Let's consider a few other solutions to the challenge of channel members with differing skill sets and function capabilities. Another common solution is a concept called partial vertical integration. Our book talks about the example of Guarantee Mutual, and how it used partial vertical integration to deal with problems of adequate communication, about the population to be insured, risk management and quote generation, and satisfaction of insured employees with claims services. It left the sales function with insurance brokers in the field because their standard compensation structure which was set at a percentage of the premiums paid, directly incentivize their sales efforts. So by doing this, the brokers who did not have to spend so much time servicing an account post-sale could focus their efforts more intensively on the channel function, the selling effort, at which they excel. Along with centralizing underwriting and service, guarantee mutual made significant investments and vertically integrated big data management systems that improve their speed and accuracy of their quotes, the enrollment of insured employees, and claims processing, while lowering the cost of managing these activities. In this case, vertical integration worked well because both improved performance of key channel functions, and it reduced channel execution costs at the same time. Another example of partial vertical integration is the transporter to melt processor facilities that we talked about in the second or third session of this course. This transporter vertically integrated storage by purchasing unused land near railroad tracks in developing specific handling processes in order to create heightened value for the manufacturing facilities that were their customers. It's important to remember that vertical integration or bringing a channel function or activity in-house and owning it is only done when you absolutely must have total control over it. In other words, it would be much more expensive or difficult to try and motivate a channel partner to do it. So if you have to have total control over how a salesperson should interact with the customer, if you have to make sure the logistics and transportation are handled in a very specific manner and with great care, or if the function is complex like customer acquisition and post-sale services then you should vertically integrate that process. Finally, a third example of improving the coordination between channel member and function asymmetries is to provide specific incentives that target the points that need better coordination. This is a form of a functional discount but because it is so pervasive, I want to bring it to your attention. In the sales world you're likely to hear the term SPIFFs, and this term stands for Sales Promotion in Field sales Forces. These are specific incentives or sales contests that encourage a specific activity. So if you've ever been asked at a checkout counter if you'd like to have Nordstrom or an REI credit card or whatever retailer you're in, that person is likely being offered a SPIFF, like a $50 cash bonus or something if you sign up. So this is a targeted action that often works best in circumstances in which the sales individual can be persuasive and where quality is uncertain or where a judgment call needs to be made as to whether the customer is open to the offer. You can also think of SPIFFs as the building blocks for sales contests. For those of you who have worked in sales, these contests are often used to get sales reps to emphasize certain products or target segments to add a short-term boost to the company's revenue targets. Now, there's a large literature of academic research that investigates what type of sales contests are most effective. There are several robust findings. Let's consider an example. If you had to offer a price to get your sales reps to strive to increase sales this month, would you offer them cash or non-cash prize? This is a question that many sales organizations face. What do you think? Well, the answer is definitely not cash. The best contests will give away prizes such as travel or electronics, furniture etc. Why? Well, there are silver reasons, but the chief reason is bragging appeal. The visibility of these prizes and the opportunity to brag to friends, family, and coworkers has tremendous value and motivates salespersons to spend the extra effort to achieve the target goal. Another reason is diminishing marginal returns. Most sales people already have strong financial incentives. Earning more money is less valuable once you've already earned a lot of it. In fact, research has shown that a firm would have to offer close to three times as much cash to achieve the equivalent effort as a non-cash award. In other words, the cost of three trips in cash would produce the same results as offering a single trip no cash. Now finally, for those of you who work in sales organizations a common question I'm asked is what the sales budget should be for contests and SPIFFs. Generally, and this is an average, the typical budget is one to three percent of sales or 10 percent of year over year sales. So let's summarize. In this lecture, we have asked the question, why is pricing through the channels so difficult? If you have not been part of an organization that has struggled with coordinating price across its channel members then you will at some point because this is such a pervasive problem. As a channel strategists, you solve these problems by recognizing that there are often three underlying conditions that are contributing to the problem and that need to be solved. These are the problems of ownership transfer, which implies that your firm no longer has control over pricing once products are sold to another channel member. The second problem is motivational. Channel members will always try to maximize their individual margins. They do not have a vision for system coordination that the channel captain has. Finally, the everyone is special problem. Channel members in their key capabilities are often so different that they cannot be treated or motivated equivalently. This is exactly why one policy does not fit all. The good news is that this isn't a new problem. So there are many solutions that have been developed to solve each of these challenges or to at least minimize their impact. It's important to note that some of these solutions may solve more than one problem. So for example, a multi-part tariff might also be able to solve function asymmetry problem at the same time. MAP policies clearly address both the ownership transfer problem and differences in channel member capabilities and asymmetries between them. So these solutions are not set in stone nor are they exhaustive for each of these problems. But I'm giving you this cheat sheet so that when you face these issues in your organization, you can begin to at least be thinking about a range of possible solutions. Of course, as with all business decisions, you choose what works best for your firm and industry given the market environment that you compete in. Finally, it is important to note that one solution that absolutely addresses all of these challenges simultaneously and completely is vertical integration. Now, this is a Nobel Prize winning insight and one that you should not miss. Vertical integration always resolves coordination issues that arise from information asymmetries in differences between organizations. There is no better solution because it allows the firm to see with full information and to resolve differences with full authority. In other words, no more moral hazard problem, and no solution can get any better than that. So vertical integration is always an option. Now, if it's such a great solution, then why don't more firms use it? You guessed it. It's incredibly expensive. So you need to have very deep pockets, but even more challenging is that it requires a firm to develop expertise in areas where it has none. This is why most M&As will fail or at least have a very rocky go of things. So for these reasons and more, many firms would prefer to stick to their knitting as they say, and instead use this range of solutions on an ad hoc or as-needed basis. With that, we wrap up our lecture on Channel Pricing.
