Gray Marketing and Diversion
Gray marketing and diversion are two very similar activities that essentially involve the unplanned and unauthorized distribution of goods through middlemen not approved by manufacturers. At the international level, it is called gray marketing; at the domestic level, it is called diversion.
Gray marketing and diversion have been on the increase in the US. Any distribution activity that falls outside of the authorization of the manufacturer fits into one of the two categories. The practice cited in Lecture #3 of OEMs selling off surplus component parts is an example of diversion, because the manufacturer did not intend for the OEM to become a distributor of parts.
So what's the problem? Gray marketers and diverters often sell at prices far below what the manufacturers would like their products to be sold for. This creates confusion among consumers, and conflict between channel members and the manufacturer.
Sometimes diverters and gray marketers pose as legitimate buyers and underhandedly procure large amounts of merchandise, which is then parceled out to retailers and sold at great discounts. In some cases the retailers are unwitting accomplices; in other cases, the retailers knowingly participate in the fraud (see HoTopic question for this week).
Gray marketing will occur if there is an established network for the product in a country, trade barriers are low, and there are significant price differentials between the various markets. In other words, there has to be a payoff from selling a product that is otherwise available at full retail, and the importation of these products can occur without raising any eyebrows or high incurring tariffs.
For example, it is possible to purchase a European car through gray marketers. The buyer can go to Europe on vacation, drive the car around Europe, and then have the gray marketer ship it back to the States, all for less than the price of the car in the US.
The globalization of product markets has opened the doors for gray marketing. With international availability and demand, it is often very easy to set up rogue importing operations, often with great profit potential.
Who is affected by gray marketing and diverting? Manufacturers are affected because their product is being sold through unauthorized distributors, which may lessen product image, and also cause problems if products need servicing. The manufacturer may want to disclaim responsibility for servicing any products sold through these dealers. Furthermore, the manufacturer may even try to disclaim any liability for product defects.
Authorized dealers are also hurt by these practices, because consumers are able to make purchases at lower prices elsewhere. The retailer loses the sale, as well as the profit. These retailers are likely to be mad at not only the gray marketer and diverter, but also the manufacturer for not taking more precautions in their dealings.
Finally, consumers may get stuck with products that the manufacturer no claims no responsibility for. If there is a recall, the gray market product may be missed or even excluded. Thus, the consumer buys these products with added risk, a trade-off for a lower price.
The prognosis for the future? Expect this practice to continue, especially with easing of trade barriers between countries. Goods can move very freely now across international borders, and enterprising businesspersons are easily tempted to become unauthorized distributors if the profit potential is great enough.
The New Product Problem
As was discussed in Lecture #2, new products can be problematic. With thousands upon thousands of "new" items being introduced each year, consumers and middlemen alike face an undaunting task trying to sort through the jungle of Marketing hype and hoopla.
The problem is especially difficult for middlemen like retailers. Paid professional buyers, whose jobs depend on their ability to increase sales for the store, must carefully analyze these new product offerings. To erroneously accept a new item that proves to be a dud can be very costly; similarly, to not accept a product that turns out to be a success can also be costly. The buyer is thus faced with a 2 X 2 grid of possible outcomes:
| Outcomes... | New Product Success | New Product Failure |
| Accepted Product | "Hit" | alpha error |
| Rejected Product | beta error | "Hit" |
Of the two type of errors, beta errors would likely prove to be the most costly. While both errors include some degree of opportunity cost, it is more difficult to recover from lost sales on something that proved to be a winner, than it is to recoup losses from carrying an item that did not sell well. At minimum, an alpha error product can be sold at cost or whatever it takes to move the product out, whereas not carrying the product allows no chance for recompense.
In Effect of New Product Type on Acceptance of New Grocery Products by Retail Buyers (Gerlich, 1990), 15 independent variables were studied to assess their impact on the buyer's decision. These 15 variables included things such as promotional activities (introductory allowances, samples, coupons), manufacturer reputation, credit, slotting fees, margin, profit potential, product category volume, and the number of competing stores carrying the product. The dependent variable was binary, indicating "accept" or "reject."
Results of the study showed only three variables to have a positive and significant effect on the outcome: manufacturer reputation, product category growth rate, and the number of competing stores. Surprisingly, none of the anticipated significant variables (e.g., slotting fees, planned advertising, margins, etc.) proved to be so.
