9.4: Product Life Cycles

9.4.1: The Product Life Cycle

Learning Objective

Discuss the rationale behind the marketing concept of product life cycles

Key Points

• Depending on its current stage in the product life cycle, a product will have different marketing, financing, manufacturing, purchasing and human resource requirements.
• In the market introduction stage (following product development), the product is released on to the market.
• Sales are low and costs are high in the market introduction stage, thus, no profits are made. There is little to no competition and demand must be created through heavy promotion.

Key Terms

decline stage

when a product is not predicted to continue to be successful or upgraded

product life cycle

The process wherein a product is introduced to a market, grows in popularity, and is then removed as demand drops gradually to zero.

maturity stage

when a product is no longer in the growth stage, but not yet in the decline stage

Example

• Product development and product life cycles go hand-in-hand. It is important that businesses continually develop new products to replace those that are declining. For example, consider the product development and life cycle of a video game. Often the games take 2 to 4 years to develop. Once they are released on to the market, their product life cycle is usually about 6 months.

Product Life Cycle: Overview

The product life cycle (PLC) describes the life of a product in the market with respect to business/commercial costs and sales measures. It proceeds through multiple phases, involves many professional disciplines and requires a multitude of skills, tools and processes.

This is not to say that product lives cannot be extended – there are many good examples of this – but rather, each product has a ‘natural’ life through which it is expected to pass.

The stages of the product life cycle are:

• Introduction
• Growth
• Maturity
• Decline

PLC management makes these three assumptions:

1. Products have a limited life and, thus, every product has a life cycle.
2. Product sales pass through distinct stages, each of which poses different challenges, problems and opportunities to its parent company.
3. Products will have different marketing, financing, manufacturing, purchasing and human resource requirements at the various stages of its life cycle.

The product life cycle begins with the introduction stage (see ). Just because a product successfully completes the launch stage and starts its life cycle, the company cannot take its success for granted.

Product Development and Product Life Cycle

The Product Life Cycle follows directly after new product development.

A company must succeed at both developing new products and managing them in the face of changing tastes, technologies and competition. A good product manager should find new products to replace those that are in the declining stage of their life cycles; learning how to manage products optimally as they move from one stage to the next.

Product Lifecycle Management Stage 1: Market Introduction

This stage is characterized by a low growth rate of sales as the product is newly launched and consumers may not know much about it. Traditionally, a company usually incurs losses rather than profits during this phase. Especially if the product is new on the market, users may not be aware of its true potential, necessitating widespread information and advertising campaigns through various media.

However, this stage also offers its share of opportunities. For example, there may be less competition. In some instances, a monopoly may be created if the product proves very effective and is in great demand.

Characteristics of the introduction stage are:

• High costs due to initial marketing, advertising, distribution and so on.
• Sales volumes are low, increasing slowly
• There may be little to no competition
• Demand must be created through promotion and awareness campaigns
• Customers must be prompted to try the product.
• Little or no profit is made owing to high costs and low sales volumes

9.4.2: Growth

Learning Objective

Identify the conditions that exist when a product is in stage 2, growth of the Product Life Cycle

Key Points

• Initial distribution is expanded as popularity increases, leading to increases in promotion as well.
• The company often looks at introduction improvements and innovations so as to cement their position in this stage, and discourage competitors from having any success in copying the product and selling substitutes.
• Increased competition in this stage may lead to falling prices as the company competes with others to gain and keep hold of market share.

Key Term

growth stage

The stage of the product life cycle where product sales, revenues and profits begin to grow as the product becomes more popular and accepted in the market.

Example

• Mini tablets, such as the iPad mini, Google Nexus 7, or Amazon Kindle Fire, are in the growth stage at the moment. The concept of having a tablet larger than a smart phone but smaller than a full-sized tablet (such as an iPad) is relatively new, and companies such as Amazon and Apple are in the stage where they are attempting to convince users to switch use them. While Apple has often been a market leader in innovations, it has lagged behind in the case of mini tablets, and this may cause it lose out on market leader status and instead play catch up.

The stages of the product life cycle are:

• Introduction
• Growth
• Maturity
• Decline

Product Lifecycle Management Stage 2: Growth

The growth stage is the period during which the product eventually and increasingly gains acceptance among consumers, the industry, and the wider general public. During this stage, the product or the innovation becomes accepted in the market, and as a result sales and revenues start to increase . Profits begin to be generated, though the break even point is likely to remain unbreached for a significant time–even until the next stage, depending on the cost and revenue structures.

