Nirmalya Kumar Executive Summary
Manufacturers and retailers traditionally have seen each other as adversaries, but the benefits g enerated by trusting relationships between such old foes as Procter & Gamble Company and W al-Mart Stores show that fear and intimidation may not be the most effective way for manufacturers and retailers to deal with each other after all. Studies of manufacturer-retailer relationships in a variety of industries reveal that exploiting power has three major drawbacks: it can come back to haunt a company if the balance of power chang es; victims will ultimately seek ways to resist such exploitation; and working as partners allows retailers and manufacturers to provide customers with g reater value than they can when they try to exploit each other.
To build a trusting relationship with their weaker partners, powerful companies can build systems that strive both to compensate their partners fairly for their
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contributions and to resolve differences in a manner that their partners perceive as fair. These systems ensure that there is two-way communication, that all channel partners are dealt with equitably, and that partners can appeal channel policies and decisions. In addition, they provide partners with a coherent rationale for policies and ensure that partners are treated with respect.
Moving a relationship from the power g ame to the trust g ame is difficult, requiring a chang e in culture, manag ement systems, and attitudes. But the success of org anizations such as Marks & Spencer, Kraft, and E.J. Ekornes all testify to the benefits of making the effort. In rapidly chang ing environments, success will g o to those who learn to make the leap of faith.
In industries as diverse as pharmaceuticals, consumer packaged goods, hardware, apparel, and furniture, the balance of power between manufacturers and retailers is shifting. Thanks to the rise of specialty superstores, the formation of buying alliances, and a consolidating wave of mergers and acquisitions, a relative handful of retailers often now control access to enormous numbers of
consumers. Manufacturers that had dominated their retailers are now finding that megaretailers hold the upper hand. In Europe, for example, the sales of each of the top six food retailers exceed the individual sales of all food manufacturers, with the exception of Nestlé and Unilever. And in the United States, Wal-Mart Stores' revenues are three times those of Procter & Gamble Company. (See the table ''Three Forces Fuel Rising Retailer Power.")
This shift raises some important questions. Although powerful companies can, and often do, use their strength
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to wring concessions from their vulnerable counterparts, is the use of fear or intimidation the most effective way to manage such relationships? Or does trust produce greater benefits? And if trust is more beneficial to both sides, what policies and procedures help breed it?
With the help of colleagues at U.S. and European universities, I have been developing a research database since 1988 to answer those questions. Almost 3,000 U.S.
Three Forces Fuel Rising Retailer Power
Emergence of Megaformats Mergers and Acquisitions Hor izontal A llianc es Meg aretailing formats
include:
Previously independent department-store chains now belong to retailing
cong lomerates.
Some European retailers have org anized themselves into cross-border buying alliances to barg ain more effectively with manufacturers.
Category killers Federated
Border Book Shops, Department Stores European Retail
Circuit City Stores, Home Macy's, Blooming dale's, A llia nc e
Depot, Office Depot, Stern's, Rich's, Goldsmith's, Royal Ahold
Staples, Toys "R" Us Lazarus, Burdines, the (Netherlands)
Bon Marché Arg yll Group
Warehouse clubs (United King dom)
Price Club, Costco Casino-Guichard
W holesale Club, Sam's May Department Stores Company Perrachon & CIE (France)
W holesale Club Lord & Taylor, Foley's,
Robinsons-May, Hecht's, Discount supercenters Kaufmann's, Filene's,
Super Kmart Centers, Famous Barr, Meier & Frank Eurogroup
W al-Mart Supercenters BML (Austria)
Similar cong lomerates Coop Switzerland
have also emerg ed outside Rewe-Handelsg ruppe
the United States: (Germany)
Coles Meyer (Australia) Vendex International
Metro (Germany) (Netherlands)
Royal Ahold (Netherlands) Ito-Yokado Company (Japan)
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and European executives have responded to our surveys and reported on more than 1,500
manufacturer-retailer relationships. In addition, I have consulted and conducted interviews with several major retailers and manufacturers in the United States, Latin America, Asia, and Europe. Through our efforts, my colleagues and I have collected information on manufacturer-retailer relationships in such industries as automobiles, computers, consumer packaged goods, earthmoving equipment,
replacement tires, semiconductors, telecommunications, and vehicle leasing.
