Distributing and Selling High-Tech Products The greatest technology is useless if it cannot be sold. Indeed a smart distribution strategy has been one of the key success fac - tors for many of the high-tech firms that managed to survive and even thrive during the recent economic downturn. In that matter the success of Dell [1], Logitech, eBay, and Cisco Sys - tems—among others—illustrates the fact that only when cus - tomers are purchasing a product does it ultimately succeed, indicating that the product meets those customers’ needs or wants. Decisions about marketing channels are among the most crucial decisions facing marketers [2]. The first decision is to choose how to balance push and pull marketing. A push strategy means that the different channels will promote and sell the product to the customers. A pull strategy relies on advertising and promotion directly to the customers motivating them to come and ask channels for the product. Usually, a push strategy makes sense when brand loyalty is low, when the choice of the product is made in the store. A pull strategy is best when customers choose the brand before going to the store, because of a strong brand loyalty or a high involvement for the product. The push/pull decisions have a significant impact on the other elements of the marketing mix, as well. The communica - tion strategy will be different if a company decides to go directly to the consumers, as opposed to going through various intermediaries. Similarly, the pricing strategy will be affected by the selection of distribution channel. One may estimate that the distribution channels account for 25% to 40% of the retail price of goods and services in high-technology businesses, while the sales channel represents between 15% to 35% of the final sales price for industrial products. Consequently, distribution channels managed efficiently can have a signifi - cant impact not only on sales but also on profit margins. 189 7 Contents 7.1 Selecting distribution channels for high-tech products 7.2 Managing distributors of high-tech products 7.3 Selling high-tech products 7.4 Summary CHAPTER Channels may also have an impact on product design, because some large distributors have enough power to impose their own requirements on their suppliers. Finally, a channel strategy requires a long-term commit - ment vis-à-vis other partners. Once a contract has been signed with a national or international distributor, for instance, a company cannot back off within 1 day and switch to another channel. Conversely, it takes a long time and experience to build an effective Internet channel or an efficient sales force. As we shall see in this chapter, if the essence of high technology is con - sidered in the process of creating a strong distribution strategy, its character - istics will impose certain priorities and choices in the selection of the various channels [3], as well as in the effective management of those different chan - nels [4]. In addition, we dedicate a specific section to the management of a proprietary sales force, which is a very common characteristic of B2B high- tech firms. 7.1 Selecting distribution channels for high-tech products Selling a good or a service requires the combination of three distinct chan- nels: a sales channel, a delivery channel, and a service channel. Those chan- nels can be joined together or can be discrete from one another. For instance, successful direct marketing firms employ the Internet, the phone, and mail as sales channels, express mail services as the delivery channel, and regional maintenance people as the service channel. Those firms inte- grate all the information about customers obtained through those different channels thanks to sophisticated customer relationship management soft - ware programs (previously introduced in Section 3.3), in order to develop a complete overview of customers’ needs, wants, and requests. For each of those three channels, the strategic decision always will be between using a direct (in-house) channel, belonging to the firm, or a third party indirect (outside) channel, or a hybrid solution combining the use of direct and indirect channels. This comes at a time when new channels like the Internet and on-line services continue to emerge [5], and new manage - ment tools, like data networks tracking in real time the inventories of all dis - tributors in a market, have combined to speed up the evolution of more traditional channels. As a matter of fact, the majority of the high-technology companies use their own sales forces to sell products directly to customers. However, the most successful organizations also count on other distribution channels in order to reach all the customers of a targeted market segment in the most efficient way [6]. Today, for instance, value-added resellers, system integrators, and distributors are becoming more prominent in the distribu - tion of electronic and telecommunication solutions. For instance, Cisco Sys - tems depends on its 35,000 partner channels for more than 90% of its revenues [7]. 