a part can only be undertaken if there is a P-Kanban to authorise it. In the absence of a P-Kanban the workforce will engage in other activities such as cleaning, maintenance, training etc.

The Kanban system removes the need for managers to forecast (or guess) what level of materials or parts must be held in stock to meet production/processing requirements and thereby reduces inventories. Kanban is intended to work within the context of a just-in-time production programme. Oakland¹⁴ says that:

“A JIT programme can succeed without a Kanban-based operation, but Kanbans will not function effectively independently of JIT.”

Materials Requirement Planning (MRP) has been extended into Manufacturing Resource Planning (MRP II). MRP II represented a move towards an integrated approach to the entire manufacturing process. Distribution Requirement Planning (DRP) applies the techniques of MRP II to warehousing and transportation activities.

Warehouse management

The functions of warehouses are to provide cost-effective storage, in suitable conditions, for the organisation's products and materials. The existence of a warehouse is justified by the extent to which it contributes to the efficiency and effectiveness of physical distribution functions. The main warehousing operations are listed in table 9.1.

Table 9.1 Warehouse operations

The geographical location of a warehouse should be determined by production sites and the physical position of target markets. In some developing countries, however, political consideration have sometimes over-ridden economic arguments and facilities such as warehouses, godowns, assembly areas and buying points for government organisation have been sub-optimally sited.

Warehouse managers have a number of important challenges including:

• determining the most appropriate unit load(s)
• optimising space utilisation
• reducing the movement of labour, equipment and products/materials to a minimum
• establish a safe, secure warehouse environment and
• keeping costs to a minimum.

Inventory management

The management of inventory can have a major impact upon the profitability of an organisation. If inventory levels are too low then there is the risk of stockouts, i.e. the inability to meet an order. This can result in a loss of revenues, profits and customer goodwill. On the other hand, if the inventory levels are too high then the organisation can experience cash flow problems since so much of its capital is tied up in stocks. When inventory levels are high then there is also an increased risk of spoilage, pilferage and obsolescence.

Managing stocks involves balancing two sets of costs: Inventory carrying costs and order processing costs. Consider the position of a company making a range of biscuits and breads. For such a company wheat will be a major raw material. The company could be so anxious to secure supplies of this vital component of its finished products that it is prepared to place a single order for its total requirement for the next year. However, this course of action would maximise the bakery's inventory carrying costs, comprised of costs of capital, storage charges, insurance, depreciation, obsolescence and shrinkage. As Figure 9.11a illustrates, inventory carrying costs increase in line with the average stock held.

Since production within a bakery tends to be a batch process, the company could adopt an alternative approach and place orders large enough to ensure that wheat stocks are only just sufficient to meet the requirements for the next batch, i.e. a just-in-time approach. This would minimise the bakery's inventory carrying costs but would mean placing a large number of orders and so order processing costs would be maximised. Order processing costs include monitoring residual stocks, selecting a supplier (which could mean having to compare a number of alternatives), raising and processing a purchase order, checking goods inwards, and processing payment. Figure 9.11b indicates that if the bakery elected to place small order for wheat they would have to place a number of orders over the year and so order processing costs would be high. The same figure shows that order processing costs decline as the size of the orders increases and the number of orders placed declines.

The optimal order size is determined by studying how these two sets of costs interact. Figure 9.11c depicts the total inventory cost which is, of course, the sum of inventory carrying costs plus order processing costs. The optimal order size is at point Q, i.e. the lowest point on the total cost curve commonly referred to as the economic order quantity (EOQ).

Figure 9.11 The Economic Order Quantity

Calculating the economic order quantity

The calculation of the economic order quantity involves only simple mathematics. The following nomenclature may be used:

Let

O = the cost of placing a order
Q = quantity ordered
N = number of times that quantity is ordered,
S = Q × N (i.e the total number of units demanded)
C = cost per unit per annum

Order processing costs = O × N

Average carrying costs = C × Q/2

Total costs = (O × N) + C × Q/2

Since NQ = S then N = S/Q

Total costs = OS/Q + CQ/2

Therefore EOQ = √OS/C

It will quickly be realised that the EOQ model, as just described, is an over-simplification of the real world. It does not incorporate such realities as the variation in sales volumes over time, variable lead times between order placement and delivery, discounts for purchasing in larger quantities and the need for safety stocks. If the EOQ model is to be useful in practice then it must be adapted to cope with these variables.

