Selective distribution is a system in which a supplier agrees to supply only to distributors fulfilling certain criteria and this so-called authorized distributor agrees to sell in return only to other authorized distributors and end-users. Selective distribution is only a method other than agency through which suppliers may control the channel of distribution all the way to end-users.
There are two main kinds of selective distribution systems: pure qualitative systems where the suppliers appoint such distributors that meet qualitative criteria primarily linked to the nature of the product, and systems with qualitative restrictions, where suppliers limit the number of resellers in certain markets territories. As will be seen below a qualitative distribution system is not normally a threat to competition, but rather beneficial.
A system with quantitative restriction on the other hand is considered harmful for competition. This kind of selective distribution has obvious similarities with exclusive distribution agreements in that they restrict a number of authorized distributors within an area and at the same time, they determine such conditions under which resale is to be made. The main difference between the models is that the selective distribution system restricts the selling on any sale to non-authorized distributors as well as restricting sales to other territories, while exclusive distribution only regulates the latter.
Hence a selective distribution system leaves only appointed dealers and final customers as potential buyers and thus thwarts potential free riders. A combination of selective and exclusive distribution is therefore considered hazardous for completion if it restricts the selected distributors’ right to actively sell to each other and end-users.
Advantages of selective distribution
The use of selective distributions can have both pro-competitive and anti-competitive effects. Historically, courts and competition authorities, especially in Europe, have been unwilling to make use of economics in their decision-making.
However, nowadays they increasingly use economic theories to determine whether a provision is to be considered anti-competitive. From an economic point of view, all agreements regarding vertical restraints are capable of being pro and anti-competitive, and the outcome depends on the circumstances.
Benefits of Selective Distribution
Generally, it can be said that there are two main reasons to choose or use selective distribution, mainly to maintain certain standards and qualities of branded products and to protect marketing and services investment by distributors.
As will be seen, there is much importance of selective distribution, such as prevention of free riding and manufacturer opportunism, which benefit consumers through making distributors want to invest in sales services. To impose vertical restraints such as a selective distribution system is costly for the suppliers why they would only do this where it provides benefits to upstream suppliers.
1.Protection of Brand Image
For many goods, especially in the luxury industry, the right brand image is vital for enhancing the demand for the product. To ensure that customers receive the right image, the supplier needs to require its retailer to invest in exclusive showrooms, sale assistance, and a comfortable shopping experience.
The retailer will not only have to able to provide the right information to the right customer, and they also have to make sure that advertisement and presentation should be such that it suits the brand image. So to protect brand image it is imperative for manufacturers and suppliers to be able to choose to sell the good only to the distributor with the right qualities.
The supplier imposes restrictions on distribution with the aim of promoting the provision of services that are appreciated by customers, thereby increasing their demand, which, when used in the right way under the right circumstances, benefits the suppliers themselves and as well as customers and distributors.
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By allowing the manufacturer to protect the image of their branded product also means allowing consumers who appreciate the value of such goods to enjoy them. If there would not be a possibility to protect the image of its branded products, such goods might disappear from the market and leave the consumer with less to choose from.
2.Protection from free-riding opportunism
Freeriding occurs when one market actor takes advantage of the investment and inputs from another market actor. This issue can arise both on an inter-brand level and intra brand level. Freeriding on an inter-brand level arises when an upstream firm invests in improving the quality of retail facilities, which benefits not only own brands but also the brands of rivals when they are sold in the same facilities. Issues with Intra brand free-riding arise on the distributors’ level.
A distributor or retailer is often required to invest in enhancing the demand for a manufacturer’s product, not only through such investments regarding the brand image as mentioned above but also through advertising, promotion, and before and after-sale services for the products in question.
For a distributor to make such investments it must know that it will regain the expenses, why it has to be protected from other distributors free-riding on its investments. If another retailer may sell the product without having to market the product itself, it can compete with lower prices, thereby thwarting the first retailer from making a profit, leading to an unwillingness to make future investments.
