8.3: Demand Analysis

8.3.1: The Demand Curve

Learning Objective

Define the demand curve

Key Points

• Demand does not only have to do with the need to have a product or a service, but it also involves the willingness and ability to buy it at the price charged for it.
• The demand curve for all consumers together follows from the demand curve of every individual consumer. The individual demands at each price are added together.
• The negative slope of the demand curve is often referred to as the “law of demand,” which means people will buy more of a service, product, or resource as its price falls.

Key Terms

derived demand

when demand for a factor of production or intermediate good occurs as a result of the demand for another intermediate or final good

Giffen good

A good which people consume more of as the price rises; Having a positive price elasticity of demand. As price rises, more is consumed which increases demand.

Veblen good

A good for which people’s preference for buying them increases as a direct function of their price, as greater price confers greater status. As the price gets higher, demand rises.

straight rebuy

the repurchase of a good with no changes to the details of the order

Example

• Demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances. Thus, any circumstance that affects the consumer’s willingness or ability to buy the good or service in question can be a non-price determinant of demand. For example, weather could effect the demand for beer at a baseball game.

Demand

When clients want a product and are willing to pay for it, we say that there is a demand for the specific product. There has to be a demand for a product before a manufacturer can sell it. Demand does not only have to do with the need to have a product or a service, but also with the willingness and ability to buy it at the price charged for it.

Example of Demand: Andrew’s Grape Jam

Andrew and his mother, Mrs. Jeffries, decided to earn extra money by selling grape jam at the local craft market. Mrs. Jeffries would buy the ingredients and make the jam. Andrew would help his mother seal it in jars and they planned to sell it at the market on Saturday mornings.

Before starting to boil the jam, they decided to test the market to see whether people would be interested in buying their product. Mrs. Jeffries therefore boiled a few jars of jam and asked their friends and family if they were interested in buying it and how much they would be willing to pay for it. Everyone was encouraged to taste some of the jam before making a decision.

The results Mrs. Jeffries received is are illustrated in the graph which indicates the demand at different prices.

Demand Curve

This graph shows the demand curve based on the number of jars and the price.

The line on the graph indicates the way in which the change in price brought about a change in demand. This is referred to as the demand curve. It specifies the amount of a product according to the demands for it at a specific price.

Demand Curve

In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity (in this case Andrew’s jam) and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule.

The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together.

Demand Curve Characteristics

According to convention, the demand curve is drawn with price on the vertical axis and quantity on the horizontal axis. The demand curve usually slopes downwards from left to right; that is, it has a negative association (two theoretical exceptions, Veblen good and Giffen good). The negative slope is often referred to as the “law of demand”, which means people will buy more of a service, product, or resource as its price falls.

Linear Demand Curve

The demand curve is often graphed as a straight line in the form Q = a – bP where “a” and “b” are parameters. The constant “a” “embodies” the effects of all factors, other than price, that affect demand.

If income were to change, for example, the effect of the change would be represented by a change in the value of “a” and be reflected graphically as a shift on the demand curve. The constant “b” is the slope of the demand curve and shows how the price of the good affects the quantity demanded.

The graph of the demand curve uses the inverse demand function in which price is expressed as a function of quantity. The standard form of the demand equation can be converted to the inverse equation by solving for P or P = a/b – Q/b.

Shift of a Demand Curve

The shift of a demand curve takes place when there is a change in any non-price determinant of demand, resulting in a new demand curve.

Non-price determinants of demand are those things that cause demand to change even if prices remain the same—in other words, changes that might cause a consumer to buy more or less of a good even if the good’s price remained unchanged.

Some of the more important factors are:

• the prices of related goods (both substitutes and complements)
• income
• population
• expectations

However, demand is the willingness and ability of a consumer to purchase a good under the prevailing circumstances. Thus, any circumstance that affects the consumer’s willingness or ability to buy the good or service in question can be a non-price determinant of demand. For example, weather could effect the demand for beer at a baseball game.

8.3.2: The Influence of Supply and Demand on Price

Learning Objective

Apply the basic laws of supply and demand to different economic  scenarios

Key Points

• There are four basic laws of supply and demand.
• Since determinants of supply and demand other than the price of the good in question are not explicitly represented in the supply-demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as “shifts” in the curves).
• Responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Key Term

equilibrium price

The price of a commodity at which the quantity that buyers wish to buy equals the quantity that sellers wish to sell.

Example

• Consider a certain commodity, such as gasoline. If there is a strong demand for gas, but there is less gasoline, then the price goes up. If conditions change and there is a smaller demand for gas, due to the presence of more electric cars for instance, then the price of the commodity decreases.

Introduction

The amount of a good in the market is the supply and the amount people want to buy is the demand. Consider a certain commodity, such as gasoline. If there is a strong demand for gas, but there is less gasoline, then the price goes up. If conditions change and there is a smaller demand for gas, due to the presence of more electric cars for instance, then the price of the commodity decreases.

The factors influencing supply include:

• Price – As the price of a product rises, its supply rises because producers are more willing to manufacture the product because it’s more profitable.
• Price of other commodities – There are two types: competitive supply (If a producer switches from producing A to producing B, the price of A will fall and hence the supply will fall because it’s less profitable to make A), and joint supply (A rise in one product may cause a rise in another. For instance, a rise in the price of wooden bedframes may cause a rise in the price of wooden desks and chairs. This means supply of wooden bedframes, chairs, and desks will rise because it’s more profitable. )
• Costs of production – If production costs rise, supply will fall because the manufacture of the product in question will become less profitable.
• Change in availability of resources – If wood becomes scarce, fewer wooden bedframes can be made, so supply will fall.

Factors influencing demand include:

• Income
• Tastes and preferences
• Prices of related goods and services
• Consumers’ expectations about future prices and incomes that can be checked
• Number of potential consumers

Supply and Demand As an Economic Model

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price). This results in an economic equilibrium of price and quantity.

The four basic laws of supply and demand are:

• If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
• If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
• If demand remains unchanged and supply increases, then it leads to lower equilibrium price and higher quantity.
• If demand remains unchanged and supply decreases, then it leads to higher equilibrium price and lower quantity.

Graphical Representation of Supply and Demand

Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Since determinants of supply and demand other than the price of the good in question are not explicitly represented in the supply-demand diagram, changes in the values of these variables are represented by moving the supply and demand curves (often described as “shifts” in the curves). By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply and Demand

The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D).
The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

A graph the plots the supply and demand for a product based on the price, supply, demand, and quantity sold.

Equilibrium

Since the demand curve slopes down and the supply curve slopes up, when they are put on the same graph, they eventually cross one another. The point where the supply line and the demand line meet is called the equilibrium point.

In general, for any good, it is at this point that quantity supplied equals quantity demanded at a set price. If there are more buyers than there are sellers at a certain price, the price will go up until either some of the buyers decide they are not interested, or some people who were previously not considering selling decide that they want to sell their good. This process normally continues until there are sufficiently few buyers and sufficiently many sellers that the numbers balance out, which should happen at the equilibrium point.

8.3.3: Elasticity of Demand

Learning Objective

Identify the key factors that determine the elasticity of demand for a good

Key Points

• Price elasticities are almost always negative; only goods which do not conform to the law of demand, such as a Veblen good and a Giffen good, have a positive PED.
• In general, the demand for a good is said to be inelastic (or relatively inelastic) when changes in price have a relatively small effect on the quantity of the good demanded.
• The demand for a good is said to be elastic (or relatively elastic) when changes in price have a relatively large effect on the quantity of a good demanded.
• A number of factors can thus affect the elasticity of demand for a good.

Key Terms

Giffen good

A good which people consume more of as the price rises; Having a positive price elasticity of demand. As price rises, more is consumed which increases demand.

conjoint analysis

Conjoint analysis is a statistical technique used in market research to determine how people value different features that make up an individual product or service.

Veblen good

A good for which people’s preference for buying them increases as a direct function of their price, as greater price confers greater status. As the price gets higher, demand rises.

Example

• In general, the more substitues there are for a product, the more elastic it is. For instance, one can get their morning juice from products other than cranberry juice. So if the price of cranberry juice were to increase by $0.25 people would drink a substitute, like apple juice, instead. Cranberry juice, therefore, is an elastic good because a change in price will cause large decrease in demand.

Elasticity of Demand: an Overview

Price elasticity of demand (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price.

More precisely, it gives the percentage change in quantity demanded in response to a one percent change in price (holding constant all the other determinants of demand, such as income). It was devised by Alfred Marshall.

Elasticity of Demand

The price elasticity of demand equation shows how the demand for a good or service changes based on the price.

Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as a Veblen good and a Giffen good, have a positive PED.

In general, the demand for a good is said to be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is, changes in price have a relatively small effect on the quantity of the good demanded.

The demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one (in absolute value): that is, changes in price have a relatively large effect on the quantity of a good demanded.

Revenue is maximized when price is set so that the PED is exactly one. The PED of a good can also be used to predict the incidence (or “burden”) of a tax on that good. Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data, and conjoint analysis.

Determinants

The overriding factor in determining PED is the willingness and ability of consumers after a price change to postpone immediate consumption decisions concerning the good and to search for substitutes (“wait and look”). A number of factors can thus affect the elasticity of demand for a good:

• Availability of substitute goods: The more and closer the substitutes available, the higher the elasticity is likely to be, as people can easily switch from one good to another if an even minor price change is made. In other words, there is a strong substitution effect. If no close substitutes are available, the substitution of effect will be small and the demand inelastic.
• Breadth of definition of a good: The broader the definition of a good (or service), the lower the elasticity. For example, Company X’s fish and chips would tend to have a relatively high elasticity of demand if a significant number of substitutes are available, whereas food in general would have an extremely low elasticity of demand because no substitutes exist.
• Percentage of income: The higher the percentage of the consumer’s income that the product’s price represents, the higher the elasticity tends to be, as people will pay more attention when purchasing the good because of its cost. The income effect is thus substantial. When the goods represent only a negligible portion of the budget, the income effect will be insignificant and demand inelastic.
• Necessity: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as in the case of insulin for those that need it.
• Duration: For most goods, the longer a price change holds, the higher the elasticity is likely to be, as more and more consumers find they have the time and inclination to search for substitutes. When fuel prices increase suddenly, for instance, consumers may still fill up their empty tanks in the short run, but when prices remain high over several years, more consumers will reduce their demand for fuel by switching to carpooling or public transportation, investing in vehicles with greater fuel economy, or taking other measures. This does not hold for consumer durables such as the cars themselves, however; eventually, it may become necessary for consumers to replace their present cars, so one would expect demand to be less elastic.
• Brand loyalty: An attachment to a certain brand—either out of tradition or because of proprietary barriers—can override sensitivity to price changes, resulting in more inelastic demand.
• Who pays: Where the purchaser does not directly pay for the good they consume, such as with corporate expense accounts, demand is likely to be more inelastic.

8.3.4: Yield Management Systems

Learning Objective

Understand the purpose of projecting demand changes, and varying prices to capture opportunities

Key Points

• Yield management systems are predicated on the idea that demand is not consistent over time for certain types of products and services. Predicting shifts in demand will therefore provide potential value to the organization.
• By accurately predicting changes in demand over time or over consumer groups, organizations can produce a profit-maximizing pricing strategy through varying price points with demand.
• Yield management is a multidisciplinary field, which requires buy in from financiers, accountants, marketers, strategists and often technical specialists in big data. 
• Knowing when to use yield management and when not to is an important strategic decision. Goods that are perishable, scarce, and which have a high fluctuation in willingness to pay are ideal for this model.
• There are ethical concerns revolving around yield management however, as charging individuals based on their ability to pay and overall demand could be as exploitation.

Key Term

yield management

The marketing strategy of identifying variance in demand, and aligning pricing strategies to maximizing profits.

Estimating Demand

When an organization begins determining the price of a given product or service, the objective is to optimize profit through maximizing revenues and minimizing cost. To do so, projections of demand and fulfilling that projected demand with the appropriate supply to maintain the optimal price point is a central strategic endeavor for a marketer. Forecasting demand and understanding the elasticity of the demand for various types of goods is greatly empowered by systems built to manage yield.

Demand Shifts

Understanding fluctuations in demand is a critical component of yield management systems. 

A graph that the plots the supply and demand for a product based on the price, supply, demand, and quantity sold.

Yield Management Systems

A yield management system is based on pricing models which are variable, which is to say that the price of a given product or service will change consistently over time. A good example of this, just as a frame of reference, would be a flight ticket. The prices for a flight from city A to city B will be different per day, per time, per airline and even per website in which you are finding that ticket. This variable pricing model is designed to maximize revenue through identifying supply, demand and optimal yield.

When To Manage Yield

Yield management is quite a complex endeavor, as it takes into account multidisciplinary considerations such as marketing, operations, financial management, statistics, and strategy to build an optimized approach to pricing which iterates and evolves over time. As a result, it is only worth building into practice when it will generate significant returns.

Yield management functions best when the following conditions are met:

•  There are a fixed amount of a given resource available (i.e. scarcity)
• The resources are perishable, or time-sensitive in some way
• There is a relatively high amount of fluctuation in regards to what consumers are willing to pay

Combining these three factors, we have scarce products which will likely expire and which are valued differently by different consumers. In these situations, managing yield through pricing properly based on timing and user can optimize profits.

Big Data

Effective yield management, like most intensive research projects, are best left to computers. Machine learning and the capacity to process large data streams (i.e. big data) can create highly reliable statistical models and segmentation of markets to enable an organization to target the appropriate consumer groups with the appropriate price at the appropriate time. This is generally accomplished through building forecasts utilizing huge data streams of past user behaviors. 

For example, the price of a flight on a given day can take into account he day of the week, time of year, inflation, market conditions, competitive current pricing, and a wide variety of other data points in order to create a statistical spread of what the price should be set at.

Ethical Concerns

Yield management systems are very useful in specific industries, but are also somewhat controversial. The criticism of yield management is fairly intuitive. If companies can set prices based upon what type of consumer you are, and can identify demand with great accuracy, it is fairly easy for organizations to exploit consumers in specific situations. 

For example, say you are stranded in a foreign country after flight cancellations, and need to get home to your two young children. You are there on business, and have an upper-middle class salary. A machine with all of that information can accurately predict that you are willing to pay a great deal more than someone else due to your dire situation. It would not be inaccurate to point out that this is somewhat predatory, and therefore potentially unethical behavior. You may pay thousands for the seat, while the person next to you paid less than 10% of what you paid.

8.4: Inputs to Pricing Decisions

8.4.1: Marginal Analysis

Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs.

Learning Objective

Identify the characteristics of a marginal price analysis relative to pricing decision making

Key Points

• Firms tend to accomplish their objective of profit maximization by increasing their production until marginal revenue equals marginal cost.
• At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit.
• In some cases, a firm’s demand and cost conditions are such that marginal profits are greater than zero for all levels of production up to a certain maximum; thus, output should be produced at the maximum level.

Key Terms

demand curve

The graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price.

game theory

A branch of applied mathematics that studies strategic situations in which individuals or organizations choose various actions in an attempt to maximize their returns.

Marginal Analysis

Pricing decisions tend to heavily involve analysis regarding marginal contributions to revenues and costs. Specifically, firms tend to accomplish their objective of profit maximization by increasing their production until marginal revenue equals marginal cost, and then charging a price which is determined by the demand curve.

In business, the practice of setting the price of a product to equal the extra cost of producing an extra unit of output is known as marginal-cost pricing. Businesses often set prices close to marginal cost during periods of poor sales. If, for example, an item has a marginal cost of $1.00 and a normal selling price of $2.00 the firm selling the item might wish to lower the price to $1.10 if demand has waned. The business would choose this approach because the incremental profit of 10 cents from the transaction is better than no sale at all.

In the marginal analysis of pricing decisions, if marginal revenue is greater than marginal cost at some level of output, marginal profit is positive and thus a greater quantity should be produced. Alternatively, if marginal revenue is less than the marginal cost, marginal profit is negative and a lesser quantity should be produced. At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit.

Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero.

The intersection of MR and MC is shown as point A. If the industry is perfectly competitive (as is assumed in the diagram), the firm faces a demand curve (D) that is identical to its marginal revenue curve (MR). Thus, this is a horizontal line at a price determined by industry supply and demand. If the firm is operating in a non-competitive market, changes would have to be made to the diagram.

Marginal Profit Maximization

This series of cost curves shows the implementation of profit maximization using marginal analysis.

A cost curve that shows how businesses set prices based on demand.

For example, the marginal revenue curve would have a negative gradient, due to the overall market demand curve. In a non-competitive environment, more complicated profit maximization solutions involve the use of game theory. In some cases, a firm’s demand and cost conditions are such that marginal profits are greater than zero for all levels of production up to a certain maximum. In this case, marginal profit plunges to zero immediately after that maximum is reached. Thus, output should be produced at the maximum level, which also happens to be the level that maximizes revenue. In other words, the profit maximizing quantity and price can be determined by setting marginal revenue equal to zero, which occurs at the maximal level of output.

8.4.2: Fixed Costs

Fixed costs are business expenses that are not dependent on the level of goods or services produced by the business.

Learning Objective

Describe the characteristics of fixed costs and they relate to pricing decisions

Key Points

• The distinction between fixed and variable costs is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns.
• Fixed costs are not permanently fixed – they will change over time – but are fixed in relation to the quantity of production for the relevant period.
• Average fixed cost (AFC) is an economic term that refers to fixed costs of production (FC) divided by the quantity (Q) of output produced.

Key Terms

lease

A contract granting use or occupation of property during a specified period in exchange for a specified rent.

discretionary

Available at one’s discretion; able to be used as one chooses; left to or regulated by one’s own discretion or judgment.

Fixed Costs

Determining the cost of producing a product or service plays a vital role in most pricing decisions. Fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month. They and are often referred to as overhead costs. This is in contrast to variable costs, which are volume-related and are paid per quantity produced. In management accounting, fixed costs are defined as expenses that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales. In marketing, it is necessary to know how costs divide between variable and fixed. This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns. In a survey of nearly 200 senior marketing managers, 60% responded that they found the “variable and fixed costs” metric very useful.

Fixed Costs and Variable Costs

The graph breaks down the difference between fixed costs and variable costs.

A graph that shows how fixed costs and variable costs impact total costs.

Fixed costs are not permanently fixed – they will change over time – but are fixed in relation to the quantity of production for the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production. Warehouse costs and the like are fixed only over the time period of the lease. By definition, there are no fixed costs in the long run. Investments in facilities, equipment, and the basic organization that can’t be significantly reduced in a short period of time are referred to as committed fixed costs. Discretionary fixed costs usually arise from annual decisions by management to spend on certain fixed cost items. Examples of discretionary costs are advertising, machine maintenance, and research and development expenditures.

Average Fixed Costs

For pricing purposes, marketers generally take into account average fixed costs. Average fixed cost (AFC) is an economics term that refers to fixed costs of production (FC) divided by the quantity (Q) of output produced . Average fixed cost is a per-unit-of-output measure of fixed costs. As the total number of goods produced increases, the average fixed cost decreases because the same amount of fixed costs is being spread over a larger number of units of output.

8.4.3: Break-Even Analysis

The break-even point is the point at which costs and revenues are equal.

Learning Objective

Analyze the concept of break even points relative to pricing decisions

Key Points

• In the linear Cost-Volume-Profit Analysis model, the break-even unit of sales can be directly computed in terms of total revenue and total costs.
• Unit contribution margin is the marginal profit per unit, or alternatively the portion of each sale that contributes to fixed costs.
• Break-even analysis is a simple and useful analytical tool, yet has a number of limitations as well.

Key Terms

break-even point

The point where total costs equal total revenue and the organization neither makes a profit nor suffers a loss.

Opportunity Costs

The costs of activities measured in terms of the value of the next best alternative forgone (that is not chosen).

Break-Even Analysis

In economics and business, specifically cost accounting, the break-even point is the point at which costs or expenses and revenue are equal – i.e., there is no net loss or gain, and one has “broken even.” 

A profit or a loss has not been made, although opportunity costs have been “paid,” and capital has received the risk-adjusted, expected return. For example, if a business sells fewer than 200 tables each month, it will make a loss. If the business sells more, it will make a profit. With this information, the business managers will then need to see if they expect to be able to make and sell 200 tables per month. If they think they cannot sell that many, to ensure viability they could:

• Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of telephone bills or other costs)
• Try to reduce variable costs (the price it pays for the tables by finding a new supplier)
• Increase the selling price of their tables

In the linear Cost-Volume-Profit Analysis model, the break-even point – in terms of Unit Sales (X) – can be directly computed in terms of Total Revenue (TR) and Total Costs (TC) as: where TFC is Total Fixed Costs, P is Unit Sale Price, and V is Unit Variable Cost. The quantity (P – V) is of interest in its own right, and is called the Unit Contribution Margin (C). It is the marginal profit per unit, or alternatively the portion of each sale that contributes to Fixed Costs. Thus the break-even point can be more simply computed as the point where Total Contribution = Total Fixed Cost:

Break-Even Analysis 

A break-even quantity can also be found using contribution margin.

A break-even analysis where the total number of units equals the total fixed costs divided by the unit contribution.

Break-Even Calculation

We can derive the calculation for the break-even quantity from the relation of total revenue to total costs.

Break-Even and Pricing Decisions

The break-even point is one of the simplest analytical tools in management. It helps to provide a dynamic view of the relationships between sales, costs, and profits. A better understanding of break-even, for example, is expressing break-even sales as a percentage of actual sales. This can give managers a chance to understand when to expect to break even (by linking the percent to when in the week/month this percent of sales might occur). In terms of pricing decisions, break-even analysis can give a company a benchmark quantity of goods to be sold. This quantity can then be used to derive the average fixed and variable costs, the sum of which can be used as the basis for markup pricing, et cetera. Some limitations of break-even analysis include:

• It is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.
• It assumes that fixed costs (FC) are constant. Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.
• It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales (i.e. linearity).
• It assumes that the quantity of goods produced is equal to the quantity of goods sold.
• In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).

8.4.4: Organizational Objectives

For the vast majority of business entities, the ultimate objective should be to increase profits, often through a better pricing strategy.

Learning Objective

Illustrate how an organization’s objectives impact its pricing decisions

Key Points

• A business can cut its costs, it can sell more, or it can find more profit with a better pricing strategy.
• When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable.
• A pivotal factor in determining a price is how consumers will perceive it.

Key Term

viable

Able to be done, possible.

Organizational Objectives

For the vast majority of business entities, the ultimate objective should be to increase profits. Pricing strategies for products or services encompass three main ways to achieve this. A business can cut its costs, it can sell more, or it can find more profit with a better pricing strategy.

When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable. Merely raising prices is not always the answer, especially in a poor economy. Too many businesses have been lost because they priced themselves out of the marketplace. On the other hand, too many business and sales staff leave “money on the table. ” The objective is to adopt a pricing strategy and manage costs such that profit will be maximized.

One strategy does not fit all, so adopting a pricing strategy is a learning curve when studying the needs and behaviors of customers and clients.

Laws Of Price Sensitivity

A pivotal factor in determining a price is how consumers will perceive it. In their book,The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine “laws” that influence how a consumer perceives a given price and how price-sensitive they are likely to be with respect to different purchase decisions. They are:

1. Reference price effect – The buyer’s price sensitivity for a given product increases the higher the product’s price relative to perceived alternatives. Perceived alternatives can vary by buyer segment, by occasion, and other factors.
2. Difficult comparison effect – Buyers are less sensitive to the price of a known or more reputable product when they have difficulty comparing it to potential alternatives.
3. Switching costs effect – The higher the product-specific investment a buyer must make to switch suppliers, the less price sensitive that buyer is when choosing between alternatives.
4. Price-quality effect – Buyers are less sensitive to price the more that higher prices signal higher quality. Products for which this effect is particularly relevant include: image products, exclusive products, and products with minimal cues for quality.
5. Expenditure effect – Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
6. End-benefit effect – This effect refers to the relationship a given purchase has to a larger overall benefit and is divided into two parts. Derived demand: The more sensitive buyers are to the price of the end benefit, the more sensitive they will be to the prices of those products that contribute to that benefit. Price proportion cost: The price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps to produce the end benefit, such as with computers. The smaller the given component’s share of the total cost of the end benefit, the less sensitive buyers will be to the component’s price.
7. Shared-cost effect – The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
8. Fairness effect – Buyers are more sensitive to the price of a product when the price is outside the range they perceive as “fair” or “reasonable” given the purchase context.
9. The framing effect – Buyers are more price sensitive when they perceive the price as a loss rather than a forgone gain, and they have greater price sensitivity when the price is paid separately rather than as part of a bundle.

Oil Price Sensitivity

The graph shows the price fluctuation of oil after consumers have significant access to information regarding the commodity.

8.4.5: Other Inputs to Pricing Decisions

Pricing decisions can have a variety of inputs, such as value-added considerations, legal price requirements, competitive positioning, and discounting.

Learning Objective

List a few of the key considerations to pricing aside from simple expense-oriented break-even analyses

Key Points

• Pricing is an important decision, as it impacts both profitability and competitive positioning.
• One particularly important pricing consideration are the legal requirements in some industries (price floors and ceilings). For example, rent-controlled housing will have price limitations an organization will have to adhere to.
• Functional value, social value, monetary value, and psychological value should all be taken into consideration when setting prices.
• Differentiation and competitive positioning relative to other industry incumbents is another important pricing consideration. Differentiation can often lead to higher margins (though often lower volume).
• For perishable goods or items which may go out of fashion (technology, clothing, etc.), discounting is a useful way to ensure that the organization gets some capital back for producing it (even if it sells at a loss on a per unit basis).

Key Term

perishable

Liable to perish, especially naturally subject to quick decomposition or decay.

Pricing Decisions

The pricing decision is an important one, both for profitability and competitive positioning. Organizations must take into account supply, demand, competition, expenses, profit margins, differentiation, quality, and legal concerns. The simplest methods of determining price include concepts such as break-even points, fixed/variable cost analysis, and marginal analysis. However, there are other concerns that need to be investigated when determining price.

Pricing Inputs

Looking at cost structures and determining break-even points is not always enough when it comes to effective pricing strategies. As a result, marketers should be familiar with the legalities of pricing (for certain commodities in particular), the value added to the consumer (willingness to pay), competitive positioning, and potential discounts.

Legal Concerns

For some products, governments will set firm price controls (i.e. price ceilings or price floors) to ensure ethical and/or accessible pricing for a given population. Just as the name implies, price floors and price ceilings will set minimum or maximum prices for some goods. This is particularly applicable to rent, real estate, banking, food and other core necessities. When operating in an industry with price ceilings or price floors, firms must adapt their pricing strategy to these legalities and ensure compliance.

Price Ceiling 

When considering pricing decisions, understanding price floors and price ceilings is important. 

A graph that shows the basic economic principles of supply and demand as they relate to the price.

Value-Added Pricing

In a perfectly practical and efficient market, the expenses would almost always lead to the appropriate price through competitive forces. However, we do not live in a world of perfect markets. As a result, there are a number of value-adds that consumers receive that are not easy or intuitive to measure from a strictly financial perspective. These include:

• Functional Value: This is a typical example of demand, where the product is valued at how well it accomplishes a function (i.e. fulfills the need).
• Monetary Value: This is another typical value example, where the cost of resources and production correlate cleanly with the price.
• Social Value: The value a consumer receives can actually be social as well as economic. This is to say that some products provide intangible value to users. Fashion is a good example here, as some fashion items return margins that are enormous due to the social perception of a given fashion item (expensive bags, for example).
• Psychological Value: Some items have value to an individual for personal reasons. A collector, for example, may pay far more than an item is worth due to a strong love for something. People who collect video game action figures, or deluxe editions, for example.

Competitive Positioning

Another input to pricing is the basic premise of differentiation to achieve higher value. This is not so much an exception to the above mentioned value-added pricing, but more of a facet of this. Branded items, for example, are often quite similar to generic versions of the same item. However, these brands add intangible value to the product above and beyond the cost of producing it. Buying brand name goods may be differentiated based upon celebrity sponsors, premium perception, social value or a wide variety of other differentiated factors. These can enable organizations to differentiate for a price premium (i.e. they can charge more for having a strong brand/position).

Discounting

There are also a number of reasons why an organization may offer discounts. Discounting is particularly useful when it comes to B2B transactions, in which a client might buy a few thousand of a given product and receive a wholesale price that is significantly lower than the price of buying each product individually. There are also situations in which a product may be sold at a price that is actually less than the cost of producing it. This is most often done when a perishable item will soon go bad anyway. In such a situation, selling at a loss is better than getting nothing at all (opportunity cost!).

Conclusion

All and all, pricing is a bit more complicated than simply understanding the expenses involve. Marketers must understand social value, legal considerations, branding, discounting, and the functional value of products and services in order to capture the full potential of a given item. Pricing can be a great opportunity to capture better margins than the competition, or could offer the ability to make a mistake and lose market share!

8.5: Pricing Objectives

8.5.1: Survival

Most executives pursue strategies that align pricing with revenue generation, enabling their organizations to survive and thrive long term.

Learning Objective

Name the different factors that impact a company’s success and survival

Key Points

• New and improved products may hold the key to a firm’s survival and ultimate success.
• All business enterprises must earn a long term profit in order to survive in the long run.
• Just as survival requires a long term profit for a business enterprise, profit requires sales. Sales patterns should be altered to ensure success.
• Management of all firms, large and small, are concerned with maintaining an adequate share of the market so their sales volume will enable the firm to survive and prosper. Prices must be set to attract the appropriate market segment in significant numbers.

Key Term

Market Share

The percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.

Example

• Companies like McDonald’s and Starbucks were able to survive the recession by being smart about how they conducted business. The both closed down locations in less-favorable neighborhoods and added more products to their menus.

Survival

Firms rely on price to cover the costs of production, pay expenses, and provide the profit incentive necessary to continue to operate the business. These factors help an organization survive. Most managers pursue strategies that enable their organizations to continue in operation for the long term. Thus, survival is one major objective pursued by company executives. For a commercial firm, the price paid by the buyer generates the firm’s revenue. If revenue falls below cost for a long period of time, the firm cannot survive. Survival is closely linked to new product development, profit, sales, market share, and image.

New Products

For several decades, business has come increasingly to the realization that new and improved products may hold the key to their survival and ultimate success. Consequently, professional management has become an integral part of this process. As a result, many firms develop new products based on an orderly procedure, employing comprehensive and relevant data and intelligent decision-making.The continuing development of a successful new product looms as the most important factor in the survival of the firm.

Profit

Making a $500,000 profit during the next year might be a pricing objective for a firm. Anything less will ensure failure. All business enterprises must earn a long term profit. For many businesses, long term profitability also allows the business to satisfy company stakeholders such as investors, employees, customers, and suppliers. Lower-than-expected or no profits will drive down stock prices and may prove disastrous for the company.

Sales

Just as survival requires a long term profit for a business enterprise, profit requires sales. The task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus, marketing management’s aim is to alter sales patterns in some desirable way.

Market Share

If the sales of Safeway Supermarkets in the Dallas-Fort Worth metropolitan area of Texas account for 30 percent of all food sales in that area, we say that Safeway has a 30 percent market share. Management of all firms, large and small, are concerned with maintaining an adequate share of the market so their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that is significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers.

Image

Price policies play an important role in affecting a firm’s position of respect and esteem in its community. Price is a highly visible communicator. It must convey the message to the community that the firm offers good value, that it is fair in its dealings with the public, that it is a reliable place to patronize, and that it stands behind its products and services.

Surviving the Recession

Pricing plays a significant role in attracting and retaining market share during tough economic times.

A picture of a McDonald’s restaurant.

8.5.2: Profit

If the sole objective of a firm is to maximize profit, there are various profit maximizing pricing methods that can be used.

Learning Objective

Recall formulas for calculating profit maximizing output quantity and marginal profit

Key Points

• In launching new products or considering the pricing of current products, managers often start with an idea of the dollar profit they desire and ask what level of sales will be needed to reach it. This can be done through profit-based sales targets.
• Profit is equal to total revenue (TR) minus total cost (TC). The profit maximizing output is the one at which this difference reaches its maximum. The corresponding price will depend on whether the firm is a perfect competitor. This is the TR-TC method.
• Marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC). If MR is greater than MC at some level of output, marginal profit is positive and thus a greater quantity should be produced. When MR = MC, Mπ is zero and this quantity is the one that maximizes profit.

Key Terms

Total cost

Total cost (TC) describes the total economic cost of production and is made up of variable costs, which vary according to the quantity of a good produced and include inputs such as labor and raw materials, plus fixed costs, which are independent of the quantity of a good produced and include inputs (capital) that cannot be varied in the short term, such as buildings and machinery.

Total Revenue

Total revenue is the total receipts of a firm from the sale of any given quantity of a product.

marginal revenue

Marginal revenue is the additional revenue that will be generated by increasing product sales by one unit.

Profit and Pricing Objectives

Some firms decide to set prices to maximize profits for either the short run or the long run. There are several methods to maximizing profits:

Profit-based Sales Targets

In launching new products or considering the pricing of current products, managers often start with an idea of the dollar profit they desire and ask what level of sales will be needed to reach it. Target volume (#) is the unit sales quantity needed to meet an earnings goal. Target revenue ($) is the corresponding figure for dollar sales. Increasingly, marketers are expected to generate volumes that meet the target profits of their firm. This will often require them to revise sales targets as prices and costs change.

The purpose of profit-based sales target metrics is to ensure that marketing and sales objectives mesh with profit targets. In target volume and target revenue calculations, managers go beyond break-even analysis (the point at which a company sells enough to cover its fixed costs) to determine the level of unit sales or revenues needed to cover a firm’s costs and attain its profit targets.

The Total Cost Method

To obtain the profit maximizing output quantity, you start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. The profit maximizing output is the one at which this difference reaches its maximum. In , the linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market, and thus cannot set its own selling price. The profit maximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB. This output level is also the one at which the total profit curve is at its maximum. If, contrary to what is assumed in the graph, the firm is not a perfect competitor in the output market, the price to sell the product at can be read off the demand curve at the firm’s optimal quantity of output.

Total Profit Maximization

This linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market. As a result, it cannot set its own selling price.

A revenue curve that shows total profit maximization based on total cost and total revenue.

The Marginal Cost Perspective

An alternative perspective relies on the relationship that, for each unit sold, marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater than marginal cost at some level of output, marginal profit is positive and thus a greater quantity should be produced, and if marginal revenue is less than marginal cost, marginal profit is negative and a lesser quantity should be produced. At the output level at which marginal revenue equals marginal cost, marginal profit is zero and this quantity is the one that maximizes profit. Since total profit increases when marginal profit is positive and total profit decreases when marginal profit is negative, it must reach a maximum where marginal profit is zero – or where marginal cost equals marginal revenue – and where lower or higher output levels give lower profit levels.

8.5.3: Return on Investment

Marketers should understand the position of their company and the returns expected when making adjustments in prices.

Learning Objective

Explain why pricing objectives focus on delivering a return on investment (ROI)

Key Points

• Return on investment is one way of considering profits in relation to capital invested.
• Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions.
• ROI provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise.

Key Terms

receivables

All the debts owed to a company by its debtors or customers.

accounts receivable

Accounts receivable refers to the money owed to a business by its clients (customers) and shown on its balance sheet as an asset.

Pricing objectives or goals give direction to the whole pricing process. Determining what your objectives are is the first step in pricing. When deciding on pricing objectives, you must consider:

1. The overall financial, marketing, and strategic objectives of the company

2. The objectives of your product or brand

3. Consumer price elasticity and price points

4. The resources you have available

One of the most common pricing objectives is obtaining a target rate of return on investment (ROI). Return on investment is one way of considering profits in relation to the capital invested. Marketing not only influences net profits but also can affect investment levels, too. New plants and equipment, inventories, and accounts receivable are three of the main categories of investments that can be affected by marketing decisions. Hence, it is important to keep all investments in mind when setting prices. It doesn’t pay to be narrow in focus.

The purpose of the return on investment metric is to measure per period rates of return on dollars invested in an economic entity. For example, this chart shows the rate of return on investments after training teachers. It provides a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise. Marketing decisions, such as setting prices, have obvious potential connection to the return on investment, but these same decisions often influence asset usage and capital requirements (for example, receivables and inventories). Marketers should understand the position of their company and the returns expected. Return on investment is often compared to expected (or required) rates of return on dollars invested.

Return on Investments

The chart shows the rate of return on investments after training teachers.

A chart that shows the return on equity per person over three years after training teachers. It looks at the cost, savings, quality gains, and marketing gains.

8.5.4: Market Share/Sales

Increasing market share is one of the most important objectives of business and pricing may offer a mechanism to increase share.

Learning Objective

Explain the relationship between market share and pricing strategies

Key Points

• Marketers need to be able to translate sales targets into market share because this will determine whether forecasts are to be attained by growing with the market or by capturing share from competitors.
• Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors.
• Losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable.

Key Term

Market Share

The percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.

Example

• Netflix recently announced that they were going to offer, for the first time, their streaming video subscription service separately from their DVD-by-mail subscription service. Streaming-only will be the default for new customers, DVD-by-mail, shown here, is an optional add-on. Much of the discussion, verging on outrage, about this move centered on a price increase for the popular one-at-a-time DVD plus streaming option. Price increases are rare and this was a large one, at least on a percentage basis; the new price is nearly double the old one. By this pricing choice Netflix is positioning itself differently, a positioning that is part of its long term strategy. The pricing decision has to be seen in the context of a longer-term strategy. Pricing decisions are always serious because they flow almost directly to the bottom line, so Reed Hastings (Netflix CEO) must have concluded that the short-term loss of income from cancelled subscriptions will be outweighed by the longer term gain in new subscribers who do not take the DVD-by-mail option. This increase in new subscribers is an increase in sales. With so few on-line streaming opportunities it wouldn’t be difficult to obtain a large market share. Netflix is signalling to these customers that streaming is a better option.

Market share is a key indicator of market competitiveness—that is, how well a firm is doing compared to its competitors. It enables them to judge not only total market growth or decline but also trends in customers’ selections among competitors. Generally, sales growth resulting from primary demand (total market growth) is less costly and more profitable than that achieved by capturing share from competitors. Conversely, losses in market share can signal serious long-term problems that require strategic adjustments. Firms with market shares below a certain level may not be viable. Similarly, within a firm’s product line, market share trends for individual products are considered early indicators of future opportunities or problems.

Just as survival requires a long-term profit for a business enterprise, profit requires sales. The task of marketing management relates to managing demand. Demand must be managed in order to regulate exchanges or sales. Thus marketing management’s aim is to alter sales patterns in some desirable way. They are concerned with maintaining an adequate share of the market so that their sales volume will enable the firm to survive and prosper. Again, pricing strategy is one of the tools that is significant in creating and sustaining market share. Prices must be set to attract the appropriate market segment in significant numbers. Decreasing price may increase demand and lead to higher market share, though it could also provoke a competitive response.

Marketers need to be able to translate sales targets into market share because this will determine whether forecasts should be attained by growing with the market or by capturing share from competitors. The latter will almost always be more difficult to achieve. Market share is closely monitored for signs of change in the competitive landscape, and it frequently drives strategic or tactical decisions. Increasing market share is one of the most important objectives of business. The main advantage of using market share as a measure of business performance is that it is less dependent upon macro environmental variables such as the state of the economy or changes in tax policy.

Pricing Strategies

Changing the pricing strategy might be part of a longer-term strategy to increase market share in on-line video streaming.

A Netflix envelope and DVD.

8.5.5: Cash Flow

Cash flow is extremely important to firms as this is how they buy goods, pay employees, fund new investments, and pay dividends.

Learning Objective

Identify the different pricing strategies for generating cash flow in an organization

Key Points

• Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products.
• One way to get cash flow quickly is through seasonal discounts. Seasonal discounts are price reductions given on out-of-season merchandise.
• Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period.

Key Terms

cash flow

The movement of money into or out of a business.

seasonal discount

price reductions given when an order is placed in a slack period

Cash flow is the movement of money into or out of a business. The measurement of cash flow can be used for calculating other parameters that give information on a company’s value and situation. Some companies will set prices so that they can recover cash flow as quickly as possible. This strategy could be due to the company spending too much of its resources on developing products. This typically requires setting prices very high, which is a disadvantage since competitors can set prices lower and gain a larger market share.

Cash flow is extremely important to a firm. This is how they buy goods, pay employees, fund new investments, and pay dividends. It is necessary to determine the effects of pricing on cash flow to a firm.

One way to get cash flow quickly is through seasonal discounts . Seasonal discounts are price reductions given for out-of-season merchandise. An example would be a discount on snowmobiles during the summer. The intention of such discounts is to spread demand over the year. This can allow for the fuller use of production facilities and improved cash flow throughout the year.

Seasonal Sales 

A quick way to generate cash flow is to offer seasonal discounts.

A picture of various sale price tags.

Another option is cash discounts. Cash discounts are reductions on the base price given to customers for paying cash or within some short time period. For example, a company can give a two percent discount on bills paid within 10 days. Another example is a gas station that gives discounts on gas prices to costumers who don’t pay with credit cards. The purpose is generally to accelerate the cash flow of the organization.

8.5.6: Status Quo

Status quo pricing is the concept that some goods within certain industries have an expected price for consumers, due to a relative norm within that market. 

Learning Objective

Recognize that some product types have relative consistent pricing, and entering those markets often requires the ability to produce at that price or lower

Key Points

• Many products and services have relatively normal expected prices, usually due to a balance of demand, competition, and economic factors.
• In order to effectively compete in those markets, organizations must refine their process to produce at the status quo price point or lower in order to satisfy the needs of consumers in that market.
• Status quo price points usually evolve organically as a byproduct of external and competitive forces.
• It is important to differentiate price fixing and status quo pricing. Price fixing is an agreement among competitive firms to set prices at the same level in order to attain a monopoly. This is illegal under antitrust laws in most countries.

Key Terms

price fixing

An agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

status quo

The state of things; the way things are, as opposed to the way they could be; the existing state of affairs.

When setting a price for a given product or service, there are countless objectives an organization may have that will impact how and why a price is determined. While there are too many objectives to provide a comprehensive list, some of the more common pricing objectives include:

• Maximizing short-term or long-term profit
• Increasing sales volume
• Increasing market share and/or growth
• Becoming a price leader
• Differentiating for a niche segment
• Social, ethical, or ideological objectives (e.g. making something available to consumers with lower incomes)
• Attaining the competitive equilibrium

Many industries have key competitors that wield a great deal of power and influence within the industry. As a result, new entrants and smaller players are often forced to attain a similar efficiency in operations and become able to sell a given good at a specific price or lower. These larger, strong players often have scale economies, which slowly make the ‘status quo’ price of a given good lower than is obtainable by other incumbents.

Status Quo Pricing

As a result of this, some firms pursue status quo pricing as a pricing objective. In this situation, they assess the overall market to determine what the going prices are for the product or service they will sell. Once this price point is established, the organization will strive to build an operational mechanism that enables the organization to be profitable at the price point (or possibly lower). This objective is particularly useful when applied to mature industries with firmly set price points and a low variance in price elasticity in the consumer groups.

These status quo price points arise organically, based on consumer behavior, competitive factors, and the price of production. Status quo prices are often associated with homogeneous goods for which the price has been lowered significantly through competition.

Price Fixing

An extremely important ethical consideration of this pricing objective is avoidance of price fixing. Price fixing is the illegal practice of various competitive firms within an industry agreeing on a fixed price for goods within an industry. If all competitive firms agree on price, there is no real practical different for the consumer between this and a monopoly.

The purpose of price fixing is identifying the highest possible optimal price point that can be charged for a given good within a market, which will in turn benefit all of the providers of that good. This is a criminal offense in the United States and can be prosecuted under the Sherman Antitrust Act.

8.5.7: Product Quality

Quality refers to the ability of a product or service to consistently meet or exceed customer requirements or expectations.

Learning Objective

Identify the different aspects and determinants of product quality

Key Points

• Some of these consequences of poor quality include loss of business, liability, decreased productivity, and increased costs.
• Good quality has its own costs, including prevention, appraisal, and failure.
• Successful management of quality requires that managers have insights on various aspects of quality such as understanding the costs and benefits of quality and recognizing the consequences of poor quality.
• Understanding the determants of quality, such as design of the product and the “ease of use” of the product, will help managers price the products accordingly.

Key Terms

quality

The ability of a product or service to consistently meet or exceed customer requirements or expectations.

return on quality

An internal management approach that evaluates the financial return of investments in quality.

Example

• The Mercedes-Benz SLR McLaren is a high quality car. People know that when they pay the price, they are getting an engine that is hand made and top of the line. Thus, Mercedes are able to charge a premium for this highly desired, high quality product.

Broadly defined, quality refers to the ability of a product or service to consistently meet or exceed customer requirements or expectations. Different customers will have different expectations, so a working definition of quality is customer-dependent. When discussing quality one must consider design, production, and service. In a culmination of efforts, it begins with careful assessment of what the customers want, then translating this information into technical specifications to which goods or services must conform. The specifications guide product and service design, process design, production of goods and delivery of services, and service after the sale or delivery.

Some of these consequences of poor quality include loss of business, liability, decreased productivity, and increased costs. However, good quality has its own costs, including prevention, appraisal, and failure. A recent and more effective approach is discovering ways to prevent problems, instead of trying to fix them once they occur. This will ultimately decrease the cost of good quality in the long run.

There are several costs associated with quality:

• Appraisal costs – costs of activities designed to ensure quality or uncover defects
• Prevention costs – costs of prevention defects from occurring
• Failure costs – Costs caused by defective parts or products or by faulty services
• Internal failures – failures discovered during production
• External failures – failures discovered after delivery to the customer
• Return on quality (ROQ) – an approach that evaluates the financial return of investments in quality

Successful management of quality requires that managers have insights on various aspects of quality. These include defining quality in operational terms, understanding the costs and benefits of quality, recognizing the consequences of poor quality and recognizing the need for ethical behavior. Understanding dimensions that customers use to judge the quality of a product or service helps organizations meet customer expectations.

Dimensions of Product Quality

• Performance– main characteristics of the product
• Aesthetics– appearance, feel, smell, taste
• Special features– extra characteristics
• Conformance– how well the product conforms to design specifications
• Reliability– consistency of performance
• Durability– the useful life of the product
• Perceived quality– indirect evaluation of quality
• Service-ability– handling of complaints or repairs

Determinants of Quality

1. Quality of Design – intention of designers to include or exclude features in a product or service. The starting point of producing quality in products begins in the “design phase”. Designing decisions may involve product or service size, shape and location. When making designs, designers must keep in mind customer wants, production or service capabilities, safety and liability, costs, and other similar considerations.
2. Quality of conformance – refers to the degree to which goods and services conform to the intent of the designer. Quality of conformance can easily be affected by factors like: capability of equipment used, skills, training, and motivation of workers, extent to which the design lends itself to production, the monitoring process to assess conformance, and the taking of corrective action.
3. Ease of use – refers to the ease of usage of the product or services for the customers. The term “ease of use” refers to user instructions. Designing a product with “ease of use” increases the chances that the product will be used in its intended design and it will continue to function properly and safely. Without ease of use, companies may lose customers, face sales returns, or legal problems from product injuries. Ease of use also applies to services. Manufacturers must make sure that directions for unpacking, assembling, using, maintaining, and adjusting the product are included. Directions for “What to do when something goes wrong” should also be included. Ease of use makes a consumer very happy and can help retain customers.

High-quality cars

The Mercedes-Benz SLR McLaren has a reputation for extremely high quality. Its handmade engine is a sign of the quality. 

8.6: General Pricing Strategies

8.6.1: Cost-Based Pricing

Just as it sounds, cost-based pricing identifies the overall fixed, variable, and indirect costs of production and prices that product accordingly.

Learning Objective

Grasp the concept of pricing based on overall costs, and identify the various cost inputs involved

Key Points

• When all operational fixed and variable costs are measured, and indirect costs are also compensated for, a price point can be determined based on overall price.
• Often referred to as cost-plus pricing, some firms (excepting non-profits) will add a margin on top of the overall cost-based pricing to ensure profitability for stakeholders.
• Differentiating between fixed, variable, and indirect costs is a central consideration for cost-based pricing strategies.
• This model is best for organizations working to compete on price, and striving for optimal efficiency in the production process.

Key Term

cost-based pricing

This pricing strategy focuses on measuring all of the costs involved in producing a given product, and pricing that product according to those costs.

Pricing on Cost

Cost-based pricing is a fairly straight-forward concept, where the organization understands the operation costs of producing a given good and prices that good as close to this cost level as possible. It is often referred to as cost-plus pricing, as the firm (unless it is a non-profit organization) must retain some value or profit from the sale. This markup can be set at a fixed percentage, such as 5%. If a given good will cost $10 to develop, a perfect cost-based pricing would be to sell it at $10. A cost-plus pricing model at 5% would be to sell the product at $10.50.

Determining Cost

While the concept of cost-based pricing is quite simple, the accurate measurement of cost can sometimes be a bit complex. There are fixed costs, variable costs, and indirect costs that all must be factored into the overall calculation. Each of these costs are impacted differently by volume, and as a result, cost-based pricing may fluctuate over time. This creates some requirements for projecting volume, basing cost off of a certain volume and understanding the potential in variance.

Fixed Cost

Fixed cost changes over time, for the simple reason that each additional unit produced will lower the average cost per unit relative to fixed investments. Take, for example, an investment in a machine for $10,000. The machine can produce 10,000 units in a year. At maximum capacity, this machine will cost $1 per unit. However, the demand is not high enough to produce at this capacity. Instead, it is only producing 5,000 units a year. Now the cost per unit is $2.

Variable Cost

The variable cost is consistent for each new unit, and as a result is not sensitive to overall volume (in most cases). What this means is that producing 1 unit will cost $5, and producing 10 units will cost $50, 100 units $500. 

Indeed, sensitivity to volume is often one of economy of scale, which is to say that purchasing inputs for production may even become cheaper the higher the quantity that is produced. As a result, variable costs and quantity have a very different relationship than fixed costs and quantity. 

Quantity 

The chart shows the relationship between fixed costs, variable costs, and total costs compared to the quantity produced and/or sold.

This simple chart underlines the relationship between fixed, variable and total cost compared to quantity produced and/or sold.

Indirect Cost

Complicating the concept of cost-based pricing is the indirect cost of doing business. Many aspects of an organization are not directly related to production, and are therefore somewhat difficult to factor into the overall equation. Salaries of corporate staff, administration costs, legal costs, office costs, utilities, electricity, and other supports must be accurately projected and built into the cost-based pricing model in order to ensure that the organization is properly pricing the product for profitability.

