Channel Conflict: Minimizing the Risks

The ever-increasing popularity of the Internet is causing every company—especially consumer goods manufacturers—to rethink many strategies and business processes. In particular, manufacturers must determine the value of offering products direct to consumers via the Internet. More important, they must decide whether bypassing retailers, wholesalers, and even their own sales force is worth the risk of channel conflict—and possible retaliation by trading partners.

Because each manufacturer faces different channel challenges, there is no single answer regarding direct online sales. Manufacturers must recognize the potential for channel conflict, determine their risk—and the possibility of retaliation—then create a customized Internet sales strategy that minimizes this risk.

Channel Conflict and Its Repercussions
The Power of the Brand
Determining Manufacturers' Vulnerability
The Ability to Retaliate
A New Model for a New Economy
Taking a Conservative Approach
Taking a More Moderate Stand
Pursuing an Aggressive Strategy
Finding the Right Strategy

Channel Conflict and Its Repercussions

Before consumer goods manufacturers decide to sell direct via the Internet, they must consider a number of factors, including:

	Potential revenue gains and losses
	Profit margins for online sales
	The opportunity for brand building
	Benefits of communicating with end users
	Product fit for remote sales
	Order fulfillment and consumer service requirements
	Infrastructure and programming investments
	Marketing and advertising support

Manufacturers that determine direct selling is a sound strategic move must consider the possibility of channel conflict. Such conflict is caused when the manufacturer tries to supplement its sales by bypassing a retailer, wholesaler, or its own sales force, or by adding a new sales channel—in this case, the Internet.

Although channel conflict is not a new concept—it has existed as long as there have been sales channels—it is gaining greater visibility because of the explosion of the Internet. At best, channel conflict can result in tension among trading partners. At worst, retailers, wholesalers, and even the internal sales force can retaliate, using such tactics as:

	Reducing the manufacturer's retail shelf space
	Decreasing marketing support for the manufacturer's products
	Providing additional shelf space or marketing support for a competing brand
	Promoting the retailer's or wholesaler's own private-label brand
	In extreme cases, dropping the manufacturer's product line

Some manufacturers have already experienced the repercussions of channel conflict. When Estée Lauder established Web sites to sell its Clinique and Bobbi Brown brands, retailer Dayton Hudson limited shelf space for all Estée Lauder products. JCPenney Company began promoting its own private-label apparel when Levi's established a Web site to sell products exclusively on the Internet.

In assessing their risk, manufacturers need to consider three factors: their brand's power in traditional channels, the impact of retaliation, and the ability of channel partners to retaliate.

The Power of the Brand

Is the manufacturer a major contributor to channel sales and profitability? What is the manufacturer's overall size? Are consumers looking for this brand? These questions are critical in determining a manufacturer's power in its traditional channels. The nature of the product—whether it is unique or a commodity—is another important consideration. Retailers and distributors have greater ability to sell other brands if the product is not differentiated in consumers' minds.

A manufacturer's market share in each channel is a general indicator of consumer preference for its brands. Obviously, higher sales—and profits—reduce a manufacturer's risk for channel conflict. But, while retailers and wholesalers cannot afford to drop a popular brand, there are many other steps they can take.

Determining Manufacturers' Vulnerability

Manufacturers must also factor in the impact of retaliation from traditional sales channels, including "big-box" and mass-merchant retailers, regional retailers, warehouse clubs, wholesalers, and sales representatives. By determining what percentage of the manufacturer's sales flows through each channel, manufacturers can begin to gauge their vulnerability to retaliation. But they should also consider profit margins for each channel and customer. If a manufacturer is earning low margins, risking channel conflict for higher margins online may be appropriate.

The Ability to Retaliate

Manufacturers also need to determine the ability of channel partners to retaliate. The overall number of retailers or other channel partners is an important consideration. Fragmentation of distribution leaves any single channel partner less powerful. However, consumer goods companies are increasingly selling to mass merchants, big-box retailers, national department stores, and so-called "category killers." These large retailers have significant clout because of their huge volumes and high consumer trust.

Retailers' and wholesalers' willingness to retaliate also depends on the percentage of their sales—and margins—generated by the manufacturer's products. Channel partners will not be inclined to retaliate against manufacturers of high-margin products. Retaliation is more likely if the manufacturer's products are a core part of the retailer's or wholesaler's sales strategy.

In addition, manufacturers must consider the strength of channel partners' private-label brands. These brands are a significant risk to manufacturers, because they can represent a powerful alternative to national brands, as consumers place increasing trust in retailers such as Wal-Mart, Kmart, and some supermarket chains.