Exploiting power may work in the short run, but it is self-defeating in the long run.
We found that although exploiting power may be advantageous in the short run, it tends to be self- defeating in the long run for three main reasons:
Exploiting power to extract unfair concessions can come back to haunt a company if its position of power changes. When they had the upper hand, consumer packaged-goods
manufacturers such as Procter & Gamble used to limit the quantities of high-demand products they would deliver to a given supermarket chain, insist that the supermarket carry all sizes of a certain product, and demand that the supermarket participate in promotional programs. Now it's payback time. In the past ten years, supermarket chains have become enormous and manufacturers' battles for shelf space have intensified. As a result, the chains have been able to demand that manufacturers pay them for carrying new products and to force them to participate in the chains' promotional programs.
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When companies systematically exploit their advantage, their victims ultimately seek ways to resist. Retailers may form associations or buying groups, develop private labels, or pursue vertical integration or mergers to counteract the power of manufacturers. European retailers such as Carrefour, Casino, J. Sainsbury, and Migros have developed quality private-label brands to compete with
internationally renowned manufacturer brands. And one major reason for the recent merger and acquisition activity in the U.S. drugstore industry is the desire of drugstore chains to increase their purchasing clout with pharmaceutical companies.
For their part, many manufacturers are reacting to the pressure tactics of traditional retailers by seeking direct links to end users through the Internet and mail-order operations and by creating their own stores. Apparel and accessory designers such as Donna Karan, Giorgio Armani, and Liz Claiborne have been opening factory outlets and their own downtown stores, and Nike and Sony Corporation have established megastores in cities such as Chicago, London, and Tokyo. Airlines are beginning to let consumers book reservations over the Internet, bypassing travel agents. And many consumer- products manufacturers have created sites on the World Wide Web, hoping this link to consumers will ultimately permit them to reduce or eliminate their dependence on retailers and dealers.
In service industries such as entertainment, one can see a similar "manufacturer" backlash. Such major producers of television programs as Warner Brothers and Paramount Pictures Corporation are spending huge sums on their new TV networks to compete with ABC,
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NBC, CBS, and Fox. The traditional networks brought this development on themselves by using their monopolistic power coercively in the past.
By working together as partners, retailers and manufacturers can provide the greatest value to customers at the lowest possible cost. Take the supermarket industry, in which adversarial relationships still prevail. Industry experts believe that seamless partnerships between manufacturers and supermarkets would accelerate the deployment of sophisticated systems such as just-in-time delivery, electronic data interchange, and so-called efficient-consumer-response systems that permit manufacturers to monitor sales in stores and to produce and ship their goods in response to actual consumer demand. Such cooperative systems could squeeze $30 billion in excess costs out of the industry by eliminating superfluous inventory, duplicate functions, and various middlemen. Moreover, the results witnessed when manufacturers and supermarket chains do cooperate suggest that both sides could increase sales volume by working together to customize offerings at different stores and for different end users. Cooperation between Kraft Foods and supermarket chains such as Publix Super Markets in Florida and Wegmans Food Markets in upstate New York has generated significant returns for both sides.
The Nature of Trust
Initially in my research, I was surprised by how often manufacturers and retailers mentioned trust when discussing their relationships. What did they mean when they said they trusted someone?
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The immediate response of most managers was that trust involved dependability—that they believed that their partners were reliable and would honor their word. The marketing director of a multinational manufacturer of consumer packaged goods observed that the retailers that his company tended to trust fulfilled agreements without always coming back to demand additional concessions or to request greater support. And if the retailers requested promotional funds in exchange for preferred shelf positions, then the manufacturer would find its products in those positions on subsequent visits to the retailers' stores.
Of course, honesty and dependability do not always promote trust. A partner that frequently promises to punish you and always follows through is honest and dependable but is not a company in which you place your trust. What really distinguishes trusting from distrusting relationships is the ability of the parties to make a leap of faith: they believe that each is interested in the other's welfare and that neither will act without first considering the action's impact on the other.