Order cycles and sales fluctuations: There are two basic approaches to incorporating sales volume variations in inventory management models: fixed order quantities and fixed order times. A fixed order quantity system allows time between orders to vary whilst the EOQ is held constant. A fixed order time system allows the size of orders placed to vary but the times between orders are fixed. Where the fixed order time system is applied, EOQ does not determine the order size. Instead, a forecast is made of demand over the next lead time and the size of the order to be placed is determined accordingly.

Both of these approaches have their advantages and the choice between them is entirely dependent upon the circumstances of the particular organisation. For instance, a supermarket chain might organise the scheduling of its transport fleet so as to minimise delivery costs. This could mean that each retail outlet is given a fixed delivery date for receiving orders. In these circumstances each store must place orders on a fixed time schedule but can vary its order quantities for each item. Where transport costs are not an overriding consideration then the same supermarket chain could apply a system of fixed order quantities but varying periods of order placement, because order processing and inventory carrying costs outweigh transport costs.

It sometimes happens that an organisation will apply one system at the retail level and the other at the warehouse level. Consider, for example, the position of a large food retailer with multiple retail outlets and several regional warehouses. With each warehouse serving a number of large retail outlets the variation in sales is likely to be greater at store level than at warehouse level (the downward fluctuations in some stores will be compensated by upward swings in others). Where this is the case, a fixed order quantity system could be imposed at the warehouse level whilst a fixed order time system applies at the retail level.

Bulk purchase discounts: Where discounts are received for placing orders of a given size these must be taken into account because they affect the EOQ. The organisation has to conduct a trade-off analysis in order to determine whether the ‘savings’ accrued from placing larger orders and the lower order processing costs due to the need to place fewer orders, outweigh the additional inventory carrying costs. The additional carrying costs are calculated as follows:

Additional inventory carrying costs = C(Q₂ - Q₁)/2

Where

Q₁ is the EOQ before taking any quantity discount into consideration, and

Q₂ is the EOQ after taking any quantity discount into consideration

The savings accrued from placing fewer orders and incurring lower order processing costs are calculated as follows:

OS/Q₁ - OS/Q₂

A comparative analysis of the two sources of savings, those from bulk discounts and those from lower order processing costs- against the additional inventory carrying costs will guide management as to whether a quantity discount should be taken or not.

Safety stocks: Inevitably, there will be occasions when demand exceeds expectations. If an organisation has not anticipated this eventuality then a stockout will occur. If the item is a raw material or component then production will be interrupted and this will add to production costs. If the item is a finished good then customers will be adversely affected and their goodwill and custom may be lost altogether. Since the costs of a stockout are potentially great, organisations usually plan to carry a safety stock as a buffer between supply and demand levels.

Decisions relating to the levels of safety stocks involve a trade-off between additional inventory carrying costs and the costs of a stockout. If customers are likely to place the order elsewhere then the cost of a stockout is the contribution to fixed costs (i.e. the sales revenue minus the variable costs). If customers are lost forever, as a result of the stockout, then the cost is the present value of the discounted stream of expected future contributions on orders lost.

Transport management

A critical issue in the management of physical distribution activities is whether the organisation should own transport facilities or hire them. There are three types of carriers which an organisation might choose between when deciding how to ship its product; private carriers, common carriers and contract carriers. Where a company owns and operates its own transport fleet it is termed a private carrier. This fleet is not usually available to any party other than the owner. Common carriers are available to any party wishing to transport goods. Common carriers charge standard rates which are published and freely available to anyone who is interested. A contract carrier serves individual shippers on a medium to long-term basis. The contract usually extends over a specified period with an option to renew the contract.