Growth Stage

The graph shows the growth stage in the overall product life cycle.

The graph shows where the growth stage is located on the product life cycle (introductory stage, growth stage, maturity stage, and decline stage). The cycle tracks total market sales.

Initial distribution is expanded further as demand starts to rise. Promotion is increased beyond the initially high levels, and word-of-mouth advertising leads to more and more potential customers hearing about the product, trying it out, and–if the company is lucky–choosing to use the product regularly. Repeat orders from initial buyers are also obtained.

If a monopoly was initially created, then it still exists in this stage. Because of this, the manufacturing company can look at ways to introduce new features, alterations, or other types of innovation to the product according to feedback from consumers and from the market in general. This would be done in order to maintain growth in sales and ensure that interest in the product continues to grow and not stagnate, thus maintaining the growth stage. In fact, the growth stage is seen as the best time to introduce product innovations, as it creates a positive image of the product and diminishes the presence of competitors who will be attempting to copy or improve the product, and present their own products as a substitute.

Features of the growth stage:

• Costs reduced due to economies of scale: as production and distribution are ramped up, economies of scale kick in and reduce the per unit costs.
• Sales volume increases significantly: as the product increases in popularity, sales volumes increase.
• Profitability begins to rise: revenues begin to exceed costs, creating profit for the company
• Public awareness increases: through increased promotion, visibility and word of mouth, public awareness grows.
• Competition begins to increase with a few new players in establishing market
• Increased competition leads to price decreases: price wars may erupt, technology may get cheaper, or other factors can ultimately lead to falling prices.

9.4.3: Maturity

Learning Objective

Identify the market conditions of a product in stage 3, maturity of the product life cycle.

Key Points

• As the company will attempt to prolong the maturity phase as long as possible, it will likely introduce alterations and innovations to the product to keep customers interested and stay a step ahead of the competition.
• Advances in technology and changes in consumer taste and demand may also add to the slowing down of sales growth of the product during this phase.
• Prices tend to drop in this phase due to lower costs as well as a high level of competition, and so industrial profits will fall as well.

Key Terms

market saturation

A situation in which a product has become distributed within a market to the fullest possible extent, leaving demand for the product at a minimum. The actual level of saturation can depend on consumer purchasing power, competition, prices, and technology.

maturity

The stage in the product life cycle where sales growth ultimately peaks, then slows as the product reaches widespread acceptance, and competition is fierce.

Example

• Many popular and known products, such as the iPod and the iPhone, are in the maturity phase at the moment. Apple managed to extend the maturity phase of the iPod by introducing the iPod touch, which introduced a touch screen and new features. It also introduced new functionalities such as the use of apps, making it much more versatile and useful than the older iPods; one could argue that the iPod touch should be considered an entirely new product rather than an innovation on earlier iPod models.

The stages of the product life cycle are:

• Introduction
• Growth
• Maturity
• Decline

Product Lifecycle Management Stage 3: Maturity

The maturity stage follows the growth stage in the product’s life cycle (see ).

Maturity Stage

The maturity stage of the product life cycle shows that sales will eventually peak and then slow down.

A graph that shows where the maturity stage is located in the product life cycle (introductory stage, growth stage, maturity stage, and decline stage).

During this stage, sales growth has started to slow down, and the product has already reached widespread acceptance in the market, in relative terms. Ultimately, during this stage, sales will peak. The company will want to prolong this phase so as to avoid decline, and this desire leads to new innovation and features in order to continue to compete with the competition which, by now, has become very established, advanced and fierce. Competitors’ products will begin to cut deeply into the company’s market position and market share. However, despite this, sales continue to grow in the early part of the maturity phase. But, these sales will peak and ultimately decline, as the graph shows.

Demand for the product ultimately decreases due to competition and market saturation, as well as new technologies and changes in consumer tastes. Actions the company takes may include:

• Improving specific features in order to resell the product (for instance, in the case of a car, the manufacturer may include alloy wheels, new colors, sport or hybrid versions, or other changes in order to keep sales going);
• Lowering prices in order to fight off competition;
• Intensifying distribution and promotional efforts;
• Differentiation efforts, in the hope that new customers will start to buy the product.
• Finding a new targeted market.

