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Lesson 4 Historical market flow: The distribution channel
Objective Understand where e-Business begins to deviate from business as usual.

Historical Market Flow

Historically, producers interacted with distributors and generic information about the product was a core component of the relationship.

Producer generates a physical product which is sent to a Distributor

There are six key items that move within the historic distribution channel:
  1. Physical product
  2. Product information
  3. Generic information
  4. Transaction information (order, information about the order, payment process, and all the information around the transaction)
  5. Needs information (information on consumer demand)
  6. Location information
In the historical market flow, everything about the distribution channel was optimized for the distribution of physical goods.

Distribution Channels

To anticipate the quantity of product to produce, a manufacturer must compile demand forecasts from downstream supply chain members. Forecasting accuracy is paramount because it is the basis for effective and efficient management of supply chains. The root challenge of SCM is to minimize costs and maintain flexibility in the face of uncertain demand. This is accomplished through capacity and inventory management. Similarly, marketers attempt to maximize revenues through demand management practices of pricing and promotion. Therefore, it is vital that
  1. marketing and
  2. operations
departments collaborate on forecasts and share harmonious incentive structures. The degree of coordination among order acquisition, supply acquisition, and production process directly affects how smoothly a firm operates. Likewise, the coordination level of buyers, suppliers, and producers directly affects how smoothly the supply chain operates. More specifically, accurate information flows between channel members are essential to SCM[1].

What makes up a Distribution Channel ?

A distribution channel is typically composed of a
  1. manufacturer,
  2. a wholesaler,
  3. a distributor, and
  4. a retailer.
The bull-whip effect[2], is a classic illustration of dysfunction in a distribution channel due to the lack of information sharing. This effect is characterized by increasing variability in orders as the orders are transferred from the retailer upstream to the distributor, then to the wholesaler, and finally to the manufacturer. Distorted demand information induces amplifications in variance as orders flow upstream. Therefore, the manufacturer bears the greatest degree of order variability. It is for this reason that manufacturers often initiate collaborative efforts with downstream channel members. Four sources of the bull-whip effect that correspond to respective channel practices or market conditions have been analyzed. The first two causes are a direct consequence of channel practices, whereas the latter two causes are market-driven. The first source, demand signal processing, is largely due to the use of past demand information to modify demand forecasts. Each channel member modifies her or his forecasts and resulting orders in isolation. These multiple forecasts blur end demand. This problem is exacerbated as lead time lengthens. Current practices employed to remedy this source of information distortion include contractual agreements to provide point of sale data from retailers to manufacturers, vendor managed inventory to centralize ordering decisions, and quick response manufacturing to decrease lead times for order fulfillment.

Information Distortion

The second source of information distortion, order batching, arises mainly from periodic review ordering practices and processing costs of placing orders. Without specified ordering times, the timing of order placement for several vendors may coincide as a result of fiscal period delineations. Additionally, a buyer may accumulate orders to minimize high costs of ordering and shipping. Measures that can alleviate these causes are automated and fixed-time ordering, electronic data interchange (EDI), and the use of third-party logistics providers to offset less than truckload diseconomies. These first two causes of information distortion generally result from each channel member individually optimizing inventory decisions.

Price fluctuations

The third cause of the bullwhip effect are price fluctuations, which result from marketing efforts such as trade promotions to generate increases in sales volumes. Wholesale price discounts result in forward buying by retailers. The lower price motivates retailers to stock up on the product for current and future periods. This strategy results in uneven production schedules for manufacturers and excess inventory carrying costs for retailers. The push for everyday low prices is an effort to do away with trade-promotion-induced order[3] variability. The final cause of the bullwhip effect occurs when there exists a perceived shortage of product supply. If the supplier adopts a rationing scheme that is proportional to the quantity ordered, buyers will simply inflate their orders to ensure receipt of their true requirements. This type of gaming can be avoided by rationing based on historical market share of buyers and information sharing between buyers and suppliers to prevent supply shortages.

A recent report by DistributedNetworks titled "Seeking customer loyalty using ecommerce business models", looked at how consumer and retail businesses are transforming to adapt to the shift from traditional shop-centric business models to a new world where the customer is increasingly at the center of a perpetual shopping experience. In this "customer-centric" online experience, retailers need to be exceptionally sensitive and responsive to when and where their potential customers are making purchase decisions (both consciously and subconsciously) throughout their online experience at ebay or Amazon.

Determining what the Consumer is Thinking

The burning question is, how can consumer and retail companies achieve this nirvana of consumer mindreading? How can they identify and keep pace with the behaviors and preferences of customers today and tomorrow? How can they ensure their online strategy is acutely tailored to attract and win the diverse and dynamic customer segments they serve?
As you will learn in the next lessons, this flow changed with the advent of the internet and ecommerce.

[1] Supply chain management: Supply chain management is the management of the flow of goods and services and includes all processes that transform raw materials into final products.
[2] bullwhip effect: The bullwhip effect is a supply chain phenomenon in which there are inefficiencies in forecast and supply chain. The bullwhip effect refers to the fluctuating swings in response to the demands of the customer, which has a cascading impact on the supply chain.
[3] trade-promotion-induced order:A trade promotion which is caused by fluctuations in the order process.