Rethinking Distribution: Adaptive Channels

Flawless distribution can seem an impossible goal. No matter how much inventory a wholesaler carries, when a customer places a rush order, the essential item is often out of stock. No matter how broad a range of services a dealer provides, what a customer desperately needs is often some out-of-the-ordinary service that the dealer has never supplied. And no matter how much effort a distributor expends to beef up its capabilities, when a customer has an emergency, the distributor often lacks the critical skills to respond.

To solve these problems, a handful of forward-looking companies are experimenting with their distribution channels to make them more flexible and responsive. Although the scope of the experiments and the specifics vary widely, each embraces a concept we call adaptive channels.

Forward-looking companies are trying to make their distribution channels more flexible.

The managers whose innovations have given rise to this concept view their distribution channels as webs of capabilities embedded in an extended enterprise. They have realized that by sharing their resources and capabilities in novel ways and new situations, they can take advantage of profit-making opportunities that they could not exploit alone. To act on this realization, these managers first identify infrequent yet critical customer requirements that they cannot fulfill routinely on their own. Then they make progressive, cooperative arrangements with other channel members for the assistance that will enable them to meet those requirements. The nature of such assistance, the procedures for providing it, and the appropriate remuneration are all defined in advance.

Business dynamics and emerging technologies make this new approach to distribution both essential and feasible. Tough competition is forcing managers to scrutinize every aspect of their operation. Increasingly, they are recognizing that distribution channels represent an untapped opportunity for major cost savings and productivity improvements. The prevalence of strategic alliances and partnerships has made managers more willing to explore new ways of working together for mutual gain. And recent developments in shared information systems and integrated logistics systems (including the emergence of highly competent suppliers such as Federal Express) make such cooperative efforts more feasible. Finally, in many markets, global competitors are providing the impetus for innovation. Excluded from established channels, these newcomers have no choice but to experiment with unconventional distribution arrangements.

The potential benefits of these new arrangements come from the opportunity to leverage resources and share capabilities within the channel. As redundant pools of inventory and duplicate service operations are pared back, costs fall, often by 15% to 20%. At the same time, the amount of business lost because of stockouts and the inability to respond to emergencies drops, sometimes by as much as 50% to 75%. Even more important, participants capitalize on new business opportunities, often to the tune of 10% more in sales, because they can offer a broader selection of products and services than they could on their own. They can also heighten customer satisfaction by augmenting their own capabilities with those of more proficient partners.

To learn more about innovative distribution practices, we conducted an extensive research study in 1994 and 1995. We started by identifying progressive manufacturers and distributors through discussions with colleagues, with managers from a variety of industries—including information technology and integrated logistics—and with the executive presidents of two distributor trade associations. Then we conducted a series of individual field interviews in the United States and Europe with 62 managers from 27 U.S., European, and Japanese organizations that are considered to be leaders in distribution.

These companies’ initiatives can be divided into three broad categories. In the first, the distribution channel is designed to ensure that the members are routinely able to cope with unexpected or unusual demands for products and services. In the second, the new arrangements focus on meeting customers’ growing demands for broader market offerings—products and services that the channel member does not normally provide. In the third, the objective is to improve the quality of service throughout the distribution channel by substituting the superior capabilities of one member for the inferior capabilities of another.

Satisfying Customers’ Extraordinary Needs

Every distribution channel occasionally faces unexpected or unusual demands. A major customer’s tractor trailer breaks down on the interstate, and the local dealer doesn’t have a vital part in stock. A machine tool distributor stretches its budget to carry as much inventory as possible only to have a customer place a big order for machine tools it doesn’t have. Information systems professionals at a large investment bank call their software supplier for emergency problem-solving assistance and get a busy signal.

