A number of independent businesses are linked with each other to form a distribution channel. Previously, these links were loose and each intermediary focused primarily on its individual goals. In the past, general distribution channel members did not fully cooperate with one another, which resulted in overall poor performance.
One main reason for this poor performance was the lack of leadership in the whole channel, which created conflicts between members. Members of the conventional distribution channel attempted to seek personal profit even at the expense of the overall profit of the entire channel. Moreover, there was no proper system of roles and duties assigned to each member and no nominated body to resolve conflicts.
The above-mentioned conventional distribution channel led to the foundation of highly specialized distribution channel structures called Vertical Marketing Systems (VMS). A vertical marketing system is composed of manufacturers, wholesalers, and retailers who work as a unified system. Members of the system own the products of others and work for the fulfillment of the overall benefit of the channel.
Each member also has sufficient power to exert control over channel activities. The vertical marketing system is dominated by manufacturers, wholesalers, and retailers so that channel behavior and conflicts are handled effectively.
Different Types of Vertical Marketing System
The vertical marketing system is further divided into the following three types on the basis of different means of power and leadership in the channel:
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Corporate Vertical Marketing System
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Contractual Vertical Marketing System
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Administered Vertical Marketing System
Each one is discussed below.
Corporate Vertical Marketing System:
A type of VMS in which sequential stages of production and distribution are combined under single ownership is called a Corporate Vertical Marketing System. There are regular organizational channels through which coordination and conflicts between different structures are managed for the smooth working of the overall chain.
Contractual Vertical Marketing System:
In a Contractual VMS, different independently working firms of production and distribution are combined with each other through contracts so that larger economies of scale and increased sales can be achieved. These advantages cannot be obtained by working independently; therefore, firms make contracts to work together as a unified channel. Coordination and conflicts among members are managed through contractual agreements.
Contractual VMS is further divided into the following three types:
i) Wholesaler-Sponsored Voluntary Chains
ii) Retailer Cooperatives
iii) Franchise Organizations
Wholesaler-Sponsored Voluntary Chains:
In this type of Contractual VMS, voluntary chains of independent retailers are organized by wholesalers to help them compete with large chain companies. For this purpose, a program is initiated by the wholesaler in which independent retailers agree to purchase their goods from that wholesaler at discounted rates and standardize their selling practices so that the whole group can compete effectively with large chain companies.
Retailer Cooperatives:
A Retailer Cooperative is a type of Contractual VMS in which a new business is organized by retailers for wholesaling purposes and sometimes for production as well. All members of the contracting group purchase their goods through retailer cooperatives, and advertising is conducted jointly through a common plan. All profits are distributed back to retailers according to their proportion of purchases.
Franchise Organization:
In a franchise organization, stages of the production and distribution process are linked by a channel member called a franchiser.
Franchises are further divided into the following three forms:
a) Manufacturer-Sponsored Retailer Franchise System
b) Manufacturer-Sponsored Wholesaler Franchise System
c) Service Firm-Sponsored Retailer Franchise System
Manufacturer-Sponsored Retailer Franchise System:
The automobile industry is composed of this form of franchise system.
Manufacturer-Sponsored Wholesaler Franchise System:
The soft drink industry adopts this form of franchise system.
Service Firm-Sponsored Retailer Franchise System:
In this form of franchise, certain retailers are given licenses by the service firm to provide the firm’s services to consumers.
The most important fact in the success of Contractual VMS is that many customers cannot differentiate between contractual and corporate systems.
Administered Vertical Marketing System:
In an Administered Vertical Marketing System, sequential stages of production and distribution are coordinated not on the basis of ownership or contracts, but on the basis of the power and size of members in the channel. Leadership is exercised by one or a few dominant channel members. Resellers provide strong trade cooperation and support to the manufacturer of a leading brand.
