Evaluate and compare vertical restraints to determine how they affect strategic decision making of the companies that use them?
Different industries or sectors may put “vertical restraints” in their contracts. I am trying to determine the purpose of these and the consequences these provisions have on strategic decision making.
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Vertical restraints in business relate to contracts between manufacturers and suppliers regarding the sale of products. These restraints could also be viewed as restrictions. The vertical restraints vary depending upon the country, industry and product that one is in. Often, these restraints relate to pricing, exclusivity of product and/or territory. The motivation to enter into this type of contract differs from the point of view of whether the company is a manufacturer or a distributor/retailer.
Here is a hypothetical example:
You are a manufacturer of a newly designed toilet bowl brush and you want to gain market share. To do this, you most likely would like to place your item in WalMart. Why? Due to the number of stores WalMart has, both in the United States and worldwide. In the United States alone, they have over 4,400 stores – unmatched by any competitor. Additionally, almost everyone has at least one toilet to clean; therefore, your goal is reach to the largest audience of everyday consumers. WalMart is known for having manufacturers lower their selling price to WalMart, thereby cutting into your profit margin as the manufacturer. However, they will agree to place your item in their weekly flyer and promote it on an end cap in the store, thus helping your item to increase its sales. If WalMart accepts your item, they may have you sign an exclusivity agreement, stating that you will not sell your item to its competitors – Target, Kmart, etc. This limits your exposure in the marketplace. So, why would either party do this? WalMart could do it so that they can claim they are the only distributor of this great new item. Consumers can only get this item at WalMart. You, the manufacturer, are willing to do this because of WalMart’s presence in the marketplace and its ability to move a significant number of units. This would help you to achieve market share, while allowing you to work with the world’s largest retailer. Potential downsides to you include a competitor copying your product and selling it to Target, Kmart, Bed, Bath & Beyond, etc. and achieving higher profit margins and taking market share from you. Other risks include the product not selling at WalMart and you have lost the ability to sell your product elsewhere. You may not be able to keep up with the demand created by WalMart and WalMart terminates your contract. Not only have you lost your good standing with WalMart, other retailers will know that your item failed at retail and will be hesitant to work with you. Or, the profit margins are so small, that you have trouble managing the finances of your company.
Other examples of vertical restraints include: distribution of movies, whereas movies are shown in select movie locations; Apple only allows iPods to be sold in certain locations; or Kohler allows their products to be sold by select distributors. There are numerous examples of vertical restraints, but these are just a few. Lastly, there is the question of whether allowing only one distributor to sell a product constitutes a monopoly. However, given the large number of vertical restraints in various industries, it is clearly beneficial to the success of companies worldwide.
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