Traditional distribution channels try to meet those challenges by forcing the manufacturer and its distributors to stock excess inventory or hire surplus personnel. Recognizing the costliness of this approach, innovative managers are experimenting with various kinds of auxiliary support systems. Such systems allow a manufacturer and its distributors to respond to extraordinary situations by sharing inventories and support services in return for prespecified remuneration. What makes the systems possible is information technology and integrated logistics systems that can monitor the availability of products and services, process orders, and deliver products and services rapidly from distant locations to customers’ sites.

Consider, for example, how Volvo GM Heavy Truck Corporation and its dealers solved a vexing business problem. Volvo GM sells commercial trucks and repair parts in the United States through a channel that includes regional warehouses and commercial truck dealers. Between 1993 and 1995, the company’s dealers had been reporting more and more stockouts on critical parts, even though inventory levels were soaring. Because they couldn’t provide consistent, timely repairs, the dealers were losing a considerable amount of business—business that constituted a major growth opportunity.

Volvo GM managers knew that the problem was related to the dealers’ inability to predict demand for parts and service accurately. Through careful market research, they learned why that was the case. Customers use replacement parts in two quite different situations: scheduled maintenance and emergency roadside repairs. In the first situation, Volvo GM’s conventional distribution system was working well because customers’ requirements varied little and the necessary parts could be ordered and delivered ahead of time. In the second, the system was extremely ineffective because the demand for emergency repairs simply could not be predicted. No matter how much inventory the company put into the channel, it seemed that almost every time a truck broke down, the critical parts were in the wrong place and not readily accessible. Little wonder that when owners learned how long they would have to wait to get their trucks moving again, they located competing dealers that had substitute parts and could make the repairs.

Once Volvo GM understood the problem, it could address it. Working with FedEx Logistics Services, the company set up a warehouse in Memphis, Tennessee, that would stock the full line of truck parts. Now when a dealer needs parts for an emergency repair, the manager calls a toll-free number and the parts are shipped out by FedEx, often on an afternoon flight so they arrive that same night. Parts can be picked up at the airport by the dealer’s personnel, delivered to the dealer’s offices, or even dropped off at the roadside repair site. Volvo GM charges dealers for the delivery service, but the dealers don’t mind because they can pass the charges on to anxious customers who are willing to pay for prompt service.

Today Volvo GM is losing less business because of stockouts, and dealers’ revenues from emergency repairs have risen significantly. Moreover, Volvo GM has eliminated three warehouses and reduced its total inventory by about 15%. Lower inventory and storage costs have more than offset increases in the company’s freight charges. Managers report that they have been overwhelmed with compliments from both dealers and customers.

Another way to ensure that distributors can routinely satisfy unexpected demands is to have channel members share the burden of maintaining safety stocks and making emergency deliveries. Machine tool builder Okuma America Corporation, a subsidiary of Japan’s Okuma Corporation, provides an outstanding example of how this can be done. The expense of stocking a full line of machine tools (which often cost more than $100,000 apiece) along with a complete assortment of repair parts (which number in the thousands) is prohibitive. Historically, it has hampered the ability of distributors to provide responsive service. To overcome the problem, Okuma created its own auxiliary support system.

Okuma requires each of its 46 distributors in North and South America to carry a minimal number of machine tools and selected repair parts in its inventory. The company tries to ensure that nearly all Okuma machine tools and parts are in stock at all times, either in its warehouse in Charlotte, North Carolina, or somewhere in the distribution channel. A shared information-technology system called Okumalink keeps distributors informed about the location and availability of machine tools and parts in Okuma warehouses in Charlotte and Japan.

When a customer orders a machine tool or a part that a distributor does not have, the distributor checks Okumalink to determine if the item is in stock. If it is available, the distributor can order it electronically. If it isn’t, the distributor can contact the other distributors through Okumalink’s E-mail system to find the closest location. Then the manager arranges for the item to be delivered directly to the customer’s plant site. Okuma further supports the availability of repair parts with a 24-hour shipment guarantee on all parts manufactured in Charlotte: If the parts are not shipped within 24 hours of receipt of the order, the customer gets them for free.