Calculating the cost of owning transport vehicles

In order to make a decision as to whether the organisation should purchase its own transport vehicles or use a common or contract carrier, the costs of ownership must be calculated. The two elements of transport costs are the fixed costs and the operating costs. Some costs are incurred irrespective of whether the vehicles are actually moving or not. These fixed costs include such items as vehicle licence duties, insurance and interest due on loans obtained to purchase vehicles. Operating, or running, costs are a function of the distances travelled by the vehicle and include fuel, tyres and repair and maintenance costs. A list of fixed and operating costs appears in the table below.

Table 9.2 Fixed and operating costs of owning transport vehicles

* Depreciation is partly a function of distances travelled by the vehicle

A simple approach to calculating the depreciation on a vehicle would be:

Alternatively, if the organisation has a policy of replacing vehicles by selling them off at set intervals then the formula becomes:

It can be seen that only the purchase price and perhaps the estimated period of ownership, if the firm has a set replacement policy, will be fixed figures whereas the others will need to be estimated. In these circumstances it is sometimes useful to obtain estimates of depreciation from other sources. These might include:

• vehicle distributors, although these may tend to be optimistic or even exaggerated

• other vehicle operators

• vehicle insurers and/or

• financial institutions who give loans for the purpose of purchasing vehicles.

Unitisation in physical distribution

There are two aspects of unitisation of physical loads and these are palletisation and containerisation. Both palletisation and containerisation serve to reduce damage to agricultural and food products whilst these are in transit, and to increase the efficiency of the distribution system as a whole.

In international trade, there is a widespread adoption of a standard pallet size of 100cm × 120cm. Any exporter who ignores this standard when trading with countries that have adopted the standard will probably incur additional costs because of the need to repalletise the load. The argument in favour of a standard pallet size is simply that the operations of each of the parties in the physical distribution system will be more efficient if they all work to a common pallet size. Ships, lorries, rail freight cars, aircraft holds and warehouses can be designed to handle the standard pallet size and achieve maximum utilisation of space¹⁵.

The introduction of trailer size containers has allowed various forms of transportation to integrate their services since these units are interchangeable between different modes of transport. Containerization has made possible the transfer of loads between ships direct on to road and rail-based carriers and, of course, between road and rail. The main advantages of containerisation are the minimisation of damage to the goods, little or no pilferage and handling times reduced to 50 percent of those achieved with other systems.

Technological advances in physical distribution

Computerised scanners: Modern retail supermarkets and wholesalers are increasingly using electronic scanners at the checkout to speed up customer flow and improve inventory management. This type of electronic point of sale (EPOS) system depends upon each product having been labelled with a unique bar code which can be read by a laser. The two main coding systems are the Universal Product Code (UPC), originating in the USA, and the European Article Number (EAN). Both coding systems have found acceptance in a large number of countries and are compatible with one another. The UPC system uses 11 digits whilst EAN uses 13 digits. The first five digits of the EAN code identifies the manufacturer or producer, the next five digits give specific product information, followed by two digits that denote the country of origin with a final check digit. These digits are represented by a series of alternate black and white bars, of varying widths, which are read by the laser scanner.

In addition to reducing the time which the customer spends at the checkout, computer linked scanners can instantly transfer the item sold from stock records to sales records. Not only does scanner technology add to customer convenience, it also provides the seller with a level of detail on inventories and sales which can significantly improve profitability. Scanners enable the distributor to not only record the product sold, or held in stock, but the pack size and the form of package. Thus, for example, a retailer using scanners will know that it is the 2 litre milk packs which are gaining in sales volumes whilst, perhaps, the 250 ml packs are increasingly slow to move off the shelves. This helps the retailer respond more quickly to changing consumer preferences and at the same time improves profitability through reducing wastage rates.

Vehicle Scheduling and Routing

Distribution is usually a sizeable component of total marketing costs. Moreover, the costs of procuring and operating transportation are generally high, sometimes prohibitive as this is often a very scarce resource. It follows that if transport facilities can be managed efficiently this can have a dramatic effect upon total marketing costs and the effectiveness of the firm's marketing system.