190 Distributing and Selling High-Tech Products Selecting a distribution channel is very important because it can make or break a product, since distributors are part of the reinforcing loop leading to increasing returns, as seen in Chapter 2. Inasmuch as their revenues depend on the size of the market they can serve, marketers tend to concentrate on the solution that appears to produce the most potential buyers. For instance, in addition to the application developers, distributors have been a major force behind the success of Microsoft Windows and the decline of Apple Computer. Companies must continuously reevaluate their distribution choices to maintain the most efficient networks. Take the case of Logitech. Today retail outlets account for 85% of Logitech’s sales, while just 15% stem from Origi - nal Equipment Manufacturer (OEM) partnerships. However, until the late 1980s, it was the opposite: The OEM business outpaced retail and the com - pany believed that its retail business would soon die, because every PC would be sold with a mouse. In contrast, OEMs figured out that PC prices were key for consumers, thus they kept up distributing PCs with standard keyboards and mice. Consequently, Logitech stuck with its retail business providing them with products slightly ahead of those sold by its OEM part - ners, such as optical wireless keyboards and mice. Five selection criteria can assist a marketing manager in his or her channel-design decisions: the size of the market, the cost of the distribution network, the type of product to be marketed, the degree of control on the distribution channels, and the channel’s flexibility. 7.1.1 Channel-design decisions according to the size of the market The size of the market and the variety in customer profiles often justify the use of indirect distribution channels so as to eliminate gaps in market cover - age. This is even more important for high-tech products, especially when they are entering the growth phase at full speed, meaning that they try to reach the majority of mainstreams customers, which make up the bulk of the market. At that time, it is necessary to add channels and even sometimes to switch from one category to another [8]. The computer market, which unquestionably follows this pattern, has gone through four characteristic phases. During the first phase (the 1950s), the systems were sophisticated and potential customers were few; this cor - responded to direct sales through contact between sales engineers and cus - tomers. From the 1970s on, the arrival of minicomputers and the increased number of users led to the development of external distribution channels, usually in the form of OEM, which added specific applications to computers before the actual sale. The development of microcomputers during the 1980s led to a greater use of distributors, who became the key success factors for Apple and Com - paq. Similarly, the popularity of microcomputers brought about the devel - opment of direct marketing. Dell was the first company to sell its computers directly by mail order without any physical intermediary and has since been imitated by a score of other firms. 7.1 Selecting distribution channels for high-tech products 191 Since the onset of the 1990s, large computer firms that want to reach a greater variety of market segments have to manage different marketing structures. These companies sell some of their smaller products, such as serv - ers or PCs, through authorized dealers, establish marketing agreements with distribution chain, such as Comp USA, Computown, or U.K.-based Tiny Computers, and are in contact with dealers in the used computer market. For consumer goods such as MP3 players, digital cameras, or PDAs, vendors such as HP, Samsung, and Sony also use electronics retailers. Major electron - ics retailers in the United States are Best Buy (500 stores), Radio Shack (5,300 stores), Musicland (1,100 stores), Tweeter, and Ultimate Electronics. Sales can also be made directly from computer to computer using elec - tronic data interchange (EDI) or the Internet, which both are experiencing strong growth. Though worldwide market estimates vary significantly from one insti - tute to another as shown in Table 7.1, clearly on-line B2B is bigger than B2C. Today it can be estimated that e-commerce represents 12% of reve - nues for telecom and technology companies. For instance, the Cisco Sys - tems and the HP Internet sites allow prospective business customers to search for products and services, review the specifications of Cisco or HP machines, and contact sales representatives to place orders or even order directly through the Internet. Similarly, Oracle Corporation, the leading database software vendor, now distributes a new product over the Internet, as well as through physical channels. In the consumer business, Dell has implemented a direct order system through the Internet, a practice imitated by Apple Computer. The rise of e-marketplaces has spurred the growth of on-line B2B, because this is where buyers and sellers could meet to procure products through on-line catalogs, auctions, or direct exchanges. At the outset most of the e-marketplaces were public or driven by consortia, such as Covisint or Supply On in the automotive industry, Aeroxchange or