Okuma’s guarantee: If the parts are not shipped within 24 hours, the customer gets them for free.

Okumalink will be upgraded to allow channel members to connect with one another directly. All the distributors will post their inventories on Okumalink and be able to scan those of their channel partners. Equally important, they will be able to arrange intrachannel exchanges of machine tools and parts electronically.

The benefits of Okuma’s auxiliary support system are considerable. Investments and costs associated with stocking and handling inventory have been reduced for all the members of the distribution network. Okuma now has 48 potential pathways—its 46 distributors and its two warehouses—for its products and services to reach each customer. The likelihood that a distributor will lose a sale because an item is out of stock has plummeted. Customer satisfaction has increased because Okuma is consistently delivering the superior service it promises.

A third example of how an auxiliary support system can ensure superior service in extraordinary situations is Microsoft’s product-support approach. Microsoft delivers most of its technical problem-solving assistance to customers by telephone. Although most requests can be handled in a timely fashion by the service engineers at one of Microsoft’s three U.S. technical-support centers, the division’s goal of answering 90% of service calls within 60 seconds is severely tested during product launches.

To handle the overload during peak periods, Microsoft relies on a carefully selected network of authorized support centers and Microsoft service providers. Microsoft programs its telephone switching system with call arrival forecasts, goals for minimum waiting time, and estimates of support staff availability—its own and that of its partners. When a Microsoft product-support engineer cannot take a call during a prespecified interval, the switching system automatically transfers the call to a designated service provider, where an engineer takes it and resolves the customer’s problem. Microsoft compensates the service providers on a per-call basis with a guaranteed number of calls per day. Fees paid to service providers reflect their investments in facilities, equipment, direct phone lines, and hiring and training of support engineers. Microsoft managers report that the system helped them handle technical service calls smoothly following the introduction of Windows 95 last year.

What Customers Want Is What They Get

Ten years ago, most large companies worked with multiple suppliers. Today that is no longer the case. Prompted in part by the quality movement, more and more managers are shrinking the number of their suppliers. The repercussions for distributors are becoming apparent. Sophisticated companies are increasingly choosing to rely on a small number of preferred distributors for maintenance, repair, and operating supplies. In these relationships, which are usually formalized through integrated-supply-management contracts, the customer effectively outsources a portion of its supply-management function to a distributor to reduce its total transaction costs. According to Frank Lynn & Associates, a distribution-industry consulting firm, the market for such contracts in the United States reached $1.8 billion in 1995 and is predicted to reach $5 billion by 1998.

Integrated-supply-management contracts provide a tremendous opportunity for distributors to increase both sales and profits; however, fulfilling such contracts typically requires a broader market offering as well. In addition, customers are likely to expect the distributor to handle their infrequent or emergency requests for unusual products and support services. Given that most distributors have limited financial resources, sell only narrow and specialized product lines, and possess limited service capabilities, such expectations can be an insurmountable obstacle. In fact, distributors operating in traditional distribution channels often forgo such business, telling prospects, “Sorry, we don’t do that.” Rather than let these opportunities vanish, forward-looking managers recognize that they can capitalize on them by forming alliances with other distributors to share complementary product lines and services.

Distributors can fulfill requests for unusual products and support services by allying with other distributors.

In these alliances, the members agree to pool their resources and capabilities in order to broaden one another’s market offerings. By joining forces, they can exploit opportunities that they wouldn’t be able to on their own, and they can meet demands that fall outside their traditional areas of specialization. In return for its contribution, each member of the alliance shares in the resulting sales and profits.

Grainger Integrated Supply Operations, a company division established in 1995 by W.W. Grainger, a large industrial distributor, shows how such an alliance works. GISO’s goal is to handle the acquisition, materials-management, and warehouse activities of major customers across as broad a range of maintenance, repair, and operating supplies and services as possible. To do so, GISO draws on three groups of suppliers: Grainger’s traditional distribution business, independent best-in-class suppliers, and an internal sourcing group. Products from these suppliers can be delivered to customers separately or consolidated into one shipment.

