Introducing
the Marketing Channel
to Price Theory
of the various areas of marketing such as promotion,
M OST
advertising, selling, pricing, product development, and dis-
BRUCE MALLEN
tribution can be enriched by economic theory.
But one area in particular has had very little integration with
economic theory — the marketing channel. "The final price of an
article is not a simple thing arrived at as a result merely of the
interaction of the forces in play at the point of sale and purchase.
It is compounded of a whole system of interlocking price relationships reaching back through the retailer, the wholesaler, the
manufacturer, and all the other marketing agents who may have
had a hand in the movement of the product to the point of ultimate
sale. It is the final fruit of an elaborate price structure complicated by such conditioning and obscuring factors as quantity
allowances, credit terms, delivery arrangements, and services rendered at each of the several stages through which the product
passes in its often devious and tortuous way to the point of
final sale."i
Economic price theory
has much to contribute to organized marketing thought.
Likewise the reality of microeconomic price theory
can be improved by its incorporation of marketing
concepts.
The author reviews several
price theories, which if properly integrated, could aid
marketing theory as applied
to the important area of
marketing channels.
Journal of Marketing,
1964), pp. 29-33.
VoJ. 28
(July,
Definition of Channel
Trade channels and channels of distribution are synonymous
with marketing channels. Eesource channels are also synonsnnous,
but they involve marketing channels from a buying rather than a
selling standpoint.
In a wide sense, channels are all the "fiows" extending from
the producer to the user. "A channel of distribution may be
thought of as the combination and sequence of agencies through
which one or more of the marketing fiows move. . . . In its simplest
form, a channel is limited to the movement of one unit of goods in
one fiow. . . . In its more complicated forms, the channel includes
all combinations and sequences of all the agencies used in all the
flows, possibly with an indication of the quantitative importance
of each. It may apply to a whole class or type of goods and to a
company, a trade, or an industry. In its most complex form, it
describes typical or actual fiows of broad classes of goods (say
consumers' goods or industrial goods) or charts the marketing
structure as a whole."^
This definition refers to the fiows of physical possession, ownership, promotion, negotiation, financing, risking, ordering, and
1 Ralph S. Alexander, "Marketing's Contribution to Economics," in
Robert A. Solo, Editor, Economics and the Piiblic Interest (New
Brunswick: Rutgers University Press, 1955), pp. 71-72.
2 Ronald S. Vaile, E. T. Grether, and Reavis Cox, Marketing in the
American Economy (New York: Ronald Press, 1952), pp. 121 and
124.
29
30
payment; and it is accepted by many authorities.^
Under this concept, such diverse agencies as railroads, warehouses, factors, advertising agencies,
and marketing research agencies would be included
as channel members.
However, the concept of channels to be used here
involves only two of the above-mentioned flows:
ownership and negotiation. The first draws merchants into the channel definition, and the second
draws agent middlemen. If any major processing is
undergone, the channel ends. For example, the
route from cotton farmer to textile mill to garment
manufacturer to consumer is not one channel, but
several.
Economic Markets ClassilBcation
How can the marketing man's concept of a channel be injected into the economist's concept of a
market? This is a crucial question, as the concept of a market place is central to microeconomic
price theory.
Economists look upon a market as the exchange
mechanism between buyers and sellers. Thus, the
exchange mechanism between a manufacturer as a
seller and a wholesaler as a buyer is one market.
A second market is the exchange mechanism between the wholesaler as a seller and the retailer as
a buyer. Finally, the exchange mechanism between
the retailer as a seller and the consumer as a buyer
is a third market. Thus, a manufacturer-wholesaler-retailer-consumer channel can be looked upon
as a series of three markets.
The type of market can be defined according to
its degree of competitiveness, which depends to a
great extent on the number of buyers and sellers
in a market. Some possible combinations are
shown in Table 1.