In turn, the efficiency and effectiveness achieved with the logistics operations of an enterprise are greatly influenced by the routing and scheduling of the vehicles available. Slater¹⁶ defines the problem of optimising the performance of the transport function in terms of load planning as follows:

“Load planning is a method or technique used to match existing customer orders with vehicles and available manpower by the generation of routes or schedules for vehicles. The efficiency of these routes or schedules determines the operating cost for the transport fleet and the potential customer service level offered by the company.”

Figure 9.12 The composition of total transport costs

Thus the motivation to work on maximising the efficiency of vehicle routing and scheduling lies in the potential to contain total transport costs whilst also retaining control over the level of services provided to customers. Where the enterprise operates a fleet of vehicles then load planning has the potential to minimise total mileage whilst maximising operating times, thereby enabling the organisation to reduce the size of its fleet or increase the number of customers/area of territory covered, or some compromise between the two.

Transportation costs are comprised of several major elements, as can be seen in figure 9.12. Nonetheless, it can be readily seen that vehicle scheduling efficiencies, or a lack of them, will have a major effect on total costs. In particular, load planning will impact upon the cost of fuel, labour, maintenance and vehicle depreciation.

Any manager charged with responsibility for the efficient operation of the transportation function will have a diverse range of factors to consider. These include the nature of the customers to be served, the vehicles available, labour force, company policies, the physical characteristics of loads, the environment and vehicle scheduling methods. These factors are more fully listed in table 9.3.

Table 9.3 Factors affecting vehicle scheduling

Slater goes on to illustrate how these factors are sequenced and how they interact, to impinge upon vehicle scheduling decisions.

Figure 9.13 Formulating the load plan

Figure 9.13 emphasises the principal objectives of vehicle routing and scheduling, i.e. the delivery of a given level of customer service, with maximum efficiency and at minimum cost.

Fixed and variable routing systems

At their most basic level, vehicle scheduling and routing methods are dichotomous: fixed routes and variable routes. In a “fixed route” system, vehicles follow a prescribed route each day and customer orders for that day are matched to the delivery route. The advantage of this system, to the customer, is that he/she knows the day and time of delivery, and he/she can plan accordingly. On the other hand, the system does not accommodate customers who require immediate delivery, unless by chance the vehicle was scheduled to be in their vicinity the same day or the day after the order was placed. In terms of efficiency, the “fixed route” system has fundamental shortcomings. It will only periodically happen that vehicle capacity and order levels, for a given day, will match exactly. On most occasions, vehicle capacity will be under-utilised or over-subscribed.

The “variable route” system is more customer oriented. This approach seeks to develop routes which match customer order patterns and is capable of amendment to meet fluctuations in day-to-day demand levels. Operating efficiency is improved since the number of drivers and vehicles on the road each day is determined by that day's order level and so total mileage and variable transport costs are minimised. However, there can be disadvantages of this system to customers since they are not always sure of the time and/or day of delivery.

It is sometimes possible to adopt a hybrid approach where a “variable route” system is operated within fixed geographical areas. Such an approach yields the benefits of both the fixed and variable routing system. Unfortunately, it does not overcome the problems of orders exceeding transport capacity, vehicle breakdowns or absenteeism on the part of drivers.

Vehicle scheduling tools

Vehicle scheduling can be a simple paper exercise or can become so complex that computer based mathematical models have to be used. Having a transport supervisor or manager plan the delivery schedule on the basis of a detailed knowledge of each driver's capabilities, the geographical area and the particulars of the customers have inherent advantages. However, fleets quickly become too large for individual personnel to produce scheduling plans which maximise efficiency and effectiveness at minimum cost. Moreover, in highly competitive markets, physical distribution costs have to be carefully managed if the marketing margin is not to be entirely eroded. Thus, to some point, most organisations will have to give consideration to applying mathematical models to vehicle scheduling decisions. In most instances, these mathematical models will prove unready unless they are manipulated by a computer.