Conclusion

Overall, when a company decides to price goods based on cost, it is important that the internal mechanisms of measurement for fixed, variable, and indirect inputs are highly accurate and developed. This cost method is often considered a low-cost method, as the firm is attempting to forward as much value as possible to the consumer. This model is best for organizations working to compete on price, and striving for optimal efficiency in the production process.

8.6.2: Demand-Based Pricing

Demand-based pricing is any pricing method that uses consumer demand – based on perceived value – as the central element.

Learning Objective

Demonstrate the meaning of and the different types of demand-based pricing

Key Points

• Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time.
• Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider.
• Psychological pricing is a marketing practice based on the theory that certain prices have a psychological impact.
• Bundle pricing is a marketing strategy that involves offering several products for sale as one combined product.
• Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers.
• Value-based pricing sets prices primarily on the value, perceived or estimated, to the customer rather than on the cost of the product or historical prices.

Key Terms

psychological pricing

a marketing practice based on the theory that nominally different prices may be perceived differently

heterogeneity

This term describes the uniqueness of service offerings.

Demand-Based Pricing

Demand-based pricing, also known as customer-based pricing, is any pricing method that uses consumer demand – based on perceived value – as the central element. These include: price skimming, price discrimination, psychological pricing, bundle pricing, penetration pricing, and value-based pricing.

Pricing factors are manufacturing cost, market place, competition, market condition, and quality of the product.

Price Skimming

Price skimming is a pricing strategy in which a marketer sets a relatively high price for a product or service at first, then lowers the price over time. In other words, price skimming is when a firm charges the highest initial price that customers will pay. As the demand of the first customers is satisfied, the firm lowers the price to attract another, more price-sensitive segment.

The objective of a price skimming strategy is to capture the consumer surplus. It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price. If this is done successfully, then theoretically no customer will pay less for the product than the maximum they are willing to pay. In practice, it is almost impossible for a firm to capture all of this surplus .

Price Skimming

These are graphical representations of price skimming. Price skimming is sometimes referred to as riding down the demand curve.

Price Descrimination

Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider. Product heterogeneity, market frictions, or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in fully competitive retail or industrial markets. Price discrimination also occurs when the same price is charged to customers that have different supply costs. Price discrimination requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing any resale, keeping the different price groups separate, making price comparisons difficult, or restricting pricing information.

Psychological Pricing

Psychological pricing is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as “odd prices”: a little less than a round number, e.g. $19.99. The theory is this drives demand greater than would be expected if consumers were perfectly rational. Bundle pricing is a marketing strategy that involves offering several products for sale as one combined product. This strategy is very common in the software business, in the cable television industry, and in the fast food industry in which multiple items are combined into a complete meal. A bundle of products is sometimes referred to as a package deal, a compilation, or an anthology.

Penetration Pricing

Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than to make profit in the short term. The main disadvantage with penetration pricing is that it establishes long term price expectations for the product as well as image preconceptions for the brand and company. This makes it difficult to eventually raise prices.

Value-based Pricing

Value-based pricing sets prices primarily, but not exclusively, on the value, perceived or estimated, to the customer rather than on the cost of the product or historical prices. Value-based-pricing is most successful when products are sold based on emotions (fashion), in niche markets, in shortages (e.g. drinks at open air festival at a hot summer day), or for indispensable add-ons (e.g. printer cartridges, headsets for cell phones). By definition, long term prices based on value-based pricing are always higher or equal to the prices derived from cost-based pricing.

8.6.3: Competitor-Based Pricing

Organizations that sell products or services may look at what price a product is generally being sold at and set that as a target for the sales price.

Learning Objective

Understand why matching the price of competitors is important, and how it can be misused (i.e. price fixing)

Key Points

• Determining the price of a product or service can be approached many different ways, from consumer willingness to pay to pursuing the lowest possible cost for the consumer.
• Competitor-based pricing is the strategic approach in which a company tries to match (or perhaps better) the price point set by key competitors within the industry.
• Competitor-based pricing is particularly useful for new entrants, who are trying to achieve the efficiency and low price of more mature and established competitors.
• Competitor-based pricing can be inappropriate in markets with limited competition, as it could essentially lead to price fixing. 

Key Term

price fixing

An illegal agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand.

Pricing Overview

Determining the optimal price for a given product or service can be approached in many different ways. Some organizations simply look at what it will cost (on average) to produce a product or service, and sell it at an acceptable profit margin above that expense rate. Other businesses may focus more on what the consumer is willing to pay, and try to capture as much of that potential as possible. Other organizations may be non-profit oriented, and will sell at the lowest possible price while remaining in business.

Pricing

Sellers price products in order to obtain a profit margin that is above the expense rate.

A fruit market in Israel.

Pricing on Competition

Organizations that sell products or services, usually in mature industries, may look at what price a product is generally being sold at and emulate that sales price. This can be done for a variety of reasons, and firms must be careful of ethical and legal concerns when considering this approach:

• Customer Expectation – In some industries, competitor-based pricing is the best way to ensure customers pay what they expect to pay. A cup of coffee, for example, is very rarely priced too much differently from the competition. Customers don’t expect to pay $5 for a coffee, and therefore companies that sell at that price point will be quickly beaten by the competition.
• Competitiveness – Along similar lines, remaining competitive (particularly for goods that are not easily differentiate) often requires matching or beating the price of the competition. Many companies will even match competitor prices as a policy, which is to say that if a consumer finds the same product somewhere else for cheaper, the organization will match that price in order to retain the customer. Competitor-based pricing ensures the organization can remain competitive.
• Follow the leader – For newer entrants in an industry, keeping pace with the industry standard or industry leader is sometimes useful. This motivates the firm to match (or exceed) the more efficient and mature players in an industry, and sets a benchmark for what is feasibly accomplished in terms of efficiency and low-cost strategies.

Legal Concerns

While competitor-based pricing may be in pursuit of the cheapest possible price for consumers, this is unfortunately not always the case. Price fixing is a risk for organizations that pursue this pricing strategy, as it essentially would allow industries which are oligopolies (with a small number of providers) to remove the competitive aspect of capitalism through establishing a fixed price across all firms.

All this really means is that organizations within certain industries are NOT allowed to agree on a price that each competitor will stick to. If organizations were allowed to do this, competition on a key component of the marketing mix would be lost completely (i.e. price). Without this competitive force, organizations would gain pricing power over consumers through price fixing. As a result, competitor-based pricing is more appropriate for firms trying to grow more efficient and become more competitive, but not as appropriate for firms who are already established.

8.6.4: Markup Pricing

Markup pricing is a strategy in which a company first calculates the cost of the product, then adds a proportion of it as markup.

Learning Objective

Examine the rationale behind the use of markup pricing as a general pricing strategy

Key Points

• Markup pricing is used primarily because it is easy to calculate and requires little information.
• The first step to determine markup price involves calculation of the cost of production, and the second step is to determine the markup over costs.
• In markup pricing, we use quantity to calculate price, but price is the determinant of quantity. To avoid this problem, the quantity is assumed.

Key Terms

marginal cost

The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. The additional cost associated with producing one more unit of output.

discretion

The freedom to make one’s own judgements.

Markup Pricing

Several varieties of markup pricing – also known as cost-plus pricing – exist, but the common thread is that one first calculates the cost of the product, then adds a proportion of it as markup. The amount to be marked up is decided at the discretion of the company. Basically, this approach sets prices that cover the cost of production and provide enough profit margin to the firm to earn its target rate of return.

Cost-plus pricing is used primarily because it is easy to calculate and requires little information. Information on demand and costs is not easily available; however, this information is necessary to generate accurate estimates of marginal costs and revenues. Moreover, the process of obtaining this additional information is expensive. Therefore, cost-plus pricing is often considered a rational approach to maximizing profits. Cost-plus pricing is especially useful in the following cases:

• Public utility pricing
• Finding out the design of the product when the selling price is predetermined, which is also known as product tailoring
• Pricing products that are designed to the specification of a single buyer
• “Monopsony Buying” – buyers have enough knowledge about the costs of a supplier. Thus, they may make the product themselves if they do not comply with the offered prices. So the relevant cost would be the cost that a buying company would incur if it made the product itself.

Calculating a Markup Price

There are two steps which form this approach. The first step involves calculation of the cost of production, and the second step is to determine the markup over costs. The total cost has two components: total variable cost and total fixed cost. In both cases, costs are computed on an average basis . In cost-plus pricing, we use quantity to calculate price, but price is the determinant of quantity. To avoid this problem, the quantity is assumed. This rate of output is based on some percentage of the firm’s capacity. The objective of determining markup over costs is to set prices in a manner that a firm earns its targeted rate of return. This return can be considered R_sX, where R_s is the ratio of the respective share of total profit. Therefore, the markup over costs on each unit of output will be X/Q. Price will be calculated through the formula in.

Cost-Plus Price Equation

A cost-plus price is equal to the average variable costs plus average fixed costs plus markup per unit.

Total Average Cost Equation

The total average cost for a product is determined by dividing the total fixed costs (TFC) and total variable costs (TVC) by the quantity of the product produced and then adding them together.

Reasons For Widespread Use

The following points explain as to why this approach is widely used:

• Even if a firm handles many products, this approach provides the means by which fair prices can be easily found.
• This approach involves calculation of full cost. Prices based on full cost look factual and precise and may be more defensible on moral grounds than prices established by other means.
• This approach reduces the cost of decision-making. Firms which prefer stability use cost-plus pricing as a guide to price products in an uncertain market where knowledge is incomplete.
• Firms are never too sure about the shape of their demand curve; neither are they very sure about the probable response to any price change. It thus becomes risky for a firm to move away from cost-plus pricing.
• The reaction of rivals to the set price is a major uncertainty. When products and production processes are similar, competitive stability is achieved by usage of cost-plus pricing. This competitive stability is achieved by setting a price that is likely to yield acceptable returns to other members of the industry.
• Management tends to know more about product costs than any other factors which can be used to price a product.
• Markup pricing ensures a seller against unpredictable or unexpected later costs.
• Price increases can be justified in terms of cost increases.

Disadvantages Of Markup Pricing

Disadvantages of this strategy include:

• Provides incentive for inefficiency
• Tends to ignore the role of consumers
• Tends to ignore the role of competitors
• Uses historical rather than replacement value
• Uses “normal” or “standard” output level to allocate fixed costs
• Includes sunk costs rather than just using incremental costs
• Ignores opportunity cost

8.6.5: Profit-Maximization Pricing

Profit maximization analysis is the process by which a firm determines the price and output level that returns the greatest profit.

Learning Objective

Describe profit maximization pricing relative to general pricing strategies

Key Points

• Fixed costs, which occur only in the short run, are incurred by the business at any level of output, including zero output.
• Variable costs change with the level of output, increasing as more product is generated.
• The profit-maximizing output is the one at which the difference between total cost and total revenue reaches its maximum.
• If a firm is not a perfect competitor in the output market, the price to sell the product at can be read off the demand curve at the firm’s optimal quantity of output.

Key Term

marginal cost

The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. The additional cost associated with producing one more unit of output.

Profit Maximization Pricing

Profit maximization is the short run or long run process by which a firm determines the price and output level that returns the greatest profit. Any costs incurred by a firm may be classed into two groups: fixed costs and variable costs.

Fixed costs, which occur only in the short run, are incurred by the business at any level of output, including zero output. These may include equipment maintenance, rent, wages of employees whose numbers cannot be increased or decreased in the short run, and general upkeep.

Variable costs change with the level of output, increasing as more product is generated. Materials consumed during production often have the largest impact on this category, which also includes the wages of employees who can be hired and laid off in the span of time (long run or short run) under consideration.

Fixed cost and variable cost, combined, equal total cost. Revenue is the amount of money that a company receives from its normal business activities, usually from the sale of goods and services (as opposed to monies from security sales such as equity shares or debt issuances).To obtain the profit maximising output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC).

Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph.

Total Profit Maximization

This linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market, and thus cannot set its own selling price.

The profit-maximizing output is the one at which this difference reaches its maximum. In the accompanying diagram, the linear total revenue curve represents the case in which the firm is a perfect competitor in the goods market and thus cannot set its own selling price. The profit-maximizing output level is represented as the one at which total revenue is the height of C and total cost is the height of B; the maximal profit is measured as CB. This output level is also the one at which the total profit curve is at its maximum.

If, contrary to what is assumed in the graph, the firm is not a perfect competitor in the output market, the price to sell the product at can be read off the demand curve at the firm’s optimal quantity of output. The above method takes the perspective of total revenue and total cost. A firm may also take the perspective of marginal revenue and marginal cost, which is based on the fact that total profit reaches its maximum point where marginal revenue equals marginal cost.

8.7: Specific Pricing Strategies

8.7.1: New Product Pricing

With a new product, competition does not exist or is minimal, hence the general pricing strategies depend on different factors.

Learning Objective

Compare and contrast penetration pricing and skimming pricing

Key Points

• Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price.
• Skimming involves goods being sold at higher prices so that fewer sales are needed to break even. By selling a product at a high price, sacrificing high sales to gain a high profit is therefore “skimming” the market.
• The decision of best strategy to use depends on a number of factors. A penetration strategy would generally be supported by the opportunity to keep costs low, and the anticipation of quick market entry by competitors. A skimming strategy is most appropriate when the opposite conditions exist.

Key Terms

Market Share

The percentage of some market held by a company.

market penetration

having gained part of a market in which similar products already exist

With a totally new product, competition does not exist or is minimal. Two general strategies are most common for setting prices:

(1) Penetration pricing

In the introductory stage of a new product’s life cycle means accepting a lower profit margin and to price relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly. Penetration pricing is the pricing technique of setting a relatively low initial entry price, often lower than the eventual market price, to attract new customers. The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with a marketing objective of increasing market share or sales volume, rather than to make profit in the short term. The advantages of penetration pricing to the firm are as follows:

• It can result in fast diffusion and adoption. This can achieve high market penetration rates quickly. This can take the competitors by surprise, not giving them time to react.
• It can create goodwill among the early adopters segment. This can create more trade through word of mouth.
• It creates cost control and cost reduction pressures from the start, leading to greater efficiency.
• It discourages the entry of competitors. Low prices act as a barrier to entry.
• It can create high stock turnover throughout the distribution channel. This can create critically important enthusiasm and support in the channel.
• It can be based on marginal cost pricing, which is economically efficient.

A penetration strategy would generally be supported by the following conditions: price-sensitive consumers, opportunity to keep costs low, the anticipation of quick market entry by competitors, a high likelihood for rapid acceptance by potential buyers, and an adequate resource base for the firm to meet the new demand and sales.

Pricing

Companies and businesses set prices at certain levels in order to attract customers.

A gas station sign in Taiwan that shows prices.

(2) Skimming

Skimming involves goods being sold at higher prices so that fewer sales are needed to break even. Selling a product at a high price and sacrificing high sales to gain a high profit is therefore “skimming” the market. Skimming is usually employed to reimburse the cost of investment of the original research into the product. It is commonly used in electronic markets when a new range, such as DVD players, are firstly dispatched into the market at a high price. This strategy is often used to target “early adopters” of a product or service. Early adopters generally have a relatively lower price-sensitivity and this can be attributed to their need for the product outweighing their need to economize, a greater understanding of the product’s value, or simply having a higher disposable income.

This strategy is employed only for a limited duration to recover most of the investment made to build the product. To gain further market share, a seller must use other pricing tactics such as economy or penetration. This method can have some setbacks as it could leave the product at a high price against the competition. A skimming strategy would generally be supported by the following conditions:

• Having a premium product. In this case, “Premium” does not just denote high cost of production and materials- it also suggests that the product may be rare or that the demand is unusually high. An example would be a USD 500 ticket for the World Series or an USD 80,000 price tag for a limited-production sports car such as this .
• Having legal protection via a patent or copyright may also allow for an excessively high price. Intel and their Pentium chip possessed this advantage for a long period of time. In most cases, the initial high price is gradually reduced to match new competition and allow new customers access to the product.

8.7.2: Product Line Pricing

Line pricing is the use of a limited number of price points for all the product offerings of a vendor.

Learning Objective

Describe the characteristics of line pricing

Key Points

• Line pricing is beneficial to customers because they want and expect a wide assortment of goods, particularly shopping goods. Many small price differences for a given item can be confusing.
• From the seller’s point of view, line pricing is simpler and more efficient to use. The product and service mix can then be tailored to select price points.
• Line pricing suffers during inflationary periods, where such a strategy can be inflexible.

Key Terms

shopping goods

Goods that require more thought and comparison than convenience goods. Consumers compare multiple attributes such as price, style, quality, and features.

product line pricing

the practice of charging different amount for goods or services that are variations on a base good or service

basing-point pricing

goods shipped from a designated city are charged the same amount

price point

Price points are prices at which demand for a given product is supposed to stay relatively high.

Line pricing is the use of a limited number of prices for all the product offerings of a vendor. This is a tradition started in the old five and dime stores in which everything cost either 5 cents or 10 cents . Its underlying rationale is that these amounts are seen as suitable price points for a whole range of products by prospective customers. It has the advantage of ease of administering, but the disadvantage of inflexibility, particularly in times of inflation or unstable prices.

Five and Dime Stores

Traditional five and dime stores followed a line pricing strategy. All of the goods were either $0.05 or $0.10. The dollar store is a modern equivalent.

Line pricing serves several purposes that benefit both buyers and sellers. Customers want and expect a wide assortment of goods, particularly shopping goods. Many small price differences for a given item can be confusing. If ties were priced at $15, $15.35, $15.75, and so on, selection would be more difficult. The customer would not be able to judge quality differences as reflected by such small increments in price. So having relatively few prices reduces this kind of confusion.

From the seller’s point of view, line pricing holds several benefits:

1. It is simpler and more efficient to use relatively fewer prices. The product and service mix can then be tailored to select price points.
2. It can result in a smaller inventory than would otherwise be the case. It might increase stock turnover and make inventory control simpler.
3. As costs change, the prices can remain the same, but the quality in the line can be changed. For example, you may have bought a $20 tie 15 years ago. You can buy a $20 tie today, but it is unlikely that today’s $20 tie is of the same fine quality as it was in the past.

8.7.3: Psychological Pricing

Psychological pricing is a marketing practice based on the theory that certain prices have meaning to many buyers.

Learning Objective

Explain the types of psychological pricing

Key Points

• Products and services frequently have customary prices in the minds of consumers. A customary price is one that customers identify with particular items.
• Odd prices appear to represent bargains or savings and therefore encourage buying. Thus, marketers often use odd prices that end in figures such as 5, 7, 8, or 9.
• A somewhat related pricing strategy is combination pricing, such as two-for-one or buy-one-get-one-free. Consumers tend to react very positively to these pricing techniques.

Key Terms

Price Points

Price points are prices at which demand for a given product is supposed to stay relatively high.

customary price

A price that customers identify with particular items.

Price, as is the case with certain other elements in the marketing mix, has multiple meanings beyond a simple utilitarian statement. One such meaning is often referred to as the psychological aspect of pricing. Inferring quality from price is a common example of the psychological aspect of price. For instance, a buyer may assume that a suit priced at $500 is of higher quality than one priced at $300.

Products and services frequently have customary prices in the minds of consumers. A customary price is one that customers identify with particular items. For example, for many decades a five-stick package of chewing gum cost five cents and a six-ounce bottle of Coca-Cola also cost five cents. Candy bars now cost 60 cents or more, which is the customary price for a standard-sized bar. Manufacturers tend to adjust their wholesale prices to permit retailers to use customary pricing.

Another manifestation of the psychological aspects of pricing is the use of odd prices. We call prices that end in such digits as 5, 7, 8, and 9 “odd prices.” Examples of odd prices include: $2.95, $15.98, or $299.99. Odd prices are intended to drive demand greater than would be expected if consumers were perfectly rational.

Odd Pricing

Odd prices end with digits like 5, 7, 8, and 9. They are intended to drive demand higher.

Psychological pricing is one cause of price points. For a long time, marketing people have attempted to explain why odd prices are used. It seemed to make little difference whether one paid $29.95 or $30.00 for an item. Perhaps one of the most often heard explanations concerns the psychological impact of odd prices on customers. The explanation is that customers perceive even prices such as $5.00 or $10.00 as regular prices. Odd prices, on the other hand, appear to represent bargains or savings and therefore encourage buying. There seems to be some movement toward even pricing; however, odd pricing is still very common. A somewhat related pricing strategy is combination pricing, such as two-for-one or buy-one-get-one-free. Consumers tend to react very positively to these pricing techniques.

The psychological pricing theory is based on one or more of the following hypotheses:

• Consumers ignore the least significant digits rather than do the proper rounding. Even though the cents are seen and not totally ignored, they may subconsciously be partially ignored.
• Fractional prices suggest to consumers that goods are marked at the lowest possible price.
• When items are listed in a way that is segregated into price bands (such as an online real estate search), the price ending is used to keep an item in a lower band, to be seen by more potential purchasers.

8.7.4: Pricing During Difficult Economic Times

During a recession, companies must consider their unique situation and what value they provide customers when devising a pricing strategy.

Learning Objective

Discuss pricing strategies during difficult economic times

Key Points

• Many companies are tempted to slash prices during a recession, but this strategy should be carefully considered.
• Cutting prices can degrade the value of the brand, lead to a price war, and also lead customers to put off buying when times are good in expectation of price cuts when times are bad.
• Unlike traditional brands that are designed with target consumers in mind, fighter brands are created specifically to combat a competitor that is threatening to take market share away from a company’s main brand.
• When the strategy works, a fighter brand not only defeats a low-priced competitor, but also opens up a new market.

Key Terms

fighter brand

A pricing strategy where a company prices items lower than the competition in order to protect or gain market share.

recession

A period of reduced economic activity

Pricing During Difficult Economic Times

Every company has a unique pricing strategy during a boom period, based on their own product, market, and managerial decision making. However, during a recession, many companies may be tempted to abandon these strategies. After all, if customers are less willing to spend money, simplistic logic suggests that, by cutting prices, you can attract more customers. However, this strategy should be approached with caution.

Cutting prices can quieten customer complaints and help boost sales for a time, but can have longer-term effects on profitability, and weaken the brand’s image. Reductions can also lead customers to expect discounts whenever the economy dips, causing them to wait to make purchases in the future.

A model of pricing based on ‘rational’ economic theory suggests that prices are set by the forces of supply and demand, and individual companies in a perfectly competitive market must follow the equilibrium price. However, real life is not so simple; people do not always act in the prescribed logic. Sometimes prices go up and people buy more, and vice versa.

A smart pricing strategy during a recession can become a competitive advantage. By knowing what value a company delivers to its customers, it can price more confidently and not panic into slashing prices when it does not necessarily need to. Price-cutting may even lead to price wars where nobody wins. If cuts must be made, companies should focus on cutting the prices of low-value items and retaining high-value products.

Price Cuts

Slashing prices on low value goods (while maintaining prices on high value goods) is a potential pricing strategy during difficult economic times.

Customers shop in a store that has lots of different sale signs.

Similarly, price increases during a recession can also be a bad idea. Many firms try to recover higher costs through price increases, which can turn away customers. Customers locked into contracts may have no regress if a company raises prices on them, but it tarnishes the seller’s reputation and will make the customer think twice when the time comes to renew.

Ultimately, the pricing strategy becomes even more important during a recession, and companies must consider all these factors when attempting to adjust. It is important to protect the brand, not alienate customers, and remember what value the company offers in order to get through the difficult economic period unscathed.

Fighter Brands

In marketing, a fighter brand (sometimes called a fighting brand) is a lower priced offering launched by a company to take on, and ideally take out, specific competitors that are attempting to under-price them. Unlike traditional brands that are designed with target consumers in mind, fighter brands are created specifically to combat a competitor that is threatening to take market share away from a company’s main brand.

The strategy is most often used in difficult economic times. As customers trade down to lower priced offers because of economic constraints, many managers at mid-tier and premium brands are faced with a classic strategic conundrum: Should they tackle the threat head-on and reduce existing prices, knowing it will reduce profits and potentially commoditize the brand? Or should they maintain prices, hope for better times to return, and in the meantime lose customers who might never come back? With both alternatives often equally unpalatable, many companies choose the third option of launching a fighter brand.

When the strategy works, a fighter brand not only defeats a low-priced competitor, but also opens up a new market. The Celeron microprocessor, shown here , is a case study of successful fighter brand. Despite the success of its Pentium processors, Intel faced a major threat from less costly processors that were better placed to serve the emerging market for low-cost personal computers, such as the AMD K6. Intel wanted to protect the brand equity and price premium of its Pentium chips, but it also wanted to avoid AMD gaining a foothold on the lower end of the market. So it created Celeron as a cheaper, less powerful version of its Pentium chips to serve this market.

Fighter Brands

The Celeron microprocessor is a case study of a successful fighter brand.

8.7.5: Everyday Low Pricing

Everyday low price is a pricing strategy offering consumers a low price without having to wait for sale price events or comparison shopping.

Learning Objective

Translate the meaning of the EDLP (everyday low price) pricing strategy

Key Points

• Every day low pricing saves retail stores the effort and expense needed to mark down prices in the store during sale events, as well as to market these events.
• One 1994 study of an 86-store supermarket grocery chain in the United States concluded that a 10% EDLP price decrease in a category increased sales volume by 3%, while a 10% Hi-Low price increase led to a 3% sales decrease.
• Trader Joe’s is an example of successful EDLP. It is unique because it does not market itself like other grocery stores do, nor are customers required to obtain membership to enjoy its low prices – at Trader Joe’s, its everyday low prices are available to everyone.

Key Terms

Hi-low price

High-low pricing (or hi-low pricing) is a type of pricing strategy adopted by companies, usually small- and medium-sized retail firms, where a firm charges a high price for an item and later sells it to customers by giving discounts or through clearance sales.

supermarket

a large self-service store that sells groceries and, usually, medications, household goods and/or clothing

Everyday low price (EDLP) is a pricing strategy promising consumers a low price without the need to wait for sale price events or comparison shopping.

EDLP saves retail stores the effort and expense needed to mark down prices in the store during sale events, as well as to market these events. EDLP is believed to generate shopper loyalty. It was noted in 1994 that the Wal-Mart retail chain in America, which follows an EDLP strategy, would buy “feature advertisements” in newspapers on a monthly basis, while its competitors would advertise 52 weeks per year.

Procter & Gamble, Wal-Mart, Food Lion, Gordmans, and Winn-Dixie are firms that have implemented or championed EDLP. One 1992 study stated that 26% of American supermarket retailers pursued some form of EDLP, meaning the other 74% were Hi-Lo promotion-oriented operators.

One 1994 study of an 86-store supermarket grocery chain in the United States concluded that a 10% EDLP price decrease in a category increased sales volume by 3%, while a 10% Hi-Low price increase led to a 3% sales decrease; but that because consumer demand at the supermarket did not respond much to changes in everyday price, an EDLP policy reduced profits by 18%, while Hi-Lo pricing increased profits by 15%.

An example of a successful brand (other than the infamous Wal-Mart) that uses the EDLP strategy is Trader Joe’s . Trader Joe’s is a private-brand label that conducts a Niche marketing strategy describing itself as the “neighborhood store. ” The firm has been growing at a steady pace, offering a wide variety of organic and natural food items that are hard to find, enabling the business to enjoy a distinctive competitive advantage.

Trader Joe’s

Trader Joe’s is unique because it doesn’t require membership for its customers to enjoy its low prices. 

Apart from the many strengths of Trader Joe’s, the most prominent is their commitment to quality and lower prices. The company has worked hard to manage this economic image of value for its products that competitors, even giant retail stores, are unable to meet. Trader Joe’s is not an ordinary store. It is unique because it does not market itself like other grocery stores do nor does it require its customers to take out a membership to enjoy its low prices.

At Trader Joe’s, its everyday low prices are available to everyone. The firm states that “every penny we save is every penny our customer saves” (Trader Joe’s 2010).

8.7.6: High/Low Pricing

High-low pricing is a strategy where most goods offered are priced higher than competitors, but lower prices are offered on other key items.

Learning Objective

Recognize the mechanism of High/Low pricing strategies

Key Points

• The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.
• The basic type of customers for the firms adopting high-low price do not have a clear idea about what a product’s price would typically be or have a strong belief that “discount sales = low price”.
• The way competition prevails in the shoe and fashion industry is through high-low price strategies.

Key Terms

belief

mental acceptance of a claim as truth regardless of supporting or contrary empirical evidence

everyday low price

Everyday low price (“EDLP”) is a pricing strategy promising consumers a low price without the need to wait for sale price events or comparison shop.

High-low pricing is a method of pricing for an organization where the goods or services offered by the organization are regularly priced higher than competitors. However, through promotions, advertisements, and or coupons, lower prices are offered on other key items consumers would want to purchase. The lower promotional prices are designed to bring customers to the organization where the customer is offered the promotional product as well as the regular higher priced products.

High-low pricing is a type of pricing strategy adopted by companies, usually small and medium sized retail firms. The basic type of customers for the firms adopting high-low price will not have a clear idea about what a product’s price would typically be or have a strong belief that “discount sales = low price. ” Customers for firms adopting this type of strategy also have strong preference in purchasing the products sold in this type or by this certain firm. They are loyal to a specific brand.

There are many big firms using this type of pricing strategy (ex: Reebok, Nike, Adidas). The way competition prevails in the shoe industry is through high-low price. Also high-low pricing is extensively used in the fashion industry by companies (ex: Macy’s and Nordstrom) This pricing strategy is not only in the shoe and fashion industry but also in many other industries. However, in these industries one or two firms will not provide discounts and works on fixed rate of earnings. Those firms will follow everyday low price strategy in order to compete in the market.

High-Low Pricing Strategies

Many big firms are using high-low pricing strategies, especially in the shoe industry (ex: Reebok, Nike, and Adidas).

A Nike swoosh on a shoe.

8.7.7: Other Pricing Strategies

One pricing strategy does not fit all, thus adapting various pricing strategies to new scenarios is necessary for a firm to stay viable.

Learning Objective

Describe various pricing strategies

Key Points

• Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price.
• Dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is often cited as a success story. Most of the passengers on any given airplane have paid different ticket prices for the same flight.
• Non-price competition means that organizations use strategies other than price to attract customers. Advertising,credit, delivery, displays, private brands, and convenience are all examples of tools used in non-price competition.

Key Terms

economies of scale

The cost advantages that an enterprise obtains due to expansion. As the scale of output is increased, factors such as facility size and usage levels of inputs cause the producer’s average cost per unit to fall.

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

Pricing strategies for products or services encompass three main ways to improve profits. The business owner can cut costs, sell more, or find more profit with a better pricing strategy. When costs are already at their lowest and sales are hard to find, adopting a better pricing strategy is a key option to stay viable. There are many different pricing strategies that can be utilized for different selling scenarios:

Cost-Plus Pricing

Cost-plus pricing is the simplest pricing method. The firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This method although simple has two flaws: it takes no account of demand and there is no way of determining if potential customers will purchase the product at the calculated price.

Limit Pricing

A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.

Dynamic Pricing

A flexible pricing mechanism made possible by advances in information technology, and employed mostly by Internet based companies. By responding to market fluctuations or large amounts of data gathered from customers – ranging from where they live to what they buy to how much they have spent on past purchases – dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay. The airline industry is often cited as a success story . In fact, it employs the technique so artfully that most of the passengers on any given airplane have paid different ticket prices for the same flight.

Dynamic Pricing

Dynamic pricing allows online companies to adjust the prices of identical goods to correspond to a customer’s willingness to pay.

An Air Canada airplane.

Non-Price Competition

Non-price competition means that organizations use strategies other than price to attract customers. Advertising, credit, delivery, displays, private brands, and convenience are all examples of tools used in non-price competition. Business people prefer to use non-price competition rather than price competition, because it is more difficult to match non-price characteristics.

Pricing Above Competitors

Pricing above competitors can be rewarding to organizations, provided that the objectives of the policy are clearly understood and that the marketing mix is used to develop a strategy to enable management to implement the policy successfully. Pricing above competition generally requires a clear advantage on some non-price element of the marketing mix. In some cases, it is possible due to a high price-quality association on the part of potential buyers. Such an assumption is increasingly dangerous in today’s information-rich environment. Consumer Reports and other similar publications make objective product comparisons much simpler for the consumer. There are also hundreds of dot.com companies that provide objective price comparisons. The key is to prove to customers that your product justifies a premium price.

Pricing Below Competitors

While some firms are positioned to price above competition, others wish to carve out a market niche by pricing below competitors. The goal of such a policy is to realize a large sales volume through a lower price and profit margins. By controlling costs and reducing services, these firms are able to earn an acceptable profit, even though profit per unit is usually less. Such a strategy can be effective if a significant segment of the market is price-sensitive and/or the organization’s cost structure is lower than competitors. Costs can be reduced by increased efficiency, economies of scale, or by reducing or eliminating such things as credit, delivery, and advertising. For example, if a firm could replace its field sales force with telemarketing or online access, this function might be performed at lower cost. Such reductions often involve some loss in effectiveness, so the trade off must be considered carefully.

8.8: Pricing Tactics

8.8.1: Discounting

Discounts and allowances are reductions to a basic price of goods or services and can occur anywhere in the distribution channel.

Learning Objective

Analyze the use and types of discounts as part of pricing tactics

Key Points

• Seasonal discounts are price reductions given for out-of-season merchandise.
• Cash discounts are reductions on base price given to customers for paying cash or within some short time period.
• Senior discounts are discounts offered to customers who are above a certain age, typically a round number such as 50, 55, 60, 65, 70, and 75.
• Educational or student discounts are price reductions given to members of educational institutions, usually students but possibly also to educators and to other institution staff.
• Quantity discounts are reductions in base price given as the result of a buyer purchasing some predetermined quantity of merchandise. A noncumulative quantity discount applies to each purchase and is intended to encourage buyers to make larger purchases.

Key Terms

functional discount

payments to distribution channel members for performing some service

quantity discount

price reductions given for large purchases

List Price

The manufacturer’s suggested retail price (MSRP), list price or recommended retail price (RRP) of a product is the price which the manufacturer recommends that the retailer sell the product.

Discounts and allowances are reductions to a basic price of goods or services. There are many different types of price reduction, each designed to accomplish a specific purpose. They can occur anywhere in the distribution channel, modifying either the manufacturer’s list price (determined by the manufacturer and often printed on the package), the retail price (set by the retailer and often attached to the product with a sticker), or the list price (which is quoted to a potential buyer, usually in written form).

Quantity discounts are reductions in base price given as the result of a buyer purchasing some predetermined quantity of merchandise. A noncumulative quantity discount applies to each purchase and is intended to encourage buyers to make larger purchases. This means that the buyer holds the excess merchandise until it is used, possibly cutting the inventory cost of the seller and preventing the buyer from switching to a competitor at least until the stock is used. A cumulative quantity discount applies to the total bought over a period of time. The buyer adds to the potential discount with each additional purchase. Such a policy helps to build repeat purchases. Building material dealers, for example, find such a policy quite useful in encouraging builders to concentrate their purchase with one dealer and to continue with the same dealer over time.

Seasonal discounts are price reductions given for out-of-season merchandise. An example would be a discount on snowmobiles during the summer. The intention of such discounts is to spread demand over the year. This can allow fuller use of production facilities and improved cash flow during the year. Electric power companies use the logic of seasonal discounts to encourage customers to shift consumption to off-peak periods. Since these companies must have production capacity to meet peak demands, the lowering of the peak can lessen the generating capacity required.

Cash discounts are reductions on base price given to customers for paying cash or within some short time period. For example, a 2% discount on bills paid within 10 days is a cash discount. The purpose is generally to accelerate the cash flow of the organization.

Trade discounts, also called functional discounts, are payments to distribution channel members for performing some function. Examples of these functions are warehousing and shelf stocking. Trade discounts are often combined to include a series of functions, for example 20/12/5 could indicate a 20% discount for warehousing the product, an additional 12% discount for shipping the product, and an additional 5% discount for keeping the shelves stocked. Trade discounts are most frequent in industries where retailers hold the majority of the power in the distribution channel (referred to as channel captains). Trade discounts are given to try to increase the volume of sales being made by the supplier.

Educational or student discounts are price reductions given to members of educational institutions, usually students but possibly also to educators and to other institution staff. The provider’s purpose is to build brand awareness early in a buyer’s life, or build product familiarity so that after graduation the holder is likely to buy the same product, for own use or for an employer, at its normal price. Educational discounts may be given by merchants directly, or via a student discount program, such as CollegeBudget in the United States or NUS and Studentdiscounts.co.uk in the United Kingdom.

Senior discounts are discounts offered to customers who are above a certain relatively advanced age, typically a round number such as 50, 55, 60, 65, 70, and 75; the exact age varies in different cases. The rationale for a senior discount offered by companies is that the customer is assumed to be retired and living on a limited income, and unlikely to be willing to pay full price; sales at reduced price are better than no sales. Non-commercial organizations may offer concessionary prices as a matter of social policy.

Discounts

Discounts, such as 75% off, are used to draw customers to purchase items.

8.8.2: Value-Based Pricing

Value-based pricing seeks to set prices primarily on the value perceived by customers rather than on the cost of the product or historical prices.

Learning Objective

Examine the rationale behind value based pricing as a pricing tactic

Key Points

• Value-based pricing is most successful when products are sold based on emotions (fashion), in niche markets, in shortages (e.g., drinks at open air festival at a hot summer day), or for indispensable add-ons (e.g., printer cartridges, headsets for cell phones).
• Although it would be nice to assume that a business has the freedom to set any price it chooses, this is not always the case. Firms are limited by constraints such as government restrictions.
• Value-based pricing is predicated upon an understanding of customer value. In many settings, gaining this understanding requires primary research through interviews with customers and various surveys. The results of such surveys often depict a customer’s willingness to pay.

Key Terms

consumer buying process

There are 5 stages of a consumer buying process. They are: The problem recognition stage, the search for information, the possibility of alternative options, the choice to purchase the product, and then finally the actual purchase of the product. This shows the complete process that a consumer will most likely, whether recognizably or not, go through when they go to buy a product.

willingness to pay

The willingness to pay (WTP) is the maximum amount a person would be willing to pay, sacrifice, or exchange in order to receive a good or to avoid something undesired, such as pollution.

Value-based pricing sets prices primarily, but not exclusively, on the value, perceived or estimated, to the customer rather than on the cost of the product or historical prices. This strategy focuses entirely on the customer as a determinant of the total price/value package. Marketers who employ value-based pricing might use the following definition: “It is what you think your product is worth to that customer at that time.” This image shows the process for value based pricing .

Value-Based Pricing

Value-based pricing focuses entirely on the customer as a determinant of the total price or value package.

A chart that shows what value-based pricing takes into account (customers, value, price, cost, and product).

Goods that are very intensely traded (e.g., oil and other commodities) or that are sold to highly sophisticated customers in large markets (e.g., automotive industry) usually are sold based on cost-based pricing. Value-based pricing is most successful when products are sold based on emotions (fashion), in niche markets, in shortages (e.g., drinks at open air festival at a hot summer day) or for indispensable add-ons (e.g., printer cartridges, headsets for cell phones).

Many customer-related factors are important in value-based pricing. For example, it is critical to understand the consumer buying process. How important is price? When is it considered? How is it used? Another factor is the cost of switching. Have you ever watched the television program,”The Price is Right”? If you have, you know that most consumers have poor price knowledge. Moreover, their knowledge of comparable prices within a product category (e.g., ketchup is typically worse). So price knowledge is a relevant factor. Finally, the marketer must assess the customers’ price expectations. How much do you expect to pay for a large pizza? Color TV? DVD? Newspaper?Swimming pool? These expectations create a phenomenon called “sticker shock” as exhibited by gasoline, automobiles, and ATM fees.

Value-based pricing is predicated upon an understanding of customer value. In many settings, gaining this understanding requires primary research. This may include evaluation of customer operations and interviews with customer personnel. Survey methods are sometimes used to determine value a customer attributes to a product or a service. The results of such surveys often depict a customer’s willingness to pay. The principal difficulty is that the willingness of the customer to pay a certain price differs between customers, between countries, even for the same customer in different settings (depending on his actual and present needs), so that a true value-based pricing at all times is impossible. Also, extreme focus on value-based pricing might leave customers with a feeling of being exploited which is not helpful for the companies in the long run.

Although it would be nice to assume that a business has the freedom to set any price it chooses, this is not always the case. There are a variety of constraints that prohibit such freedom. Some constraints are formal, such as government restrictions in respect to strategies like collusion and price-fixing. This occurs when two or more companies agree to charge the same or very similar prices. Other constraints tend to be informal. Examples include matching the price of competitors, a traditional price charged for a particular product, and charging a price that covers expected costs.

8.8.3: Geographic Pricing

Geographical pricing is the practice of modifying a basic list price based on the location of the buyer to reflect shipping costs.

Learning Objective

Describe the different types of geographic pricing from a pricing tactic perspective

Key Points

• Zone pricing is a pricing tactic where prices increase as shipping distances increase. This is sometimes done by drawing concentric circles on a map with the plant or warehouse at the center and each circle defining the boundary of a price zone.
• FOB origin (Free on Board origin) is a pricing tactic where the shipping cost from the factory or warehouse is paid by the purchaser. Ownership of the goods is transferred to the buyer as soon as it leaves the point of origin.
• Freight-absorption pricing is where the seller absorbs all or part of the cost of transportation. This amounts to a price discount and is used as a promotional tactic.

Key Terms

list price

The retail selling price of an item, as recommended by the manufacturer or retail distributor, or as listed in a catalog.

zone pricing

The practice of modifying a basic list price based on the geographical location of the buyer.

Geographical pricing is the practice of modifying a basic list price based on the geographical location of the buyer. It is intended to reflect the costs of shipping to different locations. There are several types of geographic pricing:

• FOB origin (Free on Board origin): The shipping cost from the factory or warehouse is paid by the purchaser. Ownership of the goods is transferred to the buyer as soon as it leaves the point of origin. It can be either the buyer or seller that arranges for the transportation.

FOB

FOB is used for sea freight. The purchaser is responsible for the shipping costs.

A container ship loads cargo at a loading dock.

• Uniform delivery pricing (also called postage stamp pricing): The same price is charged to all.
• Zone pricing: Prices increase as shipping distances increase. This is sometimes done by drawing concentric circles on a map with the plant or warehouse at the center and each circle defining the boundary of a price zone. Instead of using circles, irregularly shaped price boundaries can be drawn that reflect geography, population density, transportation infrastructure, and shipping cost. (The term “zone pricing” can also refer to the practice of setting prices that reflect local competitive conditions (i.e., the market forces of supply and demand, rather than actual cost of transportation). Zone pricing, as practiced in the gasoline industry in the United States, is the pricing of gasoline based on a complex and secret weighting of factors, such as the number of competing stations, number of vehicles, average traffic flow, population density, and geographic characteristics. This can result in two branded gas stations only a few miles apart selling gasoline at a price differential of as much as $0.50 per gallon. Many business people and economists state that gasoline zone pricing merely reflects the costs of doing business in a complex and volatile marketplace. Critics contend that industry monopoly and the ability to control not only industry-owned “corporate” stations, but locally owned or franchise stations, make zone pricing into an excuse to raise gasoline prices virtually at will. Oil industry representatives contend that while they set wholesale and dealer tank wagon prices, individual dealers are free to see whatever prices they wish and that this practice in itself causes widespread price variations outside industry control. Zone pricing is also used to price fares in certain metro stations.
• Basing point pricing: Certain cities are designated as basing points. All goods shipped from a given basis point are charged the same amount.
• Freight-absorption pricing: The seller absorbs all or part of the cost of transportation. This amounts to a price discount and is used as a promotional tactic.

8.8.4: Transfer Pricing

Transfer pricing describes all aspects of intracompany pricing arrangements between business entities for goods and services.

Learning Objective

Outline the concept and rationale of transfer pricing as a pricing tactic

Key Points

• Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges of goods and services within a multi-divisional organization, particularly in regard to cross-border transactions.
• Intra-company transactions across borders are growing rapidly and are becoming much more complex. Compliance with the differing requirements of multiple overlapping tax jurisdictions is a complicated and time-consuming task.
• Division managers are provided incentives to maximize their own division’s profits. The firm must set the optimal transfer prices to maximize company profits or each division will try to maximize their own profits leading to lower overall profits for the firm.

Key Terms

marginal cost

Marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good.

marginal revenue

Marginal revenue is the additional revenue that will be generated by increasing product sales by one unit.

Example

• Company X produces car engines in a plant in Michigan and puts together the entire car in Indiana. Each of these locations are a division of the company that has to meet their own profit margins. Company X tells the engine division in Michigan that they must make a profit of 500 per engine. They also tell the final assembly division in Indiana that they must make a profit of 500 per engine. They also tell the final assembly division in Indiana that they must make a profit of 2,000. The engine division in Michigan wants to set a price in which they will make the required profit. However, if they set this price too high then the Indiana division will not make their required profit, and the total company will have less of a profit. Each division must set a transfer price in which the company will be the most profitable and not based on each division being the most profitable.

Transfer pricing refers to the setting, analysis, documentation, and adjustment of charges of goods and services within a multi-divisional organization, particularly in regard to cross-border transactions. Transfer pricing describes all aspects of intra company pricing arrangements between related business entities, including transfers of intellectual property, transfers of tangible goods, services and loans, and other financing transactions.

For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary, with the choice of the transfer price affecting the division of the total profit among the parts of the company. This has led to the rise of transfer pricing regulations as governments seek to stem the flow of taxation revenue overseas, making the issue one of great importance for multinational corporations.

Intra-company transactions across borders are growing rapidly and are becoming much more complex. Compliance with the differing requirements of multiple overlapping tax jurisdictions is a complicated and time-consuming task. At the same time, tax authorities from each country are imposing stricter penalties, new documentation requirements, increased information exchange and increased audit/inspection activity.

Division managers are provided incentives to maximize their own division’s profits. The firm must set the optimal transfer prices to maximize company profits, or each division will try to maximize their own profits leading to lower overall profits for the firm. Double marginalization is when both divisions mark up prices in excess of marginal cost and overall firm profits are not optimal.

One can use marginal price determination theory to analyze optimal transfer pricing, with optimal being defined as transfer pricing that maximizes overall firm profits in a non-realistic world with no taxes, no capital risk, no development risk, no externalities, or any other frictions which exist in the real world. From marginal price determination theory, the optimum level of output is that where marginal cost equals marginal revenue. That is to say, a firm should expand its output as long as the marginal revenue from additional sales is greater than their marginal costs. In the diagram that follows , this intersection is represented by point A, which will yield a price of P*, given the demand at point B.

Optimal Transfer Pricing Diagram

From marginal price determination theory, the optimum level of output is where marginal cost equals marginal revenue.

When a firm is selling some of its product to itself, and only to itself (i.e., there is no external market for that particular transfer good), then the picture gets more complicated, but the outcome remains the same. The demand curve remains the same. The optimum price and quantity remain the same. But marginal cost of production can be separated from the firm’s total marginal costs. Likewise, the marginal revenue associated with the production division can be separated from the marginal revenue for the total firm. This is referred to as the Net Marginal Revenue in production (NMR) and is calculated as the marginal revenue from the firm minus the marginal costs of distribution.

It can be shown algebraically that the intersection of the firm’s marginal cost curve and marginal revenue curve (point A) must occur at the same quantity as the intersection of the production division’s marginal cost curve with the net marginal revenue from production (point C).

8.8.5: Consumer Penalties

Penalties, in the form of fees and restricted user access, exist for consumers who violate terms in contracts.

Learning Objective

Review the rationale and use of consumer penalties as part of pricing tactics

Key Points

• Most organizations reserve the right to restrict a user’s access to the service if they violate the terms in the agreement.
• Other forms of penalties can exist as fees. An early-termination fee is charged by a company when a customer wants or needs to be released from a contract before it expires.
• Early payment penalties and fees also exist when people pay off a loan earlier than expected, making a firm lose out on interest fees. The fees typically negate this advantage at least in part.

Key Term

surcharge

An addition of extra charge on the agreed or stated price.

Consumer Penalties

Penalties, in the form of fees and restricted user access, exist for consumers who violate terms in contracts. Terms of service are rules which one must agree to abide by in order to use a service.

Certain websites are noted for having carefully designed terms of service, particularly eBay and PayPal, which need to maintain a high level of community trust because of transactions involving money. Terms of service can cover a range of issues, including acceptable user behavior online, a company’s marketing policies, and copyright notices. Some organizations, such as Yahoo!, can change their terms of service without notice to the users.

Most organizations reserve the right to restrict a user’s access to the service if they violate the terms in the agreement. In serious cases, the user may have his or her account terminated. In extreme cases, the company may pursue legal action.

Other forms of penalties can exist as fees or surcharges. An early-termination fee is charged by a company when a customer wants or needs to be released from a contract before it expires. One example is when a renter leaves an apartment before a year-long contract is over. If tenants rent for a shorter period, or month-to-month, they are instead charged significantly more per month, and are often denied any promotional deals. Mobile phone companies in the U.S., such as Verizon Wireless , are notorious for large early-termination fees, which can be in the hundreds of dollars . Some mortgage companies also chargeearly payment penalties if the homeowner pays more than is due in order to reduce the interest owed and to shorten the remaining term of the loan. The fees typically negate this advantage, at least in part.

Mobile Phones

Mobile phone service providers often charge an early termination fee on their service, which is a form of consumer penalty.

8.9: Pricing Legal Concerns

8.9.1: Unfair Trade Practices

Unfair business practices are oppressive or unconscionable acts by companies against consumers or other stakeholders.

Learning Objective

Explain the concept of unfair trade practices relative to legal concerns and pricing

Key Points

• Unfair business acts are generally prohibited by law, so committing them may force a company to provide for the award of compensatory damages, punitive damages, and payment of the plaintiff’s legal fees.
• Two major forms of unfair trade practice are fraud and misrepresentation.
• Unfair trade practices not only affect consumers, but may affect other stakeholders as well, such as competitors and investors.

Key Terms

misrepresentation

A false statement of fact made by one party to another party, which has the effect of inducing that party into the contract.

fraud

Any act of deception carried out for the purpose of unfair, undeserved, or unlawful gain.

Example

• Samuel Israel III was a former hedge fund manager who ran the former fraudulent Bayou Hedge Fund Group, and faked his suicide to avoid jail. Approximately $450 million was raised by the group from investors. Its investors were defrauded from the start with funds being misappropriated for personal use. After poor returns in 1998, the investors were lied to about the fund’s returns and a fake accounting firm was set up to provide misleading audited results.

