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vertical market system (VMS)

Definition

Formally or informally coordinated distribution channel where its independent members work together to

achieve greater efficiency and economies of scale , and to eliminate channel-conflict arising out of disparate

individual objectives . Three common types of VMS are: (1) Administered: coordination between production

and distribution firms is achieved by the size and influence of the dominant firm , without a formal agreement

or ownership . (2) Contractual : independent production and distribution firms formally agree to integrate their

resources . Franchising is an example of this type. (3) Corporate : production firm owns a retail chain (forward

integration ) or a retail chain owns a production firm ( backward integration ).

Channel Integration : Overview

Companies the world over produce millions of dollars worthof goods for consumers. These goods reach the end-consumer through a maze of distribution systems. Over the last fewdecades, companies have realized that effective distributionsystems can be a source of competitive advantage. Companiescan develop their own distribution channels or delegate thefunctions to different channel members through channel

integration. Channel integration involves streamlining thedifferent channel activities and information flow in a manner that leads to mutual benefits to all the partners concerned. Theadvantages of channel integration are manifold. It reducestransaction costs, improves inventory management, reduces

business opportunism, acts as a barrier to new entrants, bridges the time, space, and variety gaps between productionand consumption and reduces the business opportunities lostdue to stock-outs and delayed delivery.

To gain the advantages of integration, companies have

adopted vertical marketing systems. VMSs have emerged asthe dominant mode of distribution over the traditionalsystems.

In a VMS, one of the channel members may own the others, influence the others due to better bargaining power, or develop a contractual arrangement with the different channel members. Thethree types of VMS's are administered, contractual, and corporate. An administered VMS issimilar to a conventional distribution system except that there are greater inter-organizational

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relationships and sharing of an overall objective. Contractual VMS consists of independent firmsoperating at different channel levels and forming a system on a contractual basis. Contractsdirect the channel members to cooperate with each other for mutual benefits. Franchising is oneof the best known forms of this system. The other popular forms of contractual system are theretailer-sponsored cooperative organizations (RCOs) and the wholesaler sponsored voluntary

organization (WVOs). In a corporate VMS, one of the channel members exerts complete controlover the rest of the channel partners and everyone follows the objectives and procedures asdictated by this dominant channel member.

The benefits of VMSs include improved profitability, better control on the product quality,increased efficiency in inventory management, increased ability to respond to changing marketneeds, better economic control, improved marketing know-how, decrease in costs leading to

better competitive advantage, stability in operations, and reduction in risks arising fromcompetitor actions. Another principal benefit that prompts many companies to verticallyintegrate is differentiation.

A new concept that has emerged is value-added partnerships. In this form of integration, smallfirms come together and form a system. Here, each participating channel member performs asingle channel function at a particular channel level. A horizontal marketing system is another approach that has gained widespread support. It is an arrangement within a distribution channelin which two or more firms at the same channel level work towards a common goal. In thissystem, the participating organizations usually operate in different segments and are unrelated.The advantage of this type of arrangement is that the firms pool together resources and skills theothers do not have, with the objective of exploiting the available market opportunity. Mostcompanies operate through a strategic alliance or a joint venture.

Hybrid channel systems develop when organizations begin to use a number of channels to selltheir products. These channels include a direct sale force, direct mail, telemarketing, catalogselling, and retail selling. The advantages of using hybrid channels include better product

promotion, reduction in transaction costs, increase in market and customer coverage, and the benefit of developing a customized approach to selling and distribution of products. Designinghybrid systems involves identifying the tasks required to fulfill the desired objectives and thensegregating the selling tasks and assigning them to the respective channels. Designing hybridsystems involves determining the channel characteristics, identifying the channel mix propertiesand selecting the number of channels that will bring about the desired outcomes. To effectivelymanage the hybrid channel system, the manager must be able to identify the source of anyconflict, assess its magnitude, observe the reaction of customers and channel members, andanalyze the time needed to solve the conflict. Modern information systems have enabledorganizations to effectively manage the hybrid channels and avoid overlap of activities anddraining of resources