Omkar D. Palsule Desai
Operations Management Area, IIM Indore
Email: firstname.lastname@example.org; Phone: 0731-2439567
Achieving efficiency in sales and distribution of fast moving consumer goods (FMCG) in markets with diverse consumer-characteristics has always been a critical challenge for management professionals in academia and practice both. Notwithstanding the pressure from well-established corporate retailers – such as Walmart, Kroger, Costco, Carrefour, etc. – that particularly dominate the modern trade channels, characterized by efficiently coordinated direct sales in large volume to consumers in organized settings, in developed countries – such as the USA, Canada, the European countries, etc. – FMCG manufacturers in developing and underdeveloped countries continue to adopt the traditional trade channels involving middlemen to reach out to their consumers in these unorganized markets. Over the last two decades of the twentieth century, the rise of information technology and advancements in a number of specialized management streams have particularly given a boost to relatively leaner supply chains under the modern trade.
However, the equivalent success has been elusive even to multinational manufacturers – such as Proctor & Gamble (P&G), Johnson & Johnson (J&J), etc. – in emerging markets such as India and China. In the first two decades of the twenty-first century, the emerging retail markets have accounted for more than 90 percent of FMCG sales through the traditional trade. These markets are particularly dominated by millions of small stores and are served by the manufacturers via relatively longer supply chains consisting localized middlemen. In theory and also in common belief, lengthy and decentralized supply chains are always inefficient. However, the traditional trade based FMCG supply chains in the emerging markets, such as that of Hindustan Unilever (HUL), ITC in India, have been exemplary in leveraging expertise of the middlemen and in surpassing the inefficiencies of decentralization. In this regard, the unique intervention in the Indian FMCG distribution sector in the form of entrepreneurial middlemen, popularly known as stockists that essentially provide a systematic structure to the unorganized supply chains, demands a special attention. When the modern trade is facing significant challenges for sustainability of its supply channels against the traditional trade in the emerging markets, devising a scientific approach to characterize stockists and their role in strengthening the Indian FMCG supply chains is particularly relevant. Unlike the existing literature in the area of marketing management that focuses on FMCG sales and distribution from the consumer perspective – for instance, understanding consumer behaviour, devising market segmentation strategies, brand management, etc. – Iyer and Palsule-Desai (2018) provide a foundation for further studies in this field from the supply chain perspective.
The FMCG manufacturers incorporate stockists in their supply chains as the supply-agents integrated via exclusivity contracts that connect the parent manufacturers with all retail locations within the allocated territories. The stockists are mainly responsible for ensuring product-availability at the retail locations and to coordinate with the retail stores while serving them by adopting efficient replenishment mechanisms. They not only acquire accurate demand information and local knowledge in the market, but they also develop tacit relationships and facilitate entrepreneurial drives on behalf of the manufacturers by devising localized marketing schemes and by covering the last mile over a suitable logistics network involving push-carts and bicycles when needed. Furthermore, they address the retailers’ concerns regarding low financial liquidity in the supply chain. Likewise, on the supply side the stockists play a dual role for the FMCG manufacturers – demand generation and establishing logistics network – and on the demand side they partially, yet critically, finance the operations for the retailers. In return, the manufacturers provide the stockists margin – percentage of the sales price of the products – and assistance to ensure both financial and operational sustainability of the supply chain.
In highlighting the important roles stockists play in the Indian FMCG supply chains, Iyer and Palsule-Desai (2018) propose an information asymmetry based game theoretic model of adverse selection to facilitate the manufacturers in identifying suitable stockists from those available in the market. They develop an analytical model to design screening-contracts to be offered to the stockists by the manufacturers. In this regard, the authors characterize the manufacturers’ contracts that exist in practice by capturing the nature of relationship – either substitutes or complements type – between the manufacturers’ assistance to the stockists and their implications for the stockists’ cost function depending on their capability to operate in the market for the parent manufacturers. By collecting empirical data (primary and secondary kind both) from 17 major FMCG manufacturers representing more than 80 percent of retail sales in India, the authors validate their theoretical model and establish applicability of the results in practice.
Iyer and Palsule-Desai (2018) essentially suggest that the FMCG manufacturers’ screening contracts as observed in practice can be well-described using three contextually relevant factors: (i) ease of access to retailer locations and service costs of the stockists, (ii) manufacturers’ level of dependence on the stockists’ capabilities in increasing the sales within the respective territories, and (iii) proportion of cost-efficient stockists available in the market. Using these three factors, the authors particularly describe the implications for the margins and the level of assistance offered by the manufacturers to their stockists and the stockists’ working capital investments in delivering the products to the retailers on credit. For instance, the model shows that a manufacturer’s level of assistance and margin offered both decrease as ease of access to retailer locations for a stockist increase. The decreasing operating cost for the stockist also results into decreasing working capital investment. Similarly, when the manufacturer is more dependent on the stockist to increase the sales of its products, the manufacturer offers more assistance while decreasing the margin. By the higher assistance, the stockist’s cost function is lower that results into lower per unit capital investment in delivering the products to the retail stores. Likewise, when the number of cost-efficient stockists for the manufacturer in the market is relatively higher, the latter prefers to provide more assistance and lesser margin to the former. It helps the stockist to reduce its capital investment in the channel. The implications of the three factors for the optimal screening contracts of the manufacturers are identical under both substitute and complement type relationship between the manufacturer and the stockists.
The adverse selection based asymmetric information model of Iyer and Palsule-Desai (2018) also provides managerial insights into how the contracts offered by the FMCG manufacturers to their stockists vary depending on diverse characteristics that describe markets, manufacturers, their product profiles, and the environment in which they operate. For instance, they establish why the margins for slow-moving products are relatively larger than those for fast-moving products. Similarly, they describe why margin and assistance both can be relatively higher in the rural market vis-à-vis the urban market. Furthermore, the authors describe the implications of a variety of characteristics of the supply chains – such as established versus new-entrant manufacturers, Indian versus foreign manufacturers, low versus high market potential, dense versus sparse retail environments, etc. – for the manufacturers’ screening contracts for their stockists. In this regard, the authors provide critical insights into a rather surprising fact that the margins provided by the FMCG manufacturers to their stockists in India can be as low as 0.8-1 percent, while them can be as high as 10-12 percent.
While Iyer and Palsule-Desai (2018) present an adverse selection based analytical model to a particular issue of designing screening contracts for the stockists, their work provides many interesting avenues for further studies in the FMCG supply chains in the emerging market environment. For instance, it would be critical to obtain managerial insights into devising strategies to create discrete geographic segments in a market while capturing relevant characteristics of products, consumers, and retail stores in the market. In extending the decision-making framework of Iyer and Palsule-Desai (2018) under the information asymmetric setting, obtaining insights into efficiently matching geographic territories with the available stockists would be interesting. It has been observed in the Indian metro and Tier-I cities, in particular, that the manufacturers prefer to match product categories, rather than geographic segments, to the available stockists. In this regard, aligning incentives for the stockists with those of the manufacturers is quite essential for leveraging the traditional trade based FMCG supply chains in the emerging markets.
ORIGINAL ARTICLE: Iyer, A.& O. D., Palsule-Desai. (2018). Contract Design for the Stockist in Indian Distribution Networks. Manufacturing & Service Operations Management. (forthcoming).