The stage that lasts the longest in the product life cycle is the Maturity stage. It is at this time that repeat business and purchases take the place of new customer buying. So, during the maturity stage, the following occurs:

• Costs are lowered as a result of production volumes increasing and experience curve effects
• Sales volume peaks and market saturation is reached
• Increase in numbers of competitors entering the market
• Prices tend to drop due to the proliferation of competing products
• Brand differentiation and feature diversification is emphasized to maintain or increase market share
• Industrial profits go down

9.4.4: Decline

Learning Objective

Identify the characteristics of a product in the decline stage of the product life cycle.

Key Points

• Sales volume declines as competition becomes too strong for the company in question; as well as the fact that changes in consumer tastes and new technologies also erode sales.
• Maintaining profitability increasingly becomes more about efficiency of production and distribution rather than about increasing sales.
• Usually, product termination is not about the end of the business cycle or the entire product class; rather, it is about the termination of a single product or market entrant that can no longer compete as it has reached the end of its life.

Key Term

decline

The stage of the product life style where low/negative sales growth, lower profits, and maximum competition occur, forcing the product into decline and ‘death’.

The stages of the product life cycle are:

• Introduction
• Growth
• Maturity
• Decline

Product Lifecycle Management Stage 4: Decline

The decline stage of the product life cycle is the one where the product ultimately ‘dies’ due to the low or negative growth rate in sales (see ).

Decline Stage

The decline stage of the product life cycle is the terminal stage where sales drop and production is ultimately halted.

The graph shows that the decline stage is the last part of the product life cycle (introductory stage, growth stage, maturity stage, and decline stage).

Profitability will fall, eventually to the point where it is no longer profitable to produce, and production will stop. As a number of companies start to dominate the market, it becomes increasingly difficult for the company in question to maintain its level of sales. Consumer tastes also change, as do new technologies which may make the product become ultimately obsolete (as in the case of CDs and DVDs, and now Blu-Ray).

Features of the decline stage include:

• A decline in sales volume as competition becomes severe, and popularity of the product falls;
• A fall in prices and profitability (the latter ultimately moving in the negative zone);
• A counter-optimal cost structure;
• Profit increasingly becomes a challenge of production/distribution efficiency rather than increased sales.

It is important to note that product termination is not usually the end of the business cycle; rather, it is only the end of a single entrant within the larger scope of an on-going business program.

Example: The Personal Computer (PC)

shows the actual sales and price of the personal computer from 1992 to 2002. The PC was state-of-the-art technology in 1992. Only technologically-advanced individuals would buy one at the very steep price of $1800 (and bear in mind, $1800 in 1992 was worth a lot more than it is today). A large number of companies were competing in the field. As the market grew, businesses learned to be more efficient in producing the PC and prices came down. The drop in prices and improvements in technology made PCs more attractive to other consumers. However, the market became saturated after 2000 and went into decline. PCs started to become obsolete as laptops, net books, tablets, and smart phones started to enter the market, shifting the emphasis from power to portability. The PC is still used all over the world, but its popularity has declined dramatically.

Product life cycle of the personal computer

The chart shows the rise and fall of personal computers.

9.4.5: Product Life-Cycle Curve

Learning Objective

Discuss characteristics of a product’s life cycle curve

Key Points

• Different products will have differently shaped product life cycle curves. Products like Coke and Pepsi seem to be in a permanent maturity phase, while fads like the Tamagochi have short maturities as well as steep introduction and decline phases.
• Some products have very unpredictable product life cycles owing to high levels of uncertainty and risk. For these, the product life cycle model is less useful.
• During the early stages of the product life cycle, a product will not be highly profitable. Thus, the maturity stage should be extended as long as possible.

Key Term

fad

A phenomenon that becomes popular for a very short time; the product life cycle has a steeply-sloped growth stage, a short maturity stage, and a very steep decline.

Understanding Product Life Cycle Curves

It is important for marketing managers to understand the limitations of the product life cycle model. A rise in sales per se is not necessarily evidence of growth, just as a fall in sales does not typify decline. Some products like Coca Cola and Pepsi may not experience a decline at all.