Unfair Trade Practices

Unfair business practices include oppressive or unconscionable acts by companies against consumers and others. In most countries, such practices are prohibited under the law. Unfair trade practices can occur in many different areas such as insurance claims and settlement, debt collection, and tenancy issues.

Unfair trade practices also include such acts as:

• Fraud: This is an intentional deception made for the company’s gain or to damage the other party .
• Misrepresentation: This is a false statement of fact made by one party to another party, which has the effect of inducing that party into the contract. For example, under certain circumstances, false statements or promises made by a seller of goods regarding the quality or nature of the product may constitute misrepresentation.

In addition to providing for the award of compensatory damages, laws may also provide for the award of punitive damages as well as the payment of the plaintiff’s legal fees. When statutes prohibiting unfair and deceptive business practices provide for the award of punitive damages and attorneys fees to injured parties, they provide a powerful incentive for businesses to resolve the claim through the settlement process rather than risk a more costly judgment in court.

In the European Union, each member state must regulate unfair business practices in accordance with the Unfair Commercial Practices Directive, subject to transitional periods. This is a major reform of the law concerning unfair business practices in the European Union.

Unfair trade practices not only affect consumers, but other stakeholders as well. Unfair competition in a sense means that the competitors compete on unequal terms, because favorable or disadvantageous conditions are applied to some competitors but not to others; or that the actions of some competitors actively harm the position of others with respect to their ability to compete on equal and fair terms. Often, unfair competition means that the gains of some participants are conditional on the losses of others, when the gains are made in ways which are illegitimate or unjust.

8.9.2: Illegal Price Advertising

Deceptive price advertising uses misleading or false statements in advertising and promotion and is usually illegal.

Learning Objective

Describe the concept and types of illegal price advertising

Key Points

• While deceptive price advertising is usually illegal, in practice, it can be difficult to stop or difficult to enforce any law relating to it.
• False and deceptive advertising methods include hidden fees and surcharges, “going out of business” sales, manipulation of measurement units, fillers, oversized packaging, bait and switch, etc.
• Advertising need not be proven to be deceptive for it to be illegal. What matters is the potential to deceive, which happens when consumers see the advertising to be stating to them, explicitly or implicitly, a claim that they may not realize is false and material.

Key Terms

bait-and-switch

Relating to use of bait and switch (offering one attractive exchange initially, but not honoring the offer) in business, politics, and elsewhere.

surcharge

An addition of extra charge on the agreed or stated price.

Illegal Price Advertising

Deceptive or false advertising is the use of misleading or outright false statements by companies in their advertising and promotional material. Depending on the type and the severity, deceptive advertising is usually illegal, because it is recognized that advertising has the potential to persuade people to enter into commercial transactions that they may otherwise avoid. However, advertisers still find ways to deceive consumers in ways that are legal or technically illegal but unenforceable.

Types of Illegal Price Advertising

Hidden fees and surcharges

These are fees that are not stated in the advertised price. These are particularly common for services, such as cell phone activation, broadband, gym memberships, and air travel. Generally, companies get away with it, because the fees are hidden in fine print and obfuscated by technical language.

“Going out of business” sales

Often, companies that supposedly are liquidating will raise prices on items marked for clearance, meaning that the company increases the price and “discounts” it. Thus, the discount is less than advertised. Another case, at liquidating stores (if it is a retail chain), the sales prices at the chain’s other stores is lower than the liquidator’s prices at the closing stores. On top of this, sale items are often “final sale,” meaning returns are not accepted. Thus, there is no recourse for customers.

Manipulation of measurement units and standards

Sellers may manipulate standards to mean something different than their widely understood meaning. One example is the personal computer’s hard drive. By stating the sizes of hard drives in “megabytes” of 1,000,000 bytes, instead of 1,048,576, they overstate capacity by nearly 5%. With gigabytes, the error increases to over 7% (1,073,741,824, instead of 1,000,000,000) and nearly 10% for the newer terabyte. Seagate Technology and Western Digital were sued in a class-action suit for this deception. Both companies agreed to settle the suit and reimburse customers in kind, yet they still continue to advertise this way.

In another example, Fretter Appliance stores claimed “I’ll give you five pounds of coffee if I can’t beat your best deal. ” While initially they gave away that quantity, they later redefined them as “Fretter pounds,” which, unsurprisingly, were much lighter than standard pounds.

Fillers and oversized packaging

Some products are sold with fillers, which increase the legal weight of the product with something that costs the producer very little compared to what the consumer thinks that he or she is buying. Food is an example of this, where TV dinners are filled with gravy or other sauce instead of meat. Malt and cocoa butter have been used as filler in peanut butter.

Manipulation of terms

Many terms do have some meaning, but the specific extent is not legally defined, leading to their abuse. A frequent example (until the term gained a legal definition) was “organic” food. “Light” food also is an even more common manipulation: The term has been variously used to mean low in calories, sugars, carbohydrates, salt, texture, thickness (viscosity), or even light in color. Tobacco companies, for many years, used terms like “low tar,” “light,” “ultra-light,” “mild,” or “natural” in order to imply that products with such labels have less detrimental effects on health but in recent years, it was proven that those terms were considered misleading. Naturally, these manipulations of terms are used to charge a higher price, particularly on “‘organic” products.

Incomplete/inconsistent comparison

“Better” means one item is superior to another in some way, while “best” means it is superior to all others in some way. However, advertisers frequently fail to list in what way the items are being compared (price, size, quality, etc.) and, in the case of “better,” to what they are comparing. In an inconsistent comparison, an item is compared with many others, but only compared with each on the attributes where it wins, leaving the false impression that it is the best of all products, in all ways. This is common with price-comparing Internet websites.

Bait-and-switch

Advertisers advertise an item that is unavailable when the consumer arrives at the store and is then sold a similar product at higher price. Bait-and-switch is legal in the United States, provided that ads state that there is a limited supply and that no rain checks will be offered.

Legal regulations

Advertising is regulated by the authority of the Federal Trade Commission to prohibit “unfair and deceptive acts or practices in commerce. ” What is illegal is the potential to deceive, which is interpreted to occur when consumers see the advertising to be stating to them, explicitly or implicitly, a claim that they may not realize is false and material. The goal is prevention rather than punishment, reflecting the purpose of civil law in setting things right rather than that of criminal law.

Listerine Advertisement, 1932

From 1921 until the mid-1970s, Listerine was also marketed as a preventive and remedy for colds and sore throats. In 1976, the Federal Trade Commission ruled that the claims were misleading.

8.9.3: Predatory Pricing

Predatory pricing is the practice of selling a product or service at a very low price, intending to drive competitors out of the market.

Learning Objective

Examine the characteristics of predatory pricing relative to legal concerns

Key Points

• After the weaker competitors are driven out, the surviving business can raise prices to supra competitive levels. The predator hopes to generate revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing period.
• While predatory pricing is illegal in many countries, it is very difficult to prove that a company has undertaken a strategy of predatory pricing rather than competitive pricing.
• Critics argue that the prey know that the predator cannot sustain low prices forever, so it is essentially a game of chicken: if they can ride it out, they will survive.

Key Terms

low-cost signalling

A strategy of signalling to competitors that you intend to pursue a low-cost strategy.

predatory pricing

A strategy of selling goods or services at a very low price in order to drive one’s competitors out of business (at which point one can raise one’s prices more freely).

Example

• In the Darlington Bus War, Stagecoach Group allegedly offered free bus rides in order to put the rival Darlington Corporation Transport out of business.

Predatory Pricing

Predatory pricing is the practice of selling a product or service at a very low price, with the intention of driving competitors out of the market, or create barriers to entry for potential new competitors. Since competitors cannot sustain equal or lower prices without incurring losses, they may be forced out of business. After chasing competitors out of the market, the incumbent would have fewer competitors (and may in fact be a monopoly), and can then – in theory – raise prices above what the market would otherwise bear.

In many countries, predatory pricing is considered anti-competitive and is illegal under competition laws. However, It is usually difficult to prove that prices dropped because of deliberate predatory pricing rather than legitimate price competition. In any case, competitors may be driven out of the market before the case is ever heard. Thus, many economists are doubtful that the concept of predatory pricing is actually practical and transferable to the real world.

Economic Rationale

In the short run, profits for the incumbent will fall due to predatory pricing, possibly even into negative territory. The incumbent will not mind so long as they can maintain these losses, which can be made up for once they raise prices above the would-be market level: after the weaker competitors are driven out, the surviving business can raise prices above competitive levels (to supra competitive pricing). The predator hopes to generate revenues and profits in the future that will more than offset the losses it incurred during the predatory pricing period. There must be substantial barriers to entry for new competitors for predatory pricing to succeed. But the strategy may fail if competitors are stronger than expected, or are driven out but replaced by others. In either case, this may force the predator to prolong or abandon the price reductions. The strategy may fail if the predator cannot endure the short-term losses, either because it takes longer than expected or simply because the loss was not properly estimated. So the predator should hope this strategy to works only when it is much stronger than its competitors and when barriers to entry are high. The barriers prevent new entrants to the market replacing others driven out, thereby allowing supra competitive pricing to prevail long enough to dwarf the initial loss.

Criticism and Support

Criticism

Some economists claim that true predatory pricing is rare because it is an irrational practice and that laws designed to prevent it only inhibit competition. This stance was taken by the US Supreme Court in the 1993 case Brooke Group v. Brown & Williamson Tobacco. The Federal Trade Commission has not successfully prosecuted any company for predatory pricing since. Economists argue that the competitors (the ‘prey’) know that the predator cannot sustain low prices forever, so it is essentially a game of chicken. If they can ride it out, they will survive. And even if they cannot, bankrupcy does not by itself eliminate the fallen prey’s ability to produce: the physical plant and people whose skills made it a viable business will exist, and will be available – perhaps at very low prices – to others who may replace the fallen prey once supra-competitive prices set in.Critics of laws against predatory pricing may support their case empirically by arguing that there has been no instance where such a practice has actually led to a monopoly. Conversely, they argue that there is much evidence that predatory pricing has failed miserably.

Support

Prey may not see it as a game of chicken, if they truly believe that the prey has actually found a way to achieve a lower cost of production than them. Thus, they would not know predatory pricing is occurring. They would exit the market, thinking it is no longer profitable. This is known as ‘low-cost signalling’. However, this does not support the idea that the new virtual monopoly could raise and sustain prices at monopoly levels, even though there are certain barriers to entering monopolized markets that could, in theory, prevent the entry of competition.

Examples

According to an International Herald Tribune article, the French government ordered Amazon.com to stop offering free shipping to its customers, because it was in violation of French predatory pricing laws. After Amazon refused to obey the order, the government proceeded to fine them €1,000 per day. Amazon continued to pay the fines instead of ending its policy of offering free shipping. Low oil prices during the 1990s, while being financially unsustainable, effectively stifled exploration to increase production, delayed innovation of alternative energy sources and eliminated competition from other more expensive yet productive sources of petroleum such as stripper wells. It is important to note that in both these and other cases, the predatory pricing policy is alleged, and difficult to prove comprehensively.

Oil Refinery

In the 1990s, low oil prices were considered a case of alleged predatory pricing.

8.9.4: Price Discrimination

Although there are legal concerns around monopolistic practices, price discrimination is a popular tactic for capturing consumer surplus.

Learning Objective

Construct the concept of price discrimination relative to legal concerns in pricing

Key Points

• In theoretical markets there exists perfect information, no transaction costs, and perfect substitutes, and in these cases price discrimination can only exist in monopolistic or oligopolistic markets.
• For price discrimination to take place, companies must be able to identify market segments by their price elasticity of demand, and they must be able to enforce the scheme.
• There are four degrees of price discrimination (including reverse price discrimination), that all occur under slightly different circumstances, depending on the market structure and the company’s ability to discriminate.

Key Terms

consumer surplus

The monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay.

price discrimination

Occurs when sales of identical goods or services are transacted at different prices from the same provider.

Example

• Airlines use several different types of price discrimination, including: bulk discounts to tour operators, incentive discounts for higher sales volumes to corporate buyers, seasonal discounts, etc. The price of a flight from Singapore to Tokyo can vary widely if one buys the ticket in Singapore compared to Tokyo (or New York or elsewhere). First degree price discrimination based on customer also occurs: it is not accidental that hotel or car rental firms may quote higher prices to their loyalty program’s top tier members than to the general public.

Price discrimination is the sale of identical goods or services at different prices from the same provider. Price discrimination also occurs when the same price is charged for goods with different supply costs.

Price discrimination’s effects on social efficiency are unclear; typically such behavior leads to lower prices for some consumers and higher prices for others. Output can be expanded when price discrimination is very efficient, but output can decline when discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers.

Legal Concerns

Although price discrimination is the producer’s or seller’s legal attempt to charge varying prices for the same product based on consumer demand, price discrimination can be illegal in some cases. For example, it is illegal for manufacturers to set different prices for anti-competitive purposes. Beer companies during the 1960’s attempted to price discriminate based on location to price below competitors and run them out of business.

Economic Rationale

In theoretical markets there exists perfect information, no transaction costs, and perfect substitutes. In these cases price discrimination can only exist in monopolistic or oligopolistic markets: otherwise, a buyer can buy the good at a lower price and sell it immediately at a slightly higher place (but lower than the price discrimination level), making a profit. In the real world, product heterogeneity, market frictions and moderate fixed costs allow for a level of price description in many markets.

Two conditions are necessary for price discrimination:

1. Companies must be able to identify market segments by their price elasticity of demand;
2. They must be able to enforce the scheme.

For example, airlines routinely engage in price discrimination by charging high prices for customers with relatively inelastic demand–business travelers –and discount prices for tourists who have relatively elastic demand. The airlines enforce the scheme by making the tickets non-transferable thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveler (arbitrage). Airlines must also prevent business travelers from directly buying discount tickets. Airlines accomplish this by imposing advance ticketing requirements or minimum stay requirements conditions that would be difficult for average business traveler to meet.

Third Degree Price Discrimination

Instead of supplying one price and taking the profit (old profit) the total market is broken down into two sub-markets. They’re priced separately to maximize profit. 

Three curves that show third-degree price discrimination – industry (old profit), elastic submarket (profit), and inelastic submarket (higher profit).

Types of Price Discrimination

First degree

Here, the monopoly seller knows the maximum price each individual buyer is willing to pay, allowing them to absorb the entire consumer surplus. More is produced than the non-discriminating monopoly case, and there is no deadweight loss. This is mostly a theoretical outcome.

Second degree

Price varies according to demand: larger quantities are available at a lower unit price. Unlike first degree, sellers are unable to differentiate between individual consumers, and so they provide incentives for consumers to differentiate themselves. For example, airlines differentiate according to first, business and coach passengers.

Third degree

Price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer’s identity; where the attribute in question is used as a proxy for ability/willingness to pay. Sellers are able to differentiate between different types of consumers. An example is student discounts. In third degree discrimination, it is not always advantageous to discriminate.

Fourth degree/reverse price discrimination

Prices are the same for different customers, even if organizational costs may vary. For example, a coach class airplane passenger may order a vegetarian meal. Their ticket cost is the same, but it may cost more to the airline to obtain a vegetarian meal for them.

Examples of Price Discrimination

Price discrimination is very common in services where resale is not possible; an example is student discounts at museums. Price discrimination in intellectual property is also enforced by law and by technology. In the market for DVDs, DVD players are designed–by law–with chips to prevent an inexpensive copy of the DVD (for example legally purchased in India) from being used in a higher price market (like the US).

Price discrimination can also be seen where the requirement that goods be identical is relaxed. For example, so-called “premium products” (including relatively simple products, such as cappuccino compared to regular coffee) have a price differential that is not explained by the cost of production. Some economists have argued that this is a form of price discrimination exercised by providing a means for consumers to reveal their willingness to pay. For instance, Starbucks will charge more for a coffee than, say, a local cafe, even if there is no discernable difference in quality.

8.9.5: Price Fixing

Price fixing is a collusion between competitors in order to raise prices of a good or service, at the expense of competitive pricing.

Learning Objective

Examine the characteristics of price fixing and its legal implications

Key Points

• Price fixing is inefficient, transferring some of the consumer surplus to producers and results in a deadweight loss.
• Price fixing is illegal in most developed countries. In the United States, price fixing can be prosecuted as a criminal federal offense. However, price fixing is perfectly legal in many countries.
• When sovereign nations rather than individual firms come together to control prices, the cartel may be protected from lawsuits and criminal antitrust prosecution.

Key Terms

deadweight loss

A loss of economic efficiency that can occur when equilibrium for a good or service is not achieved or is not achievable.

price fixing

In antitrust law, collusion between competitors in order to raise prices, at the expense of competitive pricing.

collusion

A secret agreement for an illegal purpose; conspiracy.

Example

• OPEC is perhaps the most important cartel in the world: the member countries come together to fix oil prices at levels beneficial to them. However, because of the sovereign nature of the members, no action is taken against them.

As it is commonly understood, the term “price fixing” refers to a collusion between sellers in a market to coordinate pricing—usually pushing it above the competitive level—for their collective benefit. While this is price fixing as commonly understood, the actual definition is much broader. It is an agreement between participants on the same side in a market to buy or sell a product, service, or commodity only at a fixed price, or maintain the market conditions such that the price is maintained at a given level by controlling supply and demand . The defining characteristic of price fixing is any agreement regarding price, whether expressed or implied. The intent of price fixing may be to push the price of a product as high as possible, leading to profits for all sellers but may also have the goal to fix, peg, discount , or stabilize prices.

There are many things sellers may do during a price fix. They might agree to sell at a common target price, set a common minimum price, buy the product from a supplier at a specified maximum price, adhere to a price book or list price, engage in cooperative price advertising, standardize financial credit terms offered to purchasers, use uniform trade-in allowances, limit discounts, discontinue a free service or fix the price of one component of an overall service, adhere uniformly to previously announced prices and terms of sale, establish uniform costs and markups, impose mandatory surcharges, purposefully reduce output or sales in order to charge higher prices, or purposefully share or pool markets, territories, or customers. These are all instances of price fixing.

Economic Argument and Legal Status

In neoclassical economics, price fixing is inefficient, transferring some of the consumer surplus to producers and results in a deadweight loss. Because of this, price fixing is illegal in most developed countries. In the US, price fixing can be prosecuted as a criminal federal offense. Under American law, even exchanging prices among competitors can violate the antitrust laws. This includes exchanging prices with either the intent to fix prices or if the exchange affects the prices individual competitors set.

In countries other than the United States, Canada, Australia, New Zealand, Japan, Korea and within the European Union, price fixing is not usually illegal and is often practiced. When the agreement to control price is sanctioned by a multilateral treaty or is entered by sovereign nations as opposed to individual firms, the cartel may be protected from lawsuits and criminal antitrust prosecution. This explains, for example, why OPEC, the global petroleum cartel, has not been prosecuted or successfully sued under US. antitrust law. International airline tickets have their prices fixed by agreement with the IATA, a practice for which there is a specific exemption in antitrust law.

Prominent Price Fixing Examples

Air Travel

In August 2007 British Airways was fined £121.5 million for price fixing. The fine was imposed after BA admitted to the price fixing of fuel surcharges on long haul flights . The allegation first came to light in 2006 when Virgin Atlantic reported the events to the authorities after it found staff members from BA and Virgin Atlantic were colluding. Virgin Atlantic has since been granted immunity by both the Office of Fair Trading and the United States Department of Justice who have been investigating the allegations since June 2006. The US Department of Justice later announced that it would fine British Airways $300 million (£148 million) for price fixing. BA maintained that fuel surcharges were “a legitimate way of recovering costs. “

Beer

In April 2007 the European commission fined Heineken €219.3m, Grolsch €31.65m and Bavaria €22.85m for operating a price fixing cartel in Holland, totalling €273.7m (InBev, another brewer, was convicted for price fixing but escaped punishment) . The brewers controlled 80% of the Dutch market, with Heineken claiming 50% and the two others 15% each. Neelie Kroes said she was “very disappointed” that the collusion took place at the very highest (boardroom) level. She added, Heineken, Grolsch, InBev and Bavaria tried to cover their tracks by using code names and abbreviations for secret meetings to carve up the market for beer sold to supermarkets, hotels, restaurants and cafes. The price fixing extended to cheaper own-brand labels and rebates for bars.

Heineken 

Heineken was fined 219.3 million euro for its role in a price fixing cartel in Holland in 2007.

7.3: Important International Bodies and Agreements

7.3.1: The North American Free Trade Agreement (NAFTA)

Learning Objective

Discuss the goals of ways that the North American Free Trade Agreement (NAFTA) serves its members

Key Points

• NAFTA protects copyright, patents and trademarks between the three countries. It was updated with the North American Agreement on Environmental Cooperation, which helped reduce pollution and set more environmental regulations.
• Since NAFTA took away taxes between products traded between the US, Canada and Mexico, Mexico has been buying more products from the US.
• Some say NAFTA has been positive for Mexico, which has seen poverty rates fall and real income rise, while others argue that NAFTA has had negative impacts on farmers in Mexico who saw food prices fall based on cheap imports from the US.

Key Terms

foreign direct investment

Direct investment into production in one country by a company in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

maquiladora

Mexican factories that take in imported raw mateirals and produce goods for export.

NAFTA

The North American Free Trade Agreement (NAFTA) is an agreement between Mexico, the United States and Canada. The agreement was signed by US President George H.W. Bush, Canadian Prime Minister Brian Mulroney, and Mexican President Carlos Salinas on December 17, 1992 in San Antonio, Texas, and took effect on January 1, 1994.

NAFTA

NAFTA is an agreement between the US, Mexico, and Canada, as represented by the 3 flags in its logo.

A flag that’s made up of the three countries in NAFTA – the US, Mexico, and Canada.

The bill removed taxes on products traded between the three countries. It also protects copyright, patents, and trademarks between those countries. It was updated with the North American Agreement on Environmental Cooperation, which helped reduce pollution and set more environmental regulations. It was also updated with the North American Agreement for Labor Cooperation, which helped people fight for better labor conditions.

Effects

Since NAFTA took away taxes for products traded between the US, Canada, and Mexico, Mexico has been buying more products from the US. It saved U.S. companies the cost of selling products to Mexico, and saved Mexican companies the cost of buying items from US companies.

A benefit of the bill is that labels on products exchanged between the three countries come in French, English and Spanish. That way, Mexicans and Americans who speak Spanish can read the Spanish label, Americans and Canadians can read the English label, and Canadians who speak French can read the French label.

NAFTA also encourages more immigration from Mexico to the US. Since small businesses can no longer be protected by tariffs, many small business owners in Mexico cannot compete with the prices of subsidized products from the US. As a result, many Mexicans have gone to the US looking for work. Some believe that NAFTA has been positive for Mexico, which has seen its poverty rates fall and real income rise.

Others argue that NAFTA has been beneficial to business owners in all three countries, but has had negative impacts on farmers in Mexico. Mexican farmers have seen food prices fall due to cheap imports from US agribusiness, while US workers in manufacturing and assembly industries have lost jobs. Critics also argue that NAFTA has contributed to the rising levels of inequality in both the US and Mexico.

Goals of NAFTA

NAFTA was created to eliminate barriers to trade and investment between the US, Canada and Mexico. The implementation of NAFTA immediately eliminated tariffs on more than one-half of Mexico’s exports to the US and more than one-third of US. exports to Mexico. Within 10 years of implementation, all US-Mexico tariffs would be eliminated except for some US agricultural exports that were to be phased out within 15 years. NAFTA also seeks to eliminate non-tariff trade barriers and to protect the intellectual property right of the products.

In the area of intellectual property, the North American Free Trade Agreement Implementation Act made changes to the copyright law of the US, foreshadowing the Uruguay Round Agreements Act of 1994 by restoring copyright (within NAFTA) on certain motion pictures which had entered the public domain.

Trade

The agreement opened the door for free trade, ending tariffs on various goods and services, and implementing equality between Canada, the US and Mexico. Since the implementation of NAFTA, the countries involved have been able to do the following:

• The US had a services trade surplus of $28.3 billion with NAFTA countries in 2009 (the latest data available).
• Foreign direct investment of Canada and Mexico in the US (stock) was $237.2 billion in 2009, up 16.5% from 2008.
• Income in the maquiladora sector has increased 15.5% since the implementation of NAFTA in 1994.
• To alleviate concerns that NAFTA would have negative environmental impacts, in 1994 the Commission for Environmental Cooperation (CEC) was given a mandate to conduct ongoing ex-post environmental assessment of NAFTA.
• Agriculture is the only section that requires three separate agreements between each pair of parties. The Canada–US agreement contains significant restrictions and tariff quotas on agricultural products, whereas the Mexico–US pact allows for a wider liberalization within a framework of phase-out periods.
• Mexico has gone from a minor player in the pre-1994 US export market to the 2^nd largest importer of U.S. agricultural products.
• According to the Department of Homeland Security Yearbook of Immigration Statistics (2006), 73,880 foreign professionals were admitted into the US for temporary employment under NAFTA.

7.3.2: The European Union (EU)

Learning Objective

Describe the economic, political and legal methodology of the European Union

Key Points

• The EU has developed a single market through a standardized system of laws which apply in all member states.
• EU policies aim to ensure the free movement of people, goods, services, and capital; enact legislation in justice and home affairs; and maintain common policies on trade, agriculture, fisheries, and regional development.
• The euro is designed to build a single market by eliminating exchange rate problems, providing price transparency, creating a single financial market and low interest rates, providing a currency used internationally, and protecting against economic fluctuations through internal trade.

Key Terms

Euro Zone

The eurozone is an economic and monetary union of 17 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender. The eurozone currently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

tariff

A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.

GDP

A measure of the economic production of a particular territory in financial capital terms over a specific time period.

The European Union

The European Union (EU) was formally established when the Maastricht Treaty—whose main architects were Helmut Kohl and François Mitterrand—came into force on November 1, 1993. The European Union is an economic and political union of 27 member states which are located primarily in Europe. Its de facto capital is Brussels. In 2004, the EU saw its biggest enlargement to date when Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia joined its ranks. On December 9, 2011, Croatia signed the EU accession treaty making it the 28^th member state as of July 2013.

The EU operates through a system of supranational independent institutions and intergovernmental negotiated decisions by the member states. Important institutions of the EU include the European Commission, the Council of the European Union, the European Council, the Court of Justice of the European Union, and the European Central Bank. The European Parliament is elected every five years by EU citizens.

The EU has developed a single market through a standardized system of laws which apply to all member states. EU policies aim to ensure the free movement of people, goods, services, and capital; enact legislation in justice and home affairs; and maintain common policies on trade, agriculture, fisheries, and regional development.

With a combined population of over 500 million inhabitants, or 7.3% of the world population, the EU generated the largest nominal world gross domestic product (GDP) of 17.6 trillion US dollars in 2011. This figure represented approximately 20% of the global GDP when measured in terms of purchasing power parity.

The Eurozone and Economy

In 2002, EU notes and coins replaced national currencies in 12 member states. Since then, the eurozone (or Euro Zone) encompasses 17 countries. The monetary policy of theeurozone is governed by the European Central Bank .

Eurozone Countries

Adopted in 2002, the euro promotes a single market within 17 countries in the European Union.

A map that highlights which countries are in the Eurozone.

The euro is designed to help build a single market by easing travel of citizens and goods; eliminating exchange rate problems; providing price transparency; creating a single financial market, price stability, and low interest rates; and providing a currency used internationally and protected against shocks by the large amount of internal trade within the eurozone. It is also intended as a political symbol of integration and stimulus for more.

Of the top 500 largest corporations measured by revenue, 161 have their headquarters in the EU. In 2007, unemployment in the EU stood at 7% while investment was at 21.4% of GDP, inflation at 2.2%, and current account balance at −0.9% of GDP. In other words, there was slightly more importing than exporting in the EU. As of August 2012, unemployment in the EU stood at 11.4%.

Political and Legal

The EU operates solely within those competencies conferred on it by the treaties and according to the principle of subsidiary (which dictates that action by the EU should only be taken where an objective cannot be sufficiently achieved by a member state alone). Laws made by the EU institutions are passed in a variety of forms. Generally speaking, they can be classified into two groups: those which come into force without the necessity for national implementation measures, and those which require national implementation measures.

On December 1, 2009, the Lisbon Treaty entered into force and reformed many aspects of the EU. In particular, it changed the legal structure of the EU, merging its three pillars system into a single legal entity provisioned with legal personality, and created a permanent President of the European Council.

The Internal Market

The single market involves the free circulation of goods, capital, people, and services within the EU, and the customs union involves the application of a common external tariff on all goods entering the market. Once goods have been admitted into the market, they cannot be subjected to customs duties, discriminatory taxes or import quotas, as they travel internally. The non-EU member states of Iceland, Norway, Liechtenstein, and Switzerland participate in the single market but not in the customs union.

Free movement of capital is intended to permit movement of investments such as property purchases and the buying of shares between countries. The free movement of persons means that EU citizens can move freely between member states to live, work, study, or retire. This required the lowering of administrative formalities and recognition of professional qualifications of other states.

The free movement of services and of establishment allows self-employed persons to move between member states to provide services on a temporary or permanent basis. While services account for 60% to 70% of GDP, legislation in the area is not as developed as in other areas.

7.3.3: The Common Market of the Southern Cone (MERCOSUR)

Learning Objective

Identify the purpose of the formation of the Common Market of the Southern Cone (MERCOSUR) and its objectives.

Key Points

• Its purpose is to promote free trade and the fluid movement of goods, people, and currency. The official languages are Guaraní, Portuguese, and Spanish.
• Intra-Mercosur merchandise trade grew from $10 billion at the inception of the trade bloc in 1991, to $88 billion in 2010.
• With a population of more than 270 million people, and a GDP of the full-member nations in excess of $3 trillion a year, Mercosur is the fifth-largest economy in the world, just behind the European Union.

Key Terms

GDP

A measure of the economic production of a particular territory in financial capital terms over a specific time period.

trade bloc

is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states.

tariff

A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.

MERCOSUR

Mercosur is an economic and political agreement among Argentina, Brazil, Paraguay, Uruguay, and Venezuela . Established in 1991 by the Treaty of Asunción, it was later amended and updated by the 1994 Treaty of Ouro Preto.

Mercosur Member Countries

Mercosur has five full member countries (Argentina, Brazil, Paraguay, Uruguay, Venezuela), and two associate members (Bolivia and Chile).

The purpose of Mercosur is to promote free trade and the fluid movement of goods, people, and currency. The official languages are Guaraní, Portuguese and Spanish. Mercosur acts as a full customs union and works toward a continuing process of South American integration into the Union of South American Nations. The program also proposed the Gaucho as a currency for regional trade.

The founding of the Mercosur Parliament was agreed at the December 2004 presidential summit.

Objectives

• Mercosur seeks the free transit of produced goods, services, and factors among the member states. Among other things, this includes the elimination of customs rights and lifting of non-tariff restrictions on the transit of goods or any other measures with similar effects.
• Mercosur seeks to fix a common external tariff (CET), adopt a common trade policy with regard to nonmember states or groups of states, and coordinate positions in regional and international commercial and economic meetings.
• Mercosur seeks to coordinate macroeconomic and sector policies of member states relating to foreign trade, agriculture, industry, taxes, monetary system, exchange and capital, services, customs, transport and communications, and any others they may agree on, in order to ensure free competition between member states.
• Mercosur seeks to commit to the integration process by making the necessary adjustments to member state’s laws in pertinent areas. The common market will allow (in addition to customs unification) the free movement of manpower and capital across the member nations. Because member states will implement the trade liberalization at different speeds, during the transition period the rights and obligations of each party will initially be equivalent but not necessarily equal.

Trade and Economy

Intra-Mercosur merchandise trade (excluding Venezuela) grew from USD 10 billion at the inception of the trade bloc in 1991, to $88 billion in 2010; Brazil and Argentina accounted for 43% of this total. The trade balance within the bloc has historically been tilted toward Brazil, which recorded an intra-Mercosur balance of over $5 billion in 2010. Trade within Mercosur amounted to only 16% of the four countries’ total merchandise trade in 2010, and trade with the European Union (20%), China (14%), and the United States (11%) was of comparable importance.

Exports from the bloc are highly diversified, and include a variety of agricultural, industrial, and energy goods. Merchandise trade with the rest of the world in 2010 resulted in a surplus for Mercosur of nearly $7 billion; trade in services, however, was in deficit by over $28 billion.

The bloc comprises a population of more than 270 million people, and the combined Gross Domestic Product of the full-member nations is in excess of $3 trillion a year according to the International Monetary Fund (IMF), making Mercosur the fifth-largest economy in the world. It is the fourth-largest trading bloc after the European Union.

7.3.4: The Asia-Pacific Economic Cooperation (APEC)

Learning Objective

Discuss the purpose of the Asia-Pacific Economic Council (APEC)

Key Points

• APEC includes newly industrialized economies and members account for approximately 40% of the world’s population, approximately 54% of the world’s gross domestic product and about 44% of world trade.
• Established in 1989 in response to the growing interdependence of Asia-Pacific economies and the advent of regional trade blocs in other parts of the world.
• APEC works to raise living standards and education levels through sustainable economic growth and to foster a sense of community and an appreciation of shared interests among Asia-Pacific countries.

Key Terms

trade bloc

is a type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states.

free trade

international trade free from government interference, especially trade free from tariffs or duties on imports

Asia-Pacific Economic Cooperation (APEC) is a forum of 21 Pacific Rim countries that seeks to promote free trade and economic cooperation throughout the Asia-Pacific region. APEC includes newly industrialized economies and its members account for approximately 40% of the world’s population, approximately 54% of the world’s gross domestic product and about 44% of world trade. APEC currently has 21 members, including most countries with a coastline on the Pacific Ocean. However, the criterion for membership is that the member is a separate economy, rather than a state. As a result, APEC uses the term member economies rather than member countries to refer to its members.

APEC’s 21 Members

APEC’s 21 members have a Pacific Coastline and a separate economy.

Reasons for Establishment

• Established in 1989 in response to the growing interdependence of Asia-Pacific economies and the advent of regional trade blocs in other parts of the world.
• In response to fears that highly industrialized Japan would come to dominate economic activity in the Asia-Pacific region.
• To establish new markets for agricultural products and raw materials beyond Europe (where demand had been declining).

Goals

During a meeting in 1994 in Bogor, Indonesia, APEC leaders adopted the Bogor Goals that aim for free and open trade and investment in the Asia-Pacific by 2010 for industrialized economies and by 2020 for developing economies. In 1995, APEC established a business advisory body named the APEC Business Advisory Council (ABAC), composed of three business executives from each member economy.

APEC works to raise living standards and education levels through sustainable economic growth and to foster a sense of community and an appreciation of shared interests among Asia-Pacific countries.

APEC carries out work in three main areas:

1. Trade and Investment Liberalization: According to the organization, when APEC was established in 1989, average trade barriers in the region stood at 16.9 percent, but was reduced to 5.5% in 2004.
2. Business Facilitation: Between 2002 and 2006 the costs of business transactions across the region was reduced by 6%, thanks to the APEC Trade Facilitation Action Plan (TFAPI). According to a 2008 research brief published by the World Bank as part of its Trade Costs and Facilitation Project, increasing transparency in the region’s trading system is critical if APEC is to meet its Bogor Goal targets. The APEC Business Travel Card, a travel document for visa-free business travel within the region is one of the concrete measures to facilitate business.
3. Economic and Technical Cooperation: APEC is considering the prospects and options for a Free Trade Area of the Asia-Pacific (FTAAP), which would include all APEC member economies. Since 2006, the APEC Business Advisory Council, promoting the theory that a free trade area has the best chance of converging the member nations and ensuring stable economic growth under free trade, has lobbied for the creation of a high-level task force to study and develop a plan for a free trade area.

Criticism

APEC has been criticized for failing to clearly define itself or serve a useful purpose. According to the organization, it is “the premier forum for facilitating economic growth, cooperation, trade and investment in the Asia-Pacific region” established to “further enhance economic growth and prosperity for the region and to strengthen the Asia-Pacific community”. However, whether it has accomplished anything constructive remains debatable, especially from the viewpoints of European countries that cannot be part of APEC.

7.3.5: The World Trade Organization (WTO)

Learning Objective

Review the purpose and status of the World Trade Organization (WTO)

Key Points

• The WTO provides a framework for negotiating and formalizing trade agreements, and a dispute resolution process aimed at enforcing participants’ adherence to WTO agreements signed by representatives of member governments.
• The General Agreement on Tariffs and Trade (GATT) preceded the WTO, but after about 40 years, its members concluded that it was straining to adapt to a new globalizing world economy. As a result, in 1994 members agreed to create the WTO at in the last round of GATT negotiations in Uruguay.
• The conflict between free trade on industrial goods and services, but retention of protectionism on farm subsidies to domestic agricultural sector and the support of international liberalization of fair trade on agricultural products remain the major obstacles in the Doha Development Round.

Key Terms

accession

The act by which one power becomes party to engagements already in force between other powers.

protectionism

A policy of protecting the domestic producers of a product by imposing tariffs, quotas or other barriers on imports.

The World Trade Organization (WTO) was officially formed on January 1, 1995 under the Marrakesh Agreement, with the goal of supervising and liberalizing international trade between participating countries. The WTO provides a framework for negotiating and formalizing trade agreements, and a dispute resolution process aimed at enforcing participants’ adherence to WTO agreements signed by representatives of member governments. The organization is attempting to complete negotiations on the Doha Development Round, which was launched in 2001 with an explicit focus on addressing the needs of developing countries. As of June 2012, the future of the Doha Round remains uncertain.

World Trade Organization

The WTO has managed international trade negotiations among its members since 1995.

A map that shows the countries in the WTO.

WTO Predecessor

The General Agreement on Tariffs and Trade (GATT) was established after World War II in the wake of other new multilateral institutions dedicated to international economic cooperation Well before GATT’s 40^th anniversary, its members concluded that the GATT system was straining to adapt to a new globalizing world economy. As a result, the WTO was formed in the final Uruguay Round of GATT in 1994. The WTO has supervision over the GATT treaties as well as 60 other agreements made during the Marrakesh Agreement.

Functions

The most important functions of the WTO are as follows:

• Oversees the implementation, administration, and operation of the covered agreements.
• Provides a forum for negotiations and for settling disputes.
• Reviews and propagates national trade policies.
• Ensures the coherence and transparency of trade policies through surveillance in global economic policy-making.
• Assists in developing, least-developed, and low-income countries in transition to adjust to WTO rules and disciplines through technical cooperation and training.
• Regularly assesses the global trade picture in its annual publications and research reports.
• Cooperates closely with the IMF and the World Bank.

Members and Observers

The WTO has 157 members and 27 observer governments. WTO members do not have to be full sovereign nation-members. Instead, they must be a customs territory with full autonomy in the conduct of their external commercial relations. Iran is the biggest economy outside the WTO. Most observers must start accession negotiations within five years of becoming observers. Fourteen states and two territories so far have no official interaction with the WTO.

The Doha Development Round

The Doha negotiations round was to be an ambitious effort to make globalization more inclusive and to help the world’s poor, particularly by slashing barriers and subsidies in farming. The initial agenda comprised both further trade liberalization and new rule-making, underpinned by commitments to strengthen substantial assistance to developing countries. According to a European Union statement, “The 2008 ministerial meeting broke down over a disagreement between exporters of agricultural bulk commodities and countries with large numbers of subsistence farmers on the precise terms of a ‘special safeguard measure’ to protect farmers from surges in imports. ” The position of the European Commission is that “The successful conclusion of the Doha negotiations would confirm the central role of multilateral liberalization and rule-making. It would confirm the WTO as a powerful shield against protectionist backsliding. ” An impasse remains and as of June 2012, agreement has not been reached, despite intense negotiations at several ministerial conferences and at other sessions.

Major Obstacles

The conflict between free trade on industrial goods and services, but retention of protectionism on farm subsidies to the domestic agricultural sector (requested by developed countries) and the substantiation of the international liberalization of fair trade on agricultural products (requested by developing countries) remain the major obstacles. These points of contention have hindered any progress to launch new WTO negotiations beyond the Doha Development Round.

Agreements

The WTO oversees about 60 different agreements which have the status of international legal texts. Some of the most important agreements are as follows:

• Agreement on Agriculture has three central “pillars”: domestic support, market access, and export subsidies.
• General Agreement on Trade in Services was established in 1995 to extend the multilateral trading system to service sector, in the same way as the General Agreement on Tariffs and Trade (GATT) provided such a system for merchandise trade.
• Agreement on Trade-Related Aspects of Intellectual Property Right sets down minimum standards for many forms of intellectual property (IP) regulation.
• Agreement on Technical Barriers to Trade ensures that technical negotiations and standards, as well as testing and certification procedures, do not create unnecessary obstacles to trade.
• Agreement on Customs Valuation adopts the “transaction value” approach and prescribes methods of customs valuation that members are to follow.

7.4: Types of International Business

7.4.1: Countertrade

Countertrade is a system of exchange in which goods and services are used as payment rather than money.

Learning Objective

Explain the various methods of countertrading

Key Points

• Countertrade is the exchange of goods or services for other goods or services. This system can be typified as simple bartering, switch trading, counter purchase, buyback, or offset.
• Switch trading: Party A and B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
• Counter purchase: Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B.
• Buyback: Party A builds a salt processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
• Offset agreement: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.

Key Terms

Switch trading

Practice in which one company sells to another its obligation to make a purchase in a given country.

counter purchase

Sale of goods and services to one company in another country by a company that promises to make a future purchase of a specific product from the same company in that country.

barter

The exchange of goods or services without involving money.

Examples

• Bartering: One party gives salt in exchange for sugar from another party.
• Switch trading: Party A and Party B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
• Counter purchase: Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B.
• Buyback: Party A builds a salt processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
• Offset agreement: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.

Countertrade means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. A monetary valuation can, however, be used in counter trade for accounting purposes. Any transaction involving exchange of goods or service for something of equal value.

Bartering

Bartering involves exchanging goods or services for other goods or services as payment.

A newspaper illustration in Harper’s Weekly where two men engaging in a barter. One man offers chickens in exchange for his yearly newspaper subscription.

There are five main variants of countertrade:

1. Barter: Exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment.
2. Switch trading: Practice in which one company sells to another its obligation to make a purchase in a given country.
3. Counter purchase: Sale of goods and services to one company in aother country by a company that promises to make a future purchase of a specific product from the same company in that country.
4. Buyback: This occurs when a firm builds a plant in a country, or supplies technology, equipment, training, or other services to the country, and agrees to take a certain percentage of the plant’s output as partial payment for the contract.
5. Offset: Agreement that a company will offset a hard currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation.

Countertrade also occurs when countries lack sufficient hard currency or when other types of market trade are impossible. In 2000, India and Iraq agreed on an “oil for wheat and rice” barter deal, subject to UN approval under Article 50 of the UN Persian Gulf War sanctions, that would facilitate 300,000 barrels of oil delivered daily to India at a price of $6.85 a barrel, while Iraq oil sales into Asia were valued at about $22 a barrel. In 2001, India agreed to swap 1.5 million tonnes of Iraqi crude under the oil-for-food program.

7.4.2: Direct Investment

FDI is practiced by companies in order to benefit from cheaper labor costs, tax exemptions, and other privileges in that foreign country.

Learning Objective

Explain the effects of foreign direct investment (FDI) for the investor and the host country

Key Points

• FDI is the flow of investments from one company to production in a foreign nation, with the purpose of lowering labor costs and gaining tax incentives.
• FDI can help the economic situations of developing countries, as well as facilitate progressive internal policy reforms.
• A major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions.

Key Term

Foreign direct investment

investment directly into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

Example

• Intel is headquartered in the United States, but it has made foreign direct investments in a number of Southeast Asian countries where they produce components of their products in Intel-owned factories.

Foreign direct investment (FDI) is investment into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

FDI is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges, such as tax exemptions, offered by the country as an incentive to gain tariff-free access to the markets of the country or the region. FDI is in contrast to portfolio investment which is a passive investment in the securities of another country, such as stocks and bonds.

One theory for how to best help developing countries, is to increase their inward flow of FDI. However, identifying the conditions that best attract such investment flow is difficult, since foreign investment varies greatly across countries and over time. Knowing what has influenced these decisions and the resulting trends in outcomes can be helpful for governments, non-governmental organizations, businesses, and private donors looking to invest in developing countries.

Sao Paulo, Brazil

Sao Paulo, Brazil, is home to a growing middle class and significant direct investments.

Paulista Avenue in Sao Paulo, Brazil.

A study from scholars at Duke University and Princeton University published in the American Journal of Political Science, “The Politics of Foreign Direct Investment into Developing Countries: Increasing FDI through International Trade Agreements,” examines trends in FDI from 1970 to 2000 in 122 developing countries to assess what the best conditions are for attracting investment. The study found the major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions. The researchers conclude that, while “democracy can be conducive to international cooperation,” the strongest indicator for higher inward flow of FDI for developing countries was the number of trade agreements and institutions to which they were party.

7.4.3: Franchising

Franchising enables organizations a low cost and localized strategy to expanding to international markets, while offering local entrepreneurs the opportunity to run an established business.

Learning Objective

Examine the benefits of international franchising

Key Points

• A franchise agreement is defined as the franchiser granting an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products.
• Franchising is designed to enable large organizations rapid access to new markets with relatively low barriers to entry.
• Advantages of franchising (for the franchiser) include low costs of entry, a localized workforce (culturally and linguistically), and a high speed method of market entry.
• Disadvantages of franchising (for the franchiser) include loss of some organizational and brand control, as well as relatively lower returns than other strategic entry models (albeit, with lower risk).

Key Terms

franchisee

A holder of a franchise; a person who is granted a franchise.

franchiser

A franchisor, a company or person who grants franchises.

What is Franchising?

In franchising, an organization (the franchiser) has the option to grant an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products. 

In this arrangement, the franchisee will take the majority of the risk in opening a new location (e.g. capital investments) while gaining the advantage of an already established brand name and operational process. In exchange, the franchisee will pay a certain percentage of the profits of the venture back to the franchiser. The franchiser will also often provide training, advertising, and assistance with products.

Why Franchise

Lower Barriers to Entry

Franchising is a particularly useful practice when approaching international markets. For the franchiser, international expansion can be both complex and expensive, particularly when the purchase of land and building of facilities is necessary. With legal, cultural, linguistics, and logistical barriers to entry in various global markets, the franchising model offers and simpler, cleaner solution that can be implemented relatively quickly.

Localization

Franchising also allows for localization of the brand, products, and distribution systems. This localization can cater to local tastes and language through empowering locals to own, manage, and employ the business. This high level of integration into the new location can create significant advantages compared to other entry models, with much lower risk.

Speed

It is also worth noting that franchising is a very efficient, low cost and quickly implemented expansionary strategy. Franchising requires very little capital investment on behalf of the parent company, and the time and effort of building the stores are similar outsources to the franchisee. As a result, franchising can be a way to rapidly expand both domestically and globally.

Starbucks’ Expansion

Starbucks operates with a wide variety of strategic alliances, including a franchising program. 

A chart that shows how various forms of strategic alliance can rapidly increase rates of expansion.

Downsides to Franchising

Franchising has some weaknesses as well, from a strategic point of view. Most importantly, organizations (the franchisers) lose a great deal of control. Quality assurance and protection of the brand is much more difficult when ownership of the franchise is external to the organization itself. Choosing partners wisely and equipping them with the tools necessary for high levels of quality and alignment with the brand values is critical (e.g., training, equipment, quality control, adequate resources).

It is also of importance to keep the risk/return ratio in mind. While the risk of franchising is much lower in terms of capital investment, so too is the returns derived from operations (depending on the franchising agreement in place). While it is a faster and cheaper mode of entry, it ultimately results in a profit share between the franchiser and the franchisee.

7.4.4: Multinational Firms

With the advent of improved communication and technology, corporations have been able to expand into multiple countries.

Learning Objective

Explain how a multinational corporation (MNC) operates

Key Points

• Multinational corporations operate in multiple countries.
• MNCs have considerable bargaining power and may negotiate business or trade policies with success.
• A corporation may choose to locate in a special economic zone, a geographical region that has economic and other laws that are more free-market-oriented than a country’s typical or national laws.

Key Term

Multinational corporation

A corporation or enterprise that operates in multiple countries.

Example

• McDonalds operates in over 119 different countries, making it a fairly large MNC by any standard

A multinational corporation (MNC) or multinational enterprise (MNE) is a corporation registered in more than one country or has operations in more than one country. It is a large corporation which both produces and sells goods or services in various countries . It can also be referred to as an international corporation. The first multinational corporation was the Dutch East India Company, founded March 20, 1602.

Ford 

Ford is a multinational corporation with operations throughout the world.

Corporations may make a foreign direct investment. Foreign direct investment is direct investment into one country by a company located in another country. Investors buy a company in the country or expand operations of an existing business in the country.

A corporation may choose to locate in a special economic zone, a geographical region with economic and other laws that are more free-market-oriented than a country’s typical or national laws.

Multinational corporations are important factors in the processes of globalization. National and local governments often compete against one another to attract MNC facilities, with the expectation of increased tax revenue, employment and economic activity. To compete, political powers push toward greater autonomy for corporations. MNCs play an important role in developing economies of developing countries.

Many economists argue that in countries with comparatively low labor costs and weak environmental and social protection, multinationals actually bring about a “race to the top.” While multinationals will see a low tax burden or low labor costs as an element of comparative advantage, MNC profits are tied to operational efficiency, which includes a high degree of standardization. Thus, MNCs are likely to adapt production processes in many of their operations to conform to the standards of the most rigorous jurisdiction in which they operate.

As for labor costs, while MNCs pay workers in developing countries far below levels in countries where labor productivity is high (and accordingly, will adopt more labor-intensive production processes), they also tend to pay a premium over local labor rates of 10% to 100%.

Finally, depending on the nature of the MNC, investment in any country reflects a desire for a medium- to long-term return, as establishing a plant, training workers and so on can be costly. Therefore, once established in a jurisdiction, MNCs are potentially vulnerable to arbitrary government intervention like expropriation, sudden contract renegotiation and the arbitrary withdrawal or compulsory purchase of licenses. Thus both the negotiating power of MNCs and the “race to the bottom” critique may be overstated while understating the benefits (besides tax revenue) of MNCs becoming established in a jurisdiction.

7.4.5: Offshoring

Offshoring entails a company moving a business process from one country to another.

