Vertical Marketing Systems

Joining producers, wholesalers, and retailers in the production and distribution of products. There are three major types of vertical marketing systems, and each uses different means for setting up leadership and power in the system: (1) corporate, where coordination and conflict management are attained by common ownership; (2) contractual, where coordination and conflict management are attained through contractual agreements among members of the system; (3) administered, where leadership is assumed by one dominant system member. The purpose of a vertical marketing system is to eliminate conflicts arising from each company's pursuit of its own financial objectives. See also horizontal marketing system.

Systems whereby hierarchical Channel of Distribution members coordinate marketing efforts to reduce conflicts. Various vertical marketing systems can be employed. One method is for an organization to own both the production and distribution operations. In this situation all distribution conflicts are eliminated. Another vertical marketing system is coordinated or controlled by the Channel Captain. Contractual agreements between channel members can also be employed to determine mutual responsibilities.

A vertical marketing system (VMS) is one in which the main members of a distribution channel—producer, wholesaler, and retailer—work together as a unified group in order to meet consumer needs. In conventional marketing systems, producers, wholesalers, and retailers are separate businesses that are all trying to maximize their profits. When the effort of one channel member to maximize profits comes at the expense of other members, conflicts can arise that reduce profits for the entire channel. To address this problem, more and more companies are forming vertical marketing systems.

Vertical marketing systems can take several forms. In a corporate VMS, one member of the distribution channel owns the other members. Although they are owned jointly, each company in the chain continues to perform a separate task. In an administered VMS, one member of the channel is large and powerful enough to coordinate the activities of the other members without an ownership stake. Finally, a contractual VMS consists of independent firms joined together by contract for their mutual benefit. One type of contractual VMS is a retailer cooperative, in which a group of retailers buy from a jointly owned wholesaler. Another type of contractual VMS is a franchise organization, in which a producer licenses a wholesaler to distribute its products.

The concept behind vertical marketing systems is similar to vertical integration. In vertical integration, a company expands its operations by assuming the activities of the next link in the chain of distribution. For example, an auto parts supplier might practice forward integration by purchasing a retail outlet to sell its products. Similarly, the auto parts supplier might practice backward integration by purchasing a steel plant to obtain the raw materials needed to manufacture its products. Vertical marketing should not be confused with horizontal marketing, in which members at the same level in a channel of distribution band together in strategic alliances or joint ventures to exploit a new marketing opportunity.

As Tom Egelhoff wrote in an online article entitled "How to Use Vertical Marketing Systems," VMS holds both advantages and disadvantages for small businesses. The main advantage of VMS is that your company can control all of the elements of producing and selling a product. In this way, you are able to see the whole picture, anticipate problems, make changes as they become necessary, and thus increase your efficiency. However, being involved in all stages of distribution can make it difficult for a small business owner to keep track of what is happening. In addition, the arrangement can fail if the personalities of the different areas do not fit together well.

For small business owners interested in forming a VMS, Egelhoff recommended starting out by developing close relationships with suppliers and distributors. "What suppliers or distributors would you buy if you had the money? These are the ones to work with and form a strong relationship," he stated. "Vertical marketing can give many companies a major advantage over their competitors."

Further Reading:

Baker, Sunny, and Kim Baker. "Going Up! Vertical Marketing on the Web." Journal of Business Strategy. May 2000.

Egelhoff, Tom. "How to Use Vertical Marketing Systems." http://www.smalltownmarketing.com.

Mullich, Joe. "Vertical Segmentation Gets More Emphasis." Advertising Age. June 10, 1996.