Differing products possess different product life cycle “shapes. ” A fad product develops as a steeply-sloped growth stage, a short maturity stage, and a steeply-sloped decline stage (for instance, the pet rock phase in the 1970s). A product like Coca-Cola and Pepsi experiences growth, but also a constant level of sales over decades. A given product may hold a unique product life cycle shape such that use of typical product life cycle models are useful only as a rough guide for marketing management.

The duration of each product’s life cycle stage is unpredictable, making it difficult to detect when maturity or decline has begun. Due to these limitations, strict adherence to the product life cycle model can lead a company to misleading objectives and strategy prescriptions.

Rather, the product life cycle model should be used as a rough guide to predict how sales patterns may play out given competitive and economic conditions. All in all, it is a useful model, but not a certainty.

The two charts and demonstrate the break-even point reached during the product life cycle as well as sales and profits in general. They show that the product does not make much profit during early periods of the life cycle, meaning the maturity stage must be extended to maximise profits.

Sales and Profits

The diagram shows the sales and profits of a given product during the course of the product life cycle.

Break Even

The diagram shows when a product is expected to break even once it is introduced into the market.

The diagram shows when a product will break even based on sales and profit.

Examples

Facebook

Facebook is in the mature phase of the product life cycle. Once it became the norm for everyone to have a Facebook account, the growth stage passed. No new or obsoleting technology is expected to appear soon which would put Facebook out of business. While Facebook competes with other social media sites like Google+ and Twitter, it appears to be holding its own. Thus, we can say that Facebook is comfortably in the maturity stage.

iPod

The iPod touch is currently in the mature phase of the product life cycle. This is because the iPod touch is just an evolution of a product that has been around for long time. Competitors like Microsoft’s Zune have just followed Apple’s design and technology, while the iPod has evolved over multiple “generations,” each adding new features and functionalities. Today, the iPod touch is more than just a music player; it plays videos, runs apps and can be used as an organizer. Such a product may be difficult to classify using the product life cycle model – is it the same old iPod, or an entirely new product?

9.4.6: Impact of the Product Life Cycle on Marketing Strategy

Learning Objective

Summarize marketing strategies that apply to product life cycles

Key Points

• During the introduction stage, the product is promoted to create awareness and develop a market for the product.
• In the growth stage, the firm seeks to build brand preference and increase market share.
• The primary objective during the maturity phase is to defend market share while maximizing profit.
• Firms have several options when deciding how to deal with a product in the decline phase.
• Marketers must take care not to miss opportunities by following strategies based on the product life cycle model too closely.

Key Term

product life cycle

The process wherein a product is introduced to a market, grows in popularity, and is then removed as demand drops gradually to zero.

Introduction

The stages through which individual products develop over time is called commonly known as the “Product Life Cycle.”

Product Life Cycle Stages

The table shows the product life cycle stages and the different marketing characteristics that accompany and identify them.

A table that shows the marketing characteristics (sales, investment cost, competition, advertising, and profit) for the various stages of the product life cycle. Each stage is rated as “high” or “low” for each characteristic.

The product life cycle is a well-known framework in marketing. Products typically go through four stages:

• Introduction
• Growth
• Maturity
• Decline

After a period of development, the product is introduced or launched into the market. It gains more and more customers as it grows and, eventually, the market stabilizes and the product becomes mature. Then after a period of time, the product is overtaken by development and the introduction of superior competitors, goes into decline, and is eventually withdrawn.

At each stage, marketing strategy varies.

Strategies for the Different Stages of the Product Life Cycle

Introduction

The need for immediate profit is not a pressure. The product is promoted to create awareness and develop a market for the product. The impact on the marketing mix and strategy is as follows:

• Product branding and quality level is established and intellectual property protection, such as patents and trademarks are obtained.
• Pricing may be low penetration to build market share rapidly or high skim pricing to recover development costs.
• Distribution is selective until consumers show acceptance of the product.
• Promotion is aimed at innovators and early adopters. Marketing communications seeks to build product awareness and educate potential consumers about the product.

Growth

Competitors are attracted into the market with very similar offerings. In the growth stage, the firm seeks to build brand preference and increase market share.

• Product quality is maintained and additional features and support services may be added.
• Pricing is maintained as the firm enjoys increasing demand with little competition.
• Distribution channels are added as demand increases and customers accept the product.
• Promotion is aimed at a broader audience.

Maturity

Those products that survive the earlier stages tend to spend longest in this phase. At maturity, the strong growth in sales diminishes. Competition may appear with similar products. The primary objective at this point is to defend market share while maximizing profit.