The free-riding problem is one of the main defenses for the use of selective distribution systems. Without protection from free-riding, it will be hard to find the right balance between prices and services to maximize consumer welfare. The problem can be solved either through price or nonprice vertical restraints. A selective distribution system solves the free-riding problem by making it if not impossible, so at least very difficult for unauthorized distributors to purchase and resell the product in question.
As long as the qualifications requirements for entering the selective distribution system are applied in a nondiscriminatory manner, all distributors will make necessary efforts to sell the products and thereby prevent others from free riding.
3. Protection from manufacturer opportunism
Manufacturer opportunism arises when the manufacturer wants the distributor to make investments ex-ante in order for him to provide better service to consumers. These investments can consist of for example human capital or special facilities.
The distributor will not make such investments as long as it cannot be assured that its investments are fully protected, why it will not accept such demands from a manufacturer which has several unauthorized dealers marketing its products on the same market. It is both common and understandable that a distributor demands exclusivity to make this kind of investment and it is normally not considered harmful for competition. The problem is usually solved through exclusive or selective distribution.
Differences between selective, exclusive, and intensive distribution
|Base||Selective distribution||Exclusive distribution||Intensive distribution|
|Outlets||Selected outlets in specific locations.||One or very few outlets||As many as possible|
|Purpose||To appeal to the different target market||to create a sense of quality based on scarcity||convenience offerings|
|Example||Selling different models with different features and price points at different outlets||Designer Michael Graves has a line of products sold exclusively at Target||soft drinks, newspaper|
Disadvantages of Selective Distribution
Selective distribution can be a threat to efficient intra- brand competition as well as leading to foreclosure on the distribution market.There is a risk that such systems lead to the competition being softened and collusion between suppliers being facilitated, especially where there is a cumulative effect of several selective distribution systems. Reduced intra-brand competition is harmful only where there is limited inter-brand competition. If a big part of the suppliers of a certain product uses selective distribution for the selling of their products, competition may be softened at both suppliers’ and distributors ‟s levels. Hence, it would also affect inter-brand competition which in turn would increase the effects of the reduced intra-brand competition.
1. Foreclosure of the market
By establishing a big selective retail network that involves most retailers, a manufacturer can prevent its competitors from accessing the market. If all the major retailers are tied to a selective network, the manufacturer‟s competitors must pay high prices for entering the market. If they choose to distribute their products through new retailers, those retailers must be built up and marketed before the products will reach a broad consumer base.
If they instead choose to distribute the products themselves, they might have to build up a complete retail business from the start, which is not only risky and pricy but also takes time in which the market for a certain product may already be subdued. Since a well-working selective distribution system makes it impossible for non-authorized dealers to obtain supplies, the method is an efficient way of avoiding pressure by price discounters on the margins of the manufacturer, as well as of the authorized distributors. The result of such foreclosure is reduced possibilities for consumers to enjoy the benefits that can be brought by selective distribution systems, such as lower prices and access to a wider range of products
2. The motivates affect the effects on competition
It has been shown that the effects of vertical restraints depend on how and why the restraints have been imposed. Empirical studies have shown that privately imposed vertical restraints are very likely to benefit consumers and only harm them in a few cases. On the other hand, restraints that are mandated by the government do not seem to improve consumer welfare, in fact, they are actually likely to reduce it, even when initiated by the consumers themselves.
It is a clear tendency for consumer well-being to be congruent with manufacturer profits, at least with respect to the voluntary adoption of vertical restraints. This also convergences with the above-mentioned fact that privately imposed restraints often gain consumers. If they would not have been beneficial for the manufacturer, they would not have existed in the first place. This also constitutes a sign that the market has a system of regulating itself in a way that increases competition.
When to use selective distribution
Selling products in selected outlets in a specific location is selective distribution. It is used when the firm is selling different products with different features and price points so that it can appeal to the different target markets.
What companies use selective distribution
Examples are many but a few of them are Whirlpool, General electric, and sony who sell their major appliances through dealer networks and selected large retailers.
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