The project of turning raw materials into consumer goods and getting the resulting products into the marketplace where consumers can purchase them requires several steps. The raw materials are supplied to the manufacturer, who produces the goods and delivers them to the distributor or wholesaler, who in turn provides the goods to the retailer who then sells the products to the end user – the customers. Because the products must be marketed at each level, this supply chain develops into a marketing channel. Marketing channels are organized in two primary ways, known as conventional and vertical.
Conventional or horizontal marketing channels are the more familiar, longstanding marketing arrangement. A channel consists of manufacturer, distributor/wholesaler, and retailer. Each of these components is self-contained and operates independently of the others. The participants work under agreements for specific transactions, such as when the wholesaler delivers to the retailer an order of items that were previously purchased from the manufacturer. Outside of these case-by-case agreements or contracts, none of the members of the channel have control over any other member.
In vertical marketing channels, all levels of the channel are controlled by one entity. This happens when a corporation acquires or holds the key assets at all levels of the channel. It may also be done through contractual agreement or cooperative structure. In the ideal situation, the different companies that make up the channel cooperate and work together through planning for the good of the channel as a whole.
A conventional channel operates when a supermarket, for example, buys from different wholesalers, such as one for produce and a different one for dairy. The produce distributor, in turn, buys from one distributor for apples and another for lettuce, and each of these seeks out different growers to supply the apples and lettuce.
By contrast, vertical channels reach all the way down to the grower or materials supplier. Starbucks, in one of the best-known examples of vertical marketing, controls through ownership most of the coffee farms and all of the coffee roasters, distributors, warehouses and retail outlets that result in the final product – a cup of coffee – sold at its coffeehouses worldwide. Other companies moving into vertical marketing include Ferraro, the maker of Nutella, which has acquired one of the world’s major suppliers of hazelnuts, the key ingredient in Nutella. Delta Airlines is another example, having acquired ownership of a refinery that produces jet fuel.
One major advantage of conventional channels is that the members are not necessarily bound to remain in the channel. For example, if a channel has one large apple grower and several smaller ones, the large grower could set the price so low that the others can’t profitably compete. In this case, the smaller growers could leave the channel and look for other opportunities to market their apples. Alternatively, all of the growers in the channel could form a cooperative that establishes rules for participating in the channel, reducing conflicts while still allowing individual growers to renew or cancel their participation from year to year. Still, many observers agree that conventional marketing channels suffer from serious enough conflicts and inefficiencies that establishing a vertical channel becomes an attractive prospect.
The prevailing wisdom accords nearly all of the advantages to the vertical marketing channel, which is said to increase efficiency, reduce conflict and allow for unified planning so all members benefit. However, vertical channels have certain disadvantages. They are less flexible, require enormous investment costs to establish through acquisition, and can dilute the company’s brand identity. In addition, vertical acquisitions are watched carefully by antitrust regulators. Vertical channels are also subject to conflict within the channel. For example, a distributor may show preferential treatment to suppliers in one region over another, simply because transportation and access are easier in the more developed first region. These conflicts are more complex and difficult to address, because they affect different levels and often have a wider reach throughout the company.