Exostar in the avia - tion industry, or consortium-led E2open and Converge for the high-tech industry. However, e-marketplaces are now more frequently private, functioning by invitation only and focusing more on process than price. In fact, because partners on a private exchange already know each other they can share cru - cial aspects of their business more efficiently: information, production 192 Distributing and Selling High-Tech Products Table 7.1 Estimates about the Worldwide B2B E-Commerce Volume in 2003 (Millions of Dollars) B2B Dollars in Millions B2C Dollars in Millions e-marketer, February 2002 1,409 e-marketer, February 2002 250 Jupiter Research 2,940 Merrill Lynch 1,317 Computer economics, June 2002 1,853 Goldman Sachs 1,392 planning, inventory management, and other supply chain processes, as well as auctions. Firms like IBM or Sun Microsystems have bought a billion dol - lars of computer hardware components through private exchanges. More than 30% of Fortune 2,000 companies had set up their own private exchanges in 2003 and the trend is accelerating, according to AMR Research. In B2C, on-line markets provide better visibility of what consumers are buying, when they are buying it, and from whom they are buying it; best of all, they bring this information instantly to marketers. Some firms such as Nedstat, NetIQ, SteelTorch, and Red Sheriff are providing marketers with real-time information about what, when, and where customers are buying. In a way, those firms are the Nielsens of the Internet. On-line businesses also provide better margins since on-line commissions tend to range from 5% to 10% of sales according to the category of the goods [9]. On the other side, privacy concerns may impede this new customer visi - bility. In the United States, Microsoft was compelled to halt its automatic downloading of information about user system configurations as part of the process of registering from Microsoft Network. In France, getting electronic information on consumers or businesses is severely restricted by law: Anyone always has the right to see the content of the information stored and may refuse to have this information used for business purposes, such as being listed on a customer database. Figure 7.1 illustrates and summarizes this development of channel- design choices and its consequences in terms of the organization for a major computer vendor. The increase in channels parallel the computer technol- ogy life cycle as much as it is necessary to reach more mainstream customers in the early or late majority. The problem with running so many distribu- tion channels is that they overlap on customer reach and, as a consequence, risk conflicting with each other. The solution for avoiding such a difficulty is to differentiate products and tailor margins to distinct retail channels, like Packard Bell NEC has done. In 2003, Packard Bell NEC introduced a distri - bution plan, dubbed “NEC Now Program,” allowing more than 250 qualified resellers and Value Added Reseller (VARs) to deliver notebooks and other products directly through direct access to NEC’s build-to-order manufactur - ing plants. The different channels are not competing because customers pay the same price, whether they purchase direct or through resellers. 7.1.2 Channel-design decisions according to the cost of the distribution network Besides the size of the market and its related volume of sales, the second selection criterion is obviously cost. Not only should the absolute value cost be considered but also the cost per customer in order to evaluate the profit - ability of different choices. The estimated sales volume can indicate the most appropriate channel (see Figure 7.2). Actually, the use of indirect distribu - tion means lower fixed costs than the use of direct distribution such as a sales force or the Internet; however, variable costs will increase more 7.1 Selecting distribution channels for high-tech products 193 194 Distributing and Selling High-Tech Products O.E.M. Dealers Agents Brokers Computer superstores Direct marketing On-line services Hyper- markets Producer − 1950 1960 1970 1980 to present Sales force Sales volume Figure 7.1 Evolution of distribution channels for a major computer vendor. Distribution cost ($) Sales ($) Distributor Salesforce Figure 7.2 Selling or distributing: profitability analysis. quickly because a distributor’s payment represents a percentage of the total sales revenue. An instructive example is the evolution of Dell and Gateway distribution strategy, which successfully pioneered a direct “build to order” model when the traditional PC vendors such as IBM, Compaq, and HP were relying on an indirect “resellers” model. In 1990, Dell decided to add “resellers” to its direct-sales channel in order to boost growth. Dell PCs were distributed through retailers such as BestBuy, SoftWarehouse Superstores, Wal-Mart, and Staples. In 1994, the company decided to pull the plug from the indirect channel, after consider - ing its associated cost and the reduced gross margin. On the average, the annual selling, general and administrative (SG&A) expenses for running one retail store total about $2 million. Gateway made a different move. In 1996, it decided to create its own retail chain, Gateway Country Stores, with about 250 stores in addition to its direct channels. The rational was to make customers more comfortable with purchasing PCs while offering the best presales and postsales services. Very quickly, the cost of its strategy had a direct impact on the total SG&A expenses of Gateway, while the volume did not grow as fast as the direct channel. Both sales and profits suffered, especially compared with Dell, which was at the same level as Gateway in 1996 and had made a clear difference in 2001 as shown in Table 7.2. 