Question

Topic: Student Questions

Vertical Integration And Outsourcing Question

Posted by Anonymous on 9/19/2008 at 8:48 PM ET 50 Points
Hi, I am writing up a report on the following question, and I am not entirely sure how to answer it.

" According to Louis Bucklin, the issue of channel performance focuses on the conflict between two dimensions of channel performance. On the one hand, consumers and users are concerned primarily with lowering the costs of the goods and services sold and, therefore, with reducing the costs of distribution. On the other hand, buyers want to benefit from and receive some marketing services in conjunction with the good or service they purchase. However, provision of these services increases the cost of distribution.
1. Compare and contrast vertical integration and outsourcing relative to the performance dimensions mentioned by Bucklin.
2. Which would tend to be superior overall?"

I was thinking of answering the first question in this way:
* Discuss how vertical integration often leads to higher costs of distribution, which translates to higher retail prices, and how outsourcing generates significant cost savings in distribution, which can lead to lower retail prices for customers. And
* Discuss how vertical integration often results in higher service quality because it offers the integrator greater control over channel performance (e.g. a manufacturer integrating upstream has greater control over how retailers are run and greater influence over sales staff)

And for the second question, I was thinking of saying outsourcing is superior because markets for distribution services are efficient, and also outsourcing is often less costly.

Am I on the right track? How should I go about answering it? Your help is very much appreciated.
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  • Posted by wnelson on 9/19/2008 at 10:49 PM Member
    Eva,

    (I assume that this is what you want to be called since calling you Vitamin would be...strange).

    First, I want to applaud you for presenting the question completely and more importantly, presenting your thoughts first! Many students who ask questions on here present their questions without their own thoughts. This severely limits the help you can receive.

    In his analysis, Bucklin is looking at "distribution" as an entity independent of the producer and the consumer, and everything that happens between the producer and consumer. You and I know this is never the case, since a channel is never pure, like this. Channels include company sales people for large customers, sales people who handle independent distributors, independent distributors, retailers, online sales, etc. However! And I stress this break. If you want to understand channel strategy, breaking it down purely is the only way to do this. If you can't understand the "independent" factors in the channel, you won't be able to understand all the interactions that blur the process.

    Now, given purist view, the channel is pulled in two directions. The consumer wants the cheapest product available and so low cost is key. The consumer is looking to off-load all selling activities and want the distributors to pick this up. This increases the cost for the distributor and the distributor would like to pass this on to the distributor. See the battle that pulls the distributor apart? Minimize costs on one hand, take on all costs on the other hand. And the producer is ultimately measuring the distributor on sales volume - which is inversely proportional to the product and channel cost.

    So, the two options for the producer are 1) Direct sales - take on all selling activities as part of the company, versus 2) Outsource all selling activities. (Again, look at this as the two extremes versus the practical "blended" approach that happens in the real world.

    In general, the direct approach yields "focus" in the sales team - they only sale your product versus most independent distributors sell a bunch of company product lines. This is in comparison to the importance that a distributor can foster at the customer by selling a significant percentage of the total "spend." If you control a significant percentage of the "spend," you have negotiation leverage with the customer and therefore power.

    This is the first question - analyzing both sides of this question. The second question involves which you think might be superior. Well, ultimately, we know the answer from observation - the answer is a "hybrid" approach with multiple paths in the channel - part owned by the company and part owned by the distributors. So your task is to define what factors would cause a company to "lean" one way versus the other. Some of the areas would involve product/service characteristics, maturity of the product/service, market maturity, and competitive landscape. For example, the superior channel design would be different for the LG Decoy - a brand new (albeit "me-too" product) in a maturing market versus an ASP software solution for website SEO would be a brand new product for an immature market.

    Think through the answer to these question from the extremes and then discuss the different factors that change the channel design.

    I hope this helps.

    Wayde
  • Posted by wnelson on 9/20/2008 at 9:47 PM Accepted
    Eva,

    That's just it! Sometimes, vertical integration can cost the consumer money when the producer passes it along and sometimes it doesn't. The differentiator between these two cases depends whether the competitive landscape is wide or narrow and whether the market landscape is wide or narrow. If the competitive landscape involves very few competitors - thus the producer has the power, then when a producer vertically integrates the channel, the consumer pays for it. If market is less diverse, then the consumer has little power, but vertical integration is very efficient at reaching the consumer so it save the consumer money.

    These are the two extremes. In between these two extremes is somewhere in between. Does that help?

    Wayde
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