Learning Objective

Explain the benefits of offshoring

Key Points

• Offshoring is the relocation of certain business processes from one country to the other, resulting in large tax breaks and lower labor costs.
• Offshoring can cause controversy in a company’s domestic country since it is perceived to impact the domestic employment situation negatively.
• Offshoring of a company’s services that were previously produced domestically can be advantageous in lowering operation costs, but has incited some controversy over the economic implications.

Key Terms

offshoring

The location of a business in another country for tax purposes.

outsourcing

The transfer of a business function to an external service provider.

captive

held prisoner; not free; confined

“Offshoring” is a company’s relocation of a business process from one country to another. This typically involves an operational process, such as manufacturing, or a supporting process, such as accounting. Even state governments employ offshoring. More recently, offshoring has been associated primarily with the sourcing of technical and administrative services that support both domestic and global operations conducted outside a given home country by means of internal (captive) or external (outsourcing) delivery models.The subject of offshoring, also known as “outsourcing,” has produced considerable controversy in the United States. Offshoring for U.S. companies can result in large tax breaks and low-cost labor.

Worldwide Offshoring Business

The worldwide offshoring business is projected to equal $500 billion by 2020.

A chart that shows growth in the worldwide offshoring business.

Offshoring can be seen in the context of either production offshoring or services offshoring. After its accession to the World Trade Organization (WTO) in 2001, the People’s Republic of China emerged as a prominent destination for production offshoring. Another focus area includes the software industry as part of Global Software Development and the development of Global Information Systems. After technical progress in telecommunications improved the possibilities of trade in services, India became a leader in this domain; however, many other countries are now emerging as offshore destinations.

The economic logic is to reduce costs. People who can use some of their skills more cheaply than others have a comparative advantage. Countries often strive to trade freely items that are of the least cost to produce.

Related terms include “nearshoring,” “inshoring,” and “bestshoring,” otherwise know as “rightshoring.” Nearshoring is the relocation of business processes to (typically) lower cost foreign locations that are still within close geographical proximity (for example, shifting United States-based business processes to Canada/Latin America). Inshoring entails choosing services within a country, while bestshoring entails choosing the “best shore” based on various criteria. Business process outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as Finance & Accounting and Customer Service) are outsourced. More specific terms can be found in the field of software development; for example, Global Information System as a class of systems being developed for/by globally distributed teams.

7.4.6: Licensing

When considering strategic entry into an international market, licensing is a low-risk and relatively fast foreign market entry tactic.

Learning Objective

Identify the benefits and risks associated with licensing as a foreign market entry model

Key Points

• Foreign market entry options include exporting, joint ventures, foreign direct investment, franchising, licensing, and various other forms of strategic alliance.
• Of these potential entry models, licensing is relatively low risk in terms of time, resources, and capital requirements.
• Advantages of licensing include localization through a foreign partner, adherence to strict international business regulations, lower costs, and the ability to move quickly.
• Disadvantages to this entry mode include loss of control, potential quality assurance issues in the foreign market, and lower returns due to lower risk.
• When deciding to license abroad, careful due diligence should be done to ensure that the licensee is a strong investment for the licensor and vice versa.

Key Terms

licensee

In a licensing relationship, the buyer of the produce, service, brand or technology being licensed.

licensor

In a licensing relationship, the owner of the produce, service, brand or technology being licensed.

When considering entering international markets, there are some significant strategic and tactical decisions to be made. Exporting, joint ventures, direct investment, franchising, licensing, and various other forms of strategic alliance can be considered as market entry modes. Each entry mode has different pros and cons, addressing issues like cost, control, speed to market, legal barriers, and cultural barriers with different degrees of efficiency.

Licensing

The 1933 Fiat 508 was manufactured under a license in Poland by Polski Fiat.

What is Licensing

A licensor (i.e. the firm with the technology or brand) can provide their products, services, brand and/or technology to a licensee via an agreement. This agreement will describe the terms of the strategic alliance, allowing the licensor affordable and low risk entry to a foreign market while the licensee can gain access to the competitive advantages and unique assets of another firm. This is potentially a strong win-win arrangement for both parties, and is a relatively common practice in international business.

Let’s consider an example. The licensor is a company involved in energy health drinks. Due to food import regulations in Japan, the licensor cannot sell the product at local wholesalers or retailers. In order to circumvent this strategic barrier, the licensor finds a local sports drink manufacturer to license their recipe to. In exchange, the licensee sells the product locally under a local brand name and kicks back 15% of the overall revenues to the licensor.

The Pros and Cons

Before deciding to use licensing as an entry strategy, it’s important to understand in which situations licensing is best suited.

Advantages

Licensing affords new international entrants with a number of advantages:

• Licensing is a rapid entry strategy, allowing almost instant access to the market with the right partners lined up.
• Licensing is low risk in terms of assets and capital investment. The licensee will provide the majority of the infrastructure in most situations.
• Localization is a complex issue legally, and licensing is a clean solution to most legal barriers to entry.
• Cultural and linguistic barriers are also significant challenges for international entries. Licensing provides critical resources in this regard, as the licensee has local contacts, mastery of local language, and a deep understanding of the local market.

Disadvantages

While the low-cost entry and natural localization are definite advantages, licensing also comes with some opportunity costs:

• Loss of control is a serious disadvantage in a licensing situation in regards to quality control. Particularly relevant is the licensing of a brand name, as any quality control issue on behalf of the licensee will impact the licensor’s parent brand.
• Depending on an international partner also creates inherent risks regarding the success of that firm. Just like investing in an organization in the stock market, licensing requires due diligence regarding which organization to partner with.
• Lower revenues due to relying on an external party is also a key disadvantage to this model. (Lower risk, lower returns.)

7.4.7: Outsourcing

Outsourcing business functions to developing foreign countries has become a popular way for companies to reduce cost.

Learning Objective

Explain why companies outsource

Key Points

• Outsourcing is the contracting of business processes to external firms, usually in developing countries where labor costs are cheaper.
• This practice has increased in prevalence due to better technology and improvements in the educational standards of the countries to which jobs are outsourced.
• The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.

Key Terms

insourcing

The obtaining of goods or services using domestic resources or employees as opposed to foreign.

outsourcing

The transfer of a business function to an external service provider.

offshoring

The location of a business in another country for tax purposes.

Example

• Corporations may outsource their helpdesk or customer service functions to 3rd party call centers in foreign countries because these skilled laborers can do these jobs at a lesser cost than their equivalents in the domestic country.

Outsourcing

Overview

Outsourcing is the contracting out of a business process, which an organization may have previously performed internally or has a new need for, to an independent organization from which the process is purchased back as a service. Though the practice of purchasing a business function—instead of providing it internally—is a common feature of any modern economy, the term outsourcing became popular in America near the turn of the 21^st century. An outsourcing deal may also involve transfer of the employees and assets involved to the outsourcing business partner. The definition of outsourcing includes both foreign or domestic contracting , which may include offshoring, described as “a company taking a function out of their business and relocating it to another country. “

Outsourcing

Outsourcing is the process of contracting an existing business process to an independent organization. The process is purchased as a service.

Businessmen talk and shake hands.

The opposite of outsourcing is called insourcing, and it is sometimes accomplished via vertical integration. However, a business can provide a contract service to another business without necessarily insourcing that business process.

Reasons for Outsourcing

Companies outsource to avoid certain types of costs. Among the reasons companies elect to outsource include avoidance of burdensome regulations, high taxes, high energy costs, and unreasonable costs that may be associated with defined benefits in labor union contracts and taxes for government mandated benefits. Perceived or actual gross margin in the short run incentivizes a company to outsource. With reduced short run costs, executive management sees the opportunity for short run profits while the income growth of the consumers base is strained. This motivates companies to outsource for lower labor costs. However, the company may or may not incur unexpected costs to train these overseas workers. Lower regulatory costs are an addition to companies saving money when outsourcing.

Import marketers may make short run profits from cheaper overseas labor and currency mainly in wealth consuming sectors at the long run expense of an economy’s wealth producing sectors straining the home county’s tax base, income growth, and increasing the debt burden. When companies offshore products and services, those jobs may leave the home country for foreign countries at the expense of the wealth producing sectors. Outsourcing may increase the risk of leakage and reduce confidentiality, as well as introduce additional privacy and security concerns.

7.4.8: Joint Ventures

In a joint venture business model, two or more parties agree to invest time, equity, and effort for the development of a new shared project.

Learning Objective

Outline the dynamics of a joint venture

Key Points

• Joint business ventures involve two parties contributing their own equity and resources to develop a new project. The enterprise, revenues, expenses and assets are shared by the involved parties.
• Since money is involved in a joint venture, it is necessary to have a strategic plan in place.
• As the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project as well as the resulting profits.

Key Term

joint venture

A cooperative partnership between two individuals or businesses in which profits and risks are shared.

Example

• Sony Ericsson is a joint venture between Swedish telecom corporation Ericsson and Japanese electronics manufacturer Sony to develop cellular devices.

Joint Ventures

A joint venture is a business agreement in which parties agree to develop a new entity and new assets by contributing equity. They exercise control over the enterprise and consequently share revenues, expenses and assets.

Joint Venture

Sony Ericsson is a joint venture between Swedish telecom corporation Ericsson and Japanese electronics manufacturer Sony.

When two or more persons come together to form a partnership for the purpose of carrying out a project, this is called a joint venture. In this scenario, both parties are equally invested in the project in terms of money, time and effort to build on the original concept. While joint ventures are generally small projects, major corporations use this method to diversify. A joint venture can ensure the success of smaller projects for those that are just starting in the business world or for established corporations. Since the cost of starting new projects is generally high, a joint venture allows both parties to share the burden of the project as well as the resulting profits.

Since money is involved in a joint venture, it is necessary to have a strategic plan in place. In short, both parties must be committed to focusing on the future of the partnership rather than just the immediate returns. Ultimately, short term and long term successes are both important.To achieve this success, honesty, integrity and communication within the joint venture are necessary.

A consortium JV (also known as a cooperative agreement) is formed when one party seeks technological expertise, franchise and brand-use agreements, management contracts, and rental agreements for one-time contracts. The JV is dissolved when that goal is reached. Some major joint ventures include Dow Corning, MillerCoors, Sony Ericsson, Penske Truck Leasing, Norampac, and Owens-Corning.

7.4.9: Contract Manufacturing

In contract manufacturing, a hiring firm makes an agreement with the contract manufacturer to produce and ship the hiring firm’s goods.

Learning Objective

Compare the benefits and risks of employing a contract manufacturer (CM)

Key Points

• A hiring firm may enter a contract with a contract manufacturer (CM) to produce components or final products on behalf of the hiring firm for some agreed-upon price.
• There are many benefits to contract manufacturing, and companies are finding many reasons why they should be outsourcing their production to other companies.
• Production outside of the company does come with many risks attached. Companies must first identify their core competencies before deciding about contract manufacture.

Key Terms

Contract manufacturing

a business model where a firm hires another firm to produce components or products

Contract manufacturing

Business model in which a firm hires a contract manufacturer to produce components or final products based on the hiring firm’s design.

A contract manufacturer (“CM”) is a manufacturer that enters into a contract with a firm to produce components or products for that firm. It is a form of outsourcing. In a contract manufacturing business model, the hiring firm approaches the contract manufacturer with a design or formula. The contract manufacturer will quote the parts based on processes, labor, tooling, and material costs. Typically a hiring firm will request quotes from multiple CMs. After the bidding process is complete, the hiring firm will select a source, and then, for the agreed-upon price, the CM acts as the hiring firm’s factory, producing and shipping units of the design on behalf of the hiring firm.

Contract Manufacturing

Ness Corporation is a contract manufacturer in Seven Hills, Australia.

Benefits

Contract manufacturing offers a number of benefits:

• Cost Savings: Companies save on their capital costs because they do not have to pay for a facility and the equipment needed for production. They can also save on labor costs such as wages, training, and benefits. Some companies may look to contract manufacture in low-cost countries, such as China, to benefit from the low cost of labor.
• Mutual Benefit to Contract Site: A contract between the manufacturer and the company it is producing for may last several years. The manufacturer will know that it will have a steady flow of business at least until that contract expires.
• Advanced Skills: Companies can take advantage of skills that they may not possess, but the contract manufacturer does. The contract manufacturer is likely to have relationships formed with raw material suppliers or methods of efficiency within their production.
• Quality: Contract Manufacturers are likely to have their own methods of quality control in place that help them to detect counterfeit or damaged materials early.
• Focus: Companies can focus on their core competencies better if they can hand off base production to an outside company.
• Economies of Scale: Contract Manufacturers have multiple customers that they produce for. Because they are servicing multiple customers, they can offer reduced costs in acquiring raw materials by benefiting from economies of scale. The more units there are in one shipment, the less expensive the price per unit will be.

Risks

Balanced against the above benefits of contract manufacturing are a number of risks:

• Lack of Control: When a company signs the contract allowing another company to produce their product, they lose a significant amount of control over that product. They can only suggest strategies to the contract manufacturer; they cannot force them to implement those strategies.
• Relationships: It is imperative that the company forms a good relationship with its contract manufacturer. The company must keep in mind that the manufacturer has other customers. They cannot force them to produce their product before a competitor’s. Most companies mitigate this risk by working cohesively with the manufacturer and awarding good performance with additional business.
• Quality: When entering into a contract, companies must make sure that the manufacturer’s standards are congruent with their own. They should evaluate the methods in which they test products to make sure they are of good quality. The company has to ensure the contract manufacturer has suppliers that also meet these standards.
• Intellectual Property Loss: When entering into a contract, a company is divulging their formulas or technologies. This is why it is important that a company not give out any of its core competencies to contract manufacturers. It is very easy for an employee to download such information from a computer and steal it. The recent increase in intellectual property loss has corporate and government officials struggling to improve security. Usually, it comes down to the integrity of the employees.
• Outsourcing Risks: Although outsourcing to low-cost countries has become very popular, it does bring along risks such as language barriers, cultural differences, and long lead times. This could make the management of contract manufacturers more difficult, expensive, and time-consuming.
• Capacity Constraints: If a company does not make up a large portion of the contract manufacturer’s business, they may find that they are de-prioritized over other companies during high production periods. Thus, they may not obtain the product they need when they need it.
• Loss of Flexibility and Responsiveness: Without direct control over the manufacturing facility, the company will lose some of its ability to respond to disruptions in the supply chain. It may also hurt their ability to respond to demand fluctuations, risking their customer service levels.

7.4.10: Exporting

Exporting is the practice of shipping goods from the domestic country to a foreign country.

Learning Objective

Explain how exports are accounted for in international trade

Key Points

• This term export is derived from the conceptual meaning as to ship the goods and services out of the port of a country.
• In national accounts “exports” consist of transactions in goods and services (sales, barter, gifts or grants) from residents to non-residents.
• Statistics on international trade do not record smuggled goods or flows of illegal services. A small fraction of the smuggled goods and illegal services may nevertheless be included in official trade statistics through dummy shipments that serve to conceal the illegal nature of the activities.

Key Terms

export

to sell (goods) to a foreign country

import

To bring (something) in from a foreign country, especially for sale or trade.

exporting

the sale of capital, goods, and services across international borders or territories

exporting

the act of selling to a foreign country

Example

• When individuals from Country A purchase goods from Country B, this process is known as exporting for Country B (since their goods are being sold) and importing for Country A (since they are buying the goods).

This term “export” is derived from the concept of shipping goods and services out of the port of a country . The seller of such goods and services is referred to as an “exporter” who is based in the country of export whereas the overseas based buyer is referred to as an “importer”. In international trade, exporting refers to selling goods and services produced in the home country to other markets.

Oil Exports 2006

The map shows barrels of oil exported per day in 2006. Russia and Saudi Arabia exported more barrels than any other oil-exporting countries.

Export of commercial quantities of goods normally requires the involvement of customs authorities in both the country of export and the country of import. The advent of small trades over the internet such as through Amazon and eBay has largely bypassed the involvement of customs in many countries because of the low individual values of these trades. Nonetheless, these small exports are still subject to legal restrictions applied by the country of export. An export’s counterpart is an import.

In national accounts, exports consist of transactions in goods and services (sales, barter, gifts, or grants) from residents to non-residents.The exact definition of exports includes and excludes specific “borderline” cases. A general delimitation of exports in national accounts is as follows: An export of a good occurs when there is a change of ownership from a resident to a non-resident; this does not necessarily imply that the good in question physically crosses any border. However, in specific cases, national accounts impute changes of ownership even though in legal terms no change of ownership takes place (e.g. cross border financial leasing, cross border deliveries between affiliates of the same enterprise, goods crossing the border for significant processing to order or repair). Smuggled goods must also be included in the export measurement.

Export of services consist of all services rendered by residents to non-residents. In national accounts, any direct purchases by non-residents in the economic territory of a country are recorded as exports of services; therefore, all expenditure by foreign tourists in the economic territory of a country is considered part of the export of services of that country. International flows of illegal services must also be included.

National accountants often need to make adjustments to the basic trade data in order to comply with national accounts concepts; the concepts for basic trade statistics often differ in terms of definition and coverage from the requirements in the national accounts:

Data on international trade in goods is mostly obtained through declarations to customs services. If a country applies the general trade system, all goods entering or leaving the country are recorded. If the special trade system (e.g., extra-EU trade statistics) is applied, goods which are received into customs warehouses are not recorded in external trade statistics unless they subsequently go into free circulation in the country of receipt.

7.4.11: Importing

Imports are the inflow of goods and services into a country’s market for consumption.

Learning Objective

Explain the methodology behind the selection of products to import

Key Points

• A country specializes in the export of goods for which it has a comparative advantage and imports those for which it has a comparative disadvantage. By doing so, the country can increase its welfare.
• Comparative advantage describes the ability of a country to produce one specific good more efficiently than other goods.
• A country enhances its welfare by importing a broader range of higher-quality goods and services at lower cost than it could produce domestically.

Key Terms

import

To bring (something) in from a foreign country, especially for sale or trade.

comparative advantage

The concept that a certain good can be produced more efficiently than others due to a number of factors, including productive skills, climate, natural resource availability, and so forth.

Example

• A country in certain tropical areas of the world has a comparative advantage at growing crops like sugar or coffee beans, but it would be much less efficient at growing wheat (due to the climate). Therefore, they should export their sugar/coffee beans and import wheat at a lower cost than trying to grow wheat themselves.

The term “import” is derived from the concept of goods and services arriving into the port of a country. The buyer of such goods and services is referred to as an “importer” and is based in the country of import whereas the overseas-based seller is referred to as an “exporter.” Thus, an import is any good (e.g. a commodity) or service brought in from one country to another country in a legitimate fashion, typically for use in trade. It is a good that is brought in from another country for sale.

Singapore

The Port of Singapore is one of the busiest ports in the world. Singapore has to import most of its food and consumer goods.

A large ship at the Port of Singapore.

Imported goods or services are provided to domestic consumers by foreign producers. An import in the receiving country is an export to the sending country. Imports, along with exports, form the basics of international trade. Import of goods normally requires the involvement of customs authorities in both the country of import and the country of export; those goods are often subject to import quotas, tariffs, and trade agreements. While imports are the set of goods and services imported, “imports” also means the economic value of all goods and services that are imported.

Imports are the inflow of goods and services into a country’s market for consumption. A country enhances its welfare by importing a broader range of higher-quality goods and services at lower cost than it could produce domestically. Comparative advantage is a concept often applied to importing and exporting. Comparative advantage is the concept that a country should specialize in the production and export of those goods and services that it can produce more efficiently than other goods and services, and that it should import those goods and services in which it has a comparative disadvantage.

7.5: Global Marketing Mix

7.5.1: The Relationship Between Product and Promotion

Product and promotion in global marketing can work together effectively with proper market research and communication techniques.

Learning Objective

Illustrate the relationship between product and promotion from a global marketing perspective

Key Points

• The “Four P’s” of marketing—product, price, placement, and promotion—are all affected as a company moves through the different phases to become and maintain dominance as a global company.
• It is the job of global marketers to create and place product advertisements in settings where local consumers will be most receptive to receiving and acting on those messages.
• Promotion is one crucial component of the global marketing mix that enables a global company to send the same message worldwide using relevant, engaging, and cost-effective techniques.

Key Term

integrated marketing communications

an approach to brand communications where the different modes work together to create a seamless experience for the customer and are presented with a similar tone and style that reinforces the brand’s core message.

The Relationship Between Product and Promotion

With the rapidly emerging force of globalization, the distinction between marketing within an organization’s home country and marketing within external markets is disappearing very quickly. With this in mind, organizations are modifying their marketing strategies to meet the challenges of the global marketplace in addition to sustaining their competitiveness within home markets. These changes also have prompted brands to customize their global marketing mix for different markets, based on local languages, needs, wants, and values.

Product Marketing

An effective global marketing plan enables brands to tweak products for local markets while using the most effective promotional channels to reach consumers.

A package of feminine products that are manufactured and sold in China.

The Marketing Mix in Global Marketing

The “Four P’s” of marketing—product, price, placement, and promotion—are all affected as a company moves through the different phases to become and maintain dominance as a global company. Promotion becomes particularly important for positioning the company in such a way that a single product can be tweaked instead of revamped for different markets. Coca-Cola is one strong example of global marketing. The drink brand uses two formulas (one with sugar and one with corn syrup) for all markets. The product packaging in every country incorporates Coca-Cola’s contour bottle design and signature ribbon in some shape or form. However, the bottle can also include the country’s native language and appear in identical sizes as other beverage bottles or cans in that country’s market.

Promotion and Product

Before launching promotional programs, global companies must first define their target markets and determine the products that will resonate most with those consumers and businesses. In addition to pinpointing which price point and distribution channels would best serve those country markets, global marketers must decide how to introduce their products. Promotional tactics for global audiences can range from television commercials to social media marketing on Facebook or YouTube. It is the job of global marketers to create and place product advertisements in settings where local consumers will be most receptive to receiving and acting on those messages.

After product research, development, and creation, promotion is generally the largest line item in a global company’s marketing budget. Integrated marketing communications can significantly increase efficiency and reduce promotional costs. Moreover, promotion is one crucial component of the mix that enables a global company to send the same message worldwide using relevant, engaging, and cost-effective techniques.

While global promotion enables global brands to engage in uniform marketing practices and promote a consistent brand and image, marketers also face the challenge of responding to differences in consumer response to marketing mix elements. Promotional and product marketing challenges also come into play when dealing with differences in brand and product development and fending off local or global competition.

7.5.2: Changes in Promotion

Local languages, colors, and religious beliefs all impact how global marketers promote their products and services in different countries.

Learning Objective

Analyze the rationale used to promote products within a global marketing mix

Key Points

• To successfully implement global marketing strategies, brands must ensure their promotional campaigns take into account how consumer behavior is shaped by internal conditions and external influences.
• Global companies must be nimble enough to adapt changing local market trends, tastes, and needs to their promotional mix.
• When launching global advertising, public relations or sales campaigns, global companies test promotion ideas to provide results that are comparable across countries.
• Using measures can be particularly helpful for marketers since they are based on visual, not verbal, elements of the promotion.

Key Terms

demographics

The observable characteristics of a population, such as physical traits, economic traits, occupational traits, and more.

measure

To ascertain the quantity of a unit of material via calculated comparison with respect to a standard.

Changes in Promotion

Before a company decides to become global, it must consider a multitude of factors unique to the international marketing environment. These factors are social, cultural, political, legal, competitive, economic, and even technological in nature. Ultimately, at the global marketing level, a company trying to speak with one voice is faced with many challenges when creating a worldwide marketing plan. Unless a company holds the same position against its competition in all markets (market leader, low cost, etc.), it is impossible to launch identical marketing plans worldwide. Thus, global companies must be nimble enough to adapt to changing local market trends, tastes, and needs .

Global Promotion

Language is usually one element that is customized in a global promotional mix.

For global advertisers, there are four potentially competing business objectives that must be balanced when developing worldwide advertising: building a brand while speaking with one voice, developing economies of scale in the creative process, maximizing local effectiveness of advertisements, and increasing the company’s speed of implementation. Global marketers can use the following approaches when executing global promotional programs: exporting executions, producing local executions, and importing ideas that travel.

Factors in Global Promotion

To successfully implement these approaches, brands must ensure their promotional campaigns take into how consumer behavior is shaped by internal conditions (e.g., demographics, knowledge, attitude, beliefs) and external influences (e.g., culture, ethnicity, family, lifestyle) in local markets.

• Language – The importance of language differences is extremely crucial in global marketing, as there are almost 3,000 languages in the world. Language differences have caused many problems for marketers in designing advertising campaigns and product labels. Language becomes even more significant if a country’s population speaks several languages.
• Colors – Colors also have different meanings in different cultures. For example, in Egypt, the country’s national color of green is considered unacceptable for packaging because religious leaders once wore it. In Japan, black and white are colors of mourning and should not be used on a product’s package. Similarly, purple is unacceptable in Hispanic nations because it is associated with death.
• Values – An individual’s values arise from his or her moral or religious beliefs and are learned through experiences. For example, Americans place a very high value on material well-being and are much more likely to purchase status symbols than people in India. In India, the Hindu religion forbids the consumption of beef.
• Business norms – The norms of conducting business also vary from one country to the next. In France, wholesalers do not like to promote products. They are mainly interested in supplying retailers with the products they need.
• Religious beliefs – A person’s religious beliefs can affect shopping patterns and products purchased in addition to his or her values. In the United States and other Christian nations, Christmas time is a major sales period. But for other religions, religious holidays do not serve as popular times for purchasing products.

There are many other factors, including a country’s political or legal environment, monetary circumstances, and technological environment that can impact a brand’s promotional mix. Companies have to be ready to quickly respond and adapt to these challenges as they evolve and fluctuate in the market of each country.

Changing the Global Promotional Mix

When launching global advertising, public relations or sales campaigns, global companies test promotional ideas using marketing research systems that provide results comparable across countries. The ability to identify the elements or moments of an advertisement that contribute to the success of a product launch or expansion is how economies of scale are maximized in marketing communications. Market research measures such as flow of attention, flow of emotion, and branding moments provide insight into what is working in an advertisement in one or many countries. These measures can be particularly helpful for marketers since they are based on visual, not verbal, elements of the promotion.

Considering these measures along with conducting extensive market research is essential to determining the success of promotional tactics in any country or region. Once brands discover what works (and what does not) in their promotional mix, those ideas can be imported by any other market. Likewise, companies can use this intelligence to modify various elements in their promotional mix that are receiving minimal or unfavorable response from global audiences.

7.5.3: Changes in Placement

Successfully positioning products on a global scale requires marketers to determine the target market’s preferred combination of attributes.

Learning Objective

Examine the rationale behind product placement from a global marketing perspective

Key Points

• Placement in global marketing involves conducting extensive research to accurately define the market, as well as the attributes that define the product’s potential environment.
• Regardless of its size or visibility, a global brand must adjust its country strategies to take into account placement and distribution in the marketing mix.
• In addition to where products are placed, global marketers must consider how these products will be distributed across the different shopping venues and communication channels unique to that particular country or market.

Key Terms

dollar store

A retail store selling inexpensive items, especially one in which all items have a price of one dollar.

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

positioning

The act of positioning; placement.

Changes in Placement

The global marketing mix comprises four main elements: product, price, placement and promotion. Although product development, promotional tactics and pricing mechanisms are the most visible during the marketing process, placement is just as important in determining how the product is distributed. Placement determines the various channels used to distribute a product across different countries, taking in factors such as competition and how similar brands are being offered to the target market.

Product Placement

Global brands attempt to place products in locations where consumers will be most receptive to the messaging.

Cases of products on the lower shelf in a grocery store.

Global marketing presents more challenges compared to domestic or local marketing. Consequently, brands competing in the global marketplace often conduct extensive research to accurately define the market, as well as the attributes that define the product’s potential environment. Successfully positioning products on a global scale also requires marketers to determine each product’s current location in the product space, as well as the target market’s preferred combination of attributes. These attributes span the range of the marketing mix, including price, promotion, distribution, packaging and competition.

Regardless of its size or visibility, a global brand must adjust its country strategies to take into account placement and distribution in the marketing mix. For example, not all cultures use or have access to vending machines. In the United States, beverages are sold by the pallet via warehouse stores. However, in India, this is not an option.

Moreover, placement decisions must also consider the product’s positioning in the marketplace. A global luxury brand would not want to be distributed via a “dollar store” in the United States. Conversely, low-end shoemakers would likely be ignored by shoppers browsing in an Italian boutique store.

In addition to where products are placed, global marketers must consider how these products will be distributed across the different shopping venues unique to that particular country or market. Customizing these placement strategies for national and local markets while retaining a strong and consistent brand image can help companies gain significant competitive advantages in the global market.

7.5.4: Changes in Pricing

Price in global marketing strategies can be influenced by distribution channels, promotional tactics, and the quality of the product.

Learning Objective

Summarize how proper pricing from a global marketing perspective impacts a company

Key Points

• In the global marketing mix, pricing factors are manufacturing cost, market place, competition, market condition, and quality of product.
• As one of the four “Ps” in the marketing mix, pricing is the only revenue generating element.
• Price will always vary from market to market, and global brands must be prepared to deal with external influences such as trade tariffs, and political and economic shifts in the target country.

Key Terms

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

tariff

A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.

jurisdiction

the limits or territory within which authority may be exercised

Changes in Pricing

Pricing is the process of determining what a company will receive in exchange for its products. In the global marketing mix, pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. As one of the four “Ps” in the marketing mix, pricing is the only revenue generating element.

Pricing

Walmart uses placement, product, and promotion work in addition to pricing in its global marketing mix.

The goal of pricing in global marketing strategies falls under three criteria:

1. Achieving the financial goals of the company and generating profits
2. Matching the realities of the marketplace and consumer buying trends
3. Support a product’s positioning so that it is consistent with product, promotion and placement

General Factors Affecting Price

Like national marketing, pricing in global marketing is affected by the other variables of the marketing mix. Price in global marketing strategies can be influenced by distribution channels, promotional tactics, and the quality of the product. For instance, if distribution is exclusive, then prices are likely to be higher. High prices will also be needed to cover high costs of manufacturing, or extensive advertising and promotional campaigns. If manufacturing costs go up due to the rise in price of some raw material, then prices will need to rise as well.

The Role of Price in Global Marketing

Price will always vary from market to market. However, global marketers must be prepared to deal with not only cultural expectations of pricing, but also external variables including trade tariffs, political and economic fluctuations, and the administrative or legal criteria of specific jurisdictions. Pricing can also be affected by the cost of production (locally or internationally), natural resources (product ingredients or components), and the cost of delivery (e.g., the availability of fuel). For instance, if a country imposes a minimum wage law that forces the company to pay more to its workers, the price of the product is likely to raise to cover some of that cost. Natural resources, such as oil, may also fluctuate in price, changing the price of the final good.

Oil 

The price of oil is a factor that impacts the prices of many goods due to increased transportation costs.

A Chevron gas sign.

Additionally, the product’s positioning in relation to the local competition influences the brand’s ultimate profit margin. Global marketers must carefully consider how to position their product in global markets, and whether their products are considered high-end, economical or something in-between according to cultural norms and customs.

7.5.5: Global Marketing and the Internet

The internet has allowed marketers to benefit from reduced geographic and time constraints, and reach consumers in various new ways.

Learning Objective

Translate the use of the Internet to marketing on a global level

Key Points

• One of the great benefits of global marketing via the Internet is the elimination of geographic and time constraints.
• The Internet provides scope and immediacy for marketers looking to reach large swaths of consumers across different demographics.
• Technological tools such as behavioral targeting, as well as online groups and communities, allow companies to effectively target consumers in different markets with different needs.

Key Terms

personalization

The act of changing an option of a multi-user software product to change the product’s behavior or style for one user.

lead

Potential opportunity for a sale or transaction, a potential customer.

Global Marketing In Light Of the Internet

The Oxford University Press defines global marketing as “marketing on a worldwide scale reconciling or taking commercial advantage of global operational differences, similarities and opportunities in order to meet global objectives. ” The emergence of the Internet in the early 1990s and its gradual commercialization through the early 2000s would coincide with the globalization of media and cultural products. Brands around the world have since attempted to take advantage as well as keep abreast of the commercial, technological, and cultural trends around Internet marketing.

Global Marketing

Some of the most popular forms of online social media are Facebook, Twitter, and Pinterest.

The Twitter logo.

Time and Space Compression

The Internet’s most obvious benefit is the elimination of geographic and time constraints. Organizations have quickly realized that operating costs can be significantly reduced by moving services from physical locations into the digital world. Employees can work remotely from locations hundreds or even thousands of miles away from office headquarters, delivering the same services to clients and customers as employees working on-site. Virtual help desks can be outsourced, allowing technical staff to log into online systems to assist customers located in distant cities, states, and countries.

This same immediacy applies to global marketing, as it allows brands to reach consumers in various ways and offer a wide range of products and services simultaneously. The scope and reach of the Internet is especially beneficial for companies looking to deliver public relations, advertising, and sales messaging consistently across a broad and diverse audience.

The costs of traditional media (television, radio, print and billboard advertising) limit this kind of reach to multinational markets. For small businesses, eMarketing opens up access to potential customers around the world, all for much less the cost than traditional advertising.

The Internet’s accessibility and low barrier to entry enable anyone with an Internet connection to book a flight, test drive a service, or purchase a product with just a few clicks of a mouse. Moreover, the perpetual nature of the Internet makes business occur 24 hours per day, seven days per week, 52 weeks per year. By speeding the time between the delivery of marketing communications and the gathering of consumer responses, the length of the consumer buying cycle is reduced and the volume of lead generation is increased.

Demographics and Targeting

One of the biggest challenges of global marketing is not only communicating a consistent message and brand image, but developing a deep understanding of the cultural differences that separate consumer markets from one another.

Luckily for global companies, web monitoring and tracking tools have become increasingly sophisticated and offer insights into consumer behavior both online and offline. The nature of the Internet is such that users tend to organize themselves into far more focused groupings and in greater concentrations than in offline settings. For example, social networking websites and personalization features can offer valuable information for global marketers looking to access hard-to-reach and overseas markets.

6.3: Marketing Mixes for Services

6.3.1: Product, Placement, Promotion, and Price

Learning Objective

Describe the 7Ps in the services marketing mix

Key Points

• In terms of product, with services there is scope for customizing the offering as per customer requirements so the customer encounter assumes particular significance.
• Pricing of services is tougher than pricing of goods because in the case of services there are attendant costs–such as labor and overhead costs–that also need to be factored in.
• Since service delivery is concurrent with its production and cannot be stored or transported, the location of the service product assumes importance.
• Since a service offering can be easily replicated, promotion becomes crucial in differentiating a service offering in the mind of the consumer.
• The essential elements of product, promotion, price and place remain in service the service marketing mix, but three additional elements–people, physical evidence and process–are included to the 7Ps mix.

Key Terms

intangible

Incorporeal property that is saleable though not material, such as bank deposits, stocks, bonds, and promissory notes.

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

heterogeneous

Diverse in kind or nature; composed of diverse parts.

noise

data that is not being used to transmit a signal, but is simply produced as an unwanted by-product of other activities

Example

• When it comes to deciding on the location of a service offering (place), a fine dining restaurant is better located in a busy, upscale market as opposed to the outskirts of a city; a holiday resort is better situated in the countryside away from the rush and noise of a city.

Introduction

To understand the services marketing mix framework, it’s necessary to understand the nature of services. According to Wolak, Kalaftis & Harris, the characteristics of services are:

• Intangibility–the service cannot be touched or viewed, so it is difficult for clients to tell in advance what they will be getting.
• Inseparability (simultaneity)–the service is being produced at the same time that the client is receiving it (eg during an online search, or a legal consultation).
• Heterogeneity (variability)–services involve people, and people are all different. There is a strong possibility that the same enquiry would be answered slightly differently by different people (or even by the same person at different times). It is important to minimize the differences in performance (through training, standard-setting and quality assurance).
• Perishability–unused capacity cannot be stored for future use. For example, spare seats on one airplane cannot be transferred to the next flight, and query-free times at the reference desk cannot be saved up until there is a busy period.

Each of these characteristics plays a role in the service marketing mix.

The Services Marketing Mix

Extending the 4Ps

The services marketing mix is an extension of the 4Ps framework. The essential elements of product, promotion, price and place remain but three additional elements – people, physical evidence and process are included to the 7Ps mix. The need for the extension is due to the high degree of direct contact between service providers and its customers, the highly visible nature of the service process, and the simultaneity of the production and consumption. Although it is possible to discuss people, physical evidence and process within the 4P framework (for example, people can be considered part of the product offering), this extension allows for a more thorough analysis of the marketing elements necessary for successful services marketing.

Product

In the case of services, the “product” is intangible, heterogeneous and perishable. Moreover, its production and consumption are inseparable. Hence, there is scope for customizing the offering as per customer requirements, and the actual customer encounter therefore assumes particular significance. However, too much customization would compromise the standard delivery of the service and adversely affect its quality. Therefore, particular care has to be taken in designing the service offering.

Pricing

Pricing of services is tougher than pricing of goods. While the latter can be priced easily by taking into account the raw material costs, in the case of services there are attendant costs–such as labor and overhead costs–that also need to be factored in.

A restaurant not only has to charge for the cost of the food served but also has to calculate a price for the ambiance provided.

Place

Since service delivery is concurrent with its production and cannot be stored or transported, the location of the service product assumes importance. Service providers have to give special thought as to where the service is provided. A fine dining restaurant is better located in a busy, upscale market as opposed to the outskirts of a city. A holiday resort is better situated in the countryside away from the rush and noise of a city.

Promotion

Since a service offering can be easily replicated, promotion becomes crucial in differentiating a service offering in the mind of the consumer. Service providers offering identical services such as airlines or banks and insurance companies invest heavily in advertising their services. This is crucial in attracting customers in a segment where the services providers have nearly identical offerings.

People

People are a defining factor in a service delivery process, since a service is inseparable from the person providing it. A restaurant is known as much for its food as for the service provided by its staff. The same is true of banks and department stores. Consequently, customer service training for staff has become a top priority for many organizations today.

Process

The process of service delivery is crucial since it ensures that the same standard of service is repeatedly delivered to the customers. Most companies have a service blue print which provides the details of the service delivery process, often going down to even defining the service script and the greeting phrases to be used by the service staff.

Physical Evidence

Since services are intangible in nature, most service providers strive to incorporate certain tangible elements into their offering to enhance customer experience. Many hair salons have well designed waiting areas, often with magazines and plush sofas for patrons to read and relax while they await their turn. Similarly, restaurants invest heavily in their interior design and decorations to offer a tangible and unique experience to their guests.

Hair Salon

When a business provides intangible services, it might incorporate certain tangible elements to enhance customers’ experience.

6.3.2: SIVA: Solution, Incentive/Information, Value, and Access

Learning Objective

Describe S.I.V.A. model and its role in the marketing mix

Key Points

• This system is basically the four Ps renamed and reworded to provide a customer focus.
• Instead of placing ads, S.I.V.A. advocates simply giving consumers the information they need to determine whether or not the product or services offered is both valuable and accessible to them.
• Instead of using economic theories to set price, S.I.V.A. advocates setting the price of a good or service based on the value a product offers to the consumers.
• Based on the S.I.V.A. model, consumers access products and services when and where they want it instead of corporations dictating the place.
• Based on the S.I.V.A. model, consumers access products and services when and where they want it instead of corporations dictating the place.

Key Term

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

Example

• The price of services is often based on value and not economic models, as services are intangible products that can’t be priced based on the input of raw materials.

Introduction

A firm in the market economy survives by producing goods and offering services that people are willing and able to buy. Consequently, ascertaining consumer demand is vital for a firm’s future viability and profits.

Many companies today have a customer focus (or market orientation). This implies that the company focuses its activities and products on consumer demands. This is also known as S.I.V.A., or Solution, Information, Value, and Access. Generally, there are three ways of doing this:

• the customer-driven approach;
• the market change identification approach; and
• the product innovation approach.

The Consumer-Driven Approach

In the consumer-driven approach, consumer wants are the drivers of all strategic marketing decisions. No strategy is pursued until it passes the test of consumer research. Every aspect of a market offering, including the nature of the product itself, is driven by the needs of potential consumers. The starting point is always the consumer.

Your Wish Is My Command

In the SIVA model, the consumer rules.

The rationale for this approach is that there is no reason to spend R&D funds developing products that people will not buy. History attests to many products that were commercial failures in spite of being technological breakthroughs.

A formal approach to this customer-focused marketing is known as S.I.V.A (Solution, Information, Value, Access). This system is basically the four Ps renamed and reworded to provide a customer focus.

The SIVA Model

The S.I.V.A. Model provides a demand/customer-centric alternative to the well-known four Ps marketing mix model (product, price, placement, promotion) of marketing management. The idea behind it is to restate the four P’s in a way that reflects today’s marketing environment where the power of building brands has shifted from corporations to communities.

Based on this model:

• Product→Solution;
• Promotion→Information;
• Price→Value; and
• Place (Distribution)→Access.

Product Becomes Solution

Here, what is being sold is driven by what the consumer needs. The community defines the product instead of the corporation. It is marketing’s duty to understand what the consumer wants and explain this to the corporations so that they, in turn, can produce the products that satisfy the needs of the consumer. You aren’t simply providing a product, you are offering a solution that meets your customer’s needs. This is what services do on a daily basis.

Promotion Becomes Information

Instead of placing ads, simply give the consumers the information they need to determine whether or not the product or services offered is both valuable and accessible to them. Many services have always operated on this basis. Customers go for a “fact finding” appointment where they learn about the service offered (by a doctor or lawyer, for example) and its price. Based on this information, they decide whether or not to become patients or clients.

Price Become Value

Instead of using economic theories to set price, S.I.V.A. advocates setting the price of a good or service based on the value a product offers to the consumers. The price of services is often determined in this manner as services are intangible products that can’t be priced based on the input of raw materials.

Place Become Access

The whole idea behind this is giving consumers access to products and services when and where they want it instead of dictating where a consumer has to go to get it. These days even beauticians are willing to come to your home to do your hair. Other service providers provide information and services on the Internet as opposed to making you come to their office.

6.4: Service Quality

6.4.1: Customer Feedback

Successful businesses work proactively to obtain information from their customers to ensure they are meeting their needs.

Learning Objective

Summarize the different methods organizations use to collect consumer feedback

Key Points

• In-person focus groups and one-on-one interviews are helpful tools that provide explanation of a product or consumer-related issues because you are going to the main source directly.
• Technology has made it increasingly easier for companies to obtain feedback from their customers.
• With the explosion of technology in the marketplace and the consumer’s everyday life, many companies are now building their own proprietary online panels of consumers which give them unencumbered access to their target market on an ongoing basis.
• Some surveys can be conducted via phone, which yields a more private conversation exchange between the customer and the service provider.

Key Terms

Virtual Online Communities

A social network of individuals who interact through specific social media, potentially crossing geographical and political boundaries in order to pursue mutual interests or goals.

Service Quality

A term which describes a comparison of a customer’s expectations as it relates to a company’s performance.

Example

• Customer feedback can be collected via direct conversations with consumers, telephone or focus group interviews, surveys, and online communities.

Customer Feedback

Service quality generally refers to a customer’s comparison of service expectations as it relates to a company’s performance. A business with a high level of service quality is likely capable of meeting customer needs while also remaining economically competitive in their respective industry. Successful businesses who remain competitive and relevant in the marketplace work proactively to obtain information from their current or potential customer base so they can ensure they are meeting their needs.

No amount of discussing with professionals, friends, or colleagues will ever replace the information that a company can receive from a real customer.

The following questions are crucial when obtaining customer feedback:

• What does the customer like?
• What do they dislike?
• How can things be improved?
• Are their needs and expectations being met?
• How much will they pay for something?
• Is convenience important?
• Should items be packaged together?
• Is after-sales service critical?

Customer feedback can be collected by:

• Asking consumers directly: This tactic comes across particularly effective during the point-of-purchase at a retail store because consumers are being probed on their experiences while they are shopping.
• Questionnaires: Distribute one-page questionnaires that ask some key questions and encourage customers to fill them out. These can be mailed out as pre-paid postcards or emailed to consumers who give their permission to be contacted.
• Focus groups: This involves gathering a number of customers, sitting them down, and discussing a range of issues relevant to a company’s business. The advantage of using this method over a questionnaire is that it will yield more detailed information and feedback, rather than “tick the box” style responses from a questionnaire. In-person focus groups and one-on-one interviews are helpful tools that provide explanation of product or consumer-related issues because you are going to the main source directly .
• Telephone: Some surveys can be conducted via phone. These yield a more private conversation exchange between the customer and the service provider.

Telephone Survey

Telephone surveys enable a private conversation to take place between the customer and service provider.

• Virtual online communities or private consumer panels: Technology has made it increasingly easier for companies to obtain feedback from their customers. With the explosion of technology in the marketplace and the consumer’s everyday life, many companies are now building their own proprietary online panels of consumers which give them unencumbered access to their target market on an ongoing basis. In exchange for their honest opinions and feedback, customers are incentivized for their time. Community blogs and forums also enable customers to provide detailed explanations of both negative as well as positive experiences with a company.

Instant feedback

Recently, many organizations have implemented feedback loops that allow them to capture feedback at the point of experience. For example, National Express, one of the UK’s leading travel companies, has invited passengers to send text messages while riding the bus. This has been shown to be useful, as it allows companies to improve their customer service before the customer defects, thus making it far more likely that the customer will return next time.

6.4.2: The Gap Model

Customers compare the service they ‘experience’ with what they ‘expect’ and when it does not match the expectation, a gap arises.

Learning Objective

List the GAP Model’s five contributory factors of unsuccessful customer service

Key Points

• GAP 1: Gap between consumer expectation and management perception: arises when the management or service provider does not correctly perceive what the customers wants or needs.
• GAP 2 : Gap between management perception and service quality specification: this is when the management or service provider might correctly perceive what the customer wants, but may not set a performance standard.
• GAP 3: Gap between service quality specification and service delivery: may arise pertaining to the service personnel. This could arise due to there being poor training, incapability or unwillingness to meet the set service standard.
• GAP 4 : Gap between service delivery and external communication: consumer expectations are highly influenced by statements made by company representatives and advertisements. The gap arises when these assumed expectations are not fulfilled at the time of service delivery.
• GAP 5: Gap between expected service and experienced service: this gap arises when the consumer misinterprets the service quality.

Key Terms

Service Quality

A term which describes a comparison of a customer’s expectations as it relates to a company’s performance.

Service quality model

Highlights the main requirements for delivering high service quality; it identifies five ‘gaps’ that cause unsuccessful delivery.

Example

• An example of GAP #4: the hospital printed on the brochure may have clean and furnished rooms, but in reality, it may be poorly maintained – in this case the patient’s expectations are not met.

The GAP Model

The Service Quality Model, also known as the GAP Model, was developed in 1985. It highlights the main requirements for delivering a high level of service quality by identifying five ‘gaps’ that can lead to unsuccessful delivery of service.

The GAP Model

The GAP Model shows the requirements for delivering quality service.

Customers generally have a tendency to compare the service they ‘experience’ with the service they ‘expect’ to receive; thus, when the experience does not match the expectation, a gap arises.

GAP 1:

Gap between consumer expectation and management perception: This gap arises when the management or service provider does not correctly perceive what the customer wants or needs. For instance – hotel administrators may think guests want better food or in-house restaurant facilities, but guests may be more concerned with the responsiveness of the staff or the cleanliness of their rooms.

Consumer Expectations

Hotel administrators might think that guests want better food or in-house restaurant facilities, but guests might be more concerned with the staff’s responsiveness.

A hotel clerk stands behind the front desk.

Factors that affect the size of the knowledge gap include:

Market
research

• Before introducing a new product or service into the market, a company must conduct market research to understand whether there would be any demand for the product, and what features should be incorporated. The better this process is conducted, the smaller the knowledge gap will be.
• There are methods of ensuring that customer desires are taken on board. These include: comprehensive studies, gauging satisfaction after individual transactions (surveys immediately after a purchase is made), customer panels and interviews, and through customer complaints.

Communication channels

• The fewer the layers between management and customer contact personnel, the more likely that customer preferences will be incorporated into higher-level decision making on the product.

GAP 2 :

Gap between management perception and service quality specification: This is when the management or service provider might correctly perceive what the customer wants, but may not set a performance standard. An example here would be that hospital administrators may tell the nurse to respond to a request ‘fast’, but may not specify ‘how fast’.

GAP 3:

Gap between service quality specification and service delivery: This gap may arise in situations pertaining to the service personnel. It could happen due to poor training, incapability or unwillingness to meet the set service standard. An example would be when a doctor’s office has very specific standards of hygiene communicated but the hired staff may have been poorly trained on the need to follow these strict protocols.

GAP 4 :

Gap between service delivery and external communication: Consumer expectations are highly influenced by statements made by company representatives and advertisements. The gap arises when these assumed expectations are not fulfilled at the time of delivery of the service. For example – a hospital printed on its brochure may have clean and furnished rooms but in reality, it may be poorly maintained – in this case the patient’s expectations are not met.

GAP 5:

Gap between expected service and experienced service: This gap arises when the consumer misinterprets the service quality. The physician may keep visiting the patient to show and ensure care, but the patient may interpret this as an indication that something is really wrong.

6.4.3: Resolving Problems Quickly

The best method of resolving problems – often before they arise – is through the delivery of excellent customer service.

Learning Objective

Describe how automation and tech support tools are used to resolve customer service issues

Key Points

• By ensuring a close relationship with the customer, knowing their wants and needs and avoiding any misunderstandings, a company is able to ensure that problems of a non-technical nature are minimized.
• With automated support, service organizations can make their services available to their customers 24 hours a day and seven days a week, by monitoring alarms, identifying problems at an early stage, and resolving issues before they become problems.
• Technical support services attempt to help the user solve specific problems with a product, rather than providing training, customization, or other support services.

Key Term

automation

The act or process of converting the controlling of a machine or a device to a more automatic system, such as a computer or electronic controls.

Resolving Problems Quickly

Problem Resolution Through Excellent Customer Service

Ultimately, the best method of resolving simple problems – often before they arise – is through the delivery of excellent customer service. By ensuring a close relationship with the customer, knowing their wants and needs and avoiding any misunderstandings, a company is able to ensure that problems of a non-technical nature are minimized, often before they even arise. Any problems that do arise can be resolved with an attentive approach to the customer, ensuring that all will be done to solve the problem as soon as possible. When the customer knows that they are valued in such a way, they tend to be much more forgiving and patient with the company.