7.1.3 Channel-design decisions according to the product characteristics High-technology products can be divided into two categories: nonstandard- ized products and standard products. Nonstandardized products require a direct sales force. Because these products are manufactured on request for a 7.1 Selecting distribution channels for high-tech products 195 Table 7.2 Evolution of Dell Versus Gateway Revenues and Operating Income 1994 1995 1996 1997 1998 1999 2000 2001 2002 Dell Net sales (dollars in millions) 2,873 3,475 5,296 7,759 12,327 18,243 25,265 31,900 31,200 SG&A (percentage of net sales) 14.7 12.2 11.3 10.6 9.8 9.8 9.4 9.8 9.6 Operating income (percentage of net sales) –1.3 7.1 7.1 9.3 10.7 11.2 9.1 8 7.2 Gateway Net sales (dollars in millions) 2,701 3,676 5,035 6,294 7,468 8,965 9,252 5,937 4,171 SG&A (percentage of net sales) 8 9.7 11.5 12.5 14.1 13.8 16.7 34.1 25.8 Operating income (percentage of net sales) 5.2 6.8 7.1 2.8 6.6 6.5 5.5 –19.9 –12.3 particular customer, personal contact with the users is necessary. The sales force has to be very knowledgeable about the product and its application, to help customers understand and employ the product. Standard products justify the use of external distributors. These products have well-defined characteristics; products such as a computer memory or a standard microprocessor are sold in large quantities and at unit costs much lower than those for nonstandardized products, justifying the use of distributors. For products that are neither entirely standard nor truly nonstandard - ized but rather in between these two categories, a marketing channel should be selected depending upon the technical complexity of the product and the need for customer service depending upon the distributor’s ability. On one side, if a company does not have enough resources to provide any customer service, it should depend upon its distributors. On the other side, if the distributor is not able to perform customer service, the product’s or the technology’s quality image can be seriously jeopardized, which in turn can challenge an entire marketing strategy. It is said that Michael Dell started Dell Computer to sell PCs directly by phone to consumers after he strove to buy PCs from dealers who knew less about computers than he did. A failure in the PC distribution channel gave birth to one of the most formi- dable new entrants in the PC industry. This is one of the reasons why Apple Computer changed its channel dis- tribution strategy in Europe at the end of 2002. Apple changed the margins that it was offering dealers. It reduced the basic margin of small, independ- ent dealers from seven to 1% or 2%; at the same time, it significantly raised the margins for large dealers providing customized solutions, demo facilities and after-sale support with a well trained staff and third-party products stocks. Apple’s goal was clearly to enhance “the development of the best possible experience for our customers” according to Mark Rogers, Apple U.K. director. 7.1.4 Channel-design decisions according to the degree of control over a distribution network Some channels decisions are dictated by the bargaining power of the com - pany. Actually some distributors are “open” and willingly share their cus - tomer and price lists as well as any other information about customer. But others are so independent that they are unmanageable. They are secretive about not sharing any information and carry out their sales policy as they think best. This has been the case recently in China on the PC market [10]. Many western PC makers have found that most of the local distributors were not able to provide technical support, customer service or mainte - nance services, contrary to what they claimed. The most capable distributors have quickly been taken over by leading Chinese PC manufacturers, such as Legend, which had cultural advantages. Furthermore, when a distributor is successful, it has a financial interest in being secretive and in handling its own marketing policy. 