Because of shifts in competitive dynamics in recent years, many companies are growing increasingly concerned about the level of faith that their distribution channel partners have in them. One study that I conducted with Lisa Scheer of the University of Missouri at Columbia and Jan-Benedict Steenkamp of the Catholic University of Leuven in Belgium measured the extent to which automobile retailers in the United States believed that the manufacturer whose product line they carried would honor its
commitments (dependability) and consider the best interests of the retailer (faith). The manufacturers included U.S., European, and Japanese companies. The results demonstrated that Ford Motor
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Company generated greater trust among its dealers than General Motors Corporation or Chrysler Corporation did. However, the Japanese manufacturers earned a higher level of trust than any of the U.S. or European companies. The executives of the U.S. automobile manufacturer that commissioned the study were concerned about the lack of faith that their dealers had in them because they believed that the support and service that dealers provided to end users would become increasingly important in attracting and retaining customers.
During my field research, I observed that manufacturers and retailers tend to believe that the partners they trust also trust them. However, an analysis of the database demonstrated that such an assumption is not always warranted. In a study I conducted with Jonathan Hibbard of Boston University and Louis Stern of Northwestern University, we examined the relationships between a major manufacturer of replacement automobile parts and 429 of its retailers. It turned out that the manufacturer had a high level of trust (an average of 5.8 on a 7-point scale) in 218 of the retailers that distrusted the
manufacturer (an average of 2.6 on the same 7-point scale). 1 A further investigation revealed the pitfall of this blind trust: Many of those 218 retailers were actively seeking and developing alternative sources of supply, whereas the manufacturer, which assumed that its trust in the retailers was mutual, was not exploring alternatives to those retailers.
The Benefits and Limits of Trust
A crucial question is whether powerful manufacturers or retailers receive more tangible benefits from building trusting relationships with partners than from exploiting
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their clout. Is trust more than just a feel-good phenomenon? The results of the study that I just described certainly suggest that it is: the retailers that trusted the manufacturer were 12% more committed to the relationship (as measured by their intent to carry the manufacturer's products in the future), were 22% less likely to have developed alternative sources of supply, and performed at higher levels for the manufacturer than the retailers that did not trust it. (See the exhibit "Having Trusting Retailers Pays Off.")
I used two different metrics to evaluate the retailers' performance for the manufacturer. One was the sales generated for the manufacturer and the second was a more holistic but more subjective evaluation. (See "A Scale to Assess Retailer Performance" at the end of this article.) The results showed that retailers with a high level of trust in the manufacturer generated 78% more sales than those with a low level. The results using the holistic evaluation were less dramatic. Still, retailers that reported that they trusted the manufacturer highly were rated as performing 11% better, a percentage that is statistically significant. When my colleagues and I used the two metrics in other industries, including vehicle leasing and computer peripherals, the results were similar.
Trust brings other benefits as well. It creates a reservoir of goodwill that helps preserve the relationship when, as will inevitably happen, one party engages in an act that its partner considers destructive. The growth of multiple-channel distribution systems has made such situations much more common in recent years. For example, manufacturers such as Compaq Computer Corporation and Goodyear Tire and Rubber Company are aggressively wooing faster-growing distributors, including so-called category killers such as Circuit City Stores
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Having Trusting Retailers Pays Off Retailers' Development of
Alternative Sources of Supply
Retailers' Commitment to the Manufacturer
Retailers' Sales of the Manufacturer's Product Line
Retailers' Performance as Rated by the Manufacturer
The four comparisons below show how a manufacturer of replacement automotive parts reaped g reater benefits when its retailers had a hig h level of trust in it. Each of the manufacturer's 429 retailers was classified into one of two g roups—retailers with hig h trust in the manufacturer or
retailers with low trust in the manufacturer—based on the retailer's response to our scale measuring retailer trust. Then the two g roups of hig h- and low-trust retailers were compared on the extent to which they were developing alternative sources of supply; their intention to continue
carrying the manufacturer's product line; unit sales g enerated for the manufacturer; and the manufacturer's rating of the retailers' performance,
measured using the scale that we developed for that purpose.
(See "A Scale to Assess Retailer Performance" at the end of this article.) The averag e scores for each g roup were converted so that the low-trust
retailers' averag e score equaled 1 00 and the hig h-trust retailers' averag e score was proportionally scaled.