Customer Support

Customer support is a range of customer services to assist customers in making cost effective and correct use of a product. It includes assistance in planning, installation, training, troubleshooting, maintenance, upgrading, and disposal of a product. Through effective and attentive customer support, any potential problems that the customer has with a product or service can be resolved quickly and cleanly.

Automation

Customer support automation involves the building of a knowledge base of known issues and their resolutions to support incidents with delivery mechanisms, often by expert systems. A service automation platform includes a suite of support solutions including proactive support, assisted support, and self support. Automation of service organizations aim to achieve, for example, lower mean time to repair (MTTR) . With automated support, service organizations can make their services available to their customers 24 hours a day and seven days a week, by monitoring alarms, identifying problems at an early stage, and resolving issues before they become problems.

Customer Support

AT&T Mobility provides technical support for some of its mobile phones through device support centers.

Automated assisted support enables remote access to sites that need instant problem solving. By automating the collection of information of devices and applications coexisting with the supported application, problems can be quickly detected and fixed.Automated self support, automates the self support process, freeing users from self-help diagnostics and troubleshooting from online libraries or knowledge bases. Support automation solutions can be integrated with customer relationship management (CRM) systems and network management systems (NMS). They can also provide full customer reports to management by tallying problems and incidents that were solved mechanically to ensure compliance with industry regulations.

Tech Support

Tech support refers to a range of services by which companies provide assistance to users of technology products such as mobile phones, televisions, computers, software products, or other electronic or mechanical goods. In general, technical support services attempt to help the user solve specific problems with a product—rather than providing training, customization, or other support services. Most companies offer technical support for the products they sell, generally for free. Others provide a fee for technical support or a fee for premium support services (no waiting in line or talking to a machine, for example).

6.4.4: Delivering Excellent Service Quality

The core task of a business is to ensure that customers come back, which can be done by delivering excellent service quality.

Learning Objective

Give examples of excellence in service quality

Key Points

• Bringing in new customers is great, but won’t keep a business profitable for long if those customers don’t come back for more–and they will only do this if they are happy.
• If repeat customers are happy then they will do your marketing for you, through word-of-mouth: telling their friends, family, and anyone who will listen how great you are.
• Personalized service is a key way to retain customers, because you show them that they are more than just a source of income to you, and that you value their patronage and your relationship with them.

Key Terms

customer service

The act of providing services to customers before, during and after a purchase.

personalized

adapted to the needs of an individual

Example

• Examples of excellence in service quality include personalized service, good return policies, complaints desks and hotlines, being able to speak to a human being when calling for service, and so on.

Delivering Excellent Service Quality

Customer Service

Customer service is at the core of any successful business, as it provides an incentive for customers to come back. Bringing in new customers is great, but won’t keep a business profitable for long if those customers don’t come back for more–and they will only do this if they are happy. If they are happy, they will do your marketing for you, spreading the word and bringing in new customers.

Maintaining a consistently high level of customer service is a challenge for any company. In order to continuously exceed customer expectations, service firms must recognize that every aspect of their business has an impact on customer service in some form, not just those aspects of their business which involve face-to-face customer contact. It comes across in a business and its employees’ attitude, customer treatment, and approach to customer service.

Examples of excellence in service quality include personalized service, good return policies, complaints desks and hotlines, being able to speak to a human being when calling for service, and so on. Customer service should be included as part of an overall approach to systematic improvement, as a customer service experience can change the entire perception a customer has of the organization .

Customer Life Cycle

Marketers should pay attention to the different stages in the customer life cycle.

A diagram that shows the customer life cycle – identify potential customers; persuade first time customers to buy and make repeat customers; transform customers into members, make them advocates, make them partners; retain lost customers.

An Example

A business should want to be known for how it is better than its competitors. If the business offers the best customer service in the local market, then that could form the basis of the customer value proposition.

Take the example of the local Chinese restaurant in the neighborhood. When entering the restaurant, the family is greeted by name and welcomed to their favorite table. Before being handed the standard menu, the owner recommends a dish that is based on the current availability of the freshest ingredients, careful to avoid the customers’ dislikes, and with a good sense of what the customers might prefer on that day, given the time of year, and given the weather. The owner automatically brings a glass of the customers’ favorite drinks and ensures that the water has a fresh slice of lemon just as the family likes. The owner knows that the family has a birthday coming up and suggests that they can have the dinner party at the restaurant or cater the event at their home if they so desire. She spends time talking to the family and knows all the other restaurants that they patronize. She knows how often they dine out.

This kind of personalized service can do much to engage the customer and it is quite conceivable that this business owner has a large share of this customer’s restaurant spending. For higher-end customers, recent surveys show that the accumulation of experiences is more important that the convenience factor of dining out. The customer most likely recommends the restaurant to all her friends. This owner can easily charge a premium to the customer for this level of service and the customer will gladly pay for it. She is able to adjust the menus to meet their requirements and draw more customers.

It is important to divide all customers in groupings that define their profitability. Good customers buy ten plus times more than marginal customers. The business should identify good customers and give them the attention they are due. Some businesses will assign staff to high-value customers. They take the opportunity to develop a deeper relationship with these customers. They will call them to get feedback on their experiences. They will thank them for being good customers. They will collaborate with them to customize the product or service so that it better fits their needs .

Customer Value Proposition

There are benefits and costs regarding the customer value proposition.

A table that shows the customer value proposition – benefits (product, service, image) and costs (price, cost of acquisition, maintenance, disposal).

5.3: Industrial Classification

5.3.1: Identifying Potential Business Customers

Learning Objective

List the characteristics that marketers use to segment organizations

Key Points

• Organizations can be segmented by industry, size, function, level, and type of individuals within the organization.
• Industry classifications can assist in determining what specific industries potential customers are in.
• Preliminary research always saves time. Failing to analyze a prospect is the main reason for a great deal of wasted prospecting time spent on a customer who should have been promptly discarded after due research.

Key Terms

market segmentation

The process of dividing a broad target market into subsets of consumers who have common needs or desires, as well as common applications for the relevant goods and services.

channel

A distribution channel.

Identifying your customer begins with formulating a value proposition. You have to be able to answer this question: “To whom is this proposition of value? ” When trying to answer this question, it helps to simplify matters by breaking the market down into components. The role of the marketing team is to understand everything there is to know about given target groups, ensuring that needs are being identified and filled.

There are three broad categories of customers who could buy your product: individuals, channels (intermediaries), and organizations. Each of these categories can be further broken down into smaller segments. This is called market segmentation – picking out the particular groups of people or organizations that benefit from your product, so you can better sell to them. Organizations can be segmented by:

• Industry
• Size
• Function
• Level
• Type of individuals within the organization

Many segmentation schemes are combinations of the above list. For example, let’s say a venture developing an innovative digital storage product decides to sell only to organizations, not individuals. It segments its potential market by size of organization, size of data storage requirements, and need for speed of retrieval. This would occur during the periods of market analysis and customer research in the product development cycle . That leads, for example, to a focus on large financial institutions and large medical centers. Within those targeted organizations, the importance and cost of the purchase dictates that the venture focuses on selling only to “C-level” executives, such as the CIO or CFO. Finally, as the technology is very new, the venture team chooses to target the executives who are technology enthusiasts—people who love new technology for its own sake and are often willing to look at it in its preliminary form.

Product Innovation Approach

In the product development cycle, the market analysis and consumer research phases are used to identify customers.

Industry classifications can assist in determining market segmentation. The North American Industry Classification System (NAICS) is used by business and government to classify business establishments according to its primary type of economic activity (process of production) in Canada, Mexico, and the United States. Thus, if a company identifies a potential customer but is uncertain what industry that customer belongs to, using the industrial classification from the NAICS can provide more detailed information on the specific business activities of that potential customer.

Having decided on a specific market, the salesperson should try to limit his prospecting to remain within that market. The ideal customer who will buy as soon as the salesperson talks to him is probably nonexistent. Nonetheless, the closer a salesperson’s prospect matches that ideal customer, the fewer sales objections will be placed in his way. It therefore makes sense to ensure that his prospects at least resemble the specification as accurately as they can. This means identifying the potential of a prospect at the very outset.

In particular, the salesperson should know the requirements that a potential customer has set for his future, his priorities, and in all probability, his financial resources. Failing to analyze a prospect is the main reason for a great deal of wasted prospecting time spent on a customer who should have been promptly discarded after due research. Good prospecting does not necessarily dismiss those whose business appears to be static, but it is certainly improves the ability to select and concentrate one’s efforts where one is more likely to secure immediate success.

5.3.2: Estimating the Addressable Market

Learning Objective

Define total addressable market (TAM)

Key Points

• TAM helps to prioritize business opportunities by serving as a quick metric of the underlying potential of a given opportunity.
• TAM can be defined as a global total (even if a specific company could not reach some of it) or, more commonly, as a market that one specific company could serve (within realistic expansion scenarios).
• The market can be categorized into separate groups called segments.

Key Terms

SAM

The percentage of the market that is already being served, either by that company or all providers.

market share

The percentage of some market held by a company.

TAM

A term that is typically used to reference the revenue opportunity available for a product or service. 

Total Addressable Market

Total addressable market (TAM), also called total available market, is a term that is typically used to reference the revenue opportunity available for a product or service. The market consists of all prospective customers for a given product, service, or idea. Customers can be purchasers who intend to resell the product or end users who intend to use or consume the product.

Estimating TAM

TAM helps to prioritize business opportunities by serving as a quick metric of the underlying potential of a given opportunity. Few organizations track market share even though it is an important metric. Though absolute sales might grow in an expanding market, a firm’s share of the market can decrease which would bode ill for future sales when the market starts to drop. Where such market share is tracked, there may be a number of aspects that will be followed:

• Overall market share
• Share of a target segment
• Relative share in relation to the market leaders
• Annual fluctuation rate of market share
• An estimation of how much of the market you can gain if there were no competitors
• An estimation of the market size that could theoretically be served with a specific product or service

Competitor Profiling

The folio plot visualizes the relative market share of a portfolio of products versus the growth of their market. The circles differ in size by their sales volume.

TAM can be defined as a global total (even if a specific company could not reach some of it) or, more commonly, as a market that one specific company could serve (within realistic expansion scenarios). This focuses strategic marketing and sales efforts and addresses actual customer needs. Including competition and distribution issues then frames the strategy within realistic boundaries and allows a company to gauge served market share (SAM), the percentage of the market that is already being served, either by that company or all providers. The North American Industry Classification (NAICS) categorizes businesses and collects data within specific economic activities, thus assisting in measuring the SAM.

The market can be categorized into separate groups called segments. Any discrete variable is a segmentation. For instance, customers might be segmented by gender (“male” or “female”) or attitudes (“progressive” or “conservative”). Numeric variables may be used to create segments, such as age (“over 30” or “under 30”) or income (“The 99%” or “The 1%”).

Market Segmentation

Segments can be obtained by any number of approaches. Minimally, an existing discrete variable may be chosen as a segmentation, also called “a priori” segmentation. At the other extreme, a research project may be commissioned to collect data on many attributes that would then be used to conduct statistical analysis to derive a segmentation, also called “post-hoc” segmentation.

Qualitative knowledge of the market based on experience may also be used to identify divisions that are likely to be useful. When a producer appeals to a market or market segment, the producer must take into account the distinction between the end user or consumer and the purchaser or decision maker. This is especially true in B2B models. The market may be individuals or organizations that are able to purchase the organization’s product. Each entity in the delivery chain will have different needs, so a complete market needs analysis must include all potential segments and all entities within each segment.

5.3.3: Categories of Business Products

Learning Objective

List the different categories for business products

Key Points

• Some categories of business products are products used to create other products (e.g., raw materials, component parts).
• Other categories of business products include products used to facilitate the creation of the products, but are not included in the product (e.g., equipment, services).
• Both the United States and Europe have lists which provide divisions and subdivisions of businesses.
• Manufacturers produce products, from raw materials to component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers.

Key Terms

raw material

Manufacturing inputs in its unprocessed, natural state.

business analysis

A research discipline of identifying needs and determining solutions to problems facing firms.

intangible

Incorporeal property that is saleable though not material, such as bank deposits, stocks, bonds, and promissory notes.

North American Industry Classification System

A system used by businesses and government to classify business establishments according to type of economic activity (process of production) in Canada, Mexico, and the United States.

business-to-business

Of businesses selling to other businesses.

Business-to-business (B2B) describes commerce transactions between businesses, such as between a manufacturer and a wholesaler or a wholesaler and a retailer. B2B transactions involve many classifications of business products, including the following:

• Raw Materials: A raw material is the basic material from which a product is manufactured or made. Agriculture and mining businesses are concerned with the production of raw materials, such as plants or minerals. Additional examples include latex, iron ore, logs, and crude oil.

Collecting Raw Materials

Latex is a raw material that’s collected from rubber trees and used to manufacture other products.

A container is attached the a tapped rubber tree to collect latex.

• Component Parts: Manufacturers produce products, from raw materials to component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers.
• Equipment: Equipment includes products used in production activities and operational activities. Equipment includes large buildings that serve as places of business for other companies. Real estate businesses generate profit from the selling, renting, and development such of properties.
• Processed Materials: These products are created from raw materials and are used in the production of another product. Examples include food preservatives and industrial glue.
• Business Services: Service businesses offer intangible goods or services and typically generate a profit by charging for labor or other services provided to government, other businesses, or consumers. Organizations including house decorators, repair services, consulting firms, restaurants, financial businesses, janitorial services, and even entertainers are types of service businesses. ( )
• Supplies: These products facilitate both production and operations, but are not part of the final product. Examples include paper, pens, and cleaning agents. These items can be purchased from retailers and distributors and delivered by transportation businesses.

There are many other divisions and subdivisions of businesses. The authoritative list of business types for North America is generally considered to be the North American Industry Classification System (NAICS; pronounced “nakes”). The equivalent European Union list is the Statistical Classification of Economic Activities in the European Community (NACE).

5.4: The Business Buying Decision Process

5.4.1: Decision-Making Units

The group of individuals responsible for making a buying decision in a B2B context are labelled the decision making unit (DMU).

Learning Objective

Describe the roles and functions that comprise decision making units in B2B organizations

Key Points

• In a business setting, major purchases typically require input from various parts of the organization, including finance, accounting, purchasing, information technology management, and senior management.
• An economic buyer is a typical member of the DMU. The buyer is buying the product to achieve some sort of business advantage.
• The infrastructure buyer, another typical member of the DMU, influences the buying decision because he’s the guy that is going to make the purchase happen.
• The user buyer, another member of the DMU, influences the buying decision because he is one of the people through which the economic buying objective will be realized.

Key Term

B2B

Business-to-business (B2B) describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer.

Decision Making Units

In the business-to-business (B2B) context (as opposed to B2C), buying decisions are made in groups. The group responsible for making the buying decision in companies is referred to as the decision making unit (DMU).

Within organizations, major purchases typically require input from various parts of the organization, including finance, accounting, purchasing, information technology management, and senior management. Highly technical purchases, such as information technology systems or production equipment, require the expertise of technical specialists. In some cases, the buying center acts as an informal ad hoc group. In other cases, the buying center is a formally sanctioned group with specific mandates, criteria, and procedures.

Purchases

The decision making unit is responsible for an organization’s buying decisions.

San Juan de Dios Market in Guadalajara, Jalisco.

For example, in the hi-tech sector, the decision making unit generally comprises the following roles:

1. The economic buyer – This individual is responsible for buying products that enable the company to achieve a business advantage. The economic buyer justifies the purchase by linking it to profit. The economic buyer’s position within the organization can range from the business unit manager level to as high as the CEO.
2. The infrastructure buyer – This role influences the buying decision at the execution level. If a product poses challenges at the installation phase, then the infrastructure buyer and/or DMU steps in to decide whether the return on investment (ROI) is worth the time and money required to set up the infrastructure. The infrastructure buyer is typically someone in the IT department.
3. The user buyer – This position influences the buying decision at the user level and decides whether the organization will achieve its financial objectives through the purchase. For instance, if end users provide negative feedback about the product, or demonstrate that the product is hard to use, then the economic buyer will determine whether the purchase will prevent the company from reaching its economic goals.

5.4.2: Buying Centers

A buying center is a group of people within an organization who make business purchase decisions.

Learning Objective

Describe the different functions and roles that comprise buying centers within B2B organizations

Key Points

• In a business setting, major purchases typically require input from various parts of the organization, such as finance, accounting, purchasing, information technology management, and senior management.
• The five main roles in a buying center are the users, influencers, buyers, deciders, and gatekeepers.
• In a generic situation, one could also consider the roles of the initiator of the buying process (who is not always the user) and the end users of the item being purchased.

Key Term

Buying Center

A group of employees, family members, or members of any type of organization responsible for finalizing major purchase decisions.

Example

• The stock market is an example of a buying center. A stock market is a public entity (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock (shares) and derivatives at an agreed price. Many people are involved in the daily transactions and the purchase decisions both on the buying side and the selling side. Stock markets allow businesses to be publicly traded, or raise additional financial capital for expansion by selling shares of ownership of the company in a public market. Major purchases of stock typically require input from various parts of the organization, such as finance, accounting, and senior management.

Buying Centers

A buying center is a group of employees, family members, or members of any type of organization responsible for finalizing major purchase decisions. In a business setting, major purchases typically require input from various parts of the organization, such as finance, accounting, purchasing, information technology management, and senior management. Highly technical purchases, such as information systems or production equipment, also require the expertise of technical specialists. In some cases the buying center is an informal ad hoc group, but in other cases, it is a formally sanctioned group with specific mandates, criteria, and procedures. The employees that constitute the buying center will vary depending on the item being purchased.

In a generic sense, there are typically six roles within buying centers. These roles include:

1. Initiators who suggest purchasing a product or service
2. Influencers who try to affect the outcome decision with their opinions
3. Deciders who have the final decision
4. Buyers who are responsible for the contract
5. End users of the item being purchased
6. Gatekeepers who control the flow of information

Because of the specialized nature of computer and software purchases, many corporations use buying centers that are specialized for information technology acquisition. These specialized buying centers typically receive information about the technology from commercial sources, peers, publications, and experience. In this process, top management, the IT director, IT professionals, and other users collaborate to find a solution.

A better buying center for marketing might include:

1. Users – The users will be the ones to use the product, initiate the purchase process, generate purchase specs, and evaluate product performance after the purchase.
2. Influencers – The influencers are the tech personnel who help develop specs and evaluate alternate products. They are important when products involve new and advanced technology.
3. Deciders – Deciders choose the products.
4. Buyers – Buyers select suppliers and negotiate the terms of purchase.
5. Gatekeepers – Gatekeepers are typically secretaries and tech personnel. They control the flow of information to and among others within the buying center. Buyers who deal directly with a vendor are gatekeepers.

Making Purchasing Decisions

The chairman of the Hong Kong Stock Exchange is an example of a member in an organization responsible for finalizing major purchase decisions.

Ronald Arculli, Chairman of the Hong Kong Stock Exchange.

5.4.3: Buying Situations

B2B buying situations are relationship-oriented, pragmatic, and negotiable compared to the average B2C exchange situation.

Learning Objective

 Recognize the key differences in the buying situation between B2B and B2C sales

Key Points

• Selling to organizations is quite different (in most cases) than selling to consumers. This means the marketing approach will also be different.
• One of the main differences between B2B and B2C is the buying situation. Buying situations in a B2B exchange are likely to be customized specifically for the client, and strategically oriented.
• Some of the key differences between B2B and B2C buying situations include the importance of relationship building, price, volume, payment, promotions, and the level of negotiation.
• From a more general perspective, a B2B marketer must be aware that their buyers are going to consider the purchase strategically as a team, and come to a practical conclusion.

Key Term

B2B

An abbreviation for business-to-business sales, in which both buyer and seller are organizations rather than individual consumers.

B2B v. B2C

When considering different buying situations as a marketing professional, one of the first questions to ask is whether the goods are being provided to customers (mass marketing B2C) or to other businesses (focused B2B). Selling to businesses usually requires a significantly different marketing approach, including differences in what the buying situation will be like.

B2B Opportunities

As a consumer base, businesses are a huge source of business in and of themselves. Selling to other businesses often has significantly higher transaction amounts (large volume), and the scale of the contracts can make marketing endeavors very cost-effective and profitable.  Just as in B2C, attracting attention through advertising, marketing, and direct sales is central to a successful marketing strategy. 

B2B consumers are often pursued quite differently than B2C consumers as a result of these different circumstances. In mass marketing, the goal is to identify channels where the organization can engage with thousands or millions of potential consumers at once. For B2B, this can also be effective but is much less common. Usually for B2B, the buying situations are a bit more personal, and the buying decision process involves much more strategic consideration.

Buying Situations

In order to understand how to market to another business, a simple first step is understanding how these types of clients approach the buying process. Business are quite different than single consumers in regards to buying strategies, often pursuing much larger contracts with much greater care. To understand the buying situations, it is useful to consider the decision-making process (spontaneity vs. strategy), differences in pricing, payment approaches, repeat purchases, relationships, and the role of a purchaser at an organization.

Spontaneity: B2B buying situations are less likely to be spontaneous, and more likely to be discussed carefully among various stakeholders. For example, a consumer may buy a soft drink without overthinking the price, manufacturer, or business relationships (e.g. just to satisfy their thirst). A grocery store, however, will carefully consider which types of soft drinks to stock, how many to buy, how to ship them, how to price them, etc.

Pricing: B2B buying situations are often less concrete in terms of overall (or per unit) pricing. Take the above example. An individual buying a soft drink will probably not barter the price down with the cashier. However, a store purchasing 10 cases each month will discuss price carefully with the soft drink producer, and will likely pay a different price per unit than other grocery stores (depending on volume, shipping, storage, etc.).

Payment: Payments between companies are generally predicated on monthly, quarterly, or annual invoices. Payments between consumers are immediate, or perhaps will rely on a credit card. This changes the buying situation, particularly when factoring in the time value of money.

Relationships: B2B purchasing situations often require the meeting of various groups in each organization. A relationship will be built on these meetings, creating trust, alignment, and agreement on how the buying process will be planned and executed. B2C purchasing situations are often much less personal, requiring little to no relationship between the organization and the consumer.

Promotions: Finally, it’s also worth noting that the method of promotion and the source of interactions between prospective buyers and sellers is often different for B2B and B2C exchanges. Trade shows, conferences, and meetings are actually forms of marketing communications and promotional strategy, as one-to-one interactions between buyers and sellers is necessary to build trust for high capital and high volume purchases.

B2B Buyer Decision Map

B2B exchanges are often practically driven. They consider what the business needs, how they can fulfill that need, and why the seller is the optimal fit to do so.

A chart that shows what B2B customers want to know. It shows the customers’ questions and what information should be shared with them. “What’s my problem?” (education and thought leadership); “How do I fix my problem?” (solutions and product suitability); “Are you right for me?” (credentials and decision support).

5.4.4: Stages of Business Buying

Understanding the stages of business buying is important to a marketing firm if it is to market its product properly.

Learning Objective

Describe the different stages within the business buying decision process

Key Points

• The stages of business buying includes recognizing the problem, developing product specs to solve the problem, searching for possible products, selecting a supplier and ordering the product, and finally evaluating the product and supplier performance.
• Buying B2B products is risky. Usually, the investment sums are high and purchasing the wrong product or service, the wrong quantity, the wrong quality or agreeing to unfavourable payment terms may put an entire business at risk.
• Making a riskier investment can yield to high returns. However, there is also a greater chance that they could lose their investment as well. This can be seen in this diagram. Those involved in the decision buying process need to weigh the risks against the expected returns.
• In order to entice and persuade a consumer to buy a product, marketers try to determine the behavioral process of how a given product is purchased. Understanding the nature of customers’ buying behavior is important to a marketing firm if it is to market its product properly.

Key Terms

B2B

Business-to-business (B2B) describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer.

B2C

The sale of goods and services from individuals or businesses to the end-user.

Stages of the Business Buying Decision Process

The main difference between B2B and B2C is who the buyer of a product or service is. The purchasing process is different in both cases and the following is a list of the stages involved in B2B buying:

Step 1: Recognize the Problem

• Machine malfunction, firm introduces or modifies a product, etc.

Step 2: Develop product specifications to solve the problem

• Buying center participants assess problem and need to determine what is necessary to resolve/satisfy it

Step 3: Search for and evaluate possible products and suppliers

• look in company files and trade directories, contact suppliers for information, solicit proposals from known vendors, examine websites, catalogs, and trade publications
• conduct a value analysis – an evaluation of each component of a potential purchase; examine quality, design, materials, item reduction/deletion to save costs, etc.
• conduct vendor analysis – a formal and systematic evaluation of current and potential vendors; focuses on price, quality, delivery service, availability and overall reliability

Step 4: Select product and supplier and order product

• This step uses the results from Step 3
• An organization can decide to use several suppliers, called multiple sourcing. Multiple sourcing reduces the possibility of a shortage by strike or bankruptcy.
• An organization can decide to use one supplier, called sole sourcing. This is often discouraged unless only one supplier exists for the product; however it is fairly common because of the improved communication and stability between buyer and supplier.

Step 5: Evaluate Product and supplier performance

• Compare products with specs
• Results become feedback for other stages in future business purchasing decisions

This 5 step process is mainly used with new-task purchases and several stages are used for modified rebuy and straight rebuy.

Understanding the stages of business buying and the nature of customers’ buying behavior is important to a marketing firm if it is to market its product properly. In order to entice and persuade a consumer to buy a product, marketers try to determine the behavioral process of how a given product is purchased.

Risks

Buying one can of soft drink involves little money, and thus little risk. If the decision for a particular brand of soft drink was not right, there are minimal implications. The worst that could happen is that the consumer does not like the taste and discards the drink immediately. Buying B2B products is much riskier. Usually, the investment sums are much higher. Purchasing the wrong product or service, the wrong quantity, the wrong quality or agreeing to unfavourable payment terms may put an entire business at risk. Additionally, the purchasing office / manager may have to justify a purchasing decision. If the decision proves to be harmful to the organization, disciplinary measures may be taken or the person may even face termination of employment.

Risk and Return

Less risky investments yield less returns. The riskier the investment, the higher the yield.

5.4.5: Measuring Vendor Performance

Firms can measure vendor quality, service, availability, and overall reliability to determine future engagement with the vendor.

Learning Objective

Describe the different tactics B2B companies use to search for and evaluate products and supplier performance

Key Points

• Supply managers evaluate suppliers utilizing the tools of value assessment and the fundamental value equation. They estimate the benefits and total costs paid to each vendor.
• Vendors play a role in two steps of the business buying decision process. Steps 3 and 5 both require researching new and current vendors and analyzing various factors to determine if they should be used again.
• Vendor analysis is a formal, systematic evaluation of current and potential vendors. This focuses on price, quality, service, availability and overall reliability.

Key Term

fundamental value equation

Customer Perceived value of a product is the difference between the prospective customer’s evaluation of all the benefits and all the cost of an offering and the perceived alternatives. Formally, it may be conceptualized as the relationship between the consumer’s perceived benefits in relation to the perceived costs of receiving these benefits. It is often expressed as the equation : Value = Benefits / Cost.

Introduction

Decision makers complete five steps when making a business buying decision:

1. Recognize the problem
2. Develop product specifications to solve the problem
3. Search for and evaluate possible products and suppliers
4. Select product and supplier and order product
5. Evaluate product and supplier performance

Vendor performance measurement plays a role in Steps 3 and 5.

Step 3: Search for and Evaluate Possible Products and Suppliers

Step 3 requires searching for and evaluating possible products and suppliers. This can be done in several ways:

• Looking in company files and trade directories, contacting suppliers for information, soliciting proposals from known vendors, and examining websites, catalogs and trade publications.
• Performing a value analysis (an evaluation of each component of a potential purchase). This examines the quality, design, and materials, with the intention of finding cost savings opportunities.
• Performing a vendor analysis (a formal, systematic evaluation of current and potential vendors). This focuses on price, quality, service, availability, and overall reliability.

Step 5: Evaluate Product and Supplier Performance

Step 5 of the business buying decision process involves evaluating product and supplier performance.

Firms need to compare products with specifications. The results become feedback for other stages in future business purchasing decisions. If a firm has any negative issues with a vendor, it is likely they will look for another one.

Business Feedback Loop

Firms need to compare products with specifications. The results become feedback for other stages in future business purchasing decisions. 

The business feedback loop includes four steps – sell the improved product, access progress (is it selling?), ask customers if they like the new product, and fix it, improve it, and make changes.

Supplier performance evaluation teams are used to monitor activity and performance data, and to rate vendors. But supplier performance evaluation teams are just one of the many teams companies deploy to address tactical issues.

Supplier certification teams help selected suppliers reach desired levels of quality, reduce costs, and improve service. Specification teams select and write functional, technical, and process requirements for goods and services to be acquired.

Supply managers evaluate suppliers utilizing the tools of value assessment and the fundamental value equation. They estimate the benefits and total costs paid to each vendor. Consistent with supply management orientation, these evaluations can be complemented with the firm’s customer feedback. In this way, supply managers can better focus or redirect the efforts of the entire supply network toward the delivery of superior value to end-users.

5.4.6: Influences on Business Buying

Environmental, organizational, and interpersonal factors all impact the business buying decision process.

Learning Objective

Give examples of how environmental, organizational, interpersonal, and individual factors influence the business buying decision process

Key Points

• The personal characteristics of the people in the buying center can be influential. Age, education level, personality, tenure, and position within the company all play a role in how a person will influence the buying process.
• The company’s objectives, purchasing policies and resources can influence the buying process.
• Firms can suffer from strategic inertia, the automatic continuation of strategies unresponsive to changing market conditions.

Key Term

Buying Center

A group of employees, family members, or members of any type of organization responsible for finalizing major purchase decisions.

Influences on Business Buying

Four main influences impact the business buying decision process: environmental factors, organizational factors, interpersonal factors, and individual factors.

Environmental Factors

Competitive conditions may enable a company’s short-term success, where the organization is able to operate irrespective of customer desires, suppliers, or other organizations in their market environment. Early entrants into emerging industries are likely to be internally focused due to few competitors. During these formative years, customer demand for new products will likely outstrips supply, while production problems and resource constraints represent more immediate threats to the survival of new businesses.

Nevertheless, as industries grow, these sectors become more competitive. New entrants are attracted to potential growth opportunities, and existing producers attempt to differentiate themselves through improved products and more efficient production processes. As a result, industry capacity often grows faster than demand and the environment shifts from a seller’s market to a buyer’s market. Firms respond to changes with aggressive promotional techniques such as advertising or price reductions to maintain market share and stabilize unit costs.

Different levels of economic development across industries or countries may favor different business philosophies. For example:

• Certain environmental and economic factors can lead to an apprehensive buying center.
• Firms can suffer from strategic inertia, or the automatic continuation of strategies unresponsive to changing market conditions.

Organizations that fall victim to strategic inertia believe that one way is the best way to satisfy their customers. Such strategic inertia is dangerous since customer needs as well as competitive offerings eventually change over time.

For example, IBM’s traditional focus on large organizational customers caused the company to devote too little effort to the much faster-growing segment of small technology start-ups. Meanwhile, IBM’s emphasis on computer technology and hardware like the IBM cell processor made the company slow to respond to the explosive growth in demand for Internet-based applications and services. Thus, in environments where such changes happen frequently, the strategic planning process needs to be ongoing and adaptive. All business participants, whether from marketing or other functional departments, must pay close attention to customer preferences and competitor activities.

IBM Cell Processor

IBM traditionally focused on large organizational customers. It did not put enough effort into small technology start-ups, which grew at a faster pace.

Organizational Factors

Organizational factors such as the company’s objectives, purchasing policies, and resources can influence the buying process.The size and composition of the buying center also plays a role in the business buying decision process.

Interpersonal Factors

The interpersonal relationships between people working in the company’s buying center can hinder the buying process. Buying center members need to trust each other and operate under full disclosure.

Individual Factors

The personal characteristics of people in the buying center can influence the buying decision process. Individual factors including age, education level, personality, job tenure, and position within the company all play a role in how a person influences the buying process.

5.4.7: Business Ethics in B2B

Marketers need to incorporate good ethics in their marketing campaigns as they are responsible for the image that a product portrays.

Learning Objective

List the pitfalls B2B companies face when ignoring ethics in market research and target marketing, and the advantages to incorporating ethics

Key Points

• Businesses are confronted with ethical decision making every day, and business leaders and managers need to reinforce the importance of using ethics as a guiding force when conducting business.
• Ethical danger points in market research include invasion of privacy and stereotyping.
• Ethical danger points in market audience include excluding potential customers from the market and targeting the vulnerable, such as children and the elderly.

Key Terms

Market Research

The systematic collection and evaluation of data regarding customers’ preferences for actual and potential products and services.

ethics

The moral principles that guide decision making and strategy.

B2B

Business-to-business (B2B) describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer.

Business Ethics in B2B

Ethics refers to the moral principles that guide decision-making and strategy. Business ethics are, therefore, encompassed in the actions of people and organizations that are considered to be morally correct. Ethical objectives may include increased recycling of waste materials or offering staff sufficient rest breaks during their work shift. Businesses that adopt an ethical stance gain from numerous advantages, including:

• Improved corporate image
• Increased customer loyalty
• Cost cutting
• Improved staff motivation
• Improved staff morale

In a B2B environment, the client is another business rather than the customer, which means more attention needs to be given to maintaining a two-way relationship between the two entities. Since business clients have more meticulous and specification-driven buying processes, and the company must ensure that needs are met at all times without taking actions that would be considered unethical.

Ethics in Market Research

Ethical danger points in market research include invasion of privacy and stereotyping. Stereotyping occurs because any analysis of real populations needs to make approximations and place individuals into groups. However, if conducted irresponsibly, stereotyping can lead to a variety of ethically undesirable results. .

Ethics in Market Research

Firms need to be careful not to use irresponsible stereotyping in the market research process.

Ethics in Market Audience

Ethical danger points in market audience include (1) excluding potential customers from the market; selective marketing is used to discourage demand from undesirable market sectors or disenfranchise them altogether; (2) targeting the vulnerable, such as children and the elderly. Examples of unethical market exclusion or selective marketing are past industry attitudes to the gay, ethnic minority and obese (“plus-size”) markets. Contrary to the popular myth that ethics and profits do not mix, the tapping of these markets has proved highly profitable. For example, 20% of US clothing sales is now plus-size. Another example is the selective marketing of health care, so that unprofitable sectors, such as the elderly, will not attempt to take benefits to which they are entitled. A further example of market exclusion is the pharmaceutical industry’s exclusion of developing countries from AIDS drugs.

Marketing ethics is the area of applied ethics that deals with the moral principles behind the operation and regulation of marketing. Ethics provides distinctions between right and wrong; businesses are confronted with ethical decision making every day, and whether or not employees decide to use ethics as a guiding force when conducting business is something that business leaders, such as managers, need to review and enforce. Marketers are ethically responsible for what is marketed, and for the image that a product portrays. With that said, marketers need to understand what constitutes good ethics and how to incorporate such practices into various marketing campaigns to better reach a targeted audience and gain trust from customers. When companies create high ethical standards upon which to approach marketing they are participating in ethical marketing. Ethical behavior should be enforced throughout company culture and through company practices.

5.4.8: Customer Service as a Supplement to Products

Customer service is provided before, during, and after the purchase of a product, and is meant to supplement and enhance customer experience.

Learning Objective

Give examples of how customer service supplement products and services

Key Points

• Customer service is an integral part of an organization’s ability to generate income and revenue, and should be included as part of an overall approach to systematic improvement.
• Customer service may be provided by a person, such as a sales and service representative, or by automated means.
• A challenge working with customer service is to ensure that you have focused your attention on the right key areas as measured by the correct Key Performance Indicator.

Key Terms

customer satisfaction

A measure of how products and services supplied by a company meet or surpass customer expectation.

Key Performance Indicator

Industry jargon for a type of performance measurement. They are commonly used by an organization to evaluate its success or the success of a particular activity in which it is engaged.

Customer Service to Supplement Products

Customer service is the provision of service to customers before, during and after a purchase. Customer support refers to a range of services including assisting clients to make cost effective product choices and getting the most from their purchases. The process includes assistance in planning, installation, training, trouble shooting, maintenance, upgrading, and disposal of a product. In the technology industry, where people buy mobile phones, televisions, computers, software products or other electronic or mechanical goods, customer service is called technical support.

Customer service is regarded as a supplement to the product, and not a replacement for any part of the product. For instance, if a product is faulty in one way, having good, responsive customer service may ameliorate to some degree the customer’s dissatisfaction, but will not make up for the deficiency in product quality. If a person buys a product that they are happy with, however, then good customer service can supplement this satisfaction.

The importance of customer service varies by product, industry and customer. Retail stores, for example, often have a desk or counter devoted to dealing with returns, exchanges and complaints, or will perform related functions at the point of sale ; the perceived success of such interactions are dependent on employees who can adjust themselves to the personality of the guest. From the point of view of an overall sales process engineering effort, customer service plays an important role in an organization’s ability to generate income and revenue. From that perspective, customer service should be included as part of an overall approach to systematic improvement; the customer service experience can change the entire perception a customer has of the organization.

Customer Service Desk

Retail stores and organizations usually have a customer service desk or counter devoted to dealing with returns, exchanges, and complaints.

Customer service may be provided by a person, such as a sales and service representative, or by automated means. An advantage with automated means is an increased ability to provide service 24-hours a day, which can complement in person customer service. Another example of automated customer service is touch-tone phone, which usually involves a main menu and the use of the keypad as options, for example “Press 1 for English, Press 2 for Spanish. “

A challenge working with customer service is to ensure that attention is focused on the right key areas as measured by the correct Key Performance Indicator. The challenge is not to come up with a lot of meaningful KPIs, of which there are many, but to select a few that reflect the company’s overall strategy. In addition to reflecting the firm’s strategy, customer service should also enable staff to limit their focus to the areas that really matter. The focus must be on those KPIs that will deliver the most value to the overall objective, for example, cost saving and service improvement. Customer service must also be delivered in such a way that staff sincerely believe they can make a difference.

4.3: Technology to Assist Market Research

4.3.1: Marketing Information Systems

Learning Objective

Show the use of marketing information systems used in research and consumer marketing

Key Points

• An MIS brings together many different kinds of data, people, equipment, and procedures to help an organization make better decisions.
• MIS not only indicates how things are going, but also why and where performance is failing to meet the plan.
• MISs produce fixed, regularly scheduled reports to middle and operational level managers to identify and inform structured and semi-structured decision problems.
• An MIS can provide endless benefits to any organization including: enabling managers to share information and work together virtually, helping marketers collaborate with customers on product designs and customer requirements, and addressing operational needs through customer management systems.

Key Term

Philip Kotler

An American academic focused on marketing. The author of Marketing Management, among dozens of other textbooks and books, and the S.C. Johnson & Son Distinguished Professor of International Marketing at the Kellogg School of Management at Northwestern University.

Example

• A company can set up an MIS that helps track ongoing consumer buying trends and behaviors which can be predicted by the analysis of sales and revenue reports from each operating region of the company.

Marketing Information Systems

A marketing information system (MIS) is a management information system designed to support marketing decision making. It brings together many different kinds of data, people, equipment and procedures to help an organization make better decisions . American academic Philip Kotler has defined it more broadly as “people, equipment, and procedures to gather, sort, analyze, evaluate, and distribute needed, timely, and accurate information to marketing decision makers. ” Not to be confused for a management information system, marketing information systems are designed specifically for managing the marketing aspects of the business.

Example of an MIS

A marketing information system supports the decision-making process in marketing.

An MIS for agriculture where farmers use a centralized server (agrarian officer or public media) to get answers about specific issues before contacting marketers with crop information.

Jobber (2007) defines it as a “system in which marketing data is formally gathered, stored, analysed and distributed to managers in accordance with their informational needs on a regular basis. “

MIS not only indicates how things are going, but also why and where performance is failing to meet the plan. These reports include near real-time performance of cost centers and projects with detail sufficient for individual accountability. MISs produce fixed, regularly scheduled reports to middle and operational level managers to identify and inform structured and semi-structured decision problems.

A traditional marketing information system can provide endless benefits to any organization in the private or public sector, despite its size or level of managerial sophistication. Some of these benefits include:

• It enables managers to share information and work together virtually.
• It helps marketers collaborate with customers on product designs and customer requirements.
• It addresses operational needs through customer management systems that focus on the day-to-day processing of customer transactions from the initial sale through customer service.
• The availability of the customer data and feedback can help the company align their business processes according to the needs of the customers. The effective management of customer data can help the company perform direct marketing and promotional activities.
• Information is considered to be an important asset for any company in the modern competitive world. The consumer buying trends and behaviors can be predicted by the analysis of sales and revenue reports from each operating region of the company.

4.3.2: Digital Surveys

Learning Objective

Describe the characteristics of digital surveys from a market research point of view

Key Points

• With the increasing use of the Internet, online questionnaires have become a popular way to collect information.
• Online Research Methods include: ethnography, focus groups, interviews, web-based experiments and clinical trials.
• The advantages of digital surveys include: questions can be displayed in different ways, data can be received immediately, collection is more cost-effective than traditional methods, and adapting surveys is quick and affordable.
• The disadvantages of digital surveys include: response rates are limited to people who can access the web, many people dislike completing questionnaires online, and people who respond to online questionnaire invitations tend to be younger.

Key Terms

focus group

A group of people, sampled from a larger population, interviewed in open session for market research or political analysis.

Online Research Method

A way in which researchers can collect data via the Internet. This is also referred to as Internet research.

ethnography

The branch of anthropology that scientifically describes specific human cultures and societies.

Example

• An example of a digital survey is a ten minute survey that would typically be written for in person use, but has been adapted to be more streamlined and web-friendly. By asking what people think of a movie trailer immediately after the trailer is released, digital surveys can conduct market research in real-time.

Digital surveys, also referred to as online questionnaires, are research tools that ask consumers questions in a virtual environment. These surveys are a type of Online Research Method (ORM). Many of these ORMs are related to older research methodologies that have been re-invented and re-imagined to work with new technologies and the on-the-go conditions of a digital environment.

With the increasing use of the Internet, online questionnaires have become a popular way of collecting information. However, the online research field remains relatively new and continues to evolve. With the growth of social media, new levels of complexity and opportunity have been created for using digital surveys to conduct market research.

Other Online Research Methods for Surveying Consumers

• Online Ethnography
• Online Focus Group
• Online Interview
• Web-based Experiments
• Online Clinical Trials

Clinical Trial

An online clinical trial is one type of research method used to survey customers.

A clinical trial bottle.

Advantages of Digital Surveys

• The administrator has greater flexibility in displaying questions. Questions can be displayed with check boxes, pull down menus, pop up menus, help screens, or submenus.
• An online forum allows responses to be received from more subjects and from anywhere in the world.
• This method is also cheaper to use, because there are fewer costs incurred from buying paper, printing materials or paying postage.
• Since data is collected into a central database, the time for analysis is substantially reduced.
• It is easier to correct errors on an online questionnaire, since the administrator does not have to reprint and redistribute all the questionnaires.

Disadvantages of Digital Surveys

• Not everyone has access to the Internet, so the response rate is limited.
• Many people are not receptive to completing questionnaires online.
• Studies indicate that the demographic that responds to online questionnaire invitations are generally younger people.

4.3.3: Databases

Learning Objective

Describe the purpose and use of databases in marketing research

Key Points

• Researchers keep consumer databases up-to-date with as much available data as possible regarding consumer behavior and product consumption.
• When companies want to conduct consumer market research, they call on these research facilities to request consumers who fit a specific demographic and behavioral profile so that these prospective respondents can then be contacted to participate in research studies.
• Database research provides the raw data that has already been contributed by the purchaser when they complete brief surveys that ask for their contact and demographic information during or after a product purchase.
• Marketers can use database research to identify common buying patterns among consumers.
• Lists that can be found in existing databases include: credit card holders, smokers, drinkers, car buyers, video buyers.

Key Terms

baby boomer

A person born in the postwar years (generally considered in the USA and other Allied countries as between 1945 and the early 1960s), when there was an increase in the birth rate following the return of servicemen at the end of World War II.

Market Research

The systematic collection and evaluation of data regarding customers’ preferences for actual and potential products and services.

database

An organized collection of data. The data are typically organized to model relevant aspects of reality (for example, the availability of rooms in hotels), in a way that supports processes requiring this information (for example, finding a hotel with vacancies).

Example

• For example, from zip code lists, marketers may determine where the wealthy consumers live in a city.

A database is an organized collection of data that is typically organized to model relevant aspects of reality (for example, the availability of rooms in hotels) in a way that supports the processes that require this information (for example, finding a hotel with vacancies). In market research, a database contains information that is collected, aggregated, and used to define segments of homogeneous consumers.

Consumer Databases in Market Research

Researchers keep consumer databases up-to-date with as much available data as possible regarding consumer behavior and product consumption. This customer information oftentimes includes, but is not limited to, a variety of data, including name and address, history of shopping and purchases, demographics, and brand and product consumption. When companies want to conduct consumer market research, they call on these research facilities to request consumers who fit a specific demographic and behavioral profile so that these prospective respondents can then be contacted to participate in research studies.

Companies may also acquire prospect data directly through the use of sweepstakes, contests, online registrations, and other lead generation activities.

Database Research

Database research provides the raw data that has already been contributed by the purchaser when they complete brief surveys that ask for their contact and demographic information during or after a product purchase . Marketers can use database research to identify common buying patterns among consumers. Lists that can be found in existing databases include: credit card holders, smokers, drinkers, car buyers, video buyers.

Customers asked for information at counter

Retail outlets such as pharmacies can request customer’s contact information at check-out for specific products as a way to help build a consumer database.

Database research is considered an extremely helpful tool in market segmentation research. For example, from zip code lists, marketers may determine where the wealthy consumers live in a city. That list can be merged with a list of moms of children 0-5 years old. The resulting list can be merged with another list of women who are Hispanic and African American to further target this niche demographic. The final list will deliver a potential market for a new baby product to be introduced and profiled in Hispanic and African American women’s magazines. The people on the potential buyers’ list could then be mailed an invitation to come test this new baby product.

4.3.4: Decision Support Systems

Learning Objective

Demonstrate the uses and effectiveness of decision support systems from a marketing perspective

Key Points

• Companies across all industries rely on decision support tools, techniques, and models to help them assess and resolve business questions.
• A DSS is a computer-based information system that helps businesses or organizations make better decisions by providing a flexible tool for analysis.
• In addition to helping management, DSSs also serve the operations and planning levels of an organization by helping them make decisions.
• Decision support systems can be either fully computerized, human, or a combination of both.
• A key component to any DSS is business intelligence reporting tools, processes, and methodologies.
• The top benefits of decision support systems include: speeding up the process of decision making, increasing organizational control, speeding up problem solving in an organization, helping automate managerial processes, improving personal efficiency, and eliminating value chain activities.

Key Term

Decision Support System

A computer-based information system that supports business or organizational decision-making activities.

Example

• American Airlines produced a DSS that helps decide how much to overbook and how to set prices for each seat so that a plane is filled and profits are maximized.

Decision Support Systems

Companies across all industries rely on decision support tools, techniques, and models to help them assess and resolve business questions. One example of this is a decision support system (DSS). A DSS is a computer-based information system that helps businesses or organizations make better decisions by providing a flexible tool for analysis. With supporting software and hardware, this tool collects data that helps an organization gather and interpret relevant business information. It then converts the information into a basis for marketing action.

Example of a DSS

A decision support system helps a company resolve business questions.

Decision support systems enable managers to obtain and manipulate information as they are making decisions. In addition to helping management, DSSs also serve the operations and planning levels of an organization by helping them make decisions, which may be rapidly changing and not easily specified in advance. Decision support systems can be either fully computerized, human, or a combination of both.

A key component to any DSS is business intelligence reporting tools, processes, and methodologies. DSSs also include knowledge-based systems and an interactive software-based system intended to help decision makers compile useful information from a combination of raw data, documents, personal knowledge, or business models.

Typical information that a decision support application might gather and present includes:

• Comparative sales figures between one period and the next
• Projected revenue figures based on product sales assumptions

Decision support systems can be developed to support the types of decision-making faced by managers in specific industries such as the airline and real estate industry. For example, American Airlines produced a DSS that helps to decide how much to overbook and how to set prices for each seat so that a plane is filled and profits are maximized. Decision support systems have become critical and useful across all types of business. In today’s global marketplace, it is imperative that companies respond quickly to market changes. Companies with comprehensive decision support systems have a significant competitive advantage.

The top benefits of decision support systems include:

• Speeding up the process of decision making
• Increasing organizational control
• Speeding up problem solving in an organization
• Helping automate managerial processes
• Improving personal efficiency
• Eliminating value chain activities

4.3.5: Competitive Intelligence

Learning Objective

Describe the characteristics of competitive intelligence or (CI)

Key Points

• Competitive intelligence entails defining, gathering, analyzing, and distributing information about products, customers, and competitors.
• Competitive intelligence seeks to make the organization more competitive relative to its entire environment and stakeholders: customers, competitors, distributors, technologies, and macro-economic data.
• There are many synonyms for competitive intelligence such as business intelligence, market intelligence, and corporate intelligence.
• At the core of this concept is the ability to understand the competition’s position and predict the likely moves that competing companies will employ based on basic business principles.
• Although the Internet is a first stop in information gathering, CI typically entails spending more time and effort gathering information by means of primary research, such as speaking with one’s own employees, customers, suppliers, or outside industry experts.
• Competitive intelligence can be executed via the following methods: primary research, secondary research, and analysis.

Key Terms

Secondary Research

This process involves the summary, collation, and synthesis of existing research rather than primary research, where data is collected from subjects or experiments.

competitive intelligence

The action of defining, gathering, analyzing, and distributing intelligence about products, customers, competitors, and any aspect of the environment needed to support executives and managers in making strategic decisions for an organization.

Primary Research

The research that involves the collection of data that does not yet exist.

primary data

information collected by the investigator conducting the research

Example

• An example of competitive intelligence is when a food and beverage company conducts primary research to find out about the latest trends in the beverage industry of a foreign country. Once they know what consumers are looking for, they can align their product development resources accordingly.

Competitive Intelligence (CI) in marketing research involves defining, gathering, analyzing, and distributing information about products, customers, and competitors and any aspect of the environment needed to support executives and managers in making strategic decisions for an organization. Although the term CI is also considered synonymous with competitor analysis, competitive intelligence extends beyond analyzing competitors. CI seeks to make the organization more competitive relative to its entire environment and stakeholders: customers, competitors, distributors, technologies, and macro-economic data.