The risk of retaliation is also affected by the number of manufacturers selling direct to consumers online. Retailers—no matter their size or stature—cannot significantly retaliate against a high percentage of their suppliers. As more manufacturers sell direct, other companies can take tentative steps toward developing an online presence.

A New Model for a New Economy

These three factors—brand power, vulnerability, and the ability of partners to retaliate—do not carry the same weight for every manufacturer. While it is not possible to determine the exact level of risk for a manufacturer, it is possible to estimate the relative risk. GMT has developed a model to help manufacturers assess their unique risk for channel conflict.

By factoring in the manufacturer's power in each channel, the impact of retaliation, and the ability of each partner to retaliate, this three-dimensional model illustrates a company's relative risk of channel conflict. A company with a low risk would appear in the bottom left-hand corner and near the back of the model. A high-risk company could be found in the upper right-hand corner, at the front of the model.

This figure represents a consumer goods manufacturer that GMT has helped in assessing its risk for channel conflict. GMT helped this client to determine that its brand power, its vulnerability, and the likelihood of retaliation are all above average.

Given this risk, this name-brand manufacturer—like all others—faces a number of strategic options, ranging from conservative to aggressive.

Manufacturers with a high level of risk will want to pursue a conservative strategy. Such an approach usually involves working with traditional channel partners to promote their retail stores or catalogs online.

Manufacturers facing high risks should be up-front with channel partners prior to an online launch, explaining how their strategies will benefit each partner and avoid direct competition. Retailers need to understand that a manufacturer's Web site will complement, not replace, brick-and-mortar stores.

While building their brands and distributing product data via their Web sites, manufacturers can also provide information—including maps, coupons, and store hours—for nearby retail locations. In addition, end-user insight gained online can be passed on to channel partners, while safeguarding consumer privacy.

Taking a More Moderate Stand

Manufacturers that are more willing to risk channel conflict—but are still wary of retaliation—may consider moderate online strategies. For example, manufacturers can reduce their risk by offering products online at prices higher than those of channel partners.

Another moderate approach involves selling only the least "threatening" products—such as parts, accessories, and exclusive products—over the Internet. Initially, products that could cause channel conflict are shown, but are unavailable for purchase; instead, consumers are directed to a partner's catalog, Web site, or brick-and-mortar store. When and if the time is right to sell these products, they can be enabled for Internet commerce with the click of a mouse. A number of GMT clients have successfully pursued this strategy.

Manufacturers can also give sales representatives and channel partners credit for online sales—even if they had little to do with the transaction. This approach can be quite effective for sales representatives and value-added resellers, which can be instrumental in installation and after-sale support.

Pursuing an Aggressive Strategy

Manufacturers at low risk for channel conflict, or those that believe they can survive retaliation, may opt for an aggressive consumer-direct strategy.

Manufacturers can segment their consumer base to determine what each market category needs and is willing to pay. While some consumers will pay more in a retail store because they can touch products, others will order online to realize cost savings. Still other consumers will seek premium-quality or specialized products offered only online, regardless of price. Manufacturers can address these different needs with their Internet offerings. To avoid the appearance of direct competition with retailers or distributors, manufacturers may sell products through an online mall or encourage "entrepreneurs" to create Web sites that sell their products. Such encouragement can mean financing, technology tools, distribution capabilities, and marketing assistance.

Consumers often look for complementary products when shopping—an opportunity that the Internet does not always provide. Manufacturers of complementary products can form a joint venture to create a Web site or online catalog, which distributes both risks and costs among partners.

Finally, manufacturers can throw caution to the wind and pursue the most aggressive strategy: sell all of their products online at competitive pricing and service levels.

There is no "cookie cutter" solution for managing channel conflict. However, GMT can work with manufacturers to determine their level of risk and potential benefits—then identify the right solution for the present and the future.

Finding the Right Strategy

Many factors—including distribution economics, product fit, and breadth of product offerings—should be considered in the decision to sell direct online. Often, these obstacles preclude consumer-direct sales efforts. But those manufacturers that decide selling online is strategically sound should view the Internet as just one part of their overall channel strategy—and consider the effects of channel conflict.

Channel conflict existed long before the Internet—and the friction caused by direct online sales will decline as manufacturers and their traditional channel partners sort out their appropriate roles. In the end, it is consumers who will choose a value proposition by voting with their money. Manufacturers, wholesalers, retailers, and the sales force must learn to coexist across a variety of sales channels—deriving profits based on the value each can add for end users.