Supplying to Mom and Pop: Traditional Retail Channel Selection in Megacities

Abstract

Problem definition: Nanostores are traditional, small and independent retailers that are present in large numbers in the megacities of the developing world. Consumer packaged goods (CPG) manufacturers can choose to deliver to nanostores either directly—visiting thousands of stores per day—or via wholesalers—saving on distribution cost but forfeiting the direct access to the store owners to develop demand. We study a manufacturer’s channel strategy within a finite time horizon. Academic/practical relevance: The channel strategy in emerging markets has both marketing and operational elements, which lead to a newly formulated problem with novel characteristics. High costs are involved in the nanostore distribution, and the difference in wholesale price, logistics cost, product availability, and market growth leads to a multidimensional problem that is not trivial to analyze. Methodology: We develop an analytical model to derive the optimal channel policy. We conduct a numerical study with parameters tuned by field data. We develop managerial insights based on our formal results and our numerical analysis. Results: The optimal channel policy structure depends mainly on two channel metrics: the gross profitability, which is the gross margin at a particular moment in time; and the growth-adjusted profitability, which includes the growth potential of a particular channel strategy to develop the market and realize future profits. With demand growth over time, we show that, in the optimal policy, there is at most one switch between the wholesale and direct-channel strategies within the time horizon. Managerial implications: Depending on the two metrics, it may be optimal to first expand the market by using the direct channel and then switch to the wholesale channel to exploit the expanded market. In other cases, it may be optimal to first expand the market slowly by using the wholesale channel and then switch to the direct channel to benefit from high demand growth. The optimal channel strategy is also dependent on the time horizon, with a longer time horizon leading to relatively longer use of the direct channel.