There are many synonyms for competitive intelligence such as business intelligence, market intelligence, and corporate intelligence.

The CI field has been growing exponentially as it is becoming a must-have core competency for many businesses. At the core of this concept is the ability to understand the competition’s position and predict the likely moves that competing companies will employ based on basic business principles.

Internet

The Internet is one method that’s used to gather information for competitive analysis.

“The Internet Messenger” statue by Buky Schwartz, located in Holon, Israel.

Although the Internet is a first stop in information gathering, CI typically entails spending more time and effort gathering information by means of primary research, such as speaking with one’s own employees, customers, suppliers, or outside industry experts. CI can typically be executed via the following methods:

• Primary research – This process involves the use of a human network to access meaningful intelligence.
• Secondary research – This process involves the use of secondary research sources, such as by gathering published information.
• Analysis – This process involves the use of analytical tools.

In essence, CI is a hybrid process of marketing research and strategic analysis that ultimately seeks to provide companies and their products with a competitive advantage in the marketplace.

4.4: Market Segmentation

4.4.1: What Are Markets

Markets are a group of potential buyers with needs and wants and the purchasing power to satisfy them.

Learning Objective

Diagram the different types of markets and their relationship to one another

Key Points

• Markets can be more tightly defined as a people who have a true need or want for the company’s offering, the ability to pay for it, and the willingness and authority to buy it. The total number of buyers must be large enough to be profitable for the company.
• Markets can also be a place such as a shopping center. This identification of markets is useful for marketing decision-making purposes because factors such as product features, price, location of facilities, and promotional design are affected by geographic factors.
• The market can be defined as an economic entity because in most cases, a market is characterized by a dynamic system of economic forces including supply, demand, competition, and government intervention.
• The primary types of markets are consumer markets, industrial markets, institutional markets, and reseller markets. These categories are not always clear-cut and in some industries, a business may be in a different category altogether or may even encompass multiple categories.

Key Terms

buyer’s market

An excess of supply over demand, leading to abnormally low prices. A situation when there is an abundance of product, prices are usually low, and customers dictate the terms of sale.

esoteric

Confidential; private.

latent

Existing or present but concealed or inactive.

Example

• Defining people as a market must meet all 5 criteria: One example is the pharmaceutical industry. There are several serious human diseases that remain uncured only because they have not been contracted by a large enough number of people to warrant the necessary research. The excessive research costs required to develop these drugs necessitates that companies are assured a certain level of profitability. Even though the first four criteria of defining people as a market may be met, a small potential customer base means no viable market exists.

Defining the Market

A basic definition of a market is a group of potential buyers with needs and wants and the purchasing power to satisfy them.

We will also consider a more expansive definition given the complexities of these components.

The Market is People: Since exchange involves two or more people, the market can be thought of as people, individuals, or groups. People constitute markets only if they currently recognize their need or desire for an existing or future product.

Individuals and members of households are the largest category of markets, but business establishments and other organized behavior systems also represent valid markets. However, people or organizations must meet all five of the following basic criteria in order to represent a valid market:

• There must be a true need or want for the product, service, or idea; this need may be recognized, unrecognized, or latent.
• The person or organization must have the ability to pay for the product via means acceptable to the marketer.
• The person or organization must be willing to buy the product.
• The person or organization must have the authority to buy the product.
• The total number of people or organizations meeting the previous criteria must be large enough to be profitable for the marketer.

The Market is a Place: The market can also be thought of as a place or as a geographical area within which trading occurs. International markets, American markets, a shopping center, and even the site of a single retail store can be called a market.

Shopping Mall

A market is a place where trading takes place. An example of a market is a shopping mall.

This identification of markets is useful for marketing decision-making purposes because factors such as product features, price, location of facilities, and promotional design are all affected by geographic factors. Finally, a market may be somewhere other than a geographical region, such as a catalog or ad that allows you to place an order without a marketing intermediary.

The Market is an Economic Entity: In most cases, a market is characterized by a dynamic system of economic forces including supply, demand, competition, and government intervention. The terms buyer’s market and seller’s market describe different conditions of bargaining strength. Finally, the extent of personal freedom and government control produces free market systems, socialistic systems, and other systems of trade and commerce.

Types of markets

The primary types of markets are consumer markets, industrial markets, institutional markets, and reseller markets.

These categories are not always clear-cut. In some industries, a business may be in a different category altogether or may even encompass multiple categories. It is also possible that a product may be sold in all four markets.

Consumer Markets

Consumer markets include individuals and households who buy consumer goods and services for their own personal use. They are not interested in reselling the product or setting themselves up as a manufacturer.

Industrial Markets

The industrial market consists of organizations and the people who work for them, those who buy products or services for use in their own businesses or to make other products. For example, a steel mill might purchase computer software, pencils, and flooring as part of the operation and maintenance of their business.

Institutional Markets

The institutional market is made up of various types of profit and nonprofit institutions, such as hospitals, schools, churches, and government agencies. Institutional markets differ from typical businesses because they are motivated by satisfying esoteric, often intangible, needs rather than profits or market share. Because institutions operate under different restrictions and employ different goals, marketers must use different strategies to be successful.

Reseller Markets

All intermediaries that buy finished or semi-finished products and resell them for profit are part of the reseller market. This market includes approximately 383,000 wholesalers and 1,300,000 retailers that operate in the US.

With the exception of products obtained directly from the producer, all products are sold through resellers. Producers are always cognizant of the fact that successful marketing to resellers is just as important as successful marketing to consumers.

4.4.2: The Importance of Market Segmentation

Segmentation splits buyers into groups with similar needs and wants to best utilize a firm’s finite resources through buyer based marketing.

Learning Objective

Examine the benefits of market segmentation

Key Points

• The market segmentation and corresponding product differentiation strategy can give a firm a temporary commercial advantage. Most market segmentations are the techniques used to attract the right customer.
• Objectives of segmentation are: 1) To reduce risk in deciding where, when, how, and to whom a product, service, or brand will be marketed; 2) To increase marketing efficiency by directing effort specifically toward the designated segment in a manner consistent with that segment’s characteristics.
• While the market is initially reduced to its smallest homogeneous components (perhaps an individual), business in practice requires the marketer to find common dimensions that will allow him to view these individuals as larger, profitable segments.

Key Terms

product differentiation

Tangibly or intangibly distinguishing a product from that of all competitors in the eyes of customers.

target

A person (or group of people) that a person or organization is trying to employ or to have as a customer, audience etc.

Example

• Segmenting example: Kellogg’s Frosties are marketed to children, while Kellogg’s Crunchy Nut Cornflakes are marketed to adults. Both goods denote two products that are marketed to two distinct groups of people, both with similar needs (a breakfast food), traits, and wants.

Market segmentation pertains to the division of a set of consumers into persons with similar needs and wants. Market segmentation allows for a better allocation of a firm’s finite resources. Due to limited resources, a firm must make choices in servicing specific groups of consumers. With growing diversity in the tastes of modern consumers, firms are taking note of the benefit of servicing a multiplicity of new markets.

Market segmentation can be defined in terms of the STP acronym, meaning Segment, Target and Position.

Benefits of Segmentation

While there may be theoretically ‘ideal’ market segments, in reality, every organization engaged in a market will develop different ways of imagining market segments, and create product differentiation strategies to exploit these segments. The market segmentation and corresponding product differentiation strategy can give a firm a temporary commercial advantage. Most market segmentations are the techniques used to attract the right customer.

In essence, the marketing objectives of segmentation analysis are:

• To reduce risk in deciding where, when, how, and to whom a product, service, or brand will be marketed
• To increase marketing efficiency by directing effort specifically toward the designated segment in a manner consistent with that segment’s characteristics

Market segmentation is a twofold process that includes:

1. Identifying and classifying people into homogeneous groupings, called segments
2. Determining which of these segments are viable target markets.

The Segmented Market

The premise of segmenting the market theorizes that people and/or organizations can be most effectively approached by recognizing their differences and adjusting accordingly. By emphasizing a segmentation approach, the exchange process should be enhanced, since a company can more precisely match the needs and wants of the customer.

While product differentiation is an effective strategy to distinguish a brand from competitors’, it also differentiates one product from another. For example, a company such as Franco-American Spaghetti has differentiated its basic product by offering various sizes, flavors, and shapes. The objective is to sell more product, to more people, more often. The problem is not competition; the problem is the acknowledgment that people within markets are different and that successful marketers must respond to these differences.

Choosing a Target Market from within a Defined Segment

While it is relatively easy to identify segments of consumers, most firms do not have the capabilities or the need to effectively market their product to all of the segments that can be identified. Rather, one or more target markets (segments) must be selected. A company selects its target market because it exhibits the strongest affinity to a particular product or brand. It is in essence the most likely to buy the product.

Kellogg’s Crunchy Nut Cereal

Kellogg’s segmented its audience into children and adults. The cereal appealed to children, while free bowling appealed to adults.

While the market is initially reduced to its smallest homogeneous components (perhaps a single individual), business in practice requires the marketer to find common dimensions that will allow him to view these individuals as larger, profitable segments.

4.4.3: Developing a Market Segmentation

A market segmentation is developed based on one of two strategies and several consumer identifying characteristics like demographics and behavior.

Learning Objective

Review the characteristics of market segmentation

Key Points

• The two major segmentation strategies followed by marketing organizations are concentration strategy and multi-segment strategy.
• Segmentation of a market to reach a target consumer base can be done by defining consumers in terms of geographic, demographic, psychographic, and behavioral characteristics.
• An ideal market segment is possible to measure, large enough to earn profit, stable, possible to reach, internally homogeneous, externally heterogeneous, consistent in response to market stimulus, reachable in a cost-effective manner, and useful in determining marketing mix.

Key Terms

market segment

A subset of consumers who have common needs and desires as well as common applications for the relevant goods and services.

psychographic

The science of using psychology and demographics to better understand consumers.

psychographic segmentation

The division of the market into subsets according to consumers’ lifestyle, personality, values, and social class.

marketing mix

A business tool used in marketing products; often crucial when determining a product or brand’s unique selling point. Often synonymous with the four Ps: price, product, promotion, and place.

Example

• What is a concentration strategy? The manufacturer of Rolex watches has chosen to concentrate on the luxury segment of the watch market. This allows them to focus all of their efforts on a single segment. If Rolex chose to use a multi-segment strategy they would be marketing to every watch user and thus their brand value would diminish. Their use of the concentration strategy has helped define themselves as a luxury brand.

Criteria for Segmenting

An ideal market segment meets all of the following criteria:

• It is possible to measure.
• It must be large enough to earn profit.
• It must be stable enough that it does not vanish after some time.
• It is possible to reach potential customers via the organization’s promotion and distribution channel.
• It is internally homogeneous (potential customers in the same segment prefer the same product qualities).
• It is externally heterogeneous. In other words, potential customers from different segments have different quality preferences.
• It responds consistently to a given market stimulus.
• It can be reached by market intervention in a cost-effective manner.
• It is useful in deciding on the marketing mix.

Segmentation Strategies

There are two major segmentation strategies followed by marketing organizations: a concentration strategy and a multi-segment strategy.

In the concentration strategy, a company chooses to focus its marketing efforts on only one market segment. Only one marketing mix is developed. This strategy is advantageous because it enables the organization to analyze the needs and wants of only one segment and then focus all its efforts on that segment. The primary disadvantage of concentration is that if demand in the segment declines, the organization’s financial position will also decline .

Concentration Strategy

Rolex focuses on customers who want a luxury watch. Rolex is a prime example of the concentration strategy in market segmentation.

In the multi-segment strategy, a company focuses its marketing efforts on two or more distinct market segments. The organization does so by developing a distinct marketing mix for each segment. They then develop marketing programs tailored to each of these segments. This strategy is advantageous because it can increase total sales since more marketing programs are focused at more customers. The disadvantage of this strategy is the higher costs stemming from the need for multiple marketing programs.

Segmenting Methods

Segmentation of a market to define a target consumer base can be done in a variety of methods such as:

Geographic Segmentation

Geographic criteria—nations, states, regions, countries, cities, neighborhoods, or zip codes–define the market segments. The geo-cluster approach combines demographic data with geographic data to create a more accurate profile of a specific consumer. In areas prone to rain, you can sell things like raincoats, umbrellas, and gumboots. In hot regions, you can sell summer wear, while in cold regions, you can sell warm clothes.

Demographic Segmentation

This consists of dividing the market into groups based on variables such as age, gender, family size, income, occupation, education, religion, race, and nationality. Demographic segmentation variables are among the most popular bases for segmenting customer groups because customer wants are closely linked to variables such as income and age and because there is a plethora of demographic data available.

Psychographic Segmentation

In psychographic segmentation, consumers are divided according to their lifestyle, personality, values, and social class. Foreigners within the same demographic group can exhibit very different psychographic profiles.

Behavioral Segmentation

Consumers are divided into groups according to their knowledge of, attitude toward, use of, or response to a product. It is actually based on the behavior of the consumer.

Occasions

Companies can segment the market according to the occasions of use, such as whether the product will be used alone or in a group, or whether it is being purchased as a present or for personal use.

Benefits

Companies can segment the market according to the benefits sought by the consumer.

Usage Rate

Markets could also be segmented by usage rates. For example, it has been suggested that targeting heavy users can lead to increased sales. Segmenting by usage could divide the market by heavy users vs. light users.

4.5: Identification of Target Markets

4.5.1: Undifferentiated Targeting

Viewing the market as a homogeneous aggregate leads to undifferentiated targeting and mass marketing.

Learning Objective

Evaluate the benefits and drawbacks of undifferentiated targeting in consumer marketing

Key Points

• Undifferentiated targeting occurs when the marketer ignores the apparent segment differences that exist within the market and uses a marketing strategy that is intended to appeal to as many people as possible.
• For certain types of widely consumed items (e.g., gasoline, soft drinks, white bread), the undifferentiated market approach makes the most sense.
• The benefits to undifferentiated targeting include a wide audience, lower (relatively) research and marketing costs, and a higher potential for sales volume.

Key Term

Mass Marketing

A market coverage strategy in which a firm decides to ignore market segment differences and appeal to the whole market with one offer or one strategy.

Undifferentiated targeting occurs when the marketer ignores the apparent segment differences that exist within the market and uses a marketing strategy that is intended to appeal to as many people as possible. In essence, the market is viewed as a homogeneous aggregate. Traditionally, undifferentiated marketing (also known as “mass marketing”) has focused on radio, television, and newspapers as the medium used to reach this broad audience. By reaching the largest audience possible, exposure to the product is maximized. In theory, this would directly correlate with a larger number of sales or buy in to the product. It is the technique of trying to spread our marketing message to anyone and everyone who are willing to listen. A truckload of general advertising is done to the mass market in the hope that some of them will hit a target. It enables us to reach a wide range of services to take any job that comes on our way.

Products

For certain types of widely consumed items (e.g., gasoline, soft drinks, white bread), the undifferentiated market approach makes the most sense. For example, toothpaste (such as the brand Crest ) isn’t made specially for one consumer, and it is sold in huge quantities. A company or individual who manufactures toothpaste wishes to get more people to buy their particular brand over another. The goal is that when a consumer has the option to select a tube of toothpaste, he would remember the product that was marketed. Often, this type of general appeal is supported by positive, emotional settings, and a great many reinforcers at the point of purchase. Walk through any supermarket, and you will observe hundreds of food products that are perceived as nearly identical by the consumer and are treated as such by the producer, especially generic items. Many mass marketed items are considered staple items. These are items people are accustomed to buying new when their old ones wear out (or are used up).

Crest Toothpaste

Toothpaste is a widely consumed product. Toothpaste isn’t marketed to a particular market segment.

Identifying products that have a universal appeal is only one of many criteria to be met if an undifferentiated approach is to work. The number of consumers exhibiting a need for the identified product must be large enough to generate satisfactory profits. A product, such as milk, would probably have universal appeal and a large market, something like a set of dentures might not. However, adequate market size is not an absolute amount and must be evaluated for each product. Two other considerations are important: the per unit profit margin and the amount of competition. Bread has a very low profit margin and many competitors, thus requiring a very large customer base. A product such as men’s jockey shorts delivers a high profit but has few competitors. Success with an undifferentiated market approach is also contingent on the abilities of the marketer to correctly identify potential customers and design an effective and competitive strategy. Since the values, attitudes, and behaviors of people are constantly changing, it is crucial to monitor these changes.

Benefits

• Wide audience: Since the target audience is broad, the number of successful hits is high despite of the low probability of a single person turning up.
• Less risky: If all the efforts in one particular area goes in vain, still the eventual loss is less compared to a loss in the narrowly focused area.
• Production cost per unit are low on account of having one production run for homogeneous product.
• Marketing research cost and advertising cost are relatively low.
• Higher potentials of sales volume and efficiency of scale in a much larger market.

4.5.2: Concentrated Targeting

Concentrated marketing is a strategy which targets very defined and specific segments of the consumer population.

Learning Objective

Evaluate the advantages and disadvantages of adopting concentration strategies in consumer marketing

Key Points

• An organization that adopts a concentration strategy gains an advantage by being able to analyze the needs and wants of only one segment and then focusing all its efforts on that segment.
• Concentrated targeting is particularly effective for small companies with limited resources as it does not require the use of mass production, mass distribution, and mass advertising.
• Since the company has focused all their efforts on one market (essentially putting all their eggs in one basket), the firm is at risk for failing if demand decreases.

Key Term

market segment

Market segmentation is a marketing strategy that involves dividing a broad target market into subsets of consumers who have common needs and desires as well as common applications for the relevant goods and services.

Example

• The target market for CVS Caremark is women since they make up 80% of the pharmacy chain’s customers. CVS has marketed its stores to aid women who are constantly multitasking. They recently redesigned 1,200 of its 6,200 stores to women, including shorter wait times for prescriptions, wider and better-lit shopping aisles, and more beauty products.

An organization that adopts a concentration strategy chooses to focus its marketing efforts on only one very defined and specific market segment. Accordingly, only one marketing mix is developed. For example, the manufacturer of Rolex watches has chosen to concentrate on the luxury segment of the watch market.

An organization that adopts a concentration strategy gains an advantage by being able to analyze the needs and wants of only one segment and then focusing all its efforts on that segment. They can focus all of their efforts to satisfying the needs of one group and do it well. This can provide a differential advantage over other organizations that market to this segment but do not concentrate all their efforts on it. Concentrated targeting is particularly effective for small companies with limited resources as it does not require the use of mass production, mass distribution, and mass advertising. However, there is no increase in the total profits of the sales as it targets just one segment of the market.

CVS 

As a concentration strategy, CVS targets women because they make up 80% of the chain’s customer base.

The primary disadvantage of concentration strategy is related to the demand of the segment. As long as demand is strong, the organization’s financial position will be strong. If demand declines, the organization’s financial position will also decline. Since the company has focused all their efforts on one market (essentially putting all their eggs in one basket), the firm is at risk for failing. Moreover, if a firm has yet to establish its loyalty among customers, a small hit in population or consumer taste can greatly affect their position.

4.5.3: Measuring a Successful Segmentation

Segmentation is a central aspect of a marketing strategy, and must be constantly assessed, measured, validated, and refined through financial and statistical methods.

Learning Objective

Recognize the variables involved in segmentation, and how different segments can be measured for profitability

Key Points

• Selling to the entire market is often less efficient than identifying, filtering, and measuring the performance of various segments to find a preferred market segment, or target market.
• Geographic, demographic, psychographic and behavioral factors are all valid and commonly used starting points for the division of a broader market into segments.
• Once a segment is identified, organizations should consider the measurability, accessibility, sustainability, and actionability of that particular segment. This helps determine if the firm can maintain a strong position within the segment.
• It is also useful to run iterative tests across other potential target markets as a benchmark, justifying (or not!) the decision to pursue a given segment.
• From a practical point of view, all of this should allow the firm to determine if a given segment is profitable in the long term and optimal compared to other ways to segment the market.

Key Term

segmentation

The process of identifying different consumer groups within a broader market, focusing on identifying the ideal segments for a marketing plan.

Segmentation

Strategically speaking, trying to sell to the entire market is often less efficient than identifying, filtering, and measuring the performance of various segments to find a preferred market segment, or target market. When pursuing the ideal target market(s), a key success factor is the ability to measure successful and unsuccessful segmentation attempts.

Measuring Market Segments

When measuring different market segments, there are countless variables organizations can consider when developing a marketing plan. Geographic, demographic, psychographic, and behavioral factors are all valid and common starting points for the division of a broader market into segments, based on variables like age, gender, buying behavior, culture, location, values, climate, spending power, marital status, profession, education, and religion.

Demographic Segmentation

When measuring market segments, variables can be utilized visually to identify specific target segments within a population.

Two tables that show market demographics. The first table shows market customers in three segments based on age. The second table shows market potential based on occupation (professional, semi-professional, trade, and unskilled).

By dividing the population based upon segments such as these, organizations can begin to consider how each variable impacts the likelihood of an initial purchase and/or repeat purchases over a given period of time. This allows the qualitative variables above to begin accumulating quantitative data points, which helps organizations look at trends in the past to predict or forecast future outcomes.

For example, a shoe manufacturer finds that the likelihood of turning an advertisement online into an online purchase is 50% higher with females between the ages of 18-30 than with males in the same age bracket. Similarly, the shoe manufacturer notices that specific cities with relatively mild climates convert 25% more often than cities with extreme climates. As a result, a segment is developed for young females in those cities. Instead of paying for advertising across an entire market, the organization can spend significantly less capital and procure a much better success rate on marketing efforts.

Determining Successful Segmentation

Once segments are identified, the organization should be investing enough into each segment to procure meaningful data on performance. As each segment is a small piece of a broader market, it’s useful to carefully consider if the organization is focusing on the ideal consumer group. There are four useful characteristics to consider when measuring segmentation:

1. Measurability – First and foremost, the segment itself should be easily measured. This means that information is available on the overall market potential (size of the market), as well as the competitive position of the companies competing for market share.
2. Accessibility – Firms must also be able to communicate directly with key consumers in order to understand their core segment and tell the brand story.
3. Sustainability – Overall profitability must be proven in a given segment in order to successfully do business. Long-term potential sustainability can be measured based on past consumer behavior coupled with the organizational ability to produce products at the right price.
4. Actionability – Finally, the firm should be able to produce a competitive advantage within this particular segment. There should be actionable opportunities for the organization to build a strong and differentiated position within the segment.

If each of these attributes are measurable, the firm can look at a few key statistics of the marketing plan to determine if a given segment is sustainable. Most notably, the organization should be able to generate a strong position within the segment, where the overall remaining profit after a sale exceeds the cost of production alongside the cost of the marketing expenses required to get the product in front of the target market.

The organization should also run careful, iterative tests across other potential target markets as a benchmark. This allows the organization to directly see the value of working with a given segment (compared to other potential segments).

Marketing Strategy and Segmentation

A business plan integrates with the marketing strategy. The above table shows relevant metrics and considerations when identifying key segments.

A table that shows how a business plan integrates with the marketing strategy.

4.6: Conducting a Segmentation

4.6.1: Determining Segmentation Variable(s)

Markets can be segmented primarily according to geographic, demographic, usage, and psychological segments—or a combination of the above.

Learning Objective

Break down market segmentation variables

Key Points

• Geography is probably the oldest basis for segmentation, and is often useful for marketers due to the amount of data available. However, there are drawbacks with focusing solely on geography.
• Demographic segmentation is also useful for certain products. However, marketers should be aware that demographics tend to change with society, and thus be aware of these changes and respond to them accordingly.
• Psychological segmentation, such as lifestyle and attitudinal variables, are also useful for particular types of products. However, obtaining information on such bases can often prove challenging.

Key Terms

psychological segments

Segmentation of markets based on psychological influences, such as personality, lifestyle choices, and attitudinal variables.

demographic segmentation

The division of the market into subsets based on characteristics of the population.

geographic segments

Segmentation of consumers based on geographical factors such as location, weather, topography, population density, etc.

Example

• As noted, religion is an interesting basis for demographic segmentation. Aside from the obvious higher demands for Christian-oriented products and services, differences in demand for secular products and services have been identified as well. For example, the Christian consumer attends movies less frequently than consumers in general. Population density can also place people in unique market segments. High-density cities such as New York City, Hong Kong, and London create the need for products such as security systems, fast-food restaurants, and public transportation.

Bases of Segmentation

There are many different ways by which a company can segment its market, and the chosen process varies from one product to another (see ). Also, since markets are very dynamic, and products change over time, the bases for segmentation must likewise change.

Bases for Segmentation

One way to segment markets is by consumer and industrial markets.

A table that shows bases for segmentation by choosing primary dimensions and breaking it down into consumer and industrial markets.

Geographic Segments

Regional differences in consumer tastes for products as a whole are well-known. Markets according to location are easily identified and large amounts of data are usually available. Also, many companies simply do not have the resources to expand beyond local or regional levels.

Closely associated with geographic location are inherent characteristics of that location: weather, topography, and physical factors such as rivers, mountains, ocean proximity, and population density.

Geography provides a convenient organizational framework. Products, salespeople, and distribution networks can all be organized around a central, specific location. However, there are drawbacks. Consumer preferences may bear no relationship to location. Other factors, such as ethnic origin or income, may overshadow location. The stereotypical Texan, for example, is hard to find in Houston, where one-third of the population has immigrated from other states. Another problem is that members of a geographic segment often tend to be too heterogeneous to qualify as a meaningful target for marketing action.

Demographic Segments

Demographics can be used to help companies develop products that meet current and future consumer needs. It can alert a company to a new segmentation, one that was not originally connected to the product. For example, women using power tools as home owners. Segmenting the consumer market by age groups is useful for several products. For example, the youth market (approximately 5 to 13) influences how their parents spend money, and when they make purchases on their own (e.g. toys and snacks). Presently, the senior market (age 65 and over) has grown in importance for producers of low-cost housing, cruises, and health care.

Gender has historically been a good basis for market segmentation. Many traditional gender-based boundaries are changing, and marketers must be aware of these changes. The emergence of the working woman, for instance, has made determining how the family income is spent more difficult. Thus, the simple classification of male versus female may be useful only if several other demographic and behavioral characteristics are considered. Income seems a better basis for segmenting markets as prices for a product increases. Income may also may uncover other buying behaviors.

Education affects product preferences and desired characteristics for certain products. Occupation is important: individuals who work in hard physical labor may demand a different set of products than a teacher or bank teller. Race, religion and national origin have also been associated with product preferences and media preferences.

Usage Segments

• The heavy user is an important basis for segmentation. This approach is very popular, particularly in the beverage industry (e.g beer, soft drinks, and spirits).
• Purchase occasion: determining the reason for an airline passenger’s trip, may be the most relevant criteria for segmenting airline consumers.
• User status: communication strategies must differ when directed at different use patterns, such as nonusers versus ex-users, or one-time users versus regular users.
• Loyalty: if companies can identify customer loyalty to their brand, and then delineate other characteristics these people have in common, they will locate the ideal target market.
• Stage of readiness: potential customers may be unaware, aware, informed, interested, desirous, and intending to buy. If a marketing manager is aware of where the specific segment of potential customers is, he or she can design the appropriate market strategy to move them through the various stages of readiness.

Psychological Segments

Segmentation should recognize psychological as well as demographic influences. For example, Phillip Morris has segmented the market for cigarette brands by appealing psychologically to consumers in the following way:

• Marlboro: the broad appeal of the American cowboy
• Benson & Hedges: sophisticated, upscale appeal
• Parliament: for those who want to avoid direct contact with tobacco

Attitudes of prospective buyers towards certain products influence their subsequent purchase of them. If people with similar attitudes can be isolated, they represent an important psychological segment.

Measurements of demographic, personality, and attitudinal variables are convenient measurements of less conspicuous motivational factors. People with similar physical and psychological characteristics may be similarly motivated. Motives can be positive (convenience), or negative (fear of pain). So marketers attempt to observe motivation directly and classify market segments accordingly.

Lifestyle segmentation has become very popular with marketers, because of the availability of measurement devices and instruments, and the intuitive categories that result from this process. Producers are targeting versions of their products and their promotions to various lifestyle segments. Lifestyle analysis begins by asking questions about the consumer’s activities, interests, and opinions. Research reveals vast amounts of information concerning attitudes toward product categories and user and non-user characteristics, which marketers can use in targeting their products.

4.6.2: Segmentation for B2B

B2B firms will segment their customers differently, due to different buying habits and procedures between businesses and end-users.

Learning Objective

Analyze B2B marketing segmentation characteristics

Key Points

• There are five major ways to segment the B2B market, including: type of customer, Standard Industrial Classification codes, end uses, common buying factors, and buyer size/geography.
• SIC classification provides a useful way for marketers to segment the market.
• By determining how the end-use of a product differs according to different users, the manufacturer can modify the product so that it appeals to different segments.
• If the first four approaches are not useful, a marketer may still have success in segmenting by customer size and geography.

Key Term

Standard Industrial Classification (SIC)

A set of codes published by the United States government that classifies business firms by the main product or service provided.

Example

• Within each SIC code, the major groups of industries are identified by the first two digits. For example, SIC number 22 are textile mills, while SIC number 34 are manufacturers of fabricated metals.

B2B Segmentation

B2B firms sell not to ultimate consumers but to other businesses. While businesses and final consumers behave similarly at times, there are also several differences. Most business buyers view their function as a problem solving approach, and have formal procedures, or routines, for their purchasing.

A B2B marketer must be able to distinguish between the industries it sells to and the different market segments that exist in each of them. There are several basic approaches to segmenting organizational markets, including: type of customer, Standard Industrial Classification codes, end uses, common buying factors, and buyer size and geography.

Type Of Customer

Industrial customers can be classified into one of three groups:

• Original equipment manufacturers (OEMs), such as Caterpillar machinery or Gibson guitars
• End-users, such as farmers who use farm machinery produced by OEMs
• After market customers, such as those who purchase spare parts for a piece of machinery

Similarly, industrial products can be classified into one of three categories, each of which is typically sold only to certain types of customers:

• Machinery and equipment (e.g. computers, bulldozers) are end products sold only to OEM and end user segments.
• Components or subassemblies (e.g. pistons, spark plugs) are sold to build and repair machinery and equipment, and are sold in all three customer segments.
• Materials (e.g. chemicals, metals) are consumed in the end-user products, and are sold only to OEMs and end users.

Standard Industrial Classification

This approach employs the Standard Industrial Classification (SIC) codes published by the United States government. The SIC codes classify business firms by the main product or service provided. There are ten basic SIC industries which firms are classified into. Within each classification, the major groups of industries can be identified by the first two numbers of the SIC code (see example).

By using SIC codes, a marketer may identify the manufacturing groups that represent potential users of the products it produces and sells. takes the two digit classification and converts it to three-, four-, five-, and seven-digit codes.

SIC Classification

SIC codes have two-digit to seven-digit classifications.

A diagram that shows different SIC code classifications – basic industry (2 digits), major group (2 digits), industry group (3 digits), specific industry (4 digits), product class (5 digits), and product (7 digits).

End Uses

Industrial marketers may segment markets by looking at the different ways and situations in which a product is used. Here, the industrial marketer typically conducts a cost / benefit analysis for each end-use application. The manufacturer must ask: What benefits does the customer seek from this product?

For example, an electric motor manufacturer learned that customers operated motors at different speeds. After making field visits to gain insight into the situation, he divided the market into slow speed and high speed segments. In the slow-speed segment, the manufacturer emphasized a competitively priced product with a maintenance advantage, while in the high-speed market product, superiority was stressed. By determining how the end-use of the product differed according to different users, the manufacturer was able to modify the product, and the marketing of the product, to appeal to these different segments more effectively.

Common Buying Factors

Marketers may segment markets by identifying groups of customers who consider the same buying factors important. Five factors are typically found to be important in most industrial buying situations: product performance, product quality, service, delivery, and price. Identifying a group of customers who value the same buying factors as important is difficult, as industrial organizations’ and resellers’ priorities often change.

Buyer Size and Geography

If the previous approaches are not useful in a particular situation, market advantages may still be realized by segmenting based on account size or geographic boundaries. Sales managers have done this for years, but only recently have organizations learned to develop several pricing strategies for customers that are close and for those who are far away. Similarly, different strategies can be developed for customers of different sizes.

4.6.3: B2B Company Characteristics

B2B businesses operate and market their goods and services differently than B2C companies, due to the different nature of the purchase.

Learning Objective

Differentiate between B2B, business to business and B2C, business to consumer characteristics

Key Points

• The volume of B2B sales is much greater than that of B2C sales.
• The purchase of B2B products is much risker than B2C products, because purchasing the wrong product or quantity, or at the wrong terms, can put the entire purchasing business at risk.
• B2B companies behave differently when buying. Purchases are usually made by committee, and decisions are specification-driven.
• B2B companies avoid mass media when promoting their brand, instead targeting their customers directly through trade shows, specialized magazines, etc.

Key Terms

B2C

The sale of goods and services from individuals or businesses to the end-user.

B2B

Commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer.

Transactions Between Businesses

B2B, or business-to-business, describes commercial transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer. The volume of B2B transactions is much higher than the volume of B2C transactions, because in a typical supply chain there will be many B2B transactions involving sub components or raw materials, and only one B2C transaction, specifically sale of the finished product to the end customer. For example, an automobile manufacturer makes several B2B transactions such as buying tires, glass for windscreens, and rubber hoses for its vehicles. The final transaction, a finished vehicle sold to the consumer, is a single B2C transaction.

While almost any B2C product or service could also be a B2B product, very few B2B products or services will be used by consumers. For example, toilet paper, a typical B2C product, is a B2B product when sold to hotels. However, few people will buy a forklift for their private use. 

Microchips

A microchip is a classic B2B product. Electronic manufacturers buy microchips to put in their products. They sell the products to final consumers.

Differences between B2B and B2C

The main difference between B2B and B2C is who the buyer of a product or service is. The purchasing process is different in both cases. Below are some of the differences between the two types of purchase.

Risk

Buying one can of soft drink involves little money, and thus little risk. If the decision for a particular brand was not right, there are very few implications. The worst that could happen is that the consumer does not like the taste and discards the drink immediately. However, buying B2B products is much riskier. Purchasing the wrong product or service, the wrong quantity, the wrong quality, or agreeing to unfavorable payment terms may put an entire business at risk.

In international trade, delivery risks, exchange rate risks, and political risks exist and may affect the business relationship between buyer and seller. Strong brands imply lower risk of using them; buying unfamiliar brands implies financial risks. Products may not meet the requirements and may need to be replaced at high cost. There exists a performance risk, as there might be something wrong with an unfamiliar brand. When buying machinery or supplies for a company, peers may not approve the purchase of an unknown brand, thus posing a risk to a purchasing manager’s reputation.

Buying behavior in a B2B environment

Timescale

For consumer brands, the buyer is an individual. In B2B there are usually committees of people in an organization. Each of the members may have different attitudes towards any brand. In addition, each party involved may have different reasons for buying or not buying a particular brand. Since there are more people involved in the decision, and since technical details may have to be discussed in length, the decision-making process for B2B products is usually much longer than in B2C.

Brand Loyalty

Companies seek long-term relationships, as any experiment with a different brand will have impacts on the entire business. Brand loyalty in B2B is therefore much higher than in consumer goods markets. While consumer goods usually cost little in comparison to B2B goods, the selling process involves high costs. Not only is it necessary to meet the buyer numerous times, but the buyer may ask for prototypes, samples, and mock-ups. Such detailed assessment serves the purpose of eliminating the risk of buying the wrong product or service.

Brand Differentiation

B2B products are generally bought by a committee of buyers, and in many cases the purchases are specification driven. As a result, it is vital that brands are clearly defined and that they target the appropriate segment. Companies can use various strategies of differentiation, leveraging on the origin of the goods or the processes used in manufacturing them. Depending on the company’s history, the competitive landscape, occupied spaces and white spaces, there could be one or many strategies a company could use. Ultimately, a strong B2B brand will reduce the perceived risk for the buyer and help sell the brand.

Brand Promotion

B2B promotions work differently from B2C brand promotions. The former avoid mass market broadcasts and generally use media that can be targeted at a specific business audience, such as direct marketing distributed online or in trade magazines. B2B companies are also present where their potential customers are, at trade shows, exhibitions, and other trade-related events.

4.6.4: Evaluating Market Segments

Segmentation involves classifying people into homogeneous groupings and determining which of these segments are viable target markets.

Learning Objective

Illustrate the purpose and method of evaluating market segments

Key Points

• Market segmentation involves dividing a broad target market into multiple subsets of consumers with common desires and common applications for the product. Marketing campaigns are designed and implemented to target these specific customer segments.
• This premise of segmentation holds that people can be most effectively approached by recognizing their differences and adjusting to them. By emphasizing a segmentation approach, the exchange process should be enhanced, since a company can more precisely match the needs and wants of the customer.
• A company following a concentration strategy focuses on one specific market segment, allowing it to understand the segment and focus on it fully, lowering costs. A multisegment strategy targets multiple segments and thus a larger market, but incurs higher marketing costs.

Key Term

market segmentation

The process of dividing a broad target market into subsets of consumers who have common needs or desires, as well as common applications for the relevant goods and services.

Example

• The manufacturer of Rolex watches has chosen to concentrate on the luxury segment of the watch market: therefore, they follow a concentration strategy.

The Segmented Market

While product differentiation is an effective strategy to distinguish your brand from competitors, it also differentiates your own products from one another. For example, a company such as Franco-American Spaghetti has differentiated its basic product by offering various sizes, flavors, and shapes. The objective is to sell more product, to more people, more often. Kraft has done the same with their salad dressings; Xerox with its multitude of office products. The problem is not competition; the problem is the acknowledgment that people within markets are different and that successful marketers must respond to these differences (see for a recap of the different market approaches).

Markets

Because all markets are different, it is important to define and approach a market using certain steps. 

A table that shows how to define and approach markets – define the market (people, place, economic entity), types of markets (consumer, industrial, institutional, reseller), and approaching the market (undifferentiated market, product differentiation, and segmental market – based on strategies).

This premise of segmenting the market theorizes that people and/or organizations can be most effectively approached by recognizing their differences and adjusting accordingly. By emphasizing a segmentation approach, the exchange process should be enhanced, since a company can more precisely match the needs and wants of the customer. While it is relatively easy to identify segments of consumers, most firms do not have the capabilities or the need to effectively market their product to all of the segments that can be identified. Rather, one or more target markets (segments) must be selected. In reality, market segmentation is both a disaggregation and aggregation process. While the market is initially reduced to its smallest homogeneous components (perhaps a single individual), business in practice requires the marketer to find common dimensions that will allow him to view these individuals as larger, profitable segments. Thus, market segmentation is a twofold process that includes:

1. Identifying and classifying people into homogeneous groupings, called segments, and;
2. Determining which of these segments are viable target markets.

In essence, the marketing objectives of segmentation analysis are:

• To reduce risk in deciding where, when, how, and to whom a product, service, or brand will be marketed
• To increase marketing efficiency by directing effort specifically toward the designated segment in a manner consistent with that segment’s characteristics.

Criteria for Segmenting

Market segmentation involves dividing a broad target market into subsets of consumers who have common needs (and/or common desires) as well as common applications for the relevant goods and services. These subsets may be divided by criteria such as age and gender, or other distinctions, such as location or income. Marketing campaigns can then be designed and implemented to target these specific customer segments. An ideal market segment meets all of the following criteria:

• It is possible to measure.
• It must be large enough to earn profit.
• It must be stable enough that it does not vanish after some time.It is possible to reach potential customers via the organization’s promotion and distribution channel.
• It is internally homogeneous (potential customers in the same segment prefer the same product qualities).
• It is externally heterogeneous, that is, potential customers from different segments have different quality preferences.
• It responds consistently to a given market stimulus.
• It can be reached by market intervention in a cost-effective manner.
• It is useful in deciding on the marketing mix.

Segmentation strategies

There are two major segmentation strategies followed by marketing organizations: a concentration strategy and a multisegment strategy. An organization that adopts a concentration strategy chooses to focus its marketing efforts on only one market segment. Thus, only one marketing mix is developed. An organization that adopts a concentration strategy gains an advantage by being able to analyze the needs and wants of only one segment and then focusing all its efforts onthat segment. This can provide a differential advantage over other organizations that market to this segment but do not concentrate all their efforts on it. The primary disadvantage of concentration is related to the demand of the segment. As long as demand is strong, the organization’s financial position will be strong. If demand declines, the organization’s financial position will also decline.

The other segmentation strategy is a multisegment strategy. When an organization adopts this strategy, it focuses its marketing efforts on two or more distinct market segments. The organization does so by developing a distinct marketing mix for each segment. They then develop marketing programs tailored to each of thesesegments. Organizations that follow a multisegment strategy usually realize an increase in total sales as more marketing programs are focused at more customers. However, the organization will most likely experience higher costs because of the need for more than one marketing program.

4.6.5: Selecting Target Markets

Strategic targeting can optimize the return on investment by selecting the best segments in the market for return on investment.

Learning Objective

Recognize the importance of segmentation and how to translate data into smart decisions

Key Points

• Identifying optimal segments within the broader market can improve the efficiency of both paid and organic marketing initiatives.
• Selecting the right segments relies heavily on good data. The first step is collecting as much information as possible on the industry, competition, key metrics, and consumers.
• Once the data is collected, organizations must strategically query the data to identify correlations that are statistically significant. In the era of big data, this is more important (and more complex) than ever.
• Once the optimal segments are identified, the organization can match their available resources with the opportunities in the market itself.

Key Term

segmentation

The act of dividing a larger population or market into smaller groups.

Why Pursue Target Markets

The purpose of identifying various market segments within the broader market is to refine the targeting of paid and organic advertising. Simply put, it’s best to narrow down an organization’s targeting to the individuals most likely to be interested in the product or service. These groups of interested consumers within the broader market is usually referred to as a target market, and should be a much more strategic place to invest capital in terms of marketing distribution.

Target Market

A target market is part of a served available market. Both of these markets are part of the total available market.

This chart visualizes the concept of a target market within the context of a broader market.

How To Select Targeted Groups

Organizing Data

To start, the organization should collect as much data as possible on the industry, competition, consumer behavior, and expected growth trajectories. Once enough data is collected, it’s useful to frame the targeting strategy by querying the data using the right questions. Some things to consider include:

• How big is each segment?
• What are the demographic, psychographic, behavioral, and geographic characteristics of each segment?
• Which segments have the competition and/or our organization already captured?
• Where is the highest growth potential?
• Which market is most closely aligned with the organization’s brand and/or operating philosophy?
• Is is practically feasible to enter where the ideal segment is (i.e. geographically)?

While there are countless other questions to ask, which will vary by industry and situation, understanding these basic concepts can quickly simplify the segmentation decision.

Visualizing Segments

Visualizing data queries to understand how consumer groups look relative to various metrics is a useful technique in building clusters and segments.

Visualizing data queries to understand how consumer groups look relative to various metrics is a useful technique in building clusters and segments.

Selecting A Segment

At this point, with the available market data at hand, it’s fairly simple to assess internal resources and external opportunities to optimize the marketing plan. The key here is to get the greatest return on marketing spend by strategically selecting the appropriate channels and using the ideal messaging to reach the selected segment.

4.7: Competitive Perceptual Positioning

4.7.1: Perceptual Mapping

Perceptual mapping is a graphic display explaining the perceptions of customers with relation to product characteristics.

Learning Objective

Evaluate the concept of perceptual mapping as part of competitive perceptual positioning

Key Points

• Perceptual maps help marketers understand where the consumer ranks their company in terms of characteristics and in comparison to competing companies.
• Perceptual maps can display consumers’ ideal points that reflect their ideal combinations of product characteristics.
• When creating a new product, a company should look for a space that is currently unoccupied by competitors and that has a high concentration of consumer desire (ideal points).
• A perceptual map is usually based more on a marketer’s knowledge of an industry than market research.

Key Terms

price elasticity

The measurement of how changing one economic variable affects others. For example:”If I lower the price of my product, how much more will I sell? “”If I raise the price, how much less will I sell? “”If we learn that a resource is becoming scarce, will people scramble to acquire it? “

demand void

Areas without any significant consumer desires; typically found in ideal point maps of perceptual mapping.

Perceptual Mapping

Perceptual mapping is a diagrammatic technique used by marketers in an attempt to visually display the perceptions of customers or potential customers. Typically the position of a product, product line, brand, or company is displayed relative to their competition. Some perceptual maps use different size circles to indicate the sales volume or market share of the various competing products.

Perceptual Map Of Competing Products

Perceptual maps commonly have two dimensions even though they are capable of having several. For example, in this perceptual map you can see consumer perceptions of various automobiles on the two dimensions of sportiness/conservative and classy/affordable. This sample of consumers felt that Porsche cars were the sportiest and classiest of the ones in the study. They felt that Plymouth cars were the most practical and conservative. Cars that are positioned close to each other were seen as similar on the relevant dimensions by the consumer. For example, consumers saw Buick, Chrysler, and Oldsmobile as similar. They are close competitors and form a competitive grouping. A company considering the introduction of a new model will look for an area on the map free from competitors.

Perceptual Mapping

Perceptual mapping ranks companies based on customers’ perceptions of certain characteristics. 

A perceptual map that shows car manufacturers based on conservative, classy distinctive, sporty, and practical affordable.

Perceptual Map Of a Consumer’s Ideal

Many perceptual maps also display consumers’ ideal points. These points reflect ideal combinations of the two product characteristics as seen by a consumer. This diagram shows a study of consumers’ ideal points in the alcohol product space. Each dot represents one respondent’s ideal combination of the two dimensions. Areas where there is a cluster of ideal points (such as A) indicates a market segment. Areas without ideal points are sometimes referred to as demand voids.

Ideal Points Maps

Ideal points maps reflect ideal combinations of two product characteristics as seen by a consumer. Marketers are able to accurately target their message to consumers based on consumer desires.

An ideal points map for the alcoholic beverage industry based on quaintness, social appeal, status, and individuality.

Combining the Competing Products and Ideal Points Maps

A company considering introducing a new product will look for areas with a high density of ideal points. They will also look for areas without competitive rivals. This is best done by placing both the ideal points and the competing products on the same map. This map displays various aspirin products as seen on the dimensions of effectiveness and gentleness. It also shows two ideal vectors. This study indicates that there is one segment that is more concerned with effectiveness than harshness, and another segment that is more interested in gentleness than strength.

Combination Map

A combination map allows companies to find a space that has unmet consumer desires.

A combination map of competing products and ideal points. It compares pain medications based on whether they are more or less effective and more or less gentle.

Intuitive Maps

Perceptual maps need not come from a detailed study. There are also intuitive maps (also called judgmental maps or consensus maps) that are created by marketers based on their understanding of their industry. The value of this type of map is questionable, as they often just give the appearance of credibility to management’s preconceptions. When detailed marketing research studies are done, methodological problems can arise, but at least the information is coming directly from the consumer. There is an assortment of statistical procedures (preference regression, multi-dimensional scaling) that can be used to convert the raw data collected in a survey into a perceptual map.

Some techniques are constructed from perceived differences between products, others are constructed from perceived similarities. Still others are constructed from cross price elasticity of demand data from electronic scanners.

4.7.2: Positioning Bases

By using customer research and perceptual mapping, a marketer can create a positioning statement using one of the three main bases.

Learning Objective

Examine positioning and the strategy behind it relative to competitive perceptual positioning

Key Points

• Functional Positions deal with solving a problem, providing benefits and getting a favorable perception from investors, stockholders and consumers.
• Symbolic Positions deal with self-image enhancement, ego identification, belongingness, social meaningfulness and affective fulfillment.
• Experiential Positions deal with providing sensory or cognitive stimulation.
• By using customer research and perceptual mapping, a marketer can create a positioning statement using one of the three main bases.

Key Terms

perceptual mapping

Perceptual mapping is a diagrammatic technique used by asset marketers that attempts to visually display the perceptions of customers or potential customers.

Experiential

Of, related to, encountered in, or derived from experience

positioning

The act of positioning; placement.

Example

• The position statement of SouthWest Airlines is, “The short-haul, no frills and low-priced airline. “

Introduction

When a company presents a product or service in a way that is differentiating from the competition, they are said to be “positioning” it. Positioning relates to a process used by marketers to create an image in the minds of a target market. While positioning used to focus on consumer positioning, it now focuses more on competitive positioning.

The Positioning Concepts

There are three basic concepts for positioning:

1. Functional Positions deal with solving a problem, providing benefits and getting a favorable perception from investors, stockholders and consumers.
2. Symbolic Positions deal with self-image enhancement, ego identification, belongingness, social meaningfulness and affective fulfillment.
3. Experiential Positions deal with providing sensory or cognitive stimulation.

Positioning is facilitated by perceptual mapping to determine the ideal points of consumers.This helps to determine if positioning should be functional, symbolic, or experiential. Strong positioning will enable a single product to appeal to different customers for different reasons. For example, two people are interested in buying a new car; one wants a car that is powerful and stylish while the other buyer is looking for a car that is reliable and safe and yet they buy the same exact car. One purchase solved a problem and exemplifies functional positioning while the other purchase is an example of symbolic and/or experiential positioning.

The Positioning Statement and Strategy

By using customer research and perceptual mapping, a marketer can create a positioning statement using one of the three main bases.

A positioning statement explains the target market for the product, the benefit of the product, and how the product is different than the competitors.

When creating a positioning statement, it is important to determine a pain point of the customer. Customers often buy on a want, rather than a need, impulse. By talking to a customer’s pain point, it is often possible to address the need impulse and the want impulse at the same time. If both of these issues can be addressed then it is easier to overcome objections regarding a product.

Wants versus Needs

What consumers want may not be what they need, but it is important to understand both.

A woman stands on a stage and discusses a PowerPoint slide that breaks down customers wants and needs.

A company can create brand positioning strategies or product positioning strategies. It is important to understand the strengths and weaknesses of both the organization and the competition when creating a positioning strategy.

4.7.3: Repositioning

Repositioning involves changing the identity of a product relative to competing products.

Learning Objective

Indicate the characteristics and application of a re-positioning as it applies to competitive perceptual positioning

Key Points

• When a company initiates a re-positioning strategy, it needs to change the expectations of stakeholders, including employees, stockholders, and financial backers.
• A company may need to consider a re-positioning strategy if they have a weak brand, if they have not remained competitive in the market, or if there is a change in the economy.
• A company may re-position a specific product line, a brand, or the entire organization.

Key Term

repositioning

Changing the identity of a product or a company in the minds of stakeholders and competitors.