The classification of economic markets in Table
1 is based primarily on the degree of concentration
and number of suppliers (manufacturers or middlemen) on the selling side, and the degree of concentration and number of middlemen on the buying,
side of the market.
1. The smaller the number and the greater the
degree of concentration on the selling side, the
less purely competitive and the more monopolistic that market becomes.
2. The smaller the number and the greater the
degree of concentration on the buying side,
the less purely competitive and the more monopsonistic that market becomes.
3. Where this diminishing number and increasing concentration are "working" on both
sides of the market, the closer that market
moves to bilateral monopoly.
In an oversimplified way, it can be said that:
3 David A. Revzan, Wholesaling in Marketing Organization (New York: John Wiley & Sons, Inc., 1961),
p. 109.
Journal of Marketing, July, 1964
TABtE 1
CLASSIFICATION OF ECONOMIC
Suppliers
(sellers)
Pure competitor
Middlenien
(buyers)
Pure competitor
Oligopolist
Monopolist
Pure competitor
Pure competitor
Oligopoly
Pure competitor
Pure competitor
Oligopsonist
Monopsonist
Oligopsonist
Monopolist
Monopsonist
Monopolist
Monopolist
MARKETS
Market
situation
Pure
competition
Oligopoly
Monopoly
Oligoposony
Monopsony
Bilateral
oligopoly
Bilateral
monopoly
Successive
monopoly
1. Pure competition means many sellers and
many buyers.
2. Oligopoly means few sellers; monopoly
means one seller.
3. Oligopsony means few buyers; monopsony
means one buyer.
4. Bilateral oligopoly means few buyers and
few sellers; and bilateral monopoly means one
buyer and one seller.
5. Successive monopoly means one seller selling to buyers, each of whom is in turn the only
reseller in the next market of the channel
series.
The more monopolistic the selling, side, the higher
the price will tend to be; and the more monopsonistic, the lower the price.
Aside from the number of micro-units involved,
these definitions include specifications for degree
of product differentiation (none in pure competition) ; degree of resource mobility and ease of
entry (complete in pure competition); and degree
of artificial restrictions (none in pure competition).
Because of these other specifications, definitions
of other types of markets not mentioned above arise,
such as monopolistic competition (pure competition
changed by product differentiation); but these will
not be dealt with here.
Theories in the Channel-Price Area
Several theories and concepts should be adapted
to a channel situation. These include vertical con• ABOUT THE AUTHOR. Bruce Mallen
Is Senior Consultant of Marketing and
Economics for P. S. Ross & Partners, Management Consultants, Canada. He is
also on the faculty of Sir George Williams University, Montreal.
Dr. Mallen received an M.S. Degree
from Columbia University, an M.B.A.
from the University of Michigan, and a
Ph.D. from New York University. He has
written several articles for Canadian and
U. S. publications, both in French and English. Two books by
Dr. Mallen—ANNOTATED BIBLIOSRAPHY O N MARKETING
IN CANADA, and THE MARKETING SYSTEM IN C A N A D A —
will be published in late 1964.
Introducing the Marketing Channel to Price Theory
31
fiict, simple monopoly, successive monopoly, vertical
price relationship, monopsony and oligopsony, bilateral monopoly and bilateral oligopoly, countervailing i)ower, inventory theory, and price level
theory.
Channel-price theory as derived from economic
theory is useful in studying the conflicting interaction of channel member firms, but is not very
useful in understanding their cooperative interactions.* Thus, while such theory concentrates on
how the total channel profit is shared among members, it does not adequately show how cooperation
is used in increasing the total.
Simple Monopoly''
If one channel member is a monopolist and the
others pure competitors, the consumer pays a price
equivalent to that of an integrated monopolist; and
the monopolist member reaps all the channel's pure
profits; that is, the sum of the pure profits of all
channel members. Pure profits are, of course, the
economist's concept of those profits over and above
the minimum return on investment required to keep
a firm in business.