When GISO receives an order, it immediately goes on-line to see whether the items are available from Grainger’s traditional distribution business. If Grainger cannot fill the order, GISO turns to its network of best-in-class suppliers—outstanding specialty distributors that carry complementary products. Written contracts with each supplier specify the products it will supply through GISO, and the suppliers set the prices of those products themselves. GISO pays the supplier immediately on delivery and then collects the revenues or holds the accounts receivable itself. To participate in GISO, the suppliers pay an annual management fee, a minor transaction fee, and logistics costs.

When GISO gets an order that neither Grainger nor the independent suppliers can meet, it turns to its own sourcing group. The group routinely scours the world to satisfy requests for unusual products and services. For example, in the summer of 1995, ARCO Alaska requested bear repellent for its oil pipeline workers. GISO managers tracked down a small business in a remote part of Alaska that manufactured the repellent. Then they determined whether spray or steam applicators would be most useful for oil pipeline workers and what size containers would be most economical. Once those decisions were made, GISO managers figured out how to get the repellent from the supplier to the workers.

Whereas GISO relies on written contracts and cooperative agreements with members of its supply alliance, other distributors achieve similar results through consortia. To form a consortium, distributors of complementary lines contribute equity and create a separate corporation that markets the members’ products and services, primarily to integrated-supply-management customers. Through the consortium, member companies can serve customers individually, when they want specialty products and technical service, or collectively, when they want broader offerings. Consortium members can also draw on their partners’ inventories when a traditional customer wants something out of the ordinary. Participating distributors share profits in the form of dividends, capital gains, or both.

For example, consider Intercore Group, a consortium created by four U.S. machine-tool distributors: Excel 2000 Machine Tools, Methods Machinery Company, Machine Tool Corporation, and Wing & Jabaay. Individually, each distributor had experienced difficulty providing timely, high-quality service, gaining large turnkey contracts from major customers, and reselling used equipment. Now when a consortium member spots an opportunity that it cannot handle alone or when it needs to provide technical assistance and doesn’t have a service engineer available, its managers ask Intercore for assistance. Intercore also gives the distributors access to their partners’ inventories of used equipment and enables them to make their own used equipment available to a broader geographic market.

Based in independent offices in Indianapolis, Indiana, the consortium is largely an administrative operation. Each distributor has transferred one or two service engineers to Intercore, and an executive from one of the distributors serves as the head of operations. The consortium maintains relations with machine tool suppliers and end users, markets technical service contracts, dispatches service engineers wherever needed, sends invoices to customers, and collects payments. Profits are distributed to the owners through dividends.

Superior Service Through Shared Capabilities

As the focus of competition has shifted from products to services, managers have become increasingly concerned about the services their distributors provide. Ideally, every participant in the distribution channel should provide the same high-quality services to every customer. In practice, of course, such consistency is virtually impossible because neither the manufacturer nor any of its distributors is likely to excel at everything. Instead, companies tend to do an outstanding job with some services and a mediocre job with others.

To overcome those discrepancies, managers commonly try to achieve the impossible goal of making every channel member equally skilled in every service. Often this effort entails forcing distributors to hire additional service personnel or sponsoring training programs for distributors. But innovative managers are trying a different approach. Recognizing that the proficiencies of some channel members can be used to bolster those of others, they are experimenting with what we call capabilities-sharing agreements.

Through such agreements, the superior service of one channel member is substituted for the inferior service of another. Each channel member offers a greater number of high-quality services at far lower costs than it could by acting alone. And each contributing distributor receives appropriate compensation when it shares its superior capability.

By sharing capabilities, channel members can offer better service at a lower cost than they could by acting alone.