Repositioning involves changing the identity of a product relative to competing products. Many famous companies have saved failing products by repositioning them in the market. When a company initiates a repositioning strategy, it needs to change the expectations of stakeholders, including employees, stockholders, and financial backers.

Apple Inc.

Apple Inc. is an example of a company that achieved re-positioning

Brand Identity

Brand identity is often involved with the success or failure of a product. A company that has achieved brand recognition can often survive the challenge of new entrants in a market. The problem with being at the top of the market, however, is that someone is always trying to knock you off. Companies that have become complacent with brand strategies sometimes find themselves knocked off their pedestal by a competitor.

Lack of a Strong Brand

Some companies lack a strong product or brand. They perform well in the market, but not exceptionally. Any changes in the market can force these companies from maintaining business to failing.

Economic Volatility

A severe change in the economy can affect a company or a brand. The hospitality industry saw this when the United States went through a recent financial crisis. Many upscale hotels and restaurants suffered because people couldn’t afford the prices.

There are Different Levels of Repositioning

An organization can reposition a product line, a brand, or an entire company. Determining which type of repositioning is needed isn’t always easy; it is important to understand the changes in the current market and how competitors will react to the change. If a change is volatile and is unprecedented, there may not be enough information available to use to make a decision. Understanding the strengths and weaknesses of a company can help determine when repositioning may be necessary and how the change should occur. When Apple switched their focus to iPod and its successors, for example, the company was able to change its financial situation and achieve success. The complete dedication of stakeholders and the creation of a product that is in demand can help companies survive a repositioning strategy.

4.8: The Consumer Decision Process

4.8.1: Need Recognition

Need recognition occurs when a consumer identifies a need and thinks of a product that might meet this need.

Learning Objective

Identify need recognition as part of the consumer decision making process

Key Points

• The 5 stages which a consumer often goes through when they are considering a purchase: problem or need recognition, information search, evaluation of alternatives, purchase, and post-purchase behavior.
• Need or problem recognition is oftentimes recognized as the first and most crucial step in the process because if a consumer does not perceive a problem or need, he generally will not move forward with considering a product purchase.
• A need can be triggered by internal or external stimuli.
• Internal stimuli refers to a personal perception experienced by the consumer, such as hunger or thirst.

Key Terms

John Dewey

He was an American philosopher, psychologist, and educational reformer whose ideas have been influential in education and social reform. Dewey was an important early developer of the philosophy of pragmatism and one of the founders of functional psychology.

Abraham Harold Maslow

He was an American psychologist who was best known for creating Maslow’s hierarchy of needs, a theory of self-actualization.

need recognition

the first step in the buying decision process, where the problem or need is understood

Buyer Decision Processes

The Buyer Decision Processes are the decision-making processes undertaken by consumers in regard to a potential market transaction before, during, and after the purchase of a product or service.

Example

• For example, a consumer who just moved to Minnesota may not realize he needs a heavy winter coat until he sees a store advertising for it, which triggers the need in his mind.

Need Recognition

The Consumer Decision Processes (also known as Buyer Decision Processes) refer to the decision-making stages that a consumer undergoes before, during, and after they purchase a product or service.

John Dewey introduced 5 stages which consumers go through when they are considering a purchase:

• Problem or need recognition
• Information search
• Evaluation of alternatives
• Purchase
• Post-purchase behavior

Problem or Need Recognition

This is the first stage of the Consumer Decision Process in which the consumer is able to recognize what the problem or need is and subsequently, what product or kind of product would be able to meet this need. It is oftentimes recognized as the first and most crucial step in the process because if consumers do not perceive a problem or need, they generally will not move forward with considering a product purchase.

Making a Decision

When making a decision, a person first needs to identify and define the problem or need recognition.

Customers look at various pieces of jewelry.

A need can be triggered by internal or external stimuli. Internal stimuli refers to a personal perception experienced by the consumer, such as hunger, thirst, and so on. For example, an elderly, single woman may feel lonely so she decides that she wants to purchase a cat. External stimuli include outside influences such as advertising or word-of-mouth. For example, a consumer who just moved to Minnesota may not realize he needs a heavy winter coat until he sees a store advertising for it, which triggers the need in his mind.

Maslow’s Hierarchy of Needs

American Psychologist Abraham Harold Maslow believes that needs are arranged in a hierarchy. Only after a human has achieved the needs of a certain stage, does he move to the next one. None of his published works included a visual representation of the hierarchy. The pyramidal diagram illustrating the Maslow needs hierarchy may have been created by a psychology textbook publisher as an illustrative device.

Abraham Maslow

Abraham Harold Maslow was an American Psychology professor who created Maslow’s Hierarchy of Needs.

This now iconic pyramid frequently depicts the spectrum of human needs, both physical and psychological, as accompaniment to articles describing Maslow’s needs theory and may give the impression that the Hierarchy of Needs is a fixed and rigid sequence of progression. Yet, starting with the first publication of his theory in 1943, Maslow described human needs as being relatively fluid—with many needs being present in a person simultaneously.

According to Maslow’s theory, when a human being ascends the levels of the hierarchy having fulfilled the needs in the hierarchy, one may eventually achieve self-actualization. Maslow eventually concluded that self-actualization was not an automatic outcome of satisfying the other human needs. Human needs as identified by Maslow:

• At the bottom of the hierarchy are the “Basic needs or Physiological needs” of a human being: food, water, sleep and sex.
• The next level is “Safety Needs: Security, Order, and Stability”. These two steps are important to the physical survival of the person.
• Once individuals have basic nutrition, shelter and safety, they attempt to accomplish more. The third level of need is “Love and Belonging”, which are psychological needs; when individuals have taken care of themselves physically, they are ready to share themselves with others, such as with family and friends.
• The fourth level is achieved when individuals feel comfortable with what they have accomplished. This is the “Esteem” level, the need to be competent and recognized, such as through status and level of success.
• Then fifth is the “Cognitive” level, where individuals intellectually stimulate themselves and explore.
• Finally, there is the “Aesthetic” level, which is the need for harmony, order and beauty.

At the top of the pyramid, “Need for Self-actualization” occurs when individuals reach a state of harmony and understanding because they are engaged in achieving their full potential.

4.8.2: Information Search

Information Search is a stage in the Consumer Decision Process during which a consumer searches for internal or external information.

Learning Objective

Examine the “information search” stage of the consumer decision process

Key Points

• During the information search, the options available to the consumer are identified or further clarified.
• An internal search refers to a consumer’s memory or recollection of a product, oftentimes triggered or guided by personal experience.
• An external search is conducted when a person who has no prior knowledge about a product seeks information from personal sources (e.g. word of mouth from friends/family) and/or public sources (e.g. online forums, consumer reports) or marketer dominated sources (e.g. sales persons, advertising).

Key Terms

External Research

When a person has no prior knowledge about a product, which then leads them to seek information from personal or public sources.

Information Search

The second of five stages that comprise the Consumer Decision Process. It can be categorized as internal or external research.

Consumer Decision Process

Also known as the Buying Decision Process, the process describes the fundamental stages that a customer goes through when deciding to buy a product. Many scholars have given their version of the buying decision model.

Example

• An example of a marketer dominated personal sources is in-store advice. For instance, when a salesperson at Macy’s explains the benefits of a parka that can withstand sub zero temperatures or a friend who purchased the parka relates its warmth and comfort in very cold climates.

Information search is considered the second of five stages that comprise the Consumer Decision Process. During this stage, a consumer who recognizes a specific problem or need will then likely be persuaded to search for information, whether it be internally or externally. This is also when the customer aims to seek the value in a prospective product or service. During this time, the options available to the consumer are identified or further clarified.

Information search can be categorized as internal or external research:

Internal research refers to a consumer’s memory or recollection of a product, oftentimes triggered or guided by personal experience. This is when a person tries to search their memory to see whether they recall past experiences with a product, brand, or service. If the product is considered a staple or something that is frequently purchased, internal information search may be enough to trigger a purchase.

External research is conducted when a person has no prior knowledge about a product, which then leads them to seek information from personal sources (e.g. word of mouth from friends/family ) and/or public sources (e.g. online forums, consumer reports) or marketer dominated sources (e.g. sales persons, advertising) especially when a person’s previous experience is limited or deemed inefficient.

Seeking Information

A consumer seeks information by asking an employee about a product. Asking an employee is external research.

A customer talks to an employee in the garden section at a store.

• Examples of personal sources that are marketer dominated, include sales person advice in a retail store.
• Personal sources that are not marketer dominated include advice from friends and family.
• Television advertising and company websites are examples of non-personal sources that are marketer dominated
• Online forums are non-personal sources that are non-marketer dominated.

Non-Personal Source

An example of a non-personal source is a search on the Internet. The search engine provides information about a subject.

4.8.3: Evaluating Alternatives

During the evaluation of alternatives stage, the consumer evaluates all the products available on a scale of particular attributes.

Learning Objective

Examine the “evaluation of alternatives” stage of the Consumer Decision Process

Key Points

• During this stage, consumers evaluate all of their products or brand options on a scale of attributes which have the ability to deliver the benefit that they are seeking.
• In order for a marketing organization to increase the likelihood that their brand is part of the evoked set for many consumers, they need to understand what benefits consumers are seeking and specifically, which attributes will be most influential to their decision-making process.
• It is important to note that consumers evaluate alternatives in terms of the functional and psychological benefits that they offer.
• During this stage, consumers can be significantly influenced by their attitude as well as the degree of involvement that they may have with the product, brand, or overall category.
• Ultimately, consumers must be able to effectively assess the value of all the products or brands in their evoked set before they can move on to the next step of the decision process.

Key Terms

Evaluation of Alternatives

This is the third stage in the Consumer Decision Process. During this stage, consumers compare the brands and products that are in their evoked set.

Evoked Set

The number of alternatives that are considered by consumers during the problem-solving process.

Example

• For example, if the customer involvement is high, then he or she will evaluate several brands, whereas if it’s low, he or she may look at only one brand.

Evaluation of alternatives is the third stage in the Consumer Buying Decision process. During this stage, consumers evaluate all of their product and brand options on a scale of attributes which have the ability to deliver the benefit that the customer is seeking . The brands and products that consumers compare – their evoked set – represent the alternatives being considered by consumers during the problem-solving process.

Exhibition Hall

In an exhibition hall, customers have a range of options to explore and evaluate.

Sometimes known as a consideration set, the evoked set tends to be small relative to the total number of options available. When a consumer commits significant time to the comparative process and reviews price, warranties, terms and condition of sale and other features it is said that they are involved in extended problem solving.

Unlike routine problem solving, extended or extensive problem solving comprises external research and the evaluation of alternatives. Whereas, routine problem solving is low-involvement, inexpensive, and has limited risk if purchased, extended problem solving justifies the additional effort with a high-priced or scarce product, service, or benefit (e.g., the purchase of a car). Likewise, consumers use extensive problem solving for infrequently purchased, expensive, high-risk, or new goods or services.

In order for a marketing organization to increase the likelihood that their brand is part of the evoked set for many consumers, they need to understand what benefits consumers are seeking and specifically, which attributes will be most influential to their decision-making process. It is important to note that consumers evaluate alternatives in terms of the functional and psychological benefits that they offer. The company also needs to check other brands of the customer’s consideration set to prepare the right plan for its own brand.

During this stage, consumers can be significantly influenced by their attitude as well as the degree of involvement that they may have with the product, brand, or overall category. For example, if the customer involvement is high, then he or she will evaluate several brands, whereas if it’s low, he or she may look at only one brand. In low involvement buying, the activity is usually frequent, habitual to a certain extent and there is generally little difference between the brands. No strong attachment exists between the buyer and the brand. Promotions are simple and repetitive. Conversely, high involvement buying involves products with many differences. The behavior is more complex and the research is more detail oriented.

Ultimately, consumers must be able to effectively assess the value of all the products or brands in their evoked set before they can move on to the next step of the decision process.

4.8.4: Purchase

During the purchase decision stage, the consumer may form an intention to buy the most preferred brand or product.

Learning Objective

Examine the “purchase decision” stage of the Consumer Decision Process

Key Points

• During this time, the consumer may form an intention to buy the most preferred brand because he has evaluated all the alternatives and identified the value that it will bring him.
• The final purchase decision, can be disrupted by two factors: 1. Negative feedback of others and our level of motivation to comply or accept the feedback. 2. The decision may be disrupted due to a situation that one did not anticipate, such as losing a job or a retail store closing down.
• During this stage, the consumer must decide the following: 1. from whom he should buy, 2. when to buy, and 3. whether to buy.

Key Term

Purchase Decision

The fourth stage in the consumer decision process and when the purchase actually takes place.

Example

• Alternatively, they may also decide that they want to make the purchase at some point in the near or far future perhaps because the price point is above their means or simply because they might feel more comfortable waiting.

The purchase decision is the fourth stage in the consumer decision process and when the purchase actually takes place. During this time, the consumer may form an intention to buy the most preferred brand because he has evaluated all the alternatives and identified the value that it will bring him.

Making a Purchase

Making a purchase decision is the final stage in the decision process.

A man buys a watermelon at a fruit stand in Lebanon.

According to Philip Kotler, Keller, Koshy and Jha (2009), the final purchase decision, can be disrupted by two factors:

1. Negative feedback of others and our level of motivation to comply or accept the feedback. For example, after going through the need recognition, information search, and alternative evaluation stages, one might choose to buy a Nikon D80 DSLR camera, but a close photographer friend might share negative feedback, which could drastically influence personal preference.
2. The decision may be disrupted due to a situation that one did not anticipate, such as losing a job or a retail store closing down.

During this stage, the consumer must decide the following:

• From whom they should buy, which is influenced by price point, terms of sale, and previous experience with or awareness of the seller and the return policy.
• When to buy, which can be influenced by the store atmosphere or environment, time pressures and constraints, the presence of a sale, and the shopping experience.
• This is also a time during the which the consumer might decide against making the purchase decision. Alternatively, they may also decide that they want to make the purchase at some point in the near or far future perhaps because the price point is above their means or simply because they might feel more comfortable waiting.

4.8.5: Post-Purchase Behavior

Post-purchase behavior is when the customer assesses whether he is satisfied or dissatisfied with a purchase.

Learning Objective

Examine the “post-purchase behavior” stage of the Consumer Decision Process

Key Points

• How the customer feels about a purchase will significantly influence whether he will purchase the product again or consider other products within the brand repertoire.
• Cognitive dissonance is when the customer experiences feelings of post-purchase psychological tension or anxiety.
• Some companies like to engage their consumers with post-purchase communications in an effort to influence their feelings about their purchase and future purchases.

Key Term

cognitive dissonance

This term is used in modern psychology to describe the state of simultaneously holding two or more conflicting ideas, beliefs, values, or emotional reactions.

Example

• An example of cognitive dissonance is when a customer might feel compelled to question whether he has made the right purchase decision.

Post-purchase behavior is the final stage in the consumer decision process when the customer assesses whether he is satisfied or dissatisfied with a purchase. How the customer feels about a purchase will significantly influence whether he will purchase the product again or consider other products within the brand repertoire. A customer will also be able to influence the purchase decision of others because he will likely feel compelled to share his feelings about the purchase.

Cognitive dissonance, another form of buyer’s remorse, is common at this stage. This is when the customer may experience feelings of post-purchase psychological tension or anxiety. For example, the customer might feel compelled to question whether he has made the right decision. They may also be exposed to advertising for a competitive product or brand which could put into question the product that they have chosen. A customer may also have a change of heart and decide that he no longer has a need for this particular product.

Cognitive Dissonance

The anterior cingulate cortex is responsible for cognitive dissonance or “buyer’s remorse.”

An MRI that shows the anterior cingulate cortex.

Some companies now opt to engage their consumers with post-purchase communications in an effort to influence their feelings about their purchase and future purchases. Offering money back guarantees also serve to extend and enrich post-purchase communications between the company and its consumers. Other examples include VIP invitations to become part of a club or special and select group of consumers who buy a particular product. Another example is when customers are asked for their contact information at the point of purchase so they can be targeted later with a follow-up call that surveys the product’s performance and consumer satisfaction. This approach could help influence or alleviate feelings of cognitive dissonance or “buyer’s remorse” following a product purchase.

4.9: Influences of Personality on the Consumer Decision Process

4.9.1: Perception

Perception in marketing is described as a process by which a consumer identifies, organizes, and interprets information to create meaning.

Learning Objective

Describe the characteristics of perception as a part of the consumer buying decision process

Key Points

• Perception is a psychological variable involved in the Purchase Decision Process that is known to influence Consumer Behavior.
• elective Perception is the process by which individuals perceive what they want to in media messages and disregard the rest.
• Seymor Smith, a prominent advertising researcher, found evidence for selective perception in advertising research in the early 1960s, and he defined it to be “a procedure by which people let in, or screen out, advertising material they have an opportunity to see or hear.
• Selective perceptions is categorized under two types: Low level – Perceptual vigilance and High level – Perceptual defense.
• Perception can be shaped by learning, memory and expectations.

Key Terms

Perception

The organization, identification and interpretation of sensory information in order to represent and understand the environment.

Purchase Decision Process

The decision-making processes undertaken by consumers in regard to a potential market transaction before, during, and after the purchase of a product or service.

Consumer Behavior

The study of individuals, groups, or organizations and the processes they use to select, secure, and dispose of products, services, experiences, or ideas to satisfy needs; and the impacts that these processes have on the consumer and society.

Perception

Perception can have various meanings but in marketing, it is often described as a process by which a consumer identifies, organizes, and interprets information to create meaning . A consumer will selectively perceive what they will ultimately classify as their needs and wants.

Necker Cube and Rubin Vase

These are two optical illusions that illustrate how perception may differ from reality. On the left, we see a cube when in fact it is a flat image on our screen. On the right, the vase actually resembles two faces looking at each other.

Perception is a psychological variable involved in the purchase decision process that is known to influence consumer behavior. Other variables included in this consumer process include: motivation, learning, attitude, personality, and lifestyle. All of these concepts are crucial in interpreting the consumer buying process and can also help guide marketing efforts.

Selective Perception is the process by which individuals perceive what they want to in media messages and disregard the rest.

Seymor Smith, a prominent advertising researcher, found evidence for selective perception in advertising research in the early 1960s, and he defined it to be “a procedure by which people let in, or screen out, advertising material they have an opportunity to see or hear. They do so because of their attitudes, beliefs, usage preferences and habits, conditioning, etc.” People who like, buy, or are considering buying a brand are more likely to notice advertising than are those who are neutral toward the brand. This fact has repercussions within the field of advertising research because any post-advertising analysis that examines the differences in attitudes or buying behavior among those aware versus those unaware of advertising is flawed unless pre-existing differences are controlled for.

Selective perceptions is categorized under two types: a low level of perception, known as perceptual vigilance, and a higher level of perception, known as perceptual defense.

Perception can be shaped by learning, memory and expectations.

4.9.2: Motivation

Motivation is a psychological incentive or reason for doing something.

Learning Objective

Review the methodology of motivation as it applies to the consumer buying decision process

Key Points

• Consumer behavior is strongly influenced by many internal and external factors.
• Internal conditions include demographics, psychographics, personality, motivation, knowledge, attitudes, beliefs, and feelings.
• External influences include culture, sub-culture, locality, royalty, ethnicity, family, social class, past experience reference groups, lifestyle, and market mix factors.
• An individual’s motivation, perception, attitude, and beliefs are considered psychological factors.

Key Terms

motivation

The psychological feature that arouses an organism to action toward a desired goal and elicits, controls, and sustains certain goal directed behaviors.

External, or extrinsic Motivation

The performance of an activity in order to attain an outcome, which then contradicts intrinsic motivation.

Intrinsic Motivation

The incentive to undertake an activity based on the expected enjoyment of the activity itself, rather than external benefits that might result.

Example

• Motivation can originate from oneself (intrinsic) or from other people (extrinsic). Intrinsic motivation is based on taking pleasure in an activity, while common extrinsic motivations are rewards, like money.

Consumer behavior is strongly influenced by many internal and external factors, including:

• Internal conditions: demographics, psychographics (lifestyle), personality motivation, knowledge, attitudes, beliefs, and feelings
• External influences: culture, sub-culture, locality, royalty, ethnicity, family, social class, past experience reference groups, lifestyle, and market mix factors

An individual’s motivation, perception, attitude, and beliefs are considered psychological factors. Other factors such as income level, personality, occupation, and lifestyle are categorized as personal factors. Motivation is versatile enough that it spans multiple areas, including physiological, behavioral, cognitive, and social.

Motivation may be rooted in a basic human need to minimize physical pain and maximize pleasure, and it may include specific needs such as eating and resting. However, motivation is ultimately linked to emotion.

Intrinsic and Extrinsic Motivation

Motivation can originate from oneself (intrinsic) or from other people (extrinsic).

• Internal, or intrinsic motivation ismotivation that is driven by an interest or enjoyment in the task itself, and exists within the individual rather than relying on any external pressure. Intrinsic motivation is based on taking pleasure in an activity rather than working towards an external reward. Intrinsic motivation has been studied since the early 1970s.
• External, or extrinsic motivation comes from outside of the individual. Common extrinsic motivations are rewards, like money, and the threat of punishment. Competition is extrinsic because it encourages the performer to win, not simply to enjoy the intrinsic rewards of the activity. A cheering crowd and trophies are also extrinsic incentives.

Widely Recognized Motivational Theories

• Incentive Theory: A reward, tangible or intangible, is presented after the occurrence of a behavior, with the intent of causing the behavior to occur again. Incentive theory in psychology treats motivation and behavior of the individual as though they are influenced by beliefs, such as engaging in activities that are expected to be profitable.
• Escape-seeking dichotomy model: Escapism and seeking are major factors influencing decision making. Escapism is a need to break away from a daily life routine, whereas seeking is described as the desire to learn or gain some inner benefits through travelling.

Drive-Reduction Theory

Clark Hull was the behaviorist who developed the drive-reduction theory of motivation.

• Drive-reduction theory: Individuals have certain biological drives, such as hunger. As time passes the strength of the drive increases if it is not satisfied (in this case by eating). Upon satisfying a drive, the drive’s strength is reduced.
• Cognitive dissonance theory: Cognitive dissonance occurs when an individual experiences an inconsistency between their views of the world around them and their own personal feelings and actions.

4.9.3: Learning

Learning in marketing is known as a psychological variable that can significantly affect the purchase decision process for consumers.

Learning Objective

Review the characteristics of learning as it relates to the consumer buying decision process

Key Points

• Learning is the process of acquiring new, or modifying existing, knowledge, behaviors, skills, values, or preferences. This process may involve synthesizing different types of information.
• Learning is considered to have a psychological influence on consumer behavior, along with motivation and personality, perception, values, beliefs, and attitudes and lifestyle.
• There are three main categories of learning theory: behaviorism, cognitivism, and constructivism.

Key Terms

Purchase Decision Process

The decision-making processes undertaken by consumers in regard to a potential market transaction before, during, and after the purchase of a product or service.

Learning

The process of acquiring new, or modifying existing, knowledge, behaviors, skills, values, or preferences. This process may involve synthesizing different types of information.

Example

• Learning is considered to have a psychological influence on consumer behavior, along with motivation and personality, perception, values, beliefs and attitudes and lifestyle.

Learning

In consumer marketing, learning is known as a psychological variable that can significantly affect the purchase decision process for consumers. Learning is the process of acquiring new, or modifying existing, knowledge, behaviors, skills, values, or preferences. This process may involve synthesizing different types of information. The ability to learn is possessed by humans, animals, and some machines.

Learning is considered to have a psychological influence on consumer behavior, along with motivation and personality, perception, values, beliefs, and attitudes and lifestyle.

Types of learning include:

• Simple non-associative learning (habituation and sensitization)
• Associative learning
• Imprinting
• Observational learning
• Episodic learning
• Multimedia learning
• E-learning
• Rote learning
• Informal learning
• Formal learning
• Tangential learning
• Dialogic learning

There are three main categories of learning theory: behaviorism, cognitivism, and constructivism. Behaviorism focuses only on the objectively observable aspects of learning. Cognitive theories look beyond behavior to explain brain-based learning. Constructivism views learning as a process in which the learner actively constructs or builds new ideas or concepts.

Merriam and Caffarella (1991) highlight four approaches or orientations to learning: behaviorist, cognitivist, humanist, and social or situational. These approaches involve contrasting ideas as to the purpose and process of learning and education, in addition to the role that educators should take.

David Kolb’s model

David Kolb’s model

The David A. Kolb styles model is based on the experiential learning theory.

The David A. Kolb styles model is based on the experiential learning theory, which was explained in his book Experiential Learning: Experience as the Source of Learning and Development (1984). The ELT model outlines two related approaches toward grasping experience: concrete experience and abstract conceptualization, as well as two related approaches toward transforming experience: reflective observation and active experimentation.

According to Kolb’s model, the ideal learning process engages all four of these modes in response to situational demands. As individuals attempt to use all four approaches, however, they tend to develop strengths in one experience-grasping approach and one experience-transforming approach. The resulting learning styles are combinations of the individual’s preferred approaches. These learning styles include:

1. Converger;
2. Diverger;
3. Assimilator;
4. Accommodator.

Convergers are characterized by abstract conceptualization and active experimentation. They are good at making practical applications of ideas and using deductive reasoning to solve problems.

Divergers tend toward concrete experience and reflective observation. They are imaginative and are good at coming up with ideas and seeing things from different perspectives.

Assimilators are characterized by abstract conceptualization and reflective observation. They are capable of creating theoretical models by means of inductive reasoning.

Accommodators use concrete experience and active experimentation. They are good at actively engaging with the world and actually doing things instead of merely reading about and studying them.

Kolb’s model gave rise to the Learning Style Inventory, an assessment method used to determine an individual’s learning style. An individual may exhibit a preference for one of the four styles—accommodating, converging, diverging, and assimilating—depending on his or her approach to learning via the experiential learning theory model.

4.9.4: Attitude

Attitude is a psychological variable that is known to affect the purchase decision process of consumers.

Learning Objective

Illustrate how attitude impacts the consume buying decision

Key Points

• An attitude can generally contain a positive or negative evaluation of people, objects, event, activities, ideas, or anything in the environment.
• Carl Jung’s definition of attitude is a “readiness of the psyche to act or react in a certain way”.
• Attitudes can be difficult to measure because attitudes are ultimately a hypothetical construct that cannot be observed directly.
• Attitudes can be measured by the use of physiological cues like facial expressions, vocal changes, and other body rate measures.

Key Terms

Carl Jung

(26 July 1875 – 6 June 1961) was a Swiss psychologist and psychiatrist who founded analytical psychology. Jung proposed and developed the concepts of the extraverted and the introverted personality, archetypes, and the collective unconscious. His work has been influential in psychiatry and in the study of religion, literature, and related fields.

attitude

an expression of favor or disfavor toward a person, place, thing, or event (the attitude object). Prominent psychologist Gordon Allport once described attitudes “the most distinctive and indispensable concept in contemporary social psychology. “

Example

• Attitudes can be measured by the use of physiological cues like facial expressions, vocal changes, and other body rate measures. For instance, fear is associated with raised eyebrows, increased heart rate and increase body tension.

Attitude is a psychological variable that is known to affect the purchase decision process of consumers. Other variables are perception, learning, personality, and lifestyle.

An attitude generally contains a positive or negative evaluation of people, objects, event, activities, ideas, or anything else in the environment. However, people can also be conflicted or ambivalent toward an object, meaning that they might at different times express both positive and negative attitudes toward the same object.

Attitude is one of Carl Jung’s 57 definitions in Chapter XI of Psychological Types. Jung’s definition of attitude is a “readiness of the psyche to act or react in a certain way.”

Carl Jung

Carl Jung developed a definition of attitude as it relates to the field of Psychology.

Attitudes can be difficult to measure because attitudes are a hypothetical construct that cannot be observed directly. Attempted measures may include the use of physiological cues like facial expressions, vocal changes, and other body rate measures. For instance, fear is associated with raised eyebrows, increased heart rate and increase body tension.

Attitudes can be changed through persuasion in response to communication. Experimental research into the factors that can affect the persuasiveness of a message include:

1. Target Characteristics: These are characteristics that refer to the person who receives and processes a message. One such trait is intelligence – more intelligent people seem to be less easily persuaded by one-sided messages. Another variable that has been studied in this category is self-esteem.
2. Source Characteristics: The major source characteristics are expertise, trustworthiness, and interpersonal attraction or attractiveness. The credibility of a perceived message has been found to be a key variable here; if one reads a report about health and believes it came from a professional medical journal, one may be more easily persuaded than if one believes it is from a popular newspaper.
3. Message Characteristics: The nature of the message plays a role in persuasion. Sometimes presenting both sides of a story is useful to help change attitudes. When people are not motivated to process the message, simply the number of arguments presented in a persuasive message will influence attitude change, such that a greater number of arguments will produce greater attitude change.
4. Cognitive Routes: A message can appeal to an individual’s cognitive evaluation to help change an attitude. In the central route to persuasion, the individual is presented with the data and motivated to evaluate the data and arrive at an attitude-changing conclusion. In the peripheral route to attitude change, the individual is encouraged to look not at the content but at the source. This is commonly seen in modern advertisements that feature celebrities.

4.9.5: Lifestyle

In consumer marketing, lifestyle is considered a psychological variable known to influence the buyer decision process for consumers.

Learning Objective

Indicate how lifestyle or personality influences buying decisions

Key Points

• Lifestyle is also referred to as a buyer characteristic in the Black Box Model, which shows the interaction of stimuli, consumer characteristics, decision process, and consumer responses.
• The Black Box Model considers the buyer’s response as a result of a conscious, rational decision process, in which it is assumed that the buyer has recognized the problem.
• The Black Box Model is related to the Black Box Theory of Behaviorism, where the focus is not set on the processes inside a consumer, but the relation between the stimuli and the response of the consumer.

Key Terms

Black Box Model

shows the interaction of stimuli, consumer characteristics, decision process and consumer responses.

Buyer Decision Process

the decision making processes undertaken by consumers in regard to a potential market transaction before, during, and after the purchase of a product or service.

Lifestyle can be broadly defined as the way a person lives. In sociology, a lifestyle typically reflects an individual’s attitudes, values, or world view. A lifestyle is a means of forging a sense of self and to create cultural symbols that resonate with personal identity.

Television and Obesity

Lifestyle choices, like increasing sedentary behaviors, can lead to obesity.

A family sits in the living room and watches television.

Not all aspects of a lifestyle are voluntary. However, in consumer marketing, lifestyle is considered a psychological variable known to influence the buyer decision process of consumers.

Lifestyle is also referred to as a buyer characteristic in the Black Box Model, which shows the interaction of stimuli, consumer characteristics, decision process, and consumer responses. The Black Box Model is related to the Black Box Theory of Behaviorism, where the focus is set not on the processes inside a consumer, but the relation between the stimuli and the response of the consumer.

In this theory, the marketing stimuli (product, price, place and promotion) are planned and processed by companies, whereas the environmental stimuli are based on the economical, political, and cultural circumstances of a society. The buyer’s “black box” contains the buyer characteristics (e.g., attitudes, motivation, perception, lifestyle, personality, and knowledge) and the decision process (e.g., problem recognition, information research, alternative evaluation, purchase decision, and post-purchase behavior) which determine the buyer’s response (e.g., product choice, brand choice, dealer choice, purchase timing, and purchase amount).

The Black Box Model considers the buyer’s response as a result of a conscious, rational decision process, in which it is assumed that the buyer has recognized the problem. However, in reality, many decisions are not made in awareness of a determined problem by the consumer.

4.9.6: Shaping Public Policy and Educating Consumers

Companies can use marketing to educate consumers on a particular issue in an effort to help shape public policy.

Learning Objective

Discuss the elements of public policy and the education of customers

Key Points

• The study of consumer behavior can be applied to improving marketing strategies, shaping public policies, influencing society, and improving consumer knowledge.
• Public policy, as government action, is generally known as the principled guide to action taken by the administrative or executive branches of the state with regard to a class of issues in a manner consistent with law and institutional customs.
• Shaping public policy is a complex and multifaceted process that involves the interplay of numerous individuals and interest groups competing and collaborating to influence policymakers to act in a particular way.
• Social marketing applies a “customer oriented” approach and uses the concepts and tools used by commercial marketers in pursuit of social goals like anti-smoking campaigns or fund raising for NGOs.
• Health promotion is broadly defined as the process of enabling people to increase control over and improve their health. It occurs through developing healthy public policy that addresses the prerequisites of health such as income, housing, food security, employment, and quality working conditions.

Key Terms

Social Marketing

the systematic application of marketing, along with other concepts and techniques, to achieve specific behavioral goals for a social good.

public policy

the set of policies (laws, plans, actions, behaviors) of a government; plans and methods of action that govern that society; a system of laws, courses of action, and priorities directing a government action.

Example

• For example, social marketers, dealing with goals such as reducing cigarette smoking or encouraging condom use, have more difficult goals. They must make potentially difficult and long-term behavioral change in target populations by educating them.

The study of consumer behavior can be applied to improving marketing strategies, shaping public policies, influencing society, and improving consumer knowledge.

Public policy, as government action, is generally known as the principled guide to action taken by the administrative or executive branches of the state with regard to a class of issues in a manner consistent with law and institutional customs. In the United States, this concept refers not only to the result of policies, but more broadly to the decision making and analysis of governmental decisions. Public policy is commonly embodied in constitutions, legislative acts, and judicial decisions.

Shaping public policy is a complex and multifaceted process that involves the interplay of numerous individuals and interest groups competing and collaborating to influence policymakers to act in a particular way. These individuals and groups use a variety of tactics and tools to advance their aims, including advocating their positions publicly, attempting to educate supporters, opponents and consumers, and mobilizing allies on a particular issue.

Social marketing can help persuade and educate consumers on societal issues with the ultimate goal of helping to shape public policy. For example, social marketers, dealing with goals such as reducing cigarette smoking or encouraging condom use, have more difficult goals. They must make potentially difficult and long-term behavioral change in target populations by educating them. Social marketing applies a “customer oriented” approach and uses the concepts and tools used by commercial marketers in pursuit of social goals like anti-smoking campaigns or fundraising for NGOs.

Anti-Smoking Campaign 

The purpose of an anti-smoking campaign is to educate consumers about health risks associated with smoking.

An anti-smoking message painted on a pedestrian crossing in the Orchard Road area in Singapore.

Health promotion is broadly defined as the process of enabling people to increase control over and improve their health. It occurs through developing healthy public policy that addresses the prerequisites of health such as income, housing, food security, employment, and quality working conditions. There is a tendency among public health officials and governments—and this is especially the case in liberal nations such as Canada and the USA—to reduce health promotion to health education and social marketing focused on changing behavioral risk factors.

4.10: Social Influences on the Consumer Decision Process

4.10.1: Roles

Consumers have different roles in purchasing products and services, and these roles can influence their buying behavior.

Learning Objective

Describe the different types of consumer roles

Key Points

• Influencers are people who have a relatively large audience in which to tout their beliefs. In the consumer world, influencers can impact the success or failure of a product by using it or shunning it.
• A prosumer is usually a serious hobbyist, with similar interests and skills of professionals. The prosumer generally uses professional (or nearly professional) equipment and has a relatively high disposable income.
• Marketers often create a “persona” for their products and services in order to represent the different user types in a target market.

Key Terms

influencer

A person who or a thing which influences.

prosumer

A serious, enthusiastic consumer: not professional (earning money), but of similar interest and skills to a (generally lower level) professional, or aspiring to such. The target market of prosumer equipment.

persona

A social role.

The Influence of Roles on Consumer Purchasing

Consumers have different roles in purchasing products and services. Here, a role is defined as the expected behavior of an individual in a society. These roles can be as part of the consumer’s family, employment, or social status, among other things. For example, the role of father can be different than the role of mother in purchasing consumer goods. Although there are many different roles that can influence how a consumer behaves, three in particular are presented here: influencers, prosumers, and personas.

Influencers

Influencers are people who have a relatively large audience in which to tout their beliefs. In the consumer world, influencers can impact the success or failure of a product by using it or shunning it. A marketer often targets influencers rather than the entire target market, because these influencers can alter the behavior of other people. Influencers can be influential buyers, retailers, or people, such as journalists or industry professionals (among others). Influencers are sometimes ranked according to six criteria: market reach (how many people the influencer will connect with), independence (no vested interest in product), frequency of impact, expertise, persuasiveness, and thoroughness (the extent to which influence is exerted across the decision lifecycle).

J.J. Abrams, “Apple Fanatic”

TV series creator J.J. Abrams can influence other people to buy certain products by saying how much he likes the product.

Prosumers

In its most common usage, a prosumer is usually a serious hobbyist, with similar interests and skills of professionals. For example, the availability and relatively low cost of photography equipment have given rise to many people who are serious about photography but are not usually paid for their work. This is an important role for marketers to consider, as the prosumer generally uses professional (or nearly professional) equipment and has relatively high disposable income. Other examples of prosumers are found in home improvement and cooking segments.

Personas

A persona is a social role. Marketers often create a “persona” for their products and services in order to represent the different user types in a target market. A marketer may decide his product is best suited for a specific demographic and will define that demographic as clearly as possible. For example, “soccer mom” might be the target market for minivans. A persona may be created to capture the “soccer mom,” perhaps by giving her a name or other defining characteristics. A persona simply helps a marketer get a clearer picture of who will be buying his product.

4.10.2: Family

Families have a tremendous influence on consumer purchasing.

Learning Objective

Describe how family dynamics and the family life cycle can influence purchasing decisions

Key Points

• One way to understand the consumer behavior of a family is to identify the decision maker for a purchase.
• Families’ influence on buying habits includes how parents play a significant role and, eventually, how a spouse and children play an even more significant role.
• People go through a family life cycle composed of different stages of purchasing patterns.

Key Term

life cycle

The useful life of a product or system; the developmental history of an individual or group in society.

Many factors influence purchasing. A consumer’s family is one of the most significant factors because a family helps shape an individual’s attitudes and behaviors. One way to understand the family’s impact on consumer behavior is to identify the decision maker for a purchase. A decision maker for a purchase can be a husband, wife, or even a child, and sometimes decisions are made in collaboration. Often, the decision maker changes based on the type of purchase or the size of the purchase. A new refrigerator, for example, is likely to be a joint decision, while a week’s groceries might be selected by a single member of the family.

Grocery Shopping

Families are a major influence on shopping patterns and consumer habits.

A man pushing his children in a shopping cart.

Influence of Family on Consumer Behavior

Families influence purchases in many ways. At first, the influence of parents is significant because of how parents help their children to develop political and religious beliefs, lifestyle choices, and consumer preferences. Most people are who they are because of their parents. A spouse and children, however, can exert an even more significant force on a consumer’s purchases. Interaction between spouses and the number and ages of children play a particularly powerful role on buying behaviors. These family influences affect how consumers look at purchases more directly than most other social influences on consumer purchasing.

Family Life Cycle

Another aspect of understanding the impact of families on buying behavior is the family life cycle. Most, though certainly not all, individuals and families pass through an orderly sequence of life stages that can be used to understand their purchasing patterns. A typical adult starts in the bachelor stage of being young and single and then moves to being part of a married couple without children. Then the married couple transition to Full Nest stages, where the family has dependent children living at home. Once the children leave, the family enters the Empty Nest Stage, which is typically where older married couples (working or retired) no longer have dependent children living with them. Finally, the individual reaches the “solitary survivor” stage of being an older single person. Consumer behavior and purchasing is different in each of these stages. Understanding the family life cycle is beneficial for marketers because it helps in defining target customers.

4.10.3: Reference Groups

Reference groups are groups that consumers will look to for help in making purchasing decisions.

Learning Objective

Distinguish between an opinion leader and reference group

Key Points

• Reference groups are groups that consumers compare themselves to or associate with. They can heavily influence purchasing patterns.
• Friends, clubs, religious groups, and celebrities can all act as reference groups.
• If a reference group endorses a product, either through use or statements about the product, those that look to the group will often purchase that product.

Key Terms

opinion leader

The agent who is an active media user and who interprets the meaning of media messages or content for lower-end media users.

target market

A group of people whose needs and preferences match the product range of a company and to whom those products are marketed.

Reference groups are groups that consumers compare themselves to or associate with. Reference groups are similar to opinion leaders in that they can have a profound influence on consumer behavior. Reference groups are considered a social influence in consumer purchasing. They are often groups that consumers will look to to make purchasing decisions. So if a reference group endorses a product, either through use or statements about the product, those that look to the group will often purchase that product. On the other hand, if a reference group disapproves of a product, those that associate with that group will probably not purchase the product.

Types of Reference Groups

Reference groups can be either formal or informal. Schools, friends, and peers are examples of informal reference groups . Clubs, associations, and religious organizations are usually formal reference groups. Individuals can also be reference groups (usually known as opinion leaders). Additionally, celebrities can be used as a reference group. A company might use a celebrity it feels will match its target market to get that market to purchase its product. For example, a few years ago Shaquille O’Neal was used to endorse Pepsi because Pepsi felt he represented the spirit of teenagers of the time.

Friends

Friends are one of the most powerful reference groups because they influencing our consumer behavior.

Two women talking to each other.

Influence of Reference Groups

Reference groups can and do have a tremendous influence on purchasing decisions. This is evident in a number of ways, such as through roles. Everyone is expected to behave in a certain way based on the reference group we belong to. Students act like students. In keeping with this idea, people will often modify their own behavior to coincide with group norms (even those that profess non-conformity are in some ways conforming with other people who want the same thing). Reference groups communicate through opinion leaders, who influence what others do, act, and buy. In the consumer world, this means that if a reference group purchases a product, those that associate with the group likely will as well.

4.10.4: Opinion Leaders

Opinion leaders are people consumers look to for guidance in making purchase decisions, usually someone with more knowledge of the subject.

Learning Objective

Discuss the importance of opinion leaders in marketing and how they can influence the success of a product or service

Key Points

• Consumers seek out help in making consumer purchases. One source of help is an opinion leader.
• Opinion leaders are usually seen as being honest and impartial. They have the standing to be able to influence others.
• Finding opinion leaders can be vital to the success of a marketing plan, as they can then influence others to purchase the product or service.
• Celebrities are often used as opinion leaders in promoting a product.

Key Terms

reference group

A reference group refers to a group to which an individual or another group is compared.

clout

Influence or effectiveness, especially political.

Our purchase decisions are influenced by any number of people or groups. We often look to opinion leaders for help in our consumer decisions. Opinion leaders are usually people who are more knowledgeable about a certain product or service than the average consumer. As such, opinion leaders can shape how a product is viewed. Consumers are constantly seeking out the advice of knowledgeable friends or acquaintances who can provide information, give advice, or actually make the decision. For some product categories, there are professional opinion leaders who are quite easy to identify–for instance, auto mechanics , beauticians, stock brokers, and physicians. All these professionals can influence the decisions consumers make within their area of expertise. Sometimes, these opinion leaders can actually be groups, known as reference groups.

Secondary Groups

Mechanics can be considered opinion leaders in the automotive industry.

Characteristics of Opinion Leaders

Opinion leaders are generally people who have the ability to influence others. They usually have deeper expertise in a certain area, and are often looked to for help in making consumer decisions. For example, a local high school teacher may be an opinion leader for parents in selecting colleges for their children. Often, an opinion leader is among the first to use a new product or service, and can then pass on his or her opinions of the product to others. Opinion leaders are often trusted and unbiased and have the social network of friends, family, and coworkers necessary to disperse information.

Opinion Leaders in Marketing

Opinion leaders are particularly useful in marketing. If a marketer can identify key opinion leaders for a certain group, she can then direct her efforts towards attracting these individuals. In marketing, celebrities are often used as opinion leaders. Although they may not actually know more about a product or service, there is usually the perception that they do. Celebrity endorsements in marketing are a way to give clout to a product or service . Opinion leaders can have a profound influence on the success of a product, and on one’s own consumer purchases.

Dale Earnhardt, Jr.

Celebrities are opinion leaders for the products or services they promote.

4.10.5: Social Classes

Marketers should understand that a person’s social class will have a major influence on the types and quantity of consumer goods purchased.

Learning Objective

Illustrate how social class impacts consumer behavior and buying patterns

Key Points

• People are usually grouped in social classes according to income, wealth, education, or type of occupation.
• There is a major difference in the consumer behavior of different social classes. The upper class, for example, has more disposable income and can thus spend more on most products.
• Each social class has distinct characteristics and approaches to consumer purchases. A marketer should understand the dynamic of the social class he or she is targeting.

Key Terms

social class

A class of people, based on social power, wealth or another criterion.

disposable income

The amount of a person’s or group’s monetary income which is available to be saved or spent (on either essential or non-essential items), after deducting all taxes and other governmental fees.

Social Class

A major influence on one’s purchasing habits and consumer behavior is the social class in which one finds him or herself. Social class is considered an external influence on consumer behavior because it is not a function of feelings or knowledge. Social class is often hard to define; in fact, many people dispute the existence of social classes in the United States. Usually, however, people are grouped in social classes according to income, wealth, education, or type of occupation. Perhaps the simplest model to define social class is a three-tiered approach that includes the rich, the middle class, and the poor. Other models have as many as a dozen levels. People in the same social class tend to have similar attitudes, live in similar neighborhoods, dress alike, and shop at the same type of stores.

Influence on Consumer Behavior

Social class can have a profound effect on consumer spending habits. Perhaps the most obvious effect is the level of disposable income of each social class. Generally, the rich have the ability to purchase more consumer goods than those with less income, and those goods are of higher quality . There is also a distinction in the type of goods purchased. For example, the upper class tend to be the primary buyers of fine jewelry and often shop at exclusive retailers. The lower class, in contrast, are much more concerned with simply getting by; they focus more on necessities.

Upper Class 

Social class has a profound effect on the types and quantity of consumer goods purchased.

A dining room table with upper class dinnerware.

Effect on Marketing

Marketers must be very aware of the social class of their target market. If a marketer wishes to target efforts toward the upper classes, then the market offering must be designed to meet their expectations in terms of quality, service, and atmosphere. A marketer should understand the dynamic of the social class as well. For example, the upper-middle class are generally ambitious, future-oriented people who have succeeded economically and now seek to enhance their quality of life. Material goods often take on major symbolic meaning for this group. Effective marketers will understand that and be able to tailor their approach accordingly.

4.10.6: Culture

Culture can have a profound effect on consumer behavior and purchasing, and can affect how a product is marketed.

Learning Objective

Discuss the three components of a culture and how they impact consumer behavior.

Key Points

• There are three components of a culture: beliefs, values, and customs. Each plays a role in influencing consumer purchasing.
• Culture can be further divided into subcultures. One’s race, religion and class are all ways subcultures can be established.
• The marketing strategy should show the product or service as reinforcing the beliefs, values and customs of the targeted culture.

Key Term

socio-economic

Of or pertaining to a combination of social and economic factors.

Culture

Culture can have a profound effect on consumer behavior and impact how a product is marketed. In this sense, culture is defined as the distinct way peoples’ experiences, customs and beliefs define how they behave . American culture, for example, values hard work, thrift and achievement. There are generally three components of a culture: beliefs, values, and customs.

Cultural Practices

Cultural practices can have a huge impact on consumer behavior.

Cultural performers take part in a show on a large stage.

• A belief is a proposition that reflects a person’s particular knowledge and assessment of something.
• Values are general statements that guide behavior and influence beliefs. The function of a value system is to help a person choose between alternatives in everyday life.
• Customs are modes of behavior that constitute culturally approved ways of behaving in specific situations. For example, taking one’s mother out for dinner and buying her presents for Mother’s Day is an American custom.

Culture can be further divided into subcultures. One’s race, religion and class are all ways subcultures can be established. For example, a person can be a part of the larger “American” culture and still be a member of other subcultures based on his or her socio-economic background. Each of these subcultures will have specific influences on consumer behavior.

Culture as an Influence on Consumer Behavior

Culture is considered an external factor in influencing consumer behavior. Since different cultures have different values, they will have different buying habits. Marketing strategies should reflect the culture that is being targeted. The strategy should show the product or service as reinforcing the beliefs, values and customs of the targeted culture. Failing to do so can result in lost sales and opportunities.

4.10.7: Consumer Misbehavior

Consumer misbehavior refers to the common occurrence of consumers acting outside the norm.

Learning Objective

Give examples of common types of consumer misbehavior and common retailer tactics for addressing consumer misbehavior issues.

Key Points

• Consumer misbehavior is specifically related to retail and other markets, and includes things from cutting in line to fights between customers to credit card fraud.
• Common types of consumer misbehavior include shoplifting, abusive behavior, credit card fraud, and black markets.
• Since the cost of consumer misbehavior can be very high, many retailers feel it is worth fighting, and use a variety of tactics to do so.

Key Terms

Black Friday

The day following Thanksgiving Day in the United States, traditionally the beginning of the Christmas shopping season.

credit card fraud

A wide-ranging term for theft and fraud committed using a credit card or any similar payment mechanism as a fraudulent source of funds in a transaction. The purpose may be to obtain goods without paying, or to obtain unauthorized funds from an account.

Consumer Misbehavior

Consumer misbehavior refers to the common occurrence of consumers acting outside the norm. It is generally recognized that there are social behaviors that are acceptable in a given situation. Anything outside of those accepted behaviors is considered misbehavior. Consumer misbehavior is specifically related to retail and other markets, and includes things from cutting in line to fights between customers to credit card fraud. Combating consumer misbehavior is an expensive, time-consuming activity. Some economists estimate the total monetary value of consumer misbehavior to be in the hundreds of billions of dollars.

Common Types of Consumer Misbehavior

Shoplifting

Shoplifting is the theft of goods from a retail establishment. Although a very common crime, it is still considered consumer misbehavior. Researchers divide shoplifters into two categories: “boosters,” professionals who resell what they steal, and “snitches,” amateurs who steal for their personal use. Researchers generally agree that shoplifters are driven by either economic or psychosocial motives. Psychosocial motivations may include peer pressure, a desire for thrill or excitement, impulse, intoxication, or compulsion.

Credit Card Fraud

Credit card fraud is a wide-ranging term for theft and fraud committed using a credit card or any similar payment mechanism as a fraudulent source of funds in a transaction. The purpose may be to obtain goods without paying, or to obtain unauthorized funds from an account. Estimates put the cost of credit card fraud to billions of dollars.

Fraud

Credit card fraud is a form of consumer misbehavior that can cost billions of dollars a year.