There are a number of standard computer “packages” available for the task of vehicle scheduling. The earliest versions of these packages were fairly inflexible in that they had certain in-built assumptions. Typical, an understandable, assumption might include vehicle capacity limitations, driver's time limitations, customer earliest/latest delivery times, etc. These computerised models did not incorporate all of the constraints placed upon the logistics operations of an enterprise. For instance, programmers could not anticipate how transport personnel would react to the “imposition” of a mathematically calculated route that test no cognisance of their local knowledge and experience or the idiosyncratic wishes of some customers. This being the case, programmers were unable to build in all of the factors which should be taken into account when designing a delivery route. As a consequence, computer generated vehicle schedules were sometimes sub-optimal, sometimes unrealistic and often resented by those who had to implement them. To improve computer-based routing, interactive computer scheduling has been introduced. Interactive computer scheduling allows the transport manager to alter any of the parameters in the mathematical model in line with his/her view of the real situation. Thus, contemporary computer-based vehicle scheduling models combine the manager's knowledge with the computer's ability to process complex mathematical models, quickly, to produce flexible schedules.

Vehicle scheduling models

There are a range of models which can be applied to vehicle scheduling. In this text, the savings method, the simplified delivery service model and the TRANSIT model will be briefly described. It is beyond the scope of this text to deal with the more complex computer-based scheduling models.

Savings method: Clark and Wright's¹⁷ “savings method” is perhaps the best known of all the vehicle scheduling models and can be applied either manually or via a computer. Suppose that retailers A and B, who are seperated by x kilometers, both receive maize meal from National Foods' depot at O. This situation is depicted in figure 9.14.

Figure 9.14 The savings method

The distances between the depot at O and retailers A and B are a and b respectively. If two vehicles were used to make the two deliveries separately, the total distance traveled would be 2a + 2b. Alternatively, if only one vehicle were used to make the two deliveries the distance covered over the round-trip is a + b + x. The saving achieved by assigning one vehicle to the round trip would be (2a + 2b) - (a + b + x) = a+b - x. More generally, the savings method formula is denoted as:

Sij = doi + doj - dij

where,

Sij = distance saved by linking together any two delivery points i and j.
doi = distance between depot O and delivery point i
doj = distance between depot O and delivery point j
dij = distance between the delivery points i and j.

Where there are more than two delivery points a matrix of distances saved is developed. This matrix displays the distances between all delivery points and between the depot, or factory, or farm, and each delivery point. The first link to be chosen will be the one showing the largest saving, given two deliveries. The sum of the orders for these two deliveries will be checked against the vehicle capacity and drivers' time constraints. If the initial linking leaves spare vehicle and driver capacity then it might be possible to add other delivery points to the link by selecting the next biggest saving. Again a check is carried out to ensure that neither vehicle capacity nor drivers' time constraints is exceeded by the new combination of deliveries. The process continues to the point where all deliveries are scheduled or the available vehicles are fully utilised.

To better understand the method of calculating the savings accrued from linking deliveries, consider the hypothetical data in figure 9.15

Figure 9.15 Applying the savings method to a vehicle scheduling problem

(Note: Numbers in brackets indicate the order size).

Figure 9.16 The savings method matrices

The savings matrix shows that route O - C - D - O gives the maximum savings in terms of distance to be travelled (17 km). To service this route 88 units of product have to be carried and this is well within the vehicle's carrying capacity. It would take 5.16 hours to complete this route (2.23 hours driving and 2.93 hours to unload the 88 units). Once this route has been completed, retailers A and B are left awaiting delivery. The O - A - B - O route takes 4.53 hours to complete and can be undertaken within the time and capacity constraint. Indeed, as the data in figure 9.16 shows, both routes can be completed within the same working day.

The simplified delivery service model: The SDS model involves the geographical division of the marketing territory into sub-areas. Each sub-area is identified by an alphanumeric code (e.g. D2). The alpha part of the code indicates a main route from the depot into a particular sales area and the numeric component breaks that sales area into suitably sized sub-areas. These sub-areas are often but not always delineated by physical boundaries such as rivers, valleys, mountains, etc. Consideration is also given to the number of customers in each area categorisation used for the purpose of the simplified delivery service.

Figure 9.17 The simplified delivery service

As orders are received, a log is built up for each delivery point sub-area. Vehicle loads are built up starting at the remotest sub-area and working inwards to the depot.