196 Distributing and Selling High-Tech Products However, it is potentially dangerous for a manufacturer to see a growing barrier between itself and its market because it would miss out on customer feedback. Furthermore, its technology can be copied by or through the dis - tributor, which the manufacturer could fail to realize until the distributor cancels an agreement. For instance, Legend, the leading PC maker in China, started in 1994 as a distributor of foreign PCs. Six years later, it moved to making and selling its own technology and quickly took control of the booming Chinese market. By 2003 Legend had more than 27% market share, $3 billion revenues, and more than 3,500 sales points. Ultimately a strong distributor may become a direct competitor. For this reason, in July 2002 HP and then Cisco in October 2002 ended their distri - bution agreement with Dell. Besides being a distributor for their digital pro - jectors and communication switches, Dell had developed its own line of low end products in the two previous years. Some of those products were com - peting head to head with high end (and profitable) HP or Cisco equipment, especially in the large business, corporate customers segment. 7.1.5 Channel-design decisions according to the flexibility of the distribution network A distribution contract is often specifically for a fairly long period of time. A consumer electronics manufacturer could not easily change from a special- ized sales force to direct sales through superstores. However, recruiting and training a network of distributors takes time and requires an investment since this network cannot be put into effect immediately. In the high-technology-product world, product ranges follow each other at a high rate and market segments are constantly changing, which makes establishing a distributor network even more difficult. In the telecom or the computer industry, distributors have replaced a traditional sales force but are now threatened by direct marketing chan - nels, such as phone or the Internet. However the most successful market - ing companies do not throw out the baby with the bath water. They know that it takes time and energy to set up, train, motivate and manage a channel. Consequently they try to extract the maximum value of their dif - ferent channels instead of turning one off, as soon as it is seems to be less effective. For instance, in 2002, Cisco initiated some major changes in its distribu - tion strategy in Europe, as well as in Middle East and Africa. Among its dis - tributors, Cisco differentiated two different categories and created 7 Cisco Distribution Partners (CDP) and 10 Cisco Authorized Distributors (CAD). In that two-tier scheme, CDPs only have a direct purchasing relationship with Cisco while CAPs procure Cisco products from a CDP and no longer directly from Cisco. Except for procurement, CDP and CAD have a direct relation - ship with Cisco for information, service and expertise. Such an organization actually means that CAD can focus more efficiently on the selling of services and Cisco solutions while relying on CDP for the logistic and supply side. It provide them with much more flexibility, faster 7.1 Selecting distribution channels for high-tech products 197 product lead time, no more inventory costs and risks, as well as freeing their working capital for use in developing their business. As for the CDPs, they get a better use and profitability from their fixed cost infrastructure through larger shipments. They also get the opportunity to generate new revenues on activities such as configurations, staging or pri - vate label; finally they increase their customer base to include CAD. By offering win-win solutions and maximizing the synergies between the dif - ferent categories of distributors this program has been extremely successful. It has allowed Cisco to increase its market share so far. 7.2 Managing distributors of high-tech products The decision to sell products through a distributor is only one step in the process. A distributor must be selected, directed, and evaluated. Again, the characteristics of high technology impose slightly different criteria compared to those of more traditional products. Every company that is looking for a distributor judges that distributor on its sales experience, financial situation, image toward customers of the tar- get markets, the number and quality of its sales people, and the quantity and brands of its current product portfolio. Moreover, since high- technology products have a high degree of innovation, a distributor must have unquestionable knowledge about a product to be able to respond to customer questions. Due to the frequent and rapid changes of high- technology products, a distributor must also be able to guarantee almost immediate availability in order to respond to demand at the right time. A distributor who sells technologically outdated products will see his custom- ers go to competitors translating into lost sales. Usually, lost sales are largely underestimated. One computer manufacturer approximated its lost sales at 5% to 10% of total sales, eventually to realize that they were actually between 15% and 20%, almost two or three times its original estimate. Furthermore, obsolescence is especially quick for some high-technology solutions with high variable costs, like computers or consumer electronics. Cellular phones or PDAs, for instance, may lose as much as 10% of their value each month; so after 7 months, their value is more than halved. Thus, today major cellular phones or PC distributors have negotiated the right to return unsold products to the vendor at no cost. Unquestionably, the best solution for restraining the impact of lost sales and obsolescence is to gauge them by running periodic customer and dis - tributor surveys. Consequently, inventory and order management for high-tech products is obviously more sophisticated than that for standard products and is fairly similar to the management of fashion stores. For example, one high-tech company received first-month orders for its latest products surpassing its manufacturing capacity by more than 25%. It decided to adapt by increasing both component stock and production. How - ever, 3 months later, orders plummeted, creating an enormous inventory. The product ended up being a flop. What happened was that tight initial 198 Distributing and Selling High-Tech Products [...]