Distribution channels and decisions

In depth

Direct, indirect, multichannel and omnichannel

Selling direct to consumers, often called direct-to-consumer or DTC, gives the producer the whole price, full control over how the product is presented, and data on every customer. It also gives the producer every function to perform and only the customers who come looking. Indirect channels give reach the producer could never build alone, at the price of a share of every sale and less control over the shelf.

Most producers do both. Multichannel distribution means selling through more than one channel at once: Lantern’s first plan uses supermarkets, natural grocers and its own cafés and online shop. Omnichannel goes further: the channels are joined up from the customer’s side, so that prices, promotions, stock information and loyalty rewards are consistent wherever the customer meets the brand, and the customer can move between channels, for example ordering online and collecting a case at a café. Verhoef, Kannan and Inman (2015) describe this shift as retailers taking a broader view of channels, managing them together rather than as separate businesses. Omnichannel needs shared systems and data, so it costs money; for a canned drink the practical omnichannel questions are mostly about consistent prices and joined-up customer data.

Distribution intensity

The second big decision is how many of the outlets that would stock the product to use. With intensive distribution the product is placed in as many outlets as possible; with selective distribution it goes to more than one but fewer than all of the outlets that would take it; with exclusive distribution only one or a very few outlets in each area may sell it.

The table follows a classic link with product classes. Convenience products, bought often and with little effort, need intensive distribution; shopping products, compared on quality and price before purchase, suit selective distribution; speciality products, which buyers will make a special effort to get, can be sold exclusively. But positioning can override the product class. A premium brand may deliberately stay out of discount outlets even though its category is sold everywhere, to protect its image and the margins of the stores that do carry it.

Intensity also changes over a product’s life. A new brand often starts selectively, in outlets where its likely buyers shop and where it can afford the fees and the in-store support, and widens distribution once it has shown that it sells. A ready-to-drink coffee is bought like a convenience product, which argues for wide availability in the long run; Lantern’s premium single-origin positioning, its 12% awareness and its limited budget argue for a selective start.

Channel economics: trade margins and the price build-up

Intermediaries are paid out of the price the shopper pays. The trade margin is the share of the shelf price that the intermediaries keep: in Lantern’s market file it is the distributor’s and the retailer’s share together. What is left is Lantern’s net price, the amount it actually receives per can. A price build-up traces the price from the producer to the shelf, or back from the shelf to the producer, showing who keeps what at each level.

Here $P$ is the shelf price, $m$ the trade margin as a share of the shelf price and $c$ Lantern’s cost of goods per can, which covers the liquid, the can, the co-packer’s fee and freight to the distributor. In the direct channel there is no trade margin, but Lantern pays fulfilment $f$ per can, so its net price is $P - f$. For the single-origin can at $3.49, with a cost of goods of $0.74:

Amounts are rounded to the cent at the end. Gross margin per can is net price minus the $0.74 cost of goods; it is before listing fees, promotion and overhead.

The same shelf price earns Lantern very different amounts. A can sold in a convenience store leaves Lantern $1.35; the same can sold through its own online shop leaves $2.30, but only to a customer who already knows Lantern well enough to order online. This is the central trade-off of place: reach costs margin. The channels that put the product in front of the most shoppers are the ones that take the largest share, because they provide the most valuable thing a new brand lacks, which is access to people who aren’t yet looking for it.

Two details trip up students and professionals alike. First, a trade margin is quoted on the shelf price, not on what the intermediary paid. The supermarkets’ 32% of the shelf price is a markup of $0.32 \div 0.68 \approx 47.1\%$ on the $2.37 Lantern receives, because $2.37 \times 1.471 \approx 3.49$. Second, when each level quotes its own margin on its own selling price, the margins compound rather than add. The market file gives only the combined 32% for supermarkets; suppose, hypothetically, the store keeps 20% of the shelf price and the distributor keeps 15% of the price it sells to the store at.

1. The store buys at $3.49 \times (1 - 0.20) = 2.792$, keeping $0.698 a can.
2. The distributor pays Lantern $2.792 \times (1 - 0.15) = 2.3732$, keeping $0.4188 a can.
3. Combined, the trade keeps $1 - 0.80 \times 0.85 = 0.32$ of the shelf price, not $20\% + 15\% = 35\%$. Adding the margins would understate Lantern’s net price by about $0.10 a can.

Listing and slotting fees

Shelf space is scarce, and a retailer that gives a new product a slot takes the risk that it won’t sell. Retailers therefore charge suppliers for access. A slotting fee (or slotting allowance) is a payment a supplier makes to a retailer to have a new product placed on its shelves or in its warehouse. The US Federal Trade Commission, studying grocery retailers in 2003, described slotting allowances as one-time payments made as a condition of initial placement, and found that both how often they were paid and how much varied widely across product categories. Retailers also charge for continuing support such as displays and promotional space.

Lantern’s market file simplifies all of this into one yearly listing fee per SKU per retail channel, covering slotting, listing and merchandising. Because the fee is per SKU, every flavour pays it separately.

Cans to cover the fee = fee ÷ gross margin per can, rounded up. The direct channel has no listing fee but costs $6,000 a year to run, which takes 2,609 cans at $2.30. A three-flavour range also adds $12,000 a year of production cost.

Read the last column against the size of each channel. Supermarkets sell 2,160,000 cans of the category a year, so 5,511 cans is about 0.26% of the channel: a modest hurdle for one flavour. Three flavours raise it to 16,532 cans before the extra production cost, and those cans have to come from shoppers who would otherwise have bought Summit Brew, Daily Grind or Arcadia, which already have the shelf and far higher awareness.

Channel conflict and channel power

The members of a channel share an interest in selling the product but disagree about how the money is divided. Channel conflict is disagreement between channel members that gets in the way of the channel working. Vertical conflict is between levels: if Lantern’s online shop sold a 12-pack at a price that worked out at $2.99 a can, supermarkets charging $3.49 would see Lantern competing with its own retailers, and might give the can a worse slot or drop it. Horizontal conflict is between members at the same level: if one supermarket chain cut Lantern to $2.79 in a price promotion, a rival chain might demand the same support or refuse to promote the brand.

How conflicts end depends on channel power. A large retailer controls access to its shoppers, and its shelf is a scarce resource every brand wants; a strong brand has shoppers who will ask for it or switch stores to find it, so retailers need it as much as it needs them. Distributors have power from their relationships and trucks. The member that coordinates the channel, sets terms and resolves disputes is sometimes called the channel captain. A new brand with 12% awareness has almost no power: it accepts the retailer’s terms and earns influence by proving that its product sells. Producers reduce conflict with clear and consistent pricing across channels, by giving channels different jobs or products (singles in stores, multipacks and subscriptions online) and by treating retail partners’ margins as part of their own plan, not as a leak.

Logistics in proportion

Behind every channel is logistics: planning and controlling the flow of goods, from the co-packer to the shopper. Lantern’s cans are shelf-stable (a fact of this fictional case), so they don’t need refrigerated trucks or warehouses; convenience stores chill them for sale. Three logistics decisions matter at launch. Inventory: enough stock to avoid empty shelves without tying up cash in cans that sit for months. Demand is seasonal: the category sells about 1,500,000 cans in the third quarter and 1,020,000 in the first, so stock has to be built before summer. Storage: in the retail channels the distributor’s warehouse holds stock; for the online shop Lantern must hold it itself or pay a fulfilment firm. Transport: the distributor’s trucks deliver to stores along with other brands; online orders go by parcel, which is why each can sold direct costs $0.45 to fulfil. An empty shelf loses more than one sale: it tells the retailer the brand can’t be relied on.