The obvious questions arose: Why weren't slotting fees and other "obviously important" variables not significant? Furthermore, why were three variables that are totally beyond the control of the manufacturer able to exert such influence?
It is highly possible that the "obviously important" variables still are "obviously important," yet did not register as such in the statistical analysis. This could occur because of a threshold effect, meaning that the variables only become "important" if some certain base level is not met or exceeded. In other words, it may well be that the buyers expect a certain level of slotting fees, planned advertising, margins, etc., and if those expectations are met, then everything is OK. If not, then those variables become "important."
As for the three significant variables, they indicate that buyers are very concerned about the reputation of the manufacturer, both with the trade and with consumers. They are also concerned about the growth trend of that product category; if the category is growing, they are more likely to accept the product. Finally, if they see several of their competitors already carrying the product, then they are likely to imitate. This leads to an interesting implication: if a manufacturer can achieve 50-percent placement, the other 50-percent should easily follow suit.
The resulting model from the above variables predicted outcomes with a high degree of accuracy. Actual data were inputed to the model, and predictions were made and compared to the actual outcome. Overall, it was correct 88.1-percent of the time. The model had a 97.9-percent accuracy with rejections, and 72.8-percent accuracy with acceptances.
These findings notwithstanding, the problem of new product introductions for middlemen is still present, and is unlikely to go away. We may have a better understanding of how they make their decisions, but that does not reduce the enormity of their decisions, nor the pressure it puts on the decision makers.
Dual Distribution and Scrambled Merchandising
The 10 distribution "paths" illustrated above show the many ways that manufacturers can see their goods delivered to end customers. A modern practice is for manufacturers to employ two or more "paths" simultaneously, in an attempt to maximize distribution. This strategy is called dual distribution.
For example, a product that is planned for intensive distribution will be sold through supermarkets, convenience stores, discount stores, and perhaps even vending machines, each in itself a separate channel of distribution.
Another modern practice is for retailers to carry merchandise that falls outside of the "traditional" scope of their business. This practice is called scrambled merchandising, and is prevalent in virtually all retail formats.
Retailers practice scrambled merchandising because they see it as doing the following:
- making it more convenient for consumers, who can now combine shopping trips into one
- allows retailers to exploit new profit opportunities with products that often have high margins
But groceries are not the only ones practicing scrambled merchandising. Discount stores such as Wal-Mart and K-Mart started carrying limited amounts of foods in the 1980s, and eventually evolved into supercenters with complete grocery departments. Convenience stores, in addition to a limited supply of food, also carry automotive products, magazines, and even video rentals. Video rental stores sell candy and popcorn. And the list goes on...
Dual distribution (for manufacturers) and scrambled merchandising (for retailers) are two very compatible and potentially beneficial business patterns. Furthermore, consumers benefit by the added availability of goods.
But there is a possible downside as well. For example, retailers who "dabble" in goods not within their traditional domain take the risk of not being able to compete price-wise with other retailers who normally carry the product. Furthermore, if there are special handling needs for the product, the scrambled merchandiser may lack the skills necessary for stocking and selling some items.
Furthermore, if manufacturers do not treat the various channels equally, conflict may arise. It is possible for manufacturers to bypass the Robinson-Patman Act by offering different prices to different "classes" of retailers (e.g., mail-order vs. stores). Perhaps a manufacturer is trying to make inroads in convenience stores. The firm may make special offers to these stores, but would not make the same offer to grocery stores. The grocery stores may take umbrage with this, and threaten retaliatory actions.
Finally, manufacturers who seek to distribute through channels about which they know nothing, may be in for some surprises. For example, convenience stores usually purchase in much smaller quanitities than do supermarkets; thus, packaging would have to reflect the c-stores' needs for fewer items.
Still, both of these practices offer opportunities for astute marketers willing to capitalize on a way to increase distribution and profits. But great care must be taken to ensure that the strategies are done correctly.
The distribution function of Marketing is enormous in scope and complexity. It is often the "hidden" variable, because so many of the decisions made regarding distribution are seldom visible to the end consumer, or at most, not recognizable. Furthermore, a wide variety of issues and opportunities must be dealt with by Marketers as they go about distributing their goods and services to their customers.