... consequence, selling high-tech products often demands a high level of competency and, as a result, a higher profile and education compared to other industries The company should take this into account when recruiting, managing, and evaluating its sales force More specifically, this means that the company must offer an attractive level of compensation to recruit 210 Distributing and Selling High-Tech Products. .. company and more a customer representative than a manufacturer’s “puppet.” An intermediary is interested Failure to repair at first try Extra training Slapdash diagnostic Time pressure Figure 7.3 A negative feedback loop in distributors’ training 200 Distributing and Selling High-Tech Products in selling products that customers will buy from it and, hence, in making it a profit For example, a high-technology... salespeople merely keep up with products that they already know well and that tend to sell, and propose only those products to their customers This behaviour impedes new products with which the sales force is less familiar and encourages a dangerous habit Consequently, the rate at which new products are announced and the high degree of innovation of many high-technology products require a hefty investment... communication, as well as for information processing and logistics Selling high-technology products often demands a high level of competency and as a result a higher profile and education compared to other industries The company should take this into account when recruiting, managing, and evaluating its sales force Finally, high-tech firms can earn more revenue and profit from aftersales activities since those... is expecting 208 Distributing and Selling High-Tech Products 7.3.3 Customer follow-up In order for the customer to enjoy the maximum benefits of a hightechnology product’s potential, he or she should have at his or her disposal training and technical assistance, followed by technical support for maintenance and repair If not, there is the chance that the product will lose its appeal and its manufacturer... factors for many high-tech firms, which have managed to survive and even thrive during the recent economic downturn Marketing channels decisions are very crucial decisions facing marketers [28] The first decision is to choose how to balance push and pull marketing, because this choice has a significant impact on the other elements of the marketing mix 214 Distributing and Selling High-Tech Products Selecting... customers and to compete more effectively, they have set up key account management structure and programs [14] Instead of assigning one sales representative a geographic 202 Distributing and Selling High-Tech Products Percentage of respondents grading the item as important or very important The distributor: 0 20 40 60 80 Number of responses Knows the market Has a good reputation Supplies maintenance and. .. R., A J Dubinsky, and R E Anderson, “Marketing Channel Management and the Sales Manager,” Industrial Marketing Management, Vol 31, No 5, 2002, pp 429–439 [13] Mehta, R., B Rosenbloom, and R Anderson, “Role of the Sales Manager in Channel Management: Impact of Organizational Variables,” Journal of Personal Selling and Sales Management, Vol 20, No 2, 2000, pp 81–89 [14] Abratt, R., and P M Kelly, “Customer-Supplier... their customer base, even though it could be rich in potential, and instead spend time on unsure prospects More than in any other industry, the sale of high-technology products requires a sales representative’s consistency and professionalism to break down the barriers of uncertainty and hesitation and to help customers faced with innovation and technology To establish a reputation as an advisor, a salesperson... potential customer organizations to visit the firm Transfers of technical information and perspectives on 7.3 Selling high-tech products 209 future developments often arise at these types of meetings and can contribute to building trust and a productive business relationship Finally, a customer can function as a referral source and convince potential customers of his or her satisfaction with a purchase Research . characteristics High-technology products can be divided into two categories: nonstandard- ized products and standard products. Nonstandardized products require. more 7.1 Selecting distribution channels for high-tech products 193 194 Distributing and Selling High-Tech Products O.E.M. Dealers Agents Brokers Computer