So let's look at the first problem of what does my channel partner need to know. The information problem is often one in which the channel member is not interested in getting on board, because they don't have the information to understand the financial value from doing so. Consider what went into Dunkin Donuts success for one of their first major strategic changes in their core product line. From their inception, Dunkin Donuts had only sold donuts and the time came when this was not going to be enough to be able to survive in an increasingly competitive market. Senior managers realize that they needed to expand their product line if they were going to continue to grow and be successful. And after substantial research, they identified muffins as the most promising product line to extend into. Now this allowed them to expand their sales volume, because muffins were brought during different times of the day from donut purchases and because it allowed them to reach new customers. Unfortunately,, muffins also required investments in ovens to be able to bake them creating expenses switching costs and risk for these channel partners the franchisees. Initially, top management presented this information to them and to store owners, but they quickly found that they faced stiff resistance from their channel partners who bought it adopting this initiative. So to get franchisees on board ,Dunkin Donuts had to go beyond just telling them to do it. They had the show them the reasons, so they piloted the initiative with a few partner franchisees and they documented the costs for ovens in terms of the time and the expense. They also documented the gains from the extended product line. Turns out that muffins were bought at different times of the day in increase the store traffic during lower volume periods for the franchisees. Thus, it generated substantial incremental profits and this also allowed franchisees to move into other market times and other additional items that can now be baked. So overall, this increase their profits substantially. Now this greater depth of information provision, the teaching and the learning together was enough to gain the acceptance of the strategic initiative by their channel partners which was essential to their survival and success for the next several years. A McDonald's is known worldwide not only for its brand and products, but for the strength of its information provision and communication with its franchisees and store owners. All franchisees must attend training at Hamburger University in Chicago where they learn all aspects of running the business firsthand from the focus on keeping your quote, eyes on the fries to details of forecasting or during production staffing in management. This training is followed up with detailed information on processes and routines along with clear sets of standards and practices that McDonald's monitors, and enforces consistently. And the result is a product and experience that is maintained consistently for McDonald customers worldwide, reinforcing the quality and reputation of the brand for franchisees and the franchiser like. Home Depot also does the same thing in their training programs. At Home Depot, there is an explicit process for everything from how to treat and deal with vendors and suppliers to how products are placed on the shelf and the motivation behind this is that by providing employees the information they need about the firm's expectations. The employees can better ensure that they treat outside vendors in a manner that's consistent with the company's position and they're able to get Outsiders to come on board with Home Depot's agenda. At Home Depot, they have a professional studio with the production team that focuses on communicating key information and training to their hundreds of thousands of employees in their locations all around the world. Now, on to the next problem or the question of what's in it for them? Successful channel captain's must be aware of the fundamental tendency of each channel member to be self-interested. That is each firm will maximize its own profits, which is based on its own production costs and prices. Thus, each firm will set a price markup or margin that's going to maximize its profits. Now, remember double generalization. If your route to market involves activities or processes from two different intermediaries, each are going to layer on its profit maximizing margin in setting customer retail prices. So why is this a problem? Well, this is the economically rational behavior for any channel member, but the simple reality is that it creates substantial problems for channel coordination. Number one, it's going to create higher retail prices and lower combined profits for the whole channel system. Number two, each party now has an incentive to under provide or free right on activities that will increase its sales volume, because the cost of these activities accrue to one channel member while the benefits accrue to everybody. So distributors will tend to under provide advertising service and support, and it also gives distributors incentives to over price, and not pass through promotions, and discounts. Left to their own devices, their channel partners won't do enough of these activities. So this is broadly related to what's known as the tragedy of the commons and that might be a term that you have heard before. The tragedy of the commons or public goods available to everyone is that each individual has an incentive to deplete it and turn it into its own private rents. For example, if 20 of goats are available to a village, then every person has an incentive to take and use one or more. Now if the goats were private goods, the incentive would be to save them into overtime triple their value. If there's a valuable resource lying about in a common area, imagine pizza at a frat party. People will try and grab as much of that resource as they can before the resources depleted even though the intention behind putting the pizza. There might have been to ensure that all people got one slice,the tendency to take more than one slice is a natural response. It's an example of people responding to incentives. So how does the channel strategist handle this? Well, consider the example of Kraft food which is a large consumer goods manufacturer. Kraft constantly faces an incentive management problem from double marginalization. So for example, consider retail advertising which is an effective way to increase sales volumes around major holidays and other key weeks throughout the year. Well, Kraft will often provide retailers with this information about the effectiveness of advertising, so that they're aware of it. But since this is costly for the retailer to do, they may choose not to undertake this action. Thus, causing the retailer to systematically under advertise Kraft products. So what can Kraft do? One is cooperative advertising where the manufacturer offers to pay a portion of retail advertising costs to subsidize this expense. A savvy manufacturer considers the cost of making customers aware in the margins that each channel member makes and can arrive at an advertising subsidy that shares these costs in a way that incense the retailer to run local ads. A pricing solution that we talked about was MSRP, the manufacturer's suggested retail price. Now MSRP acts to set a ceiling on prices since pricing above an MSRP on the package makes the distributor or retailer look bad, this helps overcome the double marginalization problem. Now many consumer packaged goods companies use this tool from Frito-Lay's to Sara Lee. They reduce the distributor's incentives to increase their prices with the use of an MSRP. Another solution is known as a slotting allowances. Slotting allowances are often offered to stop and shop by major CPG manufacturers like Kraft to give these retailers an incentive to provide shelf space for new product introduction. DuPont will offer service subsidies for automotive paint distributors to provide information paint matching services and in-store support.
