Intel, Market Development Funds, and Distributors

Tim Smith, PhD, June 2006

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If you want to frustrate a bootstrapped entrepreneur, tell them to pay for their distributors’ advertising. Then, to really get them confused, tell them that it is cost efficient. This may be what advising entrepreneurs in Market Development Funds is like, but no one said good advice and popular advice were the same.

In this article, we will explore the practice of Market Development Funds (MDF), the strategy behind them, and their economics. After establishing a common understanding of market development funds, we will then turn to a case study of Intel which reveals why Market Development Funds served Intel well in the past and why they fail to achieve the same results today.

Basics of Market Development Funds
Market Development Funds (MDF) should primarily be considered as a form of market communications. As with most marketing communication efforts, the goal is to stimulate demand and facilitate demand fulfillment. In its simplest form, MDFs pay the distributors to advertise products and services of the originating company alongside the distributors.

Market communications derived from MDFs usually convey two key pieces of informational: what to buy and where to buy it. The “what to buy” advertises the product or service of the originating company. The “where to buy” advertises the location or contact details of the distributor.

Beyond these commonalities, companies have varying conditions for determining when payments are made and the amount of support to be provided in their MDF program.

Below are some clarifying examples of MDF programs:

• For broadly marketed items, MDFs often defray the cost of periodical, billboard, or broadcast advertisements which feature the product of the originating company along with the distributor’s location or contact details.
• For well targeted and identifiable markets, MDFs often support a direct mail campaign where the mailer features the product of the originating company and the contact details of the distributor.
• For specialized markets, MDFs often defray the cost of their distributors’ conference exhibitions. Industry conference MDF programs vary from providing a small payment in exchange for displaying the originating company’s logo on the booth to providing everything short of the travel and lodging arrangements with the expectation that the Distributors will fully represent the brand.

Companies place restrictions on MDF participation according to their tactical and strategic needs. Tactically, not all market communications are effective and, as such, a company should wisely restrict the disbursement of MDFs to efforts which are likely to succeed in driving sales. Tactical requirements define the types of market communications that are supported and the way in which the product or service must be positioned. Strategically, MDF participation may be limited to specific activities, markets, products, and brand messages in order to drive focused changes in the industry landscape or customers’ perceptions.

Because of the myriad of means to execute marketing communications and the necessary limitations on MDF budgets, management approval is commonly required for each MDF supported activity.

Strategy of Market Development Funds
The strategic value of MDFs over other forms of advertising derives from the value of partnering with distributors.

Fundamentally, MDFs acknowledge that both the originating company and the distributor have a shared need to create and fulfill customer demand and that each holds different pieces of information that customers require in order to make a purchase. Beyond these basic facts, MDFs stem from the belief that both the company and the distributor can achieve their business goals more efficiently by working together.

By implementing a MDF program, the originating company shifts the dialogue with its distributors from one solely focused on negotiating the price, volume, and contract terms towards one focused on satisfying end-customer needs. In analogy, MDFs encourage distributors to fight less over the size of their slice of pie and fight more over growing the size of the pie so that there will be more to go around.

There are three easily identifiable sources of unique value to partnering with distributors in a MDF program. The primary source of value has already been discussed, that is, that MDF advertisements tell customers where to get the brand they desire. The following two relate to efficiencies gained by placing responsibilities upon the party most able to yield a positive outcome:

• Efficiencies Gained from Leveraging Domain Expertise: By allocating funds to distributors to use on the company’s behalf, MDF programs give the responsibility of identifying strong communication vehicles to the organization better positioned to make informed decisions. While the originating company may hold better information regarding national or broad market communication vehicles, distributors often hold better local knowledge. This local knowledge originates from their position downstream in the value chain. Distributor’s domain expertise may mean a better understanding of local periodicals and trade shows and usually means better contact information about potential customers.
• Synergies Gained from Coordinating Efforts: Through MDF programs, companies and their distributors coordinate the market communications variables of timing, message, and medium. By doing so, there is a reduced likelihood of advertising items that are in low supply or advertising excessively to the same market or in the same forum.