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and mass merchandisers such as Sears, Roebuck and Company and Wal-Mart. These moves are infuriating their traditional independent dealers, who resent the better price and delivery terms that their rivals are receiving. Our research shows that in such situations, trusting retailers tend to be
understanding and blame competitive conditions, whereas distrustful retailers tend to hold the manufacturer personally responsible. Consequently, trusting retailers are less likely to retaliate by dropping or neglecting the manufacturer's product line than distrustful retailers are.
Trust helps manufacturer-retailer relationships realize their full potential. When both sides trust each other, they are able to share confidential information, to invest in understanding each other's business, and to customize their information systems or dedicate people and resources to serve each other better. A trusting party typically will not feel it needs to monitor its counterpart's behavior; thus it can cut its monitoring costs. Last but not least, trust allows a company to capture the hearts and minds of channel partners so that they will go the extra mile. The relationship between Procter & Gamble and Wal-Mart illustrates how even powerful adversaries can benefit from deciding to base their
relationships on trust. (See "Two Tough Companies Learn to Dance Together" at the end of this article.)
W hen both sides trust each other, they can share information and invest in understanding each other's business.
Can a company have its cake and eat it, too? Can a company build trust while seeking to retain or increase its leverage or power over a partner? My research suggests not. Rather, trust requires companies to relinquish
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some of their independence, or, to put it another way, to become more dependent on each other.
In one study, Scheer, Steenkamp, and I separated more than 400 manufacturer-retailer relationships into four categories of differing levels of interdependence. On average, a company's level of trust and its satisfaction with the relationship (as measured on the 1-to-7 scale) were the highest and the level of perceived conflict was lowest in the relationships in which there was a high level of interdependence.
(See the exhibit ''Effects of Interdependence.")
If one thinks about it, this finding is logical. Effective relationships require both parties to make contributions. A hostage company often will try to reduce its depen-
Effects of Interdependence
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dence on its partner, an effort that only moves the relationship into the apathy quadrant. A hostage would gain much more by becoming a more valuable resource to the partner, thereby moving the relationship toward the high interdependence quadrant. Although people in many societies are socialized to prize independence, self-sufficiency, and unilateral control, no company is an island.
Effective companies build networks based on interdependence.
Although I advocate relationships based on trust, I recognize that there are underlying tensions in any manufacturer-retailer relationship. The trust strategy works only with those partners that are willing to play the trust game. Furthermore, regardless of how deeply two partners trust each other, there will always be areas of difference because the two parties inevitably will have some goals that are different.
The limits of trust are especially obvious when the manufacturer and the retailer do not have a mutually exclusive relationship. It is easier to develop trust when manufacturers offer territorial exclusivity and when retailers do not carry product lines of competing manufacturers. But if a product needs to be distributed widely, as most consumer packaged goods do, or if a retailer needs to carry a wide variety of brands, as supermarkets and mass merchandisers do, then such exclusivity is impossible.
Operating in numerous relationships with different practices is a challenge for the best of companies.
They may be tempted to apply what they have learned in one relationship to other relationships.
Procter & Gamble, for example, has tried to use two pillars of its successful dealings with Wal-Mart to support its relationships with other retailers. The pillars are multifunctional customer
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teams—each of which focuses on a single customer— and everyday low pricing (lower standard prices and an end to special promotions). P&G discovered, however, that some retailers were not large enough to warrant such teams—or even a full-time person. And some retailers have retaliated against P&G's everyday low pricing policy by reducing shelf space for P&G products.
Finally, trust is rarely all-encompassing. One may trust the partner on some issues but not on others, just as I trust my neighbor to take care of my plants but not my car while I am on vacation. Employees who interact with their company's partners must understand which information, skills, and technologies are to be protected and which are to be shared. Partners have to understand that the information they receive is to be treated in confidence. McDonald's Corporation's contract with its franchisees gives McDonald's the right to take over a franchisee's operations if the latter discloses confidential information. However, such concerns must not be allowed to impede the sharing of the information and skills required for the relationship to flourish.
Trust is rarely all-encompassing . One may trust the partner on some issues but not on others.
Creating Trust
Of course, the vast majority of manufacturer-retailer relationships are unbalanced. Huge manufacturers such as Mercedes-Benz sell their products through small mom-and-pop dealers; and major retailers such as France's Carrefour, Japan's Ito-Yokado, Britain's Marks & Spencer, and America's Toys "R"
Us buy from numer-
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