Black & Grey Market Economies

A black market or underground economy is a market in goods or services which operates outside the formal one supported by the established state power. It often involves illegal, smuggled, or counterfeit goods. In many parts of the world, black markets operate side by side with legal markets, sometimes openly. Worldwide, the underground economy is estimated to have provided 1.8 billion jobs. Similar is a gray market economy where a company makes their products available even they are not authorized to do so.

Combating Consumer Misbehavior

Although fairly expensive to do, many retailers have begun fighting consumer misbehavior. Retailers often employ more security and staff during times where the propensity for consumer misbehavior increases, such as during “Black Friday” sales. Many also use electronic tracking devices on products and closed-circuit television to fight shoplifting and fraud. Since the cost of consumer misbehavior can be so high, many retailers feel it is worth fighting.

4.11: Consumer Experience

4.11.1: Factors Influencing Experience, Involvement, and Satisfaction

The main factors that influence experience, involvement, and satisfaction with a product are personal, social, object and situational.

Learning Objective

Explain the factors influencing the consumer experience, involvement and satisfaction

Key Points

• A person’s perceptions, beliefs, attitudes, and values can substantially influence his or her experience and involvement with products.
• Personal or individual factors can also serve as strong influences, including gender, age, income level or social class, ethnicity, and sexual orientation.
• A consumer’s social network has a strong influence on the level of involvement with many products because individuals tend to rely on the opinions and advice of friends and family.
• Products that can easily conform to and enrich a consumer’s lifestyle tend to be consumed with more frequency and involvement.
• The degree of information that a consumer has about a product, including how well he or she can distinguish its characteristics, can also effect experience, involvement, and satisfaction.
• Other social influences can include opinion leaders and reference groups.

Key Terms

reference group

A concept referring to a group to which an individual or another group is compared. It is the group to which the individual relates or aspires to relate himself or herself psychologically.

culture

The arts, customs, and habits that characterize a particular society or nation. The beliefs, values, behavior and material objects that constitute a people’s way of life.

Perception

The organization, identification and interpretation of sensory information in order to represent and understand the environment.

Example

• Certain cultures highly discourage women from exposing some of their body parts as part of their religious beliefs, which inevitably affects their consumption of clothing.

In general, four main factors influence a consumers’s experience, involvement, and satisfaction with a product:

• Personal
• Object
• Situational
• Social

Personal Factors: A person’s perceptions, beliefs, attitudes, and values can substantially influence his or her experience and involvement with products. For example, certain cultures highly discourage women from exposing some of their body parts as part of their religious beliefs, which inevitably affects their consumption of clothing. Other examples of cultural influences include language, myths, customs, rituals, and laws. Consumers tend to be more involved with products that they believe can fill their own needs, which in turn are regarded as holding importance and relevance in their lives. Personal or individual factors can also serve as strong influences, including gender, age, income level or social class, ethnicity, and sexual orientation.

Personal Beliefs

Religious beliefs can impact consumers’ clothing choices. Muslin women must be covered at all times so they cannot wear bathing suits.

Woman wearing “burqini” swimwear in Egypt.

Object Factors: The degree of information that a consumers have about a product, including how well they can distinguish its characteristics, can also effect their experience, involvement, and satisfaction. Typically, the higher a consumer’s product knowledge, the more involved with it he or she will be. Deeper knowledge about a product also translates into higher involvement because the consumer perceives it as more important, especially if some of that knowledge pertains to characteristics that hold personal meaning.

Situational Factors: Products that can easily conform to and enrich a consumer’s lifestyle tend to be consumed with more frequency and involvement. For example, a busy working mother might rely heavily on her smart phone to keep her organized and effective in an effortless manner.

Social Factors: Social influence can deeply affect consumer behavior, especially as related to the products they consider and consume. A consumer’s social network has a strong influence on the products he or she uses, since individuals tend to rely on the opinions and advice of friends and family. Other social influences can include opinion leaders and reference groups.

4.11.2: Marketing Changes Due to Involvement

A company should consider the level of involvement a consumer has with a product in order to guide its marketing strategy.

Learning Objective

Examine the impact of customer involvement in consumer marketing and experience

Key Points

• In general, consumer involvement tends to be higher for products that are very expensive or are considered highly significant in the consumer’s life.
• Print advertising is considered high-involvement because newspapers and magazines provide information that can be processed clearly and can help shape attitudes and influence decisions.
• TV advertising is considered low-involvement because it presents information that is considered passive.

Key Term

consumer involvement

The level of interaction and regard that a consumer has with a given product.

Example

• Low-involvement products (e.g., some consumer packaged goods) in a category where brands are not distinctly different require that marketers provide sales and promotions as part of their marketing strategy.

Consumer involvement tends to vary dramatically depending on the type of product and its relationship to the consumer. In general, consumer involvement tends to be higher for products that are very expensive (e.g., a home, a car) or are considered highly significant in the consumer’s life (e.g., a newborn baby product).

Purchasing a Vehicle

Consumer involvement tends to be higher for expensive products like vehicles.

A Chevy Suburban.

Marketing strategy should take into account the level of involvement that a consumer has with a specific product, as this also dictates the type of information that the consumer needs to process in order to make a purchase decision.

The following levels of information processing are required, which can help dictate the marketing approach that should be used:

• Low-Involvement purchases tend to be made by habitual decisions (e.g., dish washing liquid, toothbrush). These require minimal information processing.
• Moderate-Involvement purchases tend to be made by simple decisions (e.g., orange juice, snacks). These often may require some evaluation of alternatives.
• High-Involvement purchases tend to be made by lengthy or more involved decisions (e.g., a car or a house). These are usually considered highly important to consumers and require extensive information processing.

Print advertising is considered high-involvement because newspapers and magazines provide information that can be processed clearly and can help shape attitudes and influence decisions. Television advertising is considered low-involvement because it presents information that is considered passive.

The four main types of buying behavior in consumer marketing depend on the level of consumer involvement:

High involvement & significant differences between brands (complex buying behavior):

• Example: Houses, kitchen renovation
• One-time sale
• Consumers need evaluation and pre-sale learning
• Selling activities are key

Low involvement & significant differences between brands (variety-seeking buying behavior):

• Example: Retail food stuff
• Consumers have added buying triggers
• Consumers want free samples, special deals

High involvement & few differences between brands (dissonance-reducing buying behavior):

• Example: Consumer electronics, top-line sport equipment
• Decision making is difficult both pre- and post-purchase

Low involvement & few differences between brands (habitual buying behavior):

• Example: Food, personal care products
• Brand familiarity and promotion with convenience is key
• Consumers look for price/sales promotions

3.3: External Factors

3.3.1: General Economic Conditions

Learning Objective

Illustrate how fluctuations in the economy influence consumers’ willingness and ability to buy products and services

Key Points

• There are four phases of the business cycle: prosperity, recession, depression, and recovery.
• During recession and depression, the economy is on a downward tilt. Consumers are spending less and saving more, making the job of marketers more difficult and more risky. During recovery and prosperity, consumers are spending once more. However, the job of marketers remains challenging.
• Marketers must be aware of what stage of the business cycle the economy is in. This is very difficult to predict, but research and awareness can lead to calculated risks.

Key Terms

business cycle

A long-term fluctuation in economic activity between growth and recession

depression

A period of major economic contraction; officially, four consecutive quarters of negative, real GDP growth (according to NBER).

Economic Issues

Various economic forces influence an organization’s ability to compete and consumer’s willingness and ability to buy products and services. The state of the economy is always changing–interest rates rise and fall, inflation increases and decreases. Consumers’ ability and willingness to buy changes. Economic changes will affect the demand and supply sides of the market, meaning that the marketer must always be aware of the general economic environment.

The Business Cycle

Fluctuations in our economy follow a general pattern known as the business cycle. These fluctuations in economic conditions affect supply and demand, consumer buying power, consumer willingness to spend, and the intensity of competitive behavior. The four stages in the business cycle are: prosperity, recession, depression, and recovery (see and try to identify the different stages).

Real Median Household Income, 1979-2011

The chart shows the change in household income over the last three decades. Shaded areas denote times of recession.

Prosperity

Prosperity represents a period of time during which the economy is growing. Unemployment is low, consumers’ buying power is high, and the demand for products is strong. During prosperity, consumer disposable incomes are high, and they try to improve their quality of life by purchasing products and services that are high in quality and price. The U.S. economy was in a period of prosperity from 1991 to 2000. For marketers, opportunities were plentiful during prosperity, and they attempted to expand product lines to take advantage of consumers’ increased willingness to buy.

Recession

Recession is characterized by a decrease in the rate of growth of the economy. Unemployment rises and consumer buying power declines. Recession tends to occur after periods of prosperity and inflation. During a recession, consumers’ spending power is low, as they are busy paying off debts incurred through credit purchases during more prosperous time. During recessions, marketing opportunities are reduced. Because of reduced buying power, consumers become more cautious, seeking products that are more basic and functional.

Depression

Depression represents the most serious economic downturn. Unemployment increases, buying power decreases, and all other economic indicators move downward. Consequently, consumers are unable or reluctant to purchase products, particularly big-ticket items. Also, consumers tend to delay replacement purchases. Although many marketers fail during this period, insightful marketers can gain market share.

Recovery

Recovery is a complicated economic pattern, in that some economic indicators increase while others may stay low or even decrease. Much of what happens during a recovery may be a result of intangibles, such as consumer confidence or the perception of businesses that things will get better. Tentative marketers take serious risks. Premature marketers may face dire consequences. For marketers, an important task is to attempt to determine how quickly the economy will move into a situation of prosperity. Improper forecasting can lead some firms to overextend themselves, as consumers may be slow to change purchase habits they have been accustomed to in the more difficult economic times.

How Should Marketers React?

The economy is cyclical in nature. We know that the cycles will occur. We just cannot predict exactly when or how severe the cycles will be. Assumptions must be made about money, people, and resources. For example, many organizations become less aggressive when they believe the economy is not going to grow. If they are right, they may do well. If they are wrong, those organizations that are more aggressive can perform very well often at the expense of the conservative organizations. Assumptions must also be made about such economic factors as interest rates, inflation, the nature and size of the workforce, and the availability of resources, such as energy and raw materials. For marketers, the job is to use the information available to make educated predictions about what part of the cycle the economy is in, and best to react to that.

Environmental Scanning

One technique used by organizations to monitor the environment is known as “environmental scanning,” which refers to activities directed toward obtaining information about events and trends that occur outside the organization and that can influence the organization’s decision making. In a sense, such data collection scanning acts as an early warning system for the organization. It allows marketers to understand the current state of the environment and to predict trends. A formal but simple strategic information scanning system can enhance the effectiveness of the organization’s environmental scanning efforts (see for the main internal and external factors). One element of environmental scanning is the general economic environment.

Internal and External Factors

It is important to know the internal and external factors that impact an organization.

A diagram that shows situational analysis for the internal (financial resources, technical resources, competitive situation, human resources, and product line) and external (technology, competition, economic/political, ethical/legal, and social trends) environments in an organization.

3.3.2: Consumer Income, Purchasing Power, and Confidence

Learning Objective

Illustrate the relationship between consumer purchasing power, pricing and the economy

Key Points

• Purchasing power can change if the price of goods increases/decreases, or if inflation increases/decreases. A higher real income means a higher purchasing power since real income refers to the income adjusted for inflation.
• A CPI can be used to index the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values.
• if the economy expands causing consumer confidence to be higher, consumers will be making more purchases. On the other hand, if the economy contracts or is in bad shape, confidence is lower, and consumers tend to save more and spend less.

Key Terms

consumer confidence

An economic indicator measuring the degree of optimism that consumers feel about the overall state of the economy and their personal financial situation.

consumer price index

A statistical estimate of the level of prices of goods and services bought for consumption purposes by households.

purchasing power

The amount of goods and services that can be bought with a unit of currency or by consumers.

Consumer Buying Power

A consumer’s buying power represents his or her ability to make purchases. The economy affects buying power. For example, if prices decline, consumers have greater buying power. If the value of the dollar increases relative to foreign currency, consumers have greater buying power. When inflation occurs, consumers have less buying power.

Purchasing Power

Purchasing power is the amount of goods or services that can be purchased with a unit of currency. For example, if you had taken one dollar to a store in the 1950s, you would have been able to buy a greater number of items than you would today, indicating that you would have had a greater purchasing power in the 1950s. Currency can be either a commodity money, like gold or silver, or fiat currency, or free-floating market-valued currency like US dollars. As Adam Smith noted, having money gives one the ability to “command” others’ labor, so purchasing power to some extent is power over other people, to the extent that they are willing to trade their labor or goods for money or currency.

If one’s monetary income stays the same, but the price level increases, the purchasing power of that income falls. Inflation does not always imply falling purchasing power of one’s money income since it may rise faster than the price level. A higher real income means a higher purchasing power since real income refers to the income adjusted for inflation.

Consumer Price Index (CPI)

A consumer price index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI in the United States is defined by the Bureau of Labor Statistics as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” The CPI is a statistical estimate constructed using the prices of a sample of representative items whose prices are collected periodically. It is one of several price indices calculated by most national statistical agencies. The annual percentage change in a CPI is used as a measure of inflation. A CPI can be used to index (i.e., adjust for the effect of inflation) the real value of wages, salaries, pensions, for regulating prices and for deflating monetary magnitudes to show changes in real values. In most countries, the CPI is one of the most closely watched national economic statistics.

Consumer Confidence

Consumer confidence is an economic indicator which measures the degree of optimism that consumers feel about the overall state of the economy and their personal financial situation. How confident people feel about stability of their incomes determines their spending activity and therefore serves as one of the key indicators for the overall shape of the economy. In essence, if the economy expands, causing consumer confidence to be higher, consumers will be making more purchases. On the other hand, if the economy contracts or is in bad shape, confidence is lower, and consumers tend to save more and spend less. A month-to-month diminishing trend in consumer confidence suggests that in the current state of the economy most consumers have a negative outlook on their ability to find and retain good jobs.

The ability to predict major changes in consumer confidence allows businesses to gauge the willingness of consumers to make new purchases. As a result, businesses can adjust their operations and the government can prepare for changing tax revenue. If confidence is dropping and consumers are expected to reduce their spending, most producers will tend to reduce their production volumes accordingly. For example, if manufacturers anticipate that consumers will reduce retail purchases, especially for expensive and durable goods, they will cut down their inventories in advance and may delay investing in new projects and facilities. The government will get ready for the reduction in future tax revenues. On the other hand, if consumer confidence is improving, people are expected to increase their purchases of goods and services. In anticipation of that change, manufacturers can boost production and inventories. Large employers can increase hiring rates. Government can expect improved tax revenues based on the increase in consumer spending.

Consumer confidence is formally measured by the Consumer Confidence Index (CCI), a monthly release designed to assess the overall confidence, relative financial health and spending power of the US average consumer. The CCI is an important measure used by businesses, economic analysts, and the government in order to determine the overall health of the economy (see ).

US Consumer Price Index, 1913-2006

Since 1980, due to specific targeting of inflation, the change in the US CPI has mostly stayed below 5% annually.

3.3.3: Political Environment

Learning Objective

Give examples of how government policies can influence marketing programs

Key Points

• Government regulations affecting business and marketing are often much more invasive abroad. Regulations on pricing, hiring, production, and environmental regulation will likely differ from those in the US.
• Most Western countries have entered into regional trading agreements such as NAFTA, or those governing the EU. Companies doing business in these countries should expect to face regulations such as trade barriers, tariffs, etc. depending on where they are trading from and to.
• Monetary and political stability are also key factors that multinationals should take into consideration. Political instablity carries a set of risks, such as expropriation.

Key Terms

trading bloc

A type of intergovernmental agreement, often part of a regional intergovernmental organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminated among the participating states.

expropriation

The act of expropriating; the surrender of a claim to private property; the act of depriving of private propriety rights.

tariff

A system of government-imposed duties levied on imported or exported goods; a list of such duties, or the duties themselves.

The Political Environment

The political environment in countries throughout Europe and Asia is quite different from that of the United States. In the U.S., government intervention in marketing tends to be relatively minimal compared to other countries.

The U.S. is capitalist society, it operates an economic system where both the government and private enterprise direct the economy. In other words, the U.S. government combines free enterprise with a progressive income tax, and at times, steps in to support and protect American industry from competition from overseas. For example in the 1980s the government sought to protect the automobile industry by “voluntary” export restrictions from Japan.

Nevertheless, governments outside the U.S. take this involvement one step further by influencing marketing programs within organizations in the following ways: contracts for the supply and delivery of goods and services; the registration and enforcement of trademarks, brand names, and labeling; patents; marketing communications; pricing; product safety; and environmental issues.

Political Stability

Business activity tends to grow and thrive when a nation is politically stable. Although multinational firms can still conduct business profitably, political instability within countries negatively affects marketing strategies.

Monetary Circumstances

The exchange rate of a particular nation’s currency represents the value of that currency in relation to that of another country. Governments set some exchange rates independently of the forces of supply and demand. If a country’s exchange rate is low compared to other countries, that country’s consumers must pay higher prices on imported goods. Exchange rates fluctuate widely and often create high risks for exporters and importers.

Trading Blocs and Agreements

US companies make one-third of their revenues from products marketed to countries in Asia and Latin America. The North American Free Trade Agreement (NAFTA) also boosts export sales by enabling companies to sell goods at lower prices due to reduced tariffs.

Regional trading blocs represent groups of nations that join together and formally agree to reduce trade barriers among themselves. NAFTA is such a bloc. Its members include the US, Canada, and Mexico. No tariffs exist on goods sold between NAFTA member nations. However, a uniform tariff is assessed on products from unaffiliated countries. In addition, NAFTA seeks common standards for labeling requirements, food additives, and package sizes.

One of the results of trade agreements like NAFTA is that many products previously restricted by dumping laws – laws designed to keep out foreign products – can be marketed. Dumping involves a company selling products in overseas markets at very low prices, with the intention to steal business from local competitors. These laws were designed to prevent pricing practices that could seriously harm local competition, as well as block large producers from gaining a monopoly by flooding markets with very low-priced products and raising those prices to very high levels.

Almost all the countries in the Western hemisphere have entered into one or more regional trade agreements. Such agreements are designed to facilitate trade through the establishment of a free trade area customs union or customs market. This eliminates trade barriers between member countries while maintaining trade barriers with non-member countries.

European Union Treaties 

These treaties formed the political and economic bloc known as the “European Union.”

Tariffs

The most common form of restriction of trade is the tariff, a tax placed on imported goods. Customs unions maintain common tariffs and rates for non-member countries. A common market provides for harmonious fiscal and monetary policies while free trade areas and customs unions do not.

Protective tariffs are established in order to protect domestic manufacturers against competitors by raising the prices of imported goods. Not surprisingly, US companies with a strong business ties in a foreign country may support tariffs to discourage entry by other US competitors.

Expropriation

Expropriation occurs when a foreign government takes ownership of plants and assets. Many of these facilities end up as private rather than government organizations. Because of the risk of expropriation, multinational firms are at the mercy of foreign governments, which are sometimes unstable and can change the laws they enforce at any point to meet their needs.

3.3.4: Applicable Legislation

Learning Objective

Discuss the various legal issues that impact marketing decisions

Key Points

• Product liability means that producers of products are held responsible for upholding the safety of that product for consumers. Lawsuits and settlements incentivize producers to ensure defects are minimized and safety is maintained.
• Deregulation of the airline industry has lead to increased competition and service and decreased prices (see. Deregulation of electricity in California led to price hikes and was considered harmful.
• Companies must also pay attention to existing state laws, government relationships, social legislation, federal legislation, and monetary and fiscal policies.

Key Terms

product liability

the idea that manufacturers of products are responsible for the safety of that product, which may be compromised due to defect or every day use.

legislation

Law which has been enacted by legislature or other governing body

deregulation

The process of removing constraints, especially government imposed economic regulation.

Example

• Examples of product liability in action: Two Maryland men decided to dry their hot air balloon in a commercial laundry dryer. The dryer exploded, injuring them. They sued the manufacturer and won. A two-year-old child being treated for bronchial spasms suffered brain damage from a drug overdose. The hospital staff had clearly exceeded the dosage level prescribed by the drug manufacturer. The child’s parents successfully sued the manufacturer.

Every marketing organization’s activities are influenced by legal factors that establish the rules of the game. These laws, agencies, policies, and behavioral norms are established to ensure that marketers compete legally and ethically in their efforts to provide want- and need-satisfying products and services. The various US legal issues of which marketers must be knowledgeable include the following:

• Monetary and fiscal policy: Marketing decisions are affected by factors like tax legislation, money supply, and the level of government spending. The tendency of a Republican Congress to spend on defense materials and not on the environment is an example.
• Federal legislation: Federal legislation exists to ensure such things as fair competition, fair pricing practices, and honesty in marketing communications. Anti-tobacco legislation affects the tobacco and related industries, for example.
• Government/industry relationships: Agriculture, railroads, shipbuilding, and other industries are subsidized by the government. Tariffs and import quotas imposed by the government affect certain industries (e.g.automobile). Other industries are regulated, or no longer regulated, by government (e.g. rail, trucking, and airlines). Deregulating the utilities industry had a tremendous negative effect on the Californian power industry in 2001.
• Social legislation: Marketers’ activities are affected by broad social legislation, like the civil rights laws, programs to reduce unemployment, and legislation that affects the environment (e.g. water and air pollution). The meat processing industry has spent billions of dollars trying to comply with water pollution legislation.
• State laws: State legislation affects marketers in different ways. For example, utilities in Oregon can spend only ½ per cent of their net income on advertising. California has enacted legislation to reduce the energy consumption of refrigerators and air conditioners. In New Jersey, nine dairies have paid the state over $2 million to settle a price-fixing lawsuit.
• Regulatory agencies: State regulatory agencies, for example, the US Attorney General’s Office, actively pursue marketing violations of the law. Federal agencies like the US Federal Trade Commission and the Consumer Product Safety concern themselves with all facets of business.

Every facet of business is affected by one or more laws. We will briefly discuss the three areas receiving the most notice in marketing: product liability, deregulation, and consumer protection.

Product liability

The courts are increasingly holding sellers responsible for the safety of their products. The US courts generally hold that the producer of a product is liable for any defect that causes injury in the course of normal use. Liability can even result if a court or a jury decides that a product’s design, construction, or operating instructions and safety warnings make the product unreasonably dangerous to use.

Many feel that product liability law is now as it should be—in favor of the injured product user. Consumer advocates like Ralph Nader argue that for too long, product liability favored producers at the expense of the product user. Advocates claim that the threat of lawsuits and huge settlements and restitution force companies to make safe products.

Deregulation

Deregulation means the relaxation or removal of government controls over industries that were thought to be either “natural monopolies,” such as telephones, or essential public services like airlines and trucking. When regulated, industries received protection from renegade competition.

Insulated from competition, regulated industries in the past often had little reason to lower costs; they concentrated on influencing the regulators to make favorable decisions. There was an unhealthy tension and costs rose, industries sought price increases, and regulators resisted, often depressing industry profits. That, in turn, reduced new investment and perpetuated high costs and poor service.

Industries such as the airlines, banking railroads, communications, and trucking have long been subject to government regulation. A market place shock wave hit these industries as they were deregulated. Each of these industries saw the birth of many new competitors attempting to take advantage of market opportunities uncovered by deregulation. The result was that competition intensified, prices were lowered, and many once-stable organizations suffered huge financial losses.

As new competition was permitted, and rate regulation was loosened or abandoned, the vicious cycle began to reverse itself. For example, airlines, once freed of restrictions, organized “hub and spoke” systems–outing passengers via major transfer points that provided more connections. In 1978, about 14 per cent of all passengers had to change airlines to reach their destination; by 1995, this number fell to about 1 per cent.

Consumer protection

Since the beginning of the 20^th century, there has been a concerted effort in the US to protect the consumer. Perhaps the most significant period in consumer protection was the 1960s, with the emergence of consumerism. This was a grassroots movement intended to increase the influence, power, and rights of consumers when dealing with institutions.

Marketers must always be aware of applicable legislation to avoid running foul of the law and incurring heavy fines, payouts and settlements.

Airline Industry

Deregulation of the airline industry in the US led to many new airlines, new routes, lower prices, and decreased connections for passengers.

3.3.5: Cultural Values

Learning Objective

Describe how cultural beliefs, values and customs influence marketing strategies

Key Points

• Marketers must pay attention to the dominant culture of a society, but also to subcultures created by material cultures, belief systems, socio-economic groupings, and religious and political differences.
• The sociocultural environment abroad can be very different, even if it appears similar. Even when countries share a language, they can differ greatly in how people eat, work, and do business. Taboos are often taken vary differently, and even simple things such as color can make a big difference.
• Business decisions are not free of ethics. At the individual level, managers have ethical concerns, as do customers. Even at a societal level, businesses must make ethical decisions that may contradict with purely financial considerations.

Key Terms

ethics

The set of moral principles or values that guide behavior.

culture

The beliefs, values, behavior and material objects that constitute a people’s way of life; the sum of learned beliefs, values, and customs that regulate the behavior of members of a particular society.

subculture

A group of people who share a set of secondary values, such as hipsters.

Example

• Examples of cultural barriers that marketers may face abroad are: (a) language: Language differences cause many problems for marketers in designing advertising campaigns and product labels. Language problems become even more serious once the people of a country speak several languages. For example, in Canada, labels must be in both English and French. In India, there are over 200 different dialects. (b) customs and taboos: In Russia, it is acceptable for men to greet each other with a kiss, but this custom is not acceptable in the US. In France, wine is served with most meals, but in America, soft drinks are popular. (c) values: In America we place a very high value on material well-being, so we are much more likely to purchase status symbols than people in India. (d) business norms: In Russia, plans of any kind must be approved by a seemingly endless string of committees. (e) religion: Christmas time is a major sales period in the US, but holidays in other religions are not the same.

Cultures and subcultures

Culture is the sum of learned beliefs, values, and customs that regulate the behavior of members of a particular society. Beliefs and values are guides of behavior and customs are acceptable ways of behaving. A belief is an opinion that reflects a person’s particular knowledge and assessment of an issue. Values are general statements that guide behavior and influence beliefs and attitudes. A value system helps people choose between alternatives in everyday life. Customs are overt modes of behavior that constitute culturally approved ways of behaving in specific situations. Customs vary among countries, regions, and even families. In Arab societies, for instance, usury (payment of interest) is prohibited, so special Islamic banks exist to accomodate this.

Dominant cultural values are referred to as core values; they tend to affect and reflect the core character of a particular society. Core values are slow and difficult to change. Consequently, marketing communication strategies must accurately portray and reflect these values.

Secondary values also exist in any culture. Secondary values are less permanent values that can sometimes be influenced by marketing communications. In addition, core values are held by virtually an entire culture, whereas secondary values are not.

A subculture is a group of people who share a set of secondary values, such as environmentalists. Many factors can place an individual in one or several subcultures. Five of the most important factors that create subcultures are:

• Material culture – People with similar income may create a subculture. The poor, the affluent, and the white-collar middle class are examples of material subcultures.
• Social institutions – Those who participate in a social institution may form a subculture. Examples include participation in marriage, parenthood, a retirement community, or the army.
• Belief systems – People with shared beliefs may create a subculture, such as a religious group or political party. For example, traditional Amish do not use electricity and automobiles.
• Aesthetics – Artistic people often form a subculture of their own associated with their common interests, such as art, music, dance, drama, and folklore.
• Language – People with similar dialects, accents, and vocabulary can form a subculture. Southerners and northerners are two traditional categories in the US.

Adjusting to cultural differences is perhaps the most difficult task facing marketers who operate in other countries. Before entering a foreign market, a company must decide to what extent it is willing to customize its marketing efforts to accommodate each foreign market.

The Social and Cultural Environment

The cultural environment consists of the influence of religious, familial, educational, and social systems in the marketing system. Marketers who intend to market their products overseas may be very sensitive to foreign cultures. While the differences between our cultural background in the United States and those of foreign nations may seem small, failure to consider cultural differences is one of the primary reasons for marketing failures overseas. Cultural differences include language, color, customs, taboos, values, aesthetics, time, business norms, religion, and social structures.

Ethics

Ethics is generally referred to as the set of moral principles or values that guide behavior. There is a general recognition that many, if not most, business decisions involve some ethical judgement. For example, a company may have to decide whether to build a “sweatshop” in a developing country to lower costs.

Firms hope that a consideration of ethical issues during the decision-making process will be helpful in preventing or at least decreasing the frequency of unethical behavior. Having a corporate ethics policy also seems to facilitate the process of recovery after an ethical scandal—although firms may wish otherwise, unethical acts do occur and do not often go unnoticed (see and ).

Business Ethics Survey

A survey carried out on perceptions of business ethics.

Ethical Issues

There are common ethical issues in marketing. Ethics come into account when the buyer and seller interact.

A table that shows common ethical issues in marketing (bribery, fairness, honesty, price, product, personnel, confidentiality, advertising, manipulation of data, and purchasing).

While ethics deal with the relationship between buyer and seller, there are also instances when the activities of marketing influence society as a whole. For example, when you purchase a new refrigerator, there is a need to discard your old refrigerator. If thrown in a trash dump, the old refrigerator may pose a safety risk, contaminate the soil, and contaminate the aesthetics of the countryside. Society is thus required to bear part of the cost of your purchase. The well-being of society at large should also be recognized in an organization’s marketing decisions. A definition for social marketing is provided by Alan Andreasen: “Social marketing is the adaptation of commercial marketing technologies to programs designed to influence the voluntary behavior of target audiences to improve their personal welfare and that of the society of which they are a part. “

3.3.6: Demographics

Learning Objective

Identify common demographic traits used by marketers and demographic changes in the current marketplace

Key Points

• The traditional demographic groupings identified by marketers are the baby boomers and Generation X. Each of these has its own characteristics, which forces marketers to act differently depending on who is their target market.
• Demographic changes are occurring in different areas due to different external forces. Aging populations, more educated workers, and a changing market structure mean that people spend money in different ways and on different things. Marketers must be aware of this and react accordingly.
• Generations Y and Z pose a new challenge to marketers, as their tastes and spending habits differ from previous generations. As this group discovers itself, so marketers will be able to discover them as well.

Key Terms

immigration

The act of immigrating; the passing or coming into a country for the purpose of permanent residence.

baby boomer

A person born in the postwar years (generally considered in the USA and other Allied countries as between 1945 and the early 1960s), when there was an increase in the birth rate following the return of servicemen at the end of World War II.

demographics

The observable characteristics of a population, such as physical traits, economic traits, occupational traits, and more.

Demographic Changes

Demographics describe the observable characteristics of individuals living in the culture. Demographics include our physical traits, such as gender, race, age, and height; our economic traits, such as income, savings, and net worth; our occupation-related traits, including education; our location-related traits; and our family-related traits, such as marital status and number and age of children.

It is important that marketers understand the demographic segment that they are focusing on. One differentiation is by generation–two of the biggest demographic groups are the baby boomers and generation X. These historically have been of great importance and focus to marketers. More recently, generations Y and Z have emerged, and marketers must ensure they understand how to target them most effectively. One challenge with the younger generations is that many of them are yet to understand their own tastes and desires.

Demographic trait compositions are constantly changing, and no American, Japanese, or Brazilian is “typical” anymore. There is no average family, no ordinary worker, no everyday wage and no traditional middle class. Still, marketing managers must understand consumers intimately. As we see next, some trends are old, others are new. For instance, the aging of the population has been going on for several decades, but births and birth rates in recent years have been much higher than expected. Immigration is also greater than predicted, and so is the backlash against it. In the US, interstate migration to the south and west are old trends. What is new is heavier movement in the US from the northeast rather than from the midwest and rapid growth in the mountain states.

Consider the following demographic changes and how they affect marketing:

• Households are growing more slowly and getting older. About half of all households are aged 45 and older and growing at an annual rate of one percent compared with nearly two percent in the 1980s. Marketing communicators must plan for a greater number of middle-aged households, consumers who are experienced and have a better understanding of price and value. These consumers have an interest in high-quality household goods and in-home health care.
• The traditional family barely exists now. Married couples are a slim majority of US households. Only one-third of households have children under 18, and nearly one-fourth of households are people who live alone. However, married couples dominate the affluent market, as the vast majority of very high-income households are married couples. The long-term trend of high growth in nontraditional types of households and lack of growth among married couples can only mean further segmentation of an already segmented marketplace.
• The continued increase in education. Most adults in the United States still have not completed college (approximately 67 percent), but that number continues to decline. An increasing number of people have attended some college or have an associate or technical degree. More skilled workers mean more knowledgeable and sophisticated consumers who expect more information about product attributes and benefits before making a purchase.

Higher Education

The level of education in society is a demographic that impacts producers and consumers.

Alumni Hall at Saint Anslem College Goffstown, New Hampshire.

• Jobs that do not require physical strength keep growing in number. Also, the extremely high cost of employee benefits suggests that the use of temporary workers and independent contractors will continue to grow. Marketing managers must assess whether consumers who do not have corporate benefits will become more risk-averse because they lack the safety net of company-provided pension plans and medical insurance (related: see ).
• People in the US are moving south. More than half (54 percent) of US residents live in the ten largest states, and more than half of US population growth between 1990 and 1999 occurred in these ten states. New York had the largest population of all states in 1950, but in the 1990s, fast-growing Texas pushed the barely growing New York to number three. Why? More than half of the four million immigrants that located in the United States between 1990 and 1995 moved to California, Texas, or Florida.
• The share of aggregate household income earned by the middle 60 percent of households has shrunk from 52 percent in 1973 to 49 percent 25 years later. Meanwhile, the share of such income earned by the top 20 percent (average income USD 98,600) increased from 44 percent to 48 percent. In other words, the total purchasing power of the top 20 percent of US households now equals that of the middle 60 percent.

3.3.7: Trends

Learning Objective

Explain the different types of external factors or trends used in creating marketing strategies.

Key Points

• Marketing managers must stay informed of technology trends so they can be part of the next big thing, rather than becoming outdated and suffering the consequences financially.
• Marketing managers must watch factors in the micro environment, such as supply availability, and other trends dealing with suppliers to ensure that product will be delivered to customers in the time frame required in order to maintain a strong customer relationship.
• Forecasting new trends has become increasingly important as Marketers try to understand Americans by analyzing major life events and their need to be connected to their peers through social media outlets.

Key Terms

macro environment

Major external and uncontrollable factors that influence an organization’s decision making, and affect its performance and strategies. These factors include the economic, demographics, legal, political, and social conditions, technological changes, and natural forces.

micro environment

refers to the forces that are close to the company and affect its ability to serve its customers; it includes the company itself, its suppliers, marketing intermediaries, customer markets, competitors, and publics.

Example

• Electric cars are called zero-emission vehicles by their advocates, but they do not have zero emissions according to some experts. While an electric car does not emit exhaust, the technology required to charge their batteries does, according to the US Environmental Protection Agency (EPA). Critics argue that the more electric cars that are driven, the more pollution from smokestacks at the plants that provide the electric power. This is an example of a “trend” that marketers predicted to be more popular than they actually were once mass-produced.

The Micro Environment and Trends

The micro environment refers to the forces that are close to the company and affect its ability to serve its customers. It includes the company itself, its suppliers, marketing intermediaries, customer markets, competitors, and publics. The technological environment is perhaps one of the fastest changing factors in the macro environment. This includes technological developments in areas ranging from antibiotics and medicine, to nuclear and chemical weaponry, and credit cards.

How the Micro Environment Applies to Organizations

The corporate aspect of the micro environment refers to the internal environment of a company. This includes all departments, such as management, finance, research and development, purchasing, operations, and accounting. Each of these departments has an impact on marketing decisions. For example, research and development have input as to the features a product can perform. Accounting approves the financial side of marketing plans and budgets.

The suppliers of a company are also an important aspect of the micro environment. For instance, delivering supplies late can result in customer dissatisfaction. Marketing managers must watch supply availability and other trends involving with suppliers to ensure that product will be delivered to customers within the time frame required to maintain a strong customer relationship.

Technology Trends and Marketing

As industries such as pharmaceuticals and national defense expand, they create new markets and new uses for products. Such advances require companies to compete effectively, stay abreast of the latest trends, and update their product technologies as they become outdated.

Technology is the knowledge of how to accomplish tasks and goals. Technology affects marketers in several ways. First, aggressively advancing technology is spawning new products and processes at an accelerating rate that threatens almost every existing product.

Second, competition continues to intensify between old and new organizations as many substitute technologies compete with established products. Third, product innovations that result in superior performance or cost advantages are the best means for protecting and building market position without sacrificing profit margins. This is especially true in today’s world, when many markets are experiencing flat or slow growth when excess capacity is commonplace.

History provides many examples of companies that have lost their competitive advantage because a competitor came into the market with a product that had superior cost advantage or performance characteristics. These examples are not limited to small or weak companies. Even industrial giants including AT&T, General Electric, and IBM have seen parts of their markets eroded by competition with a distinctly superior product.

‘Smart’ Electric Car

The electric car has not been as popular as marketers predicted. Hybrid cars have become increasingly popular.

Forecasting New Trends

There are thousands of forecasters who claim to be able to predict or at least determine the direction of future markets. One that has an excellent track record is Roper Starch, a research firm that has been looking at trends for over 50 years. The 2000 Roper Report identified four concepts that may help marketers understand Americans in the next decades:

• “High Pace/High Peace”: Americans’ high-speed lifestyles create new goals and needs”: As the pace of life is picking up, there is growing desire and demand for peace. The shift to “High Pace/High Peace” is evident in the marketplace. Increasingly, brands seem to be “high-pace” (efficiency-oriented, intense brands like Apple) or “high-peace” (relaxing, spa-pace brands like Banana Republic, and personalities like the Dalai Lama). Data suggest that there are opportunities for marketers to become a bridge to get people to both their high pace and high peace goals.
• “Kinnections”: The movement to connection in technology, relationships, and brands”: In a whole host of areas—from communications and computing to attitudes towards family and community—connections are up. This sense of connection is apparent in the marketplace as well in cause-related marketing and a greater desire for brands to go beyond the basics like quality and value to connect in new ways with consumers. Companies like Facebook, Twitter and LinkedIn are now synonymous with the new, ultra-connected society.
• “Diversity/Destiny”: The US increasingly is “the world’s nation”: our foreign-born population has almost tripled in the past 30 years. African-Americans, Hispanics, and other minorities make up the majority of the nation’s population growth in the past decade—and will account for an even larger proportion of the nation’s growth in the decade to come. To succeed, marketers must be culturally aware.
• “Marketing by life stage”: Marketers have traditionally relied on standard demographics to understand and predict consumer behavior. Research shows, however, that life stage can be a more powerful predictor of consumer attitudes and behavior than traditional demographic analysis. Classifying Americans by the life events they have experienced, rather than by demographic traits, can yield insights and understanding into a market that might otherwise have been overlooked.

3.4: Technology

3.4.1: Impact of Technology on Marketing

Technology, particularly the availability of big data coupled with a wide variety of digital marketing channels, offers substantial opportunity for marketing professionals.

Learning Objective

Recognize the variety of impacts technology has on the field of marketing, both for organizations and consumers

Key Points

• Alongside pretty much every facet of business, marketing has been substantially impacted by various evolving technological factors.
• Organizations have access to more data than ever before. Obtaining, organizing, and utilizing this data is a key effort of modern organizations.
• The wide variety of marketing channels available, spanning from social networks to distribution platforms like YouTube, offers more options than ever to reach consumers.
• Consumers are also impacted by technological changes in marketing. Most notably, consumers are targeted by more ads than ever before, often with higher relevance to their interests due to the huge amount of data they share.
• This has resulted in ad blindness (particularly banner ads) along with a number of concerns revolving around data sharing and privacy.

Key Term

organic

Generated according to the ranking algorithms of a search engine, as opposed to paid placement by advertisers. 

Technology has impacted the field of marketing significantly, along with virtually every other discipline in business. In marketing, the impacts of technology are diverse. Organizations are tasked with managing more marketing options than ever before, and consumers are more integrated with marketing information than they have been in the past.

Impacts on the Organization

From the organizational perspective, technology has impacted the ability to collect and organize marketing data, the channels the organization can use to reach consumers, and the process of developing different types and formats of advertising assets. Organizations have more data, more marketing formats, and more online places to communicate with consumers (i.e. social networks, blogs, search engines, YouTube videos, etc.).

When considering the impact of technology as a marketer, what’s most important is maintaining a full scope of the relevant options and channels that can be utilized to communicate with prospective and existing consumers:

• Search engine results
• Social networks (paid and organic)
• Banner ads
• Sponsored online retail content
• Online reviews and ratings
• Blog posts and web development
• Online video content (paid and organic)
• Smartphone ad formats
• Tablet ad formats

 

Web Banner Ads

When marketing materials are distributed online, it can be very complicated. Above is an example of a layout that might be encountered when developing web banner ads.

This is a great example of the complexity that can accompany online distribution of marketing materials. These are the various common formats one may encounter when developing banner ads for different channels.

Impacts on the Consumer

From the consumer side, marketing has become increasingly integrated into everyday life. From Facebook advertising to Google paid search results, the average consumer has an increasingly personalized and data-driven exposure to ‘relevant’ ad materials. This is all not to mention the various devices and distribution formats, spanning from computer browsers to mobile to tablet distribution.

Thanks to the enormous amount of information available, primarily from social networks and browsing behavior, consumers are also being impacted from a privacy point of view. From what we watch on TV to who our friends are to what career paths we are on, all of this information is being utilized thanks to social networks and browser cookies. This creates accurately catered ads, albeit alongside valid concerns of privacy.

Ad blindness is another interesting outcome of the modern technology-driven marketing. As consumers are exposed to more and more sponsored content, the ability to ignore marketing materials (particularly online) has grown quite high. As consumers are accosted with more and more content, they have evolved the capacity to consciously and subconsciously ignore sponsored ad content.

Conclusion

For organizations and consumers both, the most important takeaway is the way in which big data, diverse distribution opportunities, products and consumers are all combined. Identifying the ideal target market from the data, figuring out which channels this market tends to use (social networks, etc.), and which products fill their needs is a strategic necessity in the modern technological era for organizational success (B2C particularly). 

3.4.2: Use of New Technologies in Marketing and Research

New technologies in online marketing — smart phones, CRM systems, and social media — can aid marketers in reaching new and existing customers.

Learning Objective

Construct the flow of marketing information through the use of new technologies

Key Points

• CRM systems for marketing help the enterprise identify and target potential clients and generate leads for the sales team.
• Social media marketing refers to the process of gaining website traffic or attention through social media sites.
• Social media sites regularly used in marketing efforts include Twitter, Facebook, Foursquare, Instagram, LinkedIn, Yelp, and YouTube.

Key Terms

customer relationship management

A widely implemented model for managing a company’s interactions with customers, clients, and sales prospects. It involves using technology to organize, automate, and synchronize business processes—principally sales activities, but also those for marketing, customer service, and technical support. Also known by the acronym “CRM. “

social media

Interactive forms of media that allow users to interact with and publish to each other, generally by means of the Internet.

Use Of New Technologies In Marketing & Research

A wave of new technologies exists today to aid marketers in reaching and researching existing and prospective customers. Even tools thought of as “new” a decade ago, such as internet advertising, e-mails, and text messaging, are now seen as the norm or even antiquated. Newer technologies, including GPS, DVR’s, social media and smart phone applications, are becoming increasingly important. Two major tools being used today are customer relationship management systems (CRMs) and social media marketing.

CRM

Customer relationship management systems use technology to organize, synchronize, and automate business practices. CRM systems for marketing help the enterprise identify and target potential clients and generate leads for the sales team. A key marketing capability is the ability to track and measure multichannel campaigns, including email, search, social media, telephone, and direct mail. Metrics monitored include clicks, responses, leads, deals, and revenue. In a web-focused marketing CRM solution, organizations create and track specific web activities that help develop the client relationship. These activities may include such activities as free downloads, online video content, and online web presentations.

A certain amount of marketing information is being gathered all the time by companies as they engage in their daily operations. When a sale is made and recorded, this is marketing information that’s being gathered. When a sales representative records the shipping preferences of a customer in a firm’s CRM system, this is also marketing information that’s being collected. When a firm gets a customer complaint and records it, this too is information that should be put to use. All this data can be used to generate consumer insight. However, truly understanding customers involves not just collecting quantitative data (numbers) related to them but qualitative data, such as comments about what they think.

Social Media Marketing

Social media marketing refers to the process of gaining website traffic or attention through social media sites. Social media marketing involves using peer recommendations, building brand personality, and addressing the market as a heterogeneous group of individuals. It also uniquely encourages customers to create their own content and buzz around a product. In other words, programs usually center on efforts to create content that attracts attention and encourages readers to share it with their social networks. Hence, this form of marketing is driven by word-of-mouth; this means it generates results in earned media rather than paid media.

Event Promotion

Social media sites can be used when putting on a business marketing event.

Some examples of popular social media sites are:

Twitter

Twitter allows companies to promote products on an individual level. The use of a product can be explained in short messages that followers are more likely to read. Messages can link to the product’s website, Facebook profile, photos, videos, et cetera. This link gives followers the opportunity to spend more time interacting with the product online. This interaction can create a loyal connection between product and individual and can also lead to larger advertising opportunities.

Facebook

Facebook profiles are more detailed than Twitter. They allow a product to provide videos, photos, and longer descriptions. These also can include testimonials, as other followers can comment on the product pages for others to see.

Foursquare

Foursquare is a location-based social networking website where users can check into locations via their smartphones. Foursquare allows businesses to create a page or create a new venue or claim an existing one. A good marketing strategy for businesses to increase footfall or retain loyal customers includes offering incentives like discounts or free food/beverages for people checking in to their location, or provides special privileges for the mayor of that location.

LinkedIn

LinkedIn, being a professional business-related networking site, allows companies to create professional profiles for themselves as well as allowing their business to network and meet others. Through the use of widgets, members can promote their various social networking activities, such as Twitter stream or blog entries of their product pages, on their LinkedIn profile page. LinkedIn provides its members the opportunity to generate sales leads and business partners.

3.4.3: Marketing Innovation Trends

Innovation trends in marketing include mobile marketing, viral marketing, and more efficient usage of branding and targeting.

Learning Objective

Summarize new technological applications impact on marketing methods and trends

Key Points

• On average, SMS messages are read within four minutes, making them highly convertible.
• MMS mobile marketing can contain a timed slideshow of images, text, audio and video.
• Push notifications have helped application owners to communicate directly with their end users in a simple and effective way.
• Acting as a visual hyper-link to a page, QR codes make it easy for someone to reach a mobile optimized offer page.
• Viral marketing involves the exponential spread of a marketing message by online word of mouth.
• With the immense amount of personal and usage data currently available, targeting can be done automatically and extremely successfully.

Key Term

mobile SPAM messages

SMS sent to mobile subscribers without a legitimate and explicit opt-in by the subscriber.

Marketing Innovation Trends

The newest trends in marketing are based on and around the use of new technologies. With the ever increasing use of cell phones around the globe – especially smart phones – one of the more popular current trends is mobile marketing.

Mobile Marketing

Mobile marketing is marketing on or with a mobile device. More specifically, marketers that utilize mobile marketing use interactive wireless media to provide customers with time and location sensitive, personalized information that promotes goods, services and ideas – thereby generating value for all stakeholders. The most popular forms of mobile marketing include:

SMS Marketing

Over the past few years, SMS (short message service) marketing has become a legitimate advertising channel in some parts of the world. On average, SMS messages are read within four minutes, making them highly convertible. While this has been fruitful in developed regions such as North America and Western Europe, mobile SPAM messages remain an issue in many parts or the world. This is partly due to the carriers selling their member databases to third parties. Most mobile operators in the U.S. demand a double opt-in from the consumer and the ability for the consumer to opt-out of the service at any time by sending the word STOP via SMS.

SMS marketing services typically run off a short code, but sending text messages to an email address is another methodology. Short codes are five or six digit numbers that have been assigned by mobile operators in a given country for the use of brand campaigns and other consumer services. Due to the high price of short codes – $500 to $1000 a month – many small businesses opt to share a short code in order to reduce monthly costs. Another alternative to sending messages by short code or email is to do so through one’s own dedicated phone number. Long numbers – or those based on the international format – are also regularly utilized for mobile marketing.

MMS Marketing

Mobile content can also be delivered via MMS (multimedia message service). Nearly all new phones produced with a color screen are capable of sending and receiving standard MMS messages. MMS mobile marketing can contain a timed slideshow of images, text, audio, and video.

Push Notifications

Push notifications were first introduced to smartphones by Apple with the advent of the iPhone in 2007. They were later further popularized with the Android operation system, where the notifications are shown on the top of the screen. It has helped application owners to communicate directly with their end users in a simple and effective way. It can be much cheaper when compared to SMS marketing in the long run, but it can become quite expensive initially because of the cost involved in application development.

QR Codes

Also with the increase in smart phone usage, QR – or quick response – codes have become much more prevalent in marketing pieces both on and offline. Acting as a visual hyper-link to a page, QR codes make it easy for someone to reach a mobile optimized offer page. As such, they represent a very powerful tool for initiating consumer engagement at the time when the marketing piece is likely triggering its most emotional response. Their potential for tracking offline sources and delivering the types of analytics previously reserved for online tracking makes another powerful reason that marketers are flocking to QR codes in droves.

QR Code

A QR code is a marketing tool. Consumers can scan QR codes with their smart phones to instantly reach information or offer pages.

Other Online Marketing Trends

Besides mobile marketing, there are other trends in online marketing. Viral marketing is involves the exponential spread of a marketing messages by online word of mouth (sometimes referred to as “word of mouse”). A major component of viral communication is the meme – or a message that spreads virally and embeds itself in the collective consciousness. Viral marketing is closely tied to social media, since social media platforms and their sharing functionality are the main way that a message is able to “go viral” online.

Meme

A meme is a popular method of marketing images and ideas on the web and social networks.

Branding and target marketing have also evolved in the online realm. More than ever before, brands are creating personas and identities around themselves, rather than the products they sell. The online space allows customers to interact and converse with the brand personally and directly. Target marketing can be extremely precise on the web. With the immense amount of personal and usage data currently available, targeting can be done automatically and extremely successfully. In a world where everything is social and shared, the consumer has a lot of power. Marketers foresee that they will need to hand more control over to customers, who want to engage on deeper and more significant levels with content. The trend may go so far as to let customers create marketing content, with agencies keeping oversight and steering from the sidelines. Also, with increasing mobility and shrinking size of technological devices, consumers will expect to have round-the-clock access to all of their data, regardless of where they are and what device they are using. There are many opportunities here for even more specific and user-relevant content.