Before we go on, let's take a minute to ask, what's so difficult about channel functions? Maybe you're thinking, "Okay, this seems straight forward enough." What's so complicated about this? Turns out that many things can go wrong with your channel intermediaries. Let me give you a few examples. The first is an incident with Amazon and Johnson & Johnson. So Amazon would take possession of Johnson and Johnson inventory. They would transport and retail them, basically executing payments and negotiations on their behalf. A conflict arose because Amazon's third-party resellers were selling expired Johnson & Johnson products, which is not only dangerous, but cannibalizes the existing sales of unexpired products, and of course, hurts the brand equity. So Johnson & Johnson stopped shipping products to Amazon. Other manufacturers with the same product are doing the same. The problem here is that Amazon hosts third-party sellers but doesn't police them. So sometimes unauthorized sellers get a hold of products and resell them on Amazon. This is hurting the relationship between Amazon and Johnson & Johnson. Another problem that Amazon has with managing its functions is the problem of co-mingled inventory. Consider this guy, does he look happy? He is not. This is Matthew Frank. His company makes To-volvo brand ice-cube molds and trays. Sometimes he runs tests on Amazon where he will slow down his shipments to them and then he'll buy a whole bunch just to see what customers are getting. What he realizes is that knock-offs are getting sent to his customers whenever his stock runs low. Why is this? Turns out Amazon is a commingling policy, which vendors may not be aware of unless they noticed the fine print. Let's check this out to see how this works. Fulfillment by Amazon offers the option of stickerless, commingled inventory to simplify shipping products to Amazon. When you create your first shipment of inventory to Amazon, you will have the opportunity to set your preference to stickerless commingled inventory. This option enables you to send qualifying products to the fulfillment center without needing to label them. Amazon uses the products existing UPC to manage your inventory in fulfillment center. Products that do not qualify for commingling will need to be labeled before you send them to Amazon. In order for products to qualify a stickerless commingled, the products must meet the following criteria. The condition of your items must be new. Each unit must have a scannable Barcode. An items barcode must correspond with only one ASIN in the Amazon catalog The items cannot belong to product categories that require approval, like media and other high-value categories. If you set your preference to stickerless commingled inventory, the shipping workflow will identify any items that do not meet these criteria and instruct you to label them before sending them to a fulfillment center. When we receive stickerless units in our fulfillment centers, we place them with other new inventory with the same ASIN. When a customer orders an item from you, it is pulled from the stickerless commingled inventory. You receive payment for your sale and the quantity sold is deducted from your fulfillable quantity. So together, both of these examples rates thorny issues about what is Amazon's role and responsibility as an intermediary? Clearly, better monitoring is needed by both Amazon and its suppliers. Inventory handling obsession flows are critical for suppliers and why they use Amazon. But what's the solution to the problem? Additionally, as we've just discussed, Amazon's compensation should be influenced by this provision of channel flow quality. If you think it's easy, let me give you another example. This broader issue of who's responsible for what flows and what quality should be delivered also arose in another situation completely separate from Amazon. This is a situation of FedEx and the US government. The US government decided to clamp down on illegal transportation of goods like drugs. So the government brought suit against UPS and FedEx. UPS settled, but FedEx did not. They tried to put the job of policing shipments back on the government. So they said it's not our responsibility to look at the stuff that we ship, determine whether or not it's illegal or not, and then police that situation for you. Well, the government put the heat on and FedEx was then hit up with more charges, money-laundering, something having to do with how its drivers were paid. This illustrates the complexity of managing channel functions and flows in the critical need to understand and maybe negotiate in advance where the various responsibilities lie. The whole transportation sector in the management of this function is a really tough business. Consider that with e-commerce, the costs of shipping are increasing yet margins are dropping like mad. So in 2013, over a million UPS packages arrived late. Now, this is not consistent with CNS past practices. Christmas packages are supposed to arrive on time. The next year, 2014, UPS tried to avert this problem by hiring an extra 53,000 employees. This, of course, added 200 million in costs, and then the band for capacity dropped 10 percent that year. So all in all this hurt the annual returns in their stock value that year. We see that many things can go wrong in the management of channel functions. But this just underscores even more than need to better understand functions and how to manage these flow strategically. With that, it's now your turn again. So this is what you will need to do before we meet again. Imagine that you are a channel manager and your company is rolling out a new flooring product. This new flooring product is superior to the legacy product. In fact, a lot of money has been poured into R and D to develop this product. Very costly to innovate. It's going to displace not only the industries current leading product, but also that of the competition. So your manager wants you to sell the new flooring through current distributors at a higher wholesale price per square feet, but still keeping the same suggestive list price. Your task is to explain how you would convince distributors to adopt this new product and to promote it aggressively, knowing that their gross margins are going to fall. Before you run off, let me give you a couple of other pieces of information. The first piece of information is that these distributors are not finance savvy. In other words, they're not real numbers oriented and they don't fully allocate overhead costs in the situation. So one angle to be thinking about is how to better allocate those. This other thing to think about is that these distributors, your benchmark is today. In other words, they're very present oriented. So any new opportunity has to beat today in order to win. This is very much of what can you do for me or what have you done for me lately [inaudible] Another thing to bear in mind is that the distributors in your industry are very unaware of what you now know, which is that channel flows have costs and those historically have been borne by your company. The last thing is that your company, with this new product is going to be willing to invest in more advertising and trade show displays. They're willing to train the distributor sales force and how to sell this new flooring product. Your task is to explain how are you going to convince distributors? In other words, what are the arguments that will sway them to adopt the new product and to promote it aggressively when their gross margins are going to fail.