Economics and Market Development Funds
Like any other advertising related effort, the economic value of Market Development Funds (MDF) derives from the increased profits a company gains by stimulating demand. We can graph the concept of stimulating demand using standard microeconomics arguments with the assumption that the demand curve facing the originating company has a nonzero elasticity of demand, i.e., it is not flat.

As depicted in the graph, stimulating demand means shifting the demand curve outward. The outward shift in demand should result in either increased volumes, prices, or both. And, for any well run company, price and/or volume increases lead to gross profits increases.

In order for the MDF effort to be in the company’s best interest, it only needs to deliver an increase in gross profits greater than the cost of running the MDF program, assuming all else is unchanged. Mathematically, we can write this requirement as:

As long as this condition is met, then a MDF program is in the interest of the originating company.

Intel and Market Development Funds in the 1990’s
In the 1990’s, the above conditions held true for Intel. Advertising in general helped Intel capture a large share of the growing computer market. By coordinating the market communication task and sharing the cost with PC manufactures, Intel was able to stimulate demand and expand the market at a quickened pace.

Intel’s own advertising campaign featuring dancing workers in colored clean-room suits generated comfort and trust in the computer industry in general, and with Intel specifically. By combining Intel’s unilateral advertising efforts with those of the PC makers through the “Intel Inside” logo and associated MDF programs, Intel was able to further signal to end-customers that the brand they wanted to trust is in the computer they wanted to buy. As a result, Intel sold more processors and computer makers sold more PCs, and all parties profited from the arrangement.

From an industry structure viewpoint, Intel’s MDF program also helped them gain negotiating power over the downstream PC makers. To see how this worked, we can conduct a standard supply chain management analysis. In managing the supply chain, executives consider the inputs of production on a two dimensional grid, according to Scarcity and Importance. Items that are scarce and important are clearly strategically important, as opposed to items which are neither scarce nor critical and are consequently best classified as commodities.

From this analytical framework, it is overwhelmingly clear that Intel and their microprocessors were strategically critical to PC makers in the 1990’s. Demand often threatened to outstrip supply, thus driving the latest versions of Intel’s chips into scarcity. Not only could few companies make a microprocessor that would run the Microsoft operating systems well, but also, Intel’s marketing effort resulted in end-customers demanding computers with Intel microprocessors. End-customer demand went specifically towards Intel due to their comfort with the Intel brand and their fears, uncertainties, and doubts about the new technology in general.

Given the obvious strategic importance of Intel to PC makers, Intel was positioned to reverse the standard supply chain management paradigm of PC manufacturers so that instead of being treated as a supplier, Intel could treat them as distributors.

And that is exactly what they did. Intel drafted the terms and conditions for using their brands on the products of PC manufacturers. Then, they co-opted them into helping Intel expand the market and accelerate overall demand growth.

Intel and Market Development Funds Today
Recently, the game has been shifting for Intel. Intel’s prized position as strategically critical to their suppliers has been challenged by a number of developments, all of which can be related to an underlying fact: the computer industry is maturing.

As a more mature industry, the end-customers are more concerned with replacing an ailing or inadequate machine than they are with making their first purchase in the industry. Experience has reduced end-customers’ fears and uncertainties and heightened their demand for performance. As such, the importance of developing a brand position that overcomes these fears is reduced. For Intel, this translates into a reduced brand value from the once lofty position in the heavens to a more terrestrial, but still strong position.

Furthermore, growth rates in a more mature industry are, by definition, lower than they are in a young, developing industry. Hence, advertising is less able to stimulate demand in general. Consequently, MDF programs are less effective in raising either prices or volumes by pushing the demand curve out. For Intel and its partners in the PC manufacturing industry, this means that the value of their advertising and MDF programs has been reduced.

Increased competition always accompanies the maturing of an industry. There too, Intel has been suffering lately. AMD, a longtime competitor, has been chipping away at Intel’s lead for years, and now is a force to be reckoned with.