Otra, a $2.2 billion holding company based in the Netherlands that has approximately 70 electrical wholesaler subsidiaries located across Europe, provides a good example. Otra’s wholesalers operate for the most part independently within an agreed-upon market focus. To improve the service capabilities of all 70 wholesalers, Otra managers have designated some of them as centers of excellence. These centers possess superior knowledge or skills (such as the ability to provide outstanding electrical-system design, point-of-sale materials, or warehouse layouts) that can be transferred to other Otra companies. Otra managers encourage their wholesalers to seek assistance from the appropriate centers rather than duplicate their efforts.

For example, Beratungsgesellschaft für Licht-und Elektrotechnik (BLE)—a center of excellence in Soest, Germany—serves primarily as a training company for the employees and electrical-contractor customers of all the Otra subsidiaries. BLE runs training programs both at its own facility and at other Otra locations. In developing its programs, BLE consolidates and translates technical documentation and training materials from up to 15 suppliers of electrical products. A training session in lighting, for instance, might cover all the major suppliers’ conventional products in an integrated way and address issues common to all of their lines, such as how to use software to calculate lighting levels in the design of a customer’s lighting layouts.

Through these training programs, BLE augments the capabilities not only of Otra’s wholesalers but also of its electrical-products suppliers. BLE’s programs are often more thorough and unbiased than those of the suppliers. They also eliminate the need for each supplier to create and run separate but similar programs for each Otra wholesaler. As a result, the suppliers can save money and devote more attention to developing better technical materials and running training programs for their higher-margin specialty lines.

Independently owned channel members can achieve similar gains through capabilities-sharing contracts with more proficient partners. The technical problem-solving arrangement between Mori Seiki, a Japanese machine-tool builder, and Landré & Glinderman, a distributor based in the Netherlands, illustrates how. Because of Mori Seiki’s limited presence in Europe, the prohibitive costs of maintaining a large staff of service engineers, and occasional difficulties in dispatching service engineers from its Düsseldorf offices, the company found that it could not consistently guarantee end users prompt, on-site technical problem-solving assistance. In addition, although Mori Seiki’s engineers were quite knowledgeable about their equipment’s basic technology, they sometimes lacked the expertise to solve problems for customers who had unusual applications.

To help Mori Seiki overcome those challenges, Landré & Glinderman’s management proposed and has implemented an arrangement with Mori Seiki called “rent a service engineer.” Now when Mori Seiki receives a request for service, it determines whether it has the requisite knowledge of the customer’s application, whether a competent service engineer is available, and whether that engineer can reach the customer’s plant site promptly. If the answer to every question is yes, Mori Seiki dispatches one of its own engineers. If the answer to any question is no, Mori Seiki asks Landré & Glinderman to send one of its engineers to the customer’s plant site. Acting as a representative of Mori Seiki, the service engineer corrects the problem. Mori Seiki then pays Landré & Glinderman a prespecified per diem fee for the engineer’s time plus travel expenses.

This arrangement benefits both Mori Seiki and Landré & Glinderman. Mori Seiki can confidently offer prompt, high-quality on-site technical problem-solving assistance without incurring the high costs of hiring more engineers and regularly dispatching them across Europe and also without requiring that its European distributors’ engineers be trained in every conceivable product application. Landré & Glinderman, in turn, uses its service engineers’ time more productively and gains a higher return on related expenditures. In addition, the company has added a profitable service to its repertoire. In fact, this venture has been so successful that Landré & Glinderman has entered into a similar arrangement in Europe with Dresser Industries, a U.S. manufacturer that builds gas engines for power cogeneration systems.

From Idea to Implementation

Although the idea of a more flexible and responsive distribution system is appealing, experienced managers recognize that significant hurdles stand between the idea and its implementation. To begin with, channel members are likely to be skeptical about the rewards of participation. That is particularly the case when the benefits of the new arrangement are conceptually different and more complex than those to which the distributors are accustomed (for instance, when increased leverage or cash flow replaces a straightforward gross margin on inventory sales).