The individual responsible for vehicle scheduling will only start to combine loads intended for different sub-areas when those territories are in close proximity to the depot (e.g. A1 to G1). The principal advantage of SDS is that the delivery system is made more efficient by following convenient routes which minimise delays caused by continually crossing difficult terrain. It is a method that is especially well suited to developing countries where roads are often poor.

TRANSIT: Transit is an acronym for Time Routing And Scheduling of Industrial Transport. Like SDS, TRANSIT makes use of maps. The sales territory is overlaid with a grid with each square representing 10km square are allocated; as are driving times are allocated within each square. When this is done the scheduler follows a set procedure:

1. Orders are sorted for each 10 km square.

2. The 10km square furthest from the depot is identified.

3. The remotest 10km square is further divided into 1km squares and the orders re-sorted for each of these.

4. The scheduler begins to build up a load for the furthest 1km square.

5. As the orders are re-sorted, the total time required is calculated by adding together the driving time and the loading/unloading times for each delivery point and the driving time to the next delivery point.

6. The scheduler moves on to build up the load for the next most remote 10km square and so on.

The TRANSIT method tends to produce good, efficient and effective delivery times and make full use of the available vehicles. The routes themselves, however, are rarely as good as those produced by SDS because they take no account of natural barriers and difficult cross-country terrain.

Computer-based vehicle scheduling

Although having the benefit of simplicity, manual methods of vehicle scheduling tend to be inefficient. The task is mentally taxing and schedules are prone to making mistakes, resulting in a sub-optimal schedule. This has given impetus to the development of computerised models for vehicle scheduling.

The advantages of computer based scheduling include speed, accuracy and the potential to interface vehicle scheduling models with other components of the overall management information system (e.g. stock control, invoicing, sales analysis). The main disadvantages are that the software is complex, and is therefore expensive, and, of course, it requires a computer with a maths co-processor to run the model. Another disadvantage is that because of the complex algorithms involved in the model, most managers will not understand it well enough to correct data input errors. That is, the non-mathematical manager will fail to recognise errors in the schedules produced by the model. Robson³ however, puts a strong case for computer - based vehicle scheduling when he says that:

“Measured against present costs the likely benefits of computerised scheduling are still very significant. On a global scale it has been estimated that some 25% of the $4,000 million spent each year on distribution could be saved by the increased utilisation of vehicles.”

Chapter Summary

Channel decisions are integral to the strategic marketing plan. Distribution systems should adhere to the marketing concept, focus on target markets and have sufficient flexibility to enable an organisation to respond to market changes and new market opportunities.

A middleman's remuneration should depend upon the number of marketing functions he/she performs and, more especially, by the efficiency with which they are performed. The efficiency of most marketing systems is improved by the presence of effective intermediaries. Whilst it always possible to by-pass or remove intermediaries from a marketing system, the functions which they performed in the past will remain to be performed, as will their costs.

There are several key decision areas pertaining to the appointment of intermediaries. These include: price policy, terms and conditions of sale, territorial rights and the definition of responsibilities. In addition, a choice has to be made between extensive and intensive coverage of the market. An important aspect of the relationship with intermediaries is the recognition that intermediaries are independent of suppliers and must be marketed to rather than through. Much of the conflict between parties within the distribution system arises from incompatible goals, confusion over roles and rights and differences in perceptions of the market. Moreover, the greater the degree of independence between two members of the distribution channel, the greater the potential for conflict because the actions of one party are likely to impinge upon the performance of the other.

Marketing logistics involves both materials management and physical distribution. An efficient system of materials management can be a potent marketing instrument, as can an efficient physical distribution system. As well as helping to control costs, these two areas of management can contribute greatly to the level of customer service achieved by the organisation. The level of service offered by an organisation can be as important, sometimes more important, to its prospective customers than any other attribute which it might possess.

Total distribution costs are very much influenced by procurement costs, inventory carrying costs, and transportation costs. Management needs to understand the interrelationships between these categories of cost and to develop an understanding of the trade-offs that must be made between them. There are a number of current developments in the field of logistics management which are likely to have a major impact on the way in which this function is managed in the future. These developments include: the drive by retailers to account for direct product profitability, the move towards just-in-time materials and product supply and the evolving methodology of materials requirement planning.