Assume that the retailer is the monopolist and
the others (wholesalers and manufacturers) are
pure competitors, as for example, a single department store in an isolated town. Total costs to the
retailer are composed of the total cost of the other
levels, plus his own costs. No pure profits of the
other levels are included in his costs, as they make
none by definition (they are pure competitors).
The retailer would be in the same buying price
position, so far as the lack of suppliers' profits are
concerned, as would the vertically integrated firm.
Thus, he charges the same price as the integrated
monopolist and makes the same profits.
If the manufacturer were the monopolist and
the other channel members pure competitors, he
would calculate the maximizing profits for the channel, and then charge the wholesaler his cost plus
the total channel's pure profits, all of which would
go to him since the others are pure competitors.
The wholesaler would take this price, add it on to
his own costs, and the result would be the price to
'retailers. Then the retailers would do likewise
for the consumer price.
Thus, the prices to the wholesaler and to the
retailer are higher than in the first case (retailer
monopoly), since the channel's pure profits are
added on before the retail level. The price to the
consumer is the same as in the first case. It is of
no concern to the consumer if the pure profit elements in his price are added on by the manufacturer, wholesaler, or retailer.
Thus, under integrated monopoly, manufacturer
monopoly, wholesaler monopoly, or retailer monopoly, the consumer price is the same; but the prices
within the channel are the lowest with the retailer
monopoly, and highest with the manufacturer monopoly. Of course, the nonmonopolistic channel
members' pure profits are not affected by this intrachannel price variation, as they have no such
profits in any case.
Vertical Conflict
Palamountain isolated three forms of distributive conflict.®
1. Horizontal competition — this is competition
between middlemen of the same type; for
example, discount store versus discount store.
2. Intertype competition — this is competition
between middlemen of different types in the
same channel sector; for example, discount
store versus department store.
3. Vertical conflict — this is conflict between
channel members of different levels; for example, discount store versus manufacturer.
The first two forms, especially the first, are well
covered in ordinary economic analysis. Horizontal
competition is what usually is referred to as "competition," while intertj^e competition can be referred to as "distributive innovation."
Vertical conflict, neglected in usual microeconomic discussion, is the type which is of special
interest here. Microeconomics usually treats this
area simply (too simply) as the ordinary relationship between buyer and seller; but this overlooks
channel member conflict.
"It is apparent that a principal factor differentiating vertical conflict from horizontal and intertype
competition is that it is so directly a power conflict. Power relationships among horizontal competitors occasionally are significant, but this power
usually is narrowly limited. . . . In the plane of ver•tical conflict, however, power relationships are
direct, obvious, and important to the extent that
the market is imperfect."^
In essence, any type of channel market — where
both buyers and sellers are channel members — is
vertical conflict.
For the cooperative aspect, see Bruce Mallen "A
Theory of Retailer-Supplier Conflict, Control and Cooperation," Journal of Retailing, Vol. 39 (Summer,
1963), pp. 24-32 and 51.
Joseph C. Palamountain, The Politics of Distribution
(Cambridge: Harvard University Press, 1955).
Same reference as footnote 5, at pp. 52-53.
Successive Monopoly^
Successive monopoly — that is, monopoly at two
or more successive channel stages — can lead to a
T Alfred R. Oxenfeldt, Industrial Pricing and Market
Practices (New York: Prentice-Hall, Inc., 1951),
Chapter 7, Part I, Section A.
8 Same reference as footnote 7, at Chapter 7, Part II,
Section B.
32
higher price than an integrated monopoly for the
consumer and members, if no agreement is reached
among the monopolists.
If there are two monopolies in a channel, such as
a manufacturer monopolist and a wholesaler monopolist, the former may still try to gain all the pure
profits of the channel, as described in the previous
"monopoly" section.
Temporarily the price to the wholesaler would be
the manufacturer's costs plus the total channel's
pure profits. Under these circumstances, the wholesaler would have to charge the retailer the price
the former paid the manufacturer plus his own
costs. He could not add on pure profits as the manufacturer has kept them all for himself.