Channel members are also likely to feel threatened by new cooperative arrangements because they stand to lose long-established functions, responsibilities, and relationships. To take one simple example, despite all the talk about virtual organizations, most distributors still feel more confident about their ability to provide first-rate customer service when they have a warehouse full of inventory than when they have to share supplies with another distributor 500 miles away.

To allay such fears and doubts, innovators have to build trust and gain the commitment of potential channel members. For many organizations, pledges and guarantees are a good way to begin. By committing essential resources to the new system and guaranteeing its performance (most often with provisions for service recovery if the system fails), companies like Okuma have been able to overcome distributors’ initial reservations. Then, as experience builds, the network of relationships within the distribution channel can be broadened and deepened: soon all of Okuma’s distributors will post their inventory on Okuma-link, enabling channel members to exchange machine tools and parts electronically. (For another example of how pledges and guarantees can help in creating an adaptive distribution channel, see the insert “Getting Distributors on Board.”)

Getting Distributors on Board

Netherlands-based Dunlop-Enerka produces conveyor belts for mining and manufacturing companies around the world. In Europe, about 80% of its orders require customization: cutting and splicing lengths of belt to fit customers’ needs. This has presented a problem both for Dunlop-Enerka, which sells directly to original equipment manufacturers, and for its distributors, which handle maintenance, repair, and operating-supply sales. Traditionally, the company tried to solve the problem by stocking huge quantities of belts of various sizes in locations throughout the continent. But the result was burdensome inventory costs.

In 1990, Dunlop-Enerka’s managers decided to develop an auxiliary support system for its European operations. To secure the participation of its distributors, the company began by pledging its own resources. It created a shared multilingual information system called Dunlocomm, bought and installed computer monitors at all the participating distributors’ sites, and provided free systems training for the distributors’ personnel. Dunlocomm monitors the inventory in stock at the company’s warehouses and at the distributors’ sites on a daily basis. When a distributor needs an out-of-stock belt, it can use the system to locate the nearest source and arrange, by phone or fax, for its delivery the next day.

To allay distributors’ fears that they would be unable to get the equipment they needed, Dunlop-Enerka guaranteed the availability of all the stocks listed on Dunlocomm. If a distributor needed a belt that was supposed to be in stock but wasn’t, Dunlop-Enerka would customize the order from its own inventory and guarantee delivery within 24 hours.

Reassured by these pledges and guarantees, distributors throughout Europe agreed to list their inventories on Dunlocomm. Initially, distributors’ inventories dropped precipitously—causing Dunlop-Enerka’s stock to soar. But over time, the company’s inventory level has dropped by 20%. The result: thanks to lower costs and faster inventory turns, Dunlop-Enerka’s profit margins have risen by an average of 5% per product line, generating income that the company has chosen to invest in new-product development. Product innovations funded by these investments have increased Dunlop-Enerka’s total sales by 30% over the past five years. Distributors’ profits have also risen as their inventories have declined and their ability to provide fast and reliable service has improved.

Equitable compensation is another essential ingredient in designing new distribution systems. Although this statement may seem obvious, delivering fair and consistent rewards is more difficult than most managers think. In part, the problem arises because manufacturers and distributors often do not have a clear understanding of the specific investments and resources that each partner will contribute and the specific gains that each partner will receive. Before negotiating the terms of a new arrangement, therefore, each potential participant should evaluate both its own position and that of its channel partner.

Parallel sets of T-accounts (like those in an accounting ledger) can be a useful tool in the evaluation process. Each channel partner constructs two sets of T-accounts, one for itself and one for its partner. In one column, the managers list all the investments the company will have to make; in the other, all the gains it expects. These accounts can provide a basis for identifying discrepancies and negotiating perceived inequities.