Inventories are a major cost element in the management of physical distribution and as such must be carefully controlled. Managers are required to find the economic balance between order processing costs and stockholding costs. At the same time, they need to consider order cycles, fluctuations in demand and the size of the safety stock required. In transport management the key issues relate to the efficient and effective scheduling and routing of vehicles. Three of the most commonly used models are the savings method, the simplified delivery service model and TRANSIT. Each of these is aimed at reducing the time and cost of delivery and the improvement of customer service levels.

Key Terms

Review Questions

From your knowledge of this chapter, give brief responses to each of the following questions:

1. Explain what is meant by a pull strategy.

2. Which costs decline as the number of warehouses operated by an organisation increases?

3. For what type of products is extensive distribution most likely to be used?

4. How would you respond to the charge that all middlemen are parasites?

5. In what important respect do sales agents and brokers differ from most other kinds of intermediary?

6. What is the ‘Dutch method’?

7. In your own words, define the term ‘vertical marketing system’.

8. Give two examples of items that could be classed as order processing costs.

9. What is meant by the term ‘tied agreement’?

10. Name 5 criteria that could be used in measuring the customer service levels achieved by a particular warehouse.

11. Outline the key steps in developing a customer service policy.

12. Name 3 areas of decision making in which DPP can be applied by retailers

13. Complete the following sentence: “The key to establishing good working relations with intermediaries is…”

14. What is a Kanban system?

15. What is the essential requirement before JIT can be made to work?

16. Explain the terms ‘fixed and variable routing systems’.

References

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2. Bennett, P.D. (1988) Marketing, International Student Edition, McGraw-Hill, P390.

3. Gaedeke, R.M. (1983) Marketing Principles and Applications, West Publishing Company, Minnesota, p.221.

4. McVey, P. (January 1960) “Are Channels of Distribution What the Textbooks Say?” Journal of Marketing, pp 61–64.

5. Knipscher, H.C., Sabrani, M., Soedjana, T.D. and De Boer, A.J. (1987) The Small Ruminant Market System in Indonesia: A Review, Agricultural Systems, pp. 87–103.

6. Business Week, (May 4, 1981) “Caterpillar - Sticking to Basics to Stay Competitive.” p.77.

7. Rosson, P. (1974) “Changing Traditional Distribution Systems”, Physical Distribution, No. 4, Vol. 5, pp. 305–316.

8. McHenry, D.E., (1969) “A Problem in Development: An Attempt to Form a Viable Fisherman's Cooperative Society for Lake Tanganyika”, In: Universities Social Sciences Council Conference Proceedings, Kampala, University of East Africa, Makere College.

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10. Gaedeke, R.M. Tootelian (1983) Marketing Principles and Applications, West Publishing Company, Minnesota, p.300.

11. Bowersox, D.J., Smykap, E.W. and La Londe, B.J. (1968) Physical Distribution Management, The MacMillan Company. pp. 27–28.

12. McGoldrick, P. (1990) Retail Marketing, McGraw-Hill, New York p.148.

13. Rushton, A. and Oxley, J. (1991) Handbook of Logistics and Distribution Management, Kogan Page, p.22.

14. Oakland, J.S. (1993) Total Quality Management: The Route to Improving Performance, Second Edition, Butterworth-Heinmann, p.96.

15. Beechner, E.S., Crawford, I.M., Hill, R.W., Tomlinson, F.R., (1994) How To Export Fresh Fruit And Vegetables To The E.C. Cranfield University Press.

16. Slater, A., “Vehicle Load Planning”, International Journal of Physical Distribution and Materials Management, vol.10, No.2, 1979,pp. 79–99.

17. Clarke, G. and Wright, J.W. (1964) “Scheduling of Vehicles from A Central Depot To a Number of Delivery Points.” Operations Research, Vol. II, pp. 568–581.

18. Robson, A. “An Introduction To Computerised Vehicle Scheduling.” (1982) Institute Of Grocery Distribution Research Services, p.32.