• Product features may be enhanced to differentiate the product from that of competitors.
• Pricing may be lower because of the new competition.
• Distribution becomes more intensive, and incentives may be offered to encourage preference over competing products.
• Promotion emphasizes product differentiation.

Decline

At this point, there is a downturn in the market. For example, more innovative products are introduced or consumer tastes have changed. There is intense price cutting, and many more products are withdrawn from the market. Profits can be improved by reducing marketing spending and cost cutting.

As sales decline, the firm has several options:

• Maintain the product, possibly rejuvenating it by adding new features and finding new uses.
• Harvest the product–reduce costs and continue to offer it, possibly to a loyal niche segment.
• Discontinue the product, liquidating remaining inventory or selling it to another firm that is willing to continue the product.

By imaginatively repositioning their products, companies can change how customers mentally categorize them. They can rescue products struggling in the maturity phase of their life cycles and get them back to the growth phase. And in some cases, they might be able take their new products forward straight into the growth phase.

The Con of Using Product Life Cycles to Direct Strategies

According to Harvard Business School professor Youngme Moon, though the product life cycle concept has been used successfully over the past 40 years, it has made marketers assume that there is only one trajectory for successful products. By viewing the product life cycle in the same way, marketers pursue similar positioning strategies for products and services during each stage of the life cycle. In the process, they miss out on opportunities to differentiate themselves.

9.5: Managing Existing Products

9.5.1: When to Extend Product Lines

A company can extend its product line using a down-market stretch, an up-market stretch, or a move both ways.

Learning Objective

Describe the nature of a product line extension

Key Points

• A line extension should only be considered when the producer can profitably produce a product that compares well with the base product.
• Changing market environmental factors often indicate when the timing suites a product line extension.
• The environmental cues help organizations determine if they should stretch down-market, up-market, or both ways.

Key Term

product line

A product line is the marketing strategy of offering several related products for sale as individual units.

Example

• A company may notice strong growth opportunities as mass retailers such as Wal-Mart, Best Buy, and others attract a growing number of shoppers who want value-priced goods and decide to extend a product line to meet this demand.

Introduction

A product line extension is the use of an established product’s brand name for a new item in the same product platform. Thus, line extension occurs when the company lengthens its product line beyond its current range. The company can extend its product line with a down-market stretch, an up-market stretch, or a move both ways.

Down-Market Stretch

A company positioned in the middle market may want to introduce a lower-priced line for any of the three reasons:

1. The company may notice strong growth opportunities as mass retailers such as Wal-Mart, Best Buy, and others attract a growing number of shoppers who want value-priced goods;
2. The company may wish to tie up lower-end competitors who might otherwise try to move up-market. If the company has been attacked by a low-end competitor, it often decides to counterattack by entering the low end of the market;
3. The company may find that the middle market is stagnating or declining.

Up-Market Stretch

Companies may wish to enter the high end of the market for more growth, higher margins, or simply to position themselves as full-line manufacturers. Many markets have spawned surprising upscale segments:

• Starbucks in coffee;
• Haagen-Dazs in ice cream; and
• Evian in bottled water.

Leading Japanese auto companies have each introduced an upscale automobile:

• Toyota’s Lexus;
• Nissan’s Infiniti; and
• Honda’s Acura.

Note that the companies invented entirely new names rather than using or including their own names

Two-Way Stretch

Companies serving the middle market might decide to stretch their line in both directions. Texas Instruments (TI) introduced its first calculators in the medium-price-medium-quality end of the market. Gradually, it added calculators at the lower end taking the share from Bowmar, and at the higher end to compete with Hewlett-Packard. This two-way stretch won Texas Instruments (TI) an early market leadership in the hand-calculator market.

Examples include:

Take Your Pick

Coca-Cola’s product line offers a variety of Coke flavors.

Different varieties of Coke – regular Coke, Vanilla Coke, Cherry Coke, and Coke Zero Vanilla.

• Zen LXI, Zen VXI;
• Surf, Surf Excel, Surf Excel Blue;
• Splendour, Splendour Plus;
• Coca-Cola, Diet Coke, Vanilla Coke;
• Clinic All Clear, Clinic Plus; and
• Reese’s Peanut Butter Cups, Reese’s Pieces and Reese’s Puff Cereal.