However, unlike the situation when the wholesaler was a pure competitor and was forced to receive no pure profits, this wholesaler can now cut
back on the supply he will sell to the retailer, in
order to maximize profits. This reduction in supply
will increase the price to the retailer more than
when the wholesaler was a pure competitor and
only the manufacturer was a monopolist. The retailer must now pay not only the costs of the wholesaler and manufacturer, but also the pure profits
of both.
The cutback in supply of the wholesaler will also
reduce his purchases from the manufacturer, and
cause the latter's profits to fall. The manufacturer
may then recalculate his pricing, policy to take account of his profit decline. He may make agreements with the wholesaler such that both their
profits are maximized instead of allowing either of
them to try to obtain all of the channel's pure profits.
Vertical Price Relationship
The indeterminateness of the successive monopoly
analysis (as the latter cannot predict price without
knowing the nature of the members' agreement or
disagreement), can be aided by an analysis by
E. R. Hawkins.9
As well as assuming that the channel members
know the shape of the final consumer demand curve,
Hawkins assumes that they know the demand curves
that they themselves face. (Of course, the consumer demand curve is the one faced by the retailer.) With this assumption he can arrive at the
particular price at every level.
Monopsony and Oligopsony"
A monopsonistic or oligopsonistic channel member can obtain lower buying prices. His selling
» E. R. Hawkins, "Vertical Price Relationship," in Cox
and Alderson, Editors, Theory in Marketing (Homewood, Illinois: Ricbard D. Irwin, Inc., 1950), Cbapter 11.
10 Joe S. Bain, Pricing, Distribution and Employment
(New York: Henry Holt and Company, 1953, revised
edition), pp. 382-394.
Journal of Marketing, July, 1964
price depends on the market structure on his selling side. If it is competitive, he passes on his low
buying price to the next level; and if it is not, he
may simply increase his margin.
The mass retailer may be a monopsonist on some
products and a competitor on others. He may also
be a monopolist or competitor on his selling side,
no matter what is his buying, role.
Thus, he can be a monopsonist and a (seller)
competitor with one product, and have a different
combination with others. His role is often oligopsonist and competitor, and he would thus pass on
his price savings to consumers.
Bilateral Monopoly and Bilateral Oligopoly^^
Bilateral monopoly, where the selling channel
member is a monopolist ajnd the buying channel
member is a monopsonist, is rare. Depending on
the bargaining, power of each, the price to the
buying member may be lower or higher.
One authority believes that price to the oligopsonist (or monopsonist) depends on who possesses
the dominant bargaining power. If the monopolist
(oligopolist) has it, then the price will be higher.
"It will be noted that the tendency of bilateral monopoly (between a monopolistic seller and a monopsonistic buyer who is in turn a monopolistic reseller) is to arrive at a price-quantity solution for
the final market — to which the monopsonist resells—the same as would be reached if the monopolist and the monopsonist were members of a single
firm with a monopoly in the final market. There
are no added output restrictions because of the
passage of the good first through a bilateral monopoly market on its way to the final market. . . .
However, any monopolistic output restriction in a
final market (where the buyer resells) will reBut Wroe Alderson says that experience shows
bilateral monopoly actually makes for a lower price
to the consumer relative to monopoly.i^ It is from
this ability to offer the consumer a low price, rather
than the ability to exploit him with a monopoly
price, that these large channel members derive
their power.
11 Ricbard B. HeMebower, "Mass Distribution: A Pbase
of Bilateral Oligopoly or of Competition?" in Robert
D. Buzzell, Editor, Adaptive Behaviour in Marketing
(Chicago: American Marketing Association, 1957) ;
Fritz Macblup and Martha Taber, "Bilateral Monopoly, Successive Monopoly and Vertical Integration,"
Economica, Vol. 27 (May, 1960), pp. 101-117; Bain,
same reference as footnote 10, at pp. 394-396.