Although this approach may seem elementary—even simplistic—companies that have used it find it a powerful tool. For example, before Microsoft proposed a compensation system for its service providers, its managers identified and quantified the investments those partners would have to make and the operating costs they would incur. At the same time, the managers learned that the prospective service providers were worried that they would not receive enough calls per month to justify their expenditures on equipment and service personnel. Based on a more thorough understanding of their potential partners’ concerns, Microsoft’s managers proposed a compensation agreement that would entail a set fee per call and a minimum number of calls per day. This arrangement enables service providers to cover operating costs, to earn a fair return on their investments in systems and training, and to plan their operations based on a guaranteed minimum compensation.

As the Microsoft example suggests, companies that have successfully implemented new channel arrangements usually go beyond the trade discounts that historically have been the sole means of compensating distributors for sharing resources. Based on average resale costs and profit margins, a trade discount is supposed to allow a distributor to recover its costs and achieve a reasonable profit. But innovators are turning more and more to new methods of compensation such as fee-for-service arrangements and functional allowances, which reflect the distributor’s actual costs and provide dependable revenues.

Under a fee-for-service arrangement, a channel member is paid a predetermined amount for performing a particular task. Microsoft and Mori Seiki, for example, pay their partners set fees for providing technical assistance to customers in extraordinary situations. LeBlond Makino, a Japanese-owned machine-tool builder, has taken this approach one step further by specifying the number of service days or hours it expects its distributor partners to provide. In essence, distributors are kept on retainer because they are paid whether or not they actually provide service.

Other companies are using functional allowances to compensate channel members for sharing their capabilities. The agreement between Shell Chemical Company and GLS Corporation, a major distributor of composite materials and thermoplastics, provides a good example. Shell’s synthetic-rubber compound, Kraton, is a versatile material with many applications. In order to devote the company’s own resources to developing sales in markets with substantial applications (such as adhesives and lubricants), Shell turned to GLS for help in introducing Kraton to the smaller, more fragmented market for plastic molded goods.

In the mid-1980s, GLS became Kraton’s exclusive U.S. supplier for that market. To meet the challenge, GLS created its own applications-support laboratory staffed with two chemists and a materials engineer. It also hired sales engineers and trained them to provide product-specification and applications assistance, as well as technical sales presentations. In return, GLS received both a functional allowance for market development, which was paid as a reduction in the acquisition price of the Kraton, and bonuses for sales growth.

GLS not only found applications and customers for the compound; it also developed its own proprietary line of thermoplastics made with Kraton, called Dynaflex. Shell’s management was so pleased with GLS’s results that it singled out the company and two other distributors as “branded network compounders” (companies that have the right to manufacture other thermoplastics from Kraton and to use the Kraton name). Now when Shell’s managers identify an emerging application for Kraton that they cannot handle because of constraints in resources or capabilities, they immediately turn it over to the network. The results? Sales of Kraton, Dynaflex, and their derivatives have grown to account for almost 20% of GLS’s sales; and GLS has become one of the largest purchasers of Shell’s synthetic-rubber products.

Companies that have been most successful in redesigning their distribution channels are strongly committed to experimentation. Volvo GM, for example, has no intention of stopping with the gains it has already achieved. Plans to enhance its auxiliary support system through a shared on-line inventory database are well under way. Soon, when dealers need parts for emergency repairs, they will be able to scan the inventories of all the other Volvo GM truck dealers to find the nearest location, further reducing inventories and increasing dealers’ responsiveness.

As companies gain experience, the benefits of experimentation and innovation will only increase. Thanks to the flexibility that technological and service advances now allow, we expect other new arrangements to emerge as more managers recognize opportunities to streamline their existing operations, broaden their selection of products and services, and improve their after-sales service. The winners will be those who best link their manufacturing, service, and distribution functions to meet customers’ needs.

A version of this article appeared in the July–August 1996 issue of Harvard Business Review.