• AMD has had recent success in the server market, a market dominated by business customers rather than household customers, where price-to-performance ratios have a relatively greater weight than brands do in guiding purchase decisions.
• AMD has been able to consistently close the technical gap between their products and Intel’s, to the point that AMD clearly leads in some aspects of the technology, while Intel maintains their lead in others.
• AMD has led in shifting the paradigm away from measuring processor performance according to clock speed towards measuring performance in terms of power consumption. At this point in the industry’s development, processor power consumption metrics often have financial and usability consequences greater than computing speed in laptop and server markets.
• AMD, like Intel, has been able to bring on more capacity to reduce hiccups in the supply chain, thus reducing scarcity.

Combined, these facts help to explain the reasons for the recent grumblings about Intel’s MDF program. It is not that Intel’s MDF program is fundamentally flawed, but rather that its position of dominance in the industry has been weakened. Issues of scarcity and importance remain between Intel and PC makers, but the relative scarcity and relative importance of Intel has been reduced.

The current discussions concerning Intel’s MDF programs are an outgrowth of the overall change in the industry structure. Even the recent lawsuits filed in the EU concerning their MDF program are doubtful to result in any significant damages for Intel. Rather this and other skirmishes reflect a shift taking place between Intel and other industry participants, both competitors and PC makers. The change is that Intel’s ability to unilaterally call the shots is eroding.

Even though Intel’s MDF program is not as useful today for Intel as it was a decade ago, it is still useful.

Intel’s MDF programs remain useful today for the same reasons they always were. They leverage the domain expertise of the PC makers concerning the markets they serve. They create synergies in managing marketing communications, supplies, and forums. Most fundamental of all, they tell end-customers where to get the brand they want.

Conclusion
As Intel comes out of the heavens and back into the troposphere, their MDF program should be scaled back, but not scrapped. By comparing the Intel case study to the underlying strategy, economics, and features of MDF programs in general, we can see that MDF programs continue to provide value to Intel and its partners, but less value than it did in the heyday of the 1990’s. As executives charged with leading our own ships, we can take from this case an understanding of why companies and entrepreneurs should sometimes pay their distributors to advertise on their behalf.

But neither our intellectual edification, the clarification of the efficacy of MDF programs, nor the obvious industry dynamics of the PC market are of much comfort to Paul Ortellini, CEO of Intel. Rather, I suspect Mr. Ortellini is more concerned about creating a leaner, more focused Intel similar to Mr. Zander’s Motorola, rather than making much ado about nothing.

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References
1.  “Intel Inside”, The Economist, April 15th, 2006, p. 66.
2.  Don Clark, “AMD Swings to Profit In Its Advance on Rival Intel”, Wall
     Street Journal, April 13, 2006, p. A3.
3.  Don Clark, “As Intel Slips, Smaller AMD Makes Strides”, Wall Street
     Journal, April 21, 2006, p. B1.
4.  Don Clark, “Intel Launches Brand Targeting Corporate Market Vital to
     AMD”, Wall Street Journal, April 25, 2006, p. B4.
5.  Don Clark, “Intel Promises Sweeping Overhaul Amid PC Slowdown,
     Rival’s Gains”, Wall Street Journal, April 28, 2006, p. A1.
6.  “AMD to Sell Chips Using Less Power for a Higher Price”, Wall Street
     Journal, May 16, 2006, p. B4.
7.  “AMD Details Next-Generation Chip Design”, Wall Street Journal, May
     17, 2006, p. A14.
8.  Don Clark and Christopher Lawton, “Dell to Use AMD Chips in Some
     Servers”, Wall Street Journal, May 19, 2006, p. A3.
9.  “Not Paranoid Enough”, The Economist, May 27th, 2006, p. 58.
10. Don Clark, “AMD’s German Chip Output to Grow with $2.5 Billion Plan”,
       Wall Street Journal, May 30, 2006, p. B2.
11. “AMD Set to Launch Media-Oriented PCs”, Wall Street Journal, May 31,
       2006, p. B2.
12. Don Clark, “AMD to License Technology to Other Chip Makers”, Wall
       Street Journal, June 2, 2006, p. A15.

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Author
Tim Smith, PhD, Editor in Chief of The Wiglaf Journal and Adjunct Professor of Marketing at DePaul University.

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