12 Same reference as footnote 10, at p. 485.
13 Wroe Alderson, "Factors Governing tbe Development of Marketing Channels" in Ricbard M. Clewett,
Editor, Marketing Channels for Manufactured Products (Homewood, Illinois: Ricbard D. Irwin, Inc.,
1954), pp. 5-34.
Introducing the Marketing Channel to Price Theory
33
Countervailing
Countervailing power — the ability of a buying
channel member to offset the power of a selling
member when competition dissolves as a regulator
—is similar to bilateral monopoly. However, proponents of this theory claim that big sellers automatically cause the rise of big buyers.
Various authors have discussed the validity of
countervailing power.^^ In summary, it can be
said that although there are various reasons for
the rise of mass retailing and although these retailers are not always so effective in countervailing
big producers, nevertheless countervailance is an
important pricing-channel dynamic.
in one channel sector must infiuence the price level
in another sector. However, this may not hold
true for the short run.
One study concludes that short-run wholesale
price index changes are not useful in predicting
consumer prices, nor are they paralleled by retail
price index changes.^'^ Aside from purely structural
differences in the make-up of these indexes, the
difference is explained by the following: price
variations of seasonal goods, differences in distribution costs at different channel levels, cumulating
tendency of fixed percentage markup pricing, different competitive situations at different channel
levels, varying level of inventories, desire of price
stability, and different elasticities of buyers at
various channel levels.
Inventory Theory'"
Inventory theory stresses the role of merchants'
stocks in times of changing, consumer demand:
1. The tendency of channel members to absorb
increases in demand through inventory increases rather than price increases.
2. Their tendency to absorb demand decreases
through price decreases rather than inventory
decreases.
Price-Level Theory
It appears obvious that the level of prices (a
macroeconomic rather than microeconomic concept)
i*John K. Galbraith, Amierican Capitalism,, The Concept of Countervailing Power (Boston: Houghton
Mifflin Co., 1956, revised edition) Chapter 9.
IB For example, Alex Hunter, "Notes on Countervailing
Power," The EconomAe Joumal, Vol. 68 (March,
1958), pp. 89-103.
i«Wilford, J. Eiteman, Price Determination (Ann Arbor: Bureau of Business Research, Report No. 16,
School of Business Administration, University of
Michigan, 1949).
The Challenge to Theorists
Quentin L. Coons' challenge to the economic
theorist must be met.^^ ^.nd it must be met in a
constructive fashion. There is a definite need to
integrate marketing thought into economic theory
— not only channel concepts, but concepts from all
the marketing areas. Some of the attacks on marketing by economists are a direct result of this
failure to integrate these concepts. Moreover, the
meeting of this challenge will aid in the develoj)ment of a marketing theory and increase the reality
of economic theory.
Helen B. Jung and Theodore R. Gates, "Do Retail
Prices Follow Wholesale Prices?" in Stanley C.
Hollander, Editor, Explorations in Retailing (East
Lansing: Michigan State University, 1959),pp. 48-51.
Quentin L. Coons, "Marketing's Challenge to Economics," JOURNAL OF MARKETING Vol. WJ (July, 1963),
pp. 11-15.
Need Reprints of Journal of Marketing Articles?
Order them NOW from the . . .
American Marketing Association
230 North Michigan Ave.
Chicago I, Illinois
Reprints of every article in this isswe are available (as long as the supply lasts) at
the following prices:
Single reprint
$1.00
4 to 99, each of same article... $ .50
2 reprints of same article
1.50
First 100 of same article
40.00
3 reprints of same article
1.80
Additional 100s of same article . 20.00
For quantities of 100 or over, covers may be ordered for $20.00 for the first 100,
and $16.00 for each additional 100.
Special prices for large quantities
Duplication, reprinting, or republication of any portion of the JOURNAL OF
MARKETING is strictly prohibited unless the written consent of the Editor is
first obtained.