A line extension strategy should only be considered when the producer is certain that the capability exists to efficiently manufacture a product that compares well with the base product. The producer should also be sure of profitable competition in this new market.

9.5.2: When to Modify Products

While the decision to modify products happens ideally at the design stage, products can be changed during any phase of the life cycle.

Learning Objective

Name the external factors that can influence product development

Key Points

• Products are modified to compete more effectively in the market, and appeal to evolving consumer and business demands.
• Multiple stakeholders ranging from employees and customers can influence product modifications.
• Product time, cost, visual appeal, usability and reliability are all factors that influence how and when a product is modified.
• External influences often prompt manufacturers to modify products. These are usually driven by competitive pressures, globalization, new technologies, or unexpected and significant events.

Key Terms

modified rebuy

the repurchase of a good with changes to the details of the order

stakeholders

A person or organization with a legitimate interest in a given situation, action or enterprise. It can range from employees and investors of a company to the customers purchasing from the company.

iterative

Of a procedure that involves repetition of steps (iteration) to achieve the desired outcome; in computing this may involve a mechanism such as a loop.

recall

To withdraw, retract (one’s words etc. ); to revoke (an order).

Example

• Large companies, in particular food producers, will slightly alter a product to attract new attention to it. For example, a soft drink company can produce a limited edition flavor of the product to renew sales levels and give it continuing interest.

When to Modify Products

The product life cycle (PLC) encompasses the multiple phases products pass through during their ‘life’ in the market. Products travel through market introduction, growth, maturity, saturation and decline, posing different challenges, opportunities and problems to manufacturers and sellers depending on industry and target audience. At some point during the life cycle, products may be modified to compete more effectively in the market, and appeal to evolving consumer and business demand .

Phases in the Product Life Cycle

Modification decisions often (but not always) happen before products are introduced to the market.

Product Design Stage

At the design stage, developers and engineers must assess the importance of various requirements from a wide range sources. Stakeholders typically contribute input during product development, demanding something different from the product designer and design process.

Factors that can influence whether products are modified at the design stage include:

• Overall production time and cost
• Price, appearance, and prestige value
• Usability and functionality
• Assembly and reliability

Stakeholders’ needs vary from one another and it is the product designer’s job to incorporate those needs into their design. Product design is an iterative process, and often needs to be modified due to manufacturing constraints or conflicting requirements. Where a customer order fits into the timeline depends on the industry type and whether the products are for example, built to order, engineered to order, or assembled to order.

Market Influences

Although product manufacturers painstakingly consider numerous details and possibilities of what could go wrong, many new designs ultimately fail or become obsolete. These product failures usually go back to the manufacturer for modifications, and are later re-introduced to the market. Other products are never re-introduced and deleted entirely from the product roadmap. Product development can take as many as five to six attempts before achieving success in the marketplace.

Innovation provides much of the competitive impetus for the development of new products, with new technology often requiring a new design interpretation. It only takes one manufacturer to create a new product paradigm to force the rest of the industry to catch up, fueling further innovation. While some products are completely new innovations, others are simply minor modifications to existing products.

New and rapidly changing technologies, evolving trends, increased demand and globalization are all factors that play into the decision to add product features and functionality. Unpredictable forces such as mass contamination can lead to product recalls, and the modification or destruction of large quantities of products. In 2007, millions of toys manufactured in China were recalled due to discoveries of lead paint and fears of lead poisoning in children. Product recalls, which can happen at any stage of a product life cycle, are costly and can severely damage a brand’s reputation if managed poorly.

9.6: New Product Development

9.6.1: The Need for New Products

In dynamic markets companies must constantly introduce new products and services to keep up with changing consumer wants and needs.

Learning Objective

Discuss the common challenges of developing successful new products

Key Points

• A company must establish a series of successful products over time if it wants to maintain a consistent stream of sales, or grow sales over time.
• New product generation involves multiple stages and a high level of financial investment, and has no guarantee of success.
• When a new product is introduced, companies must still convince buyers to adopt them into their routines, in order for sales to be consistent.
• Innovation may be ‘continuous’ or ‘discontinuous’ – the former occurring in established markets, while the latter has the potential to create new markets or consumer behaviors.

Key Terms

planned obsolescence

a policy of deliberately planning or designing a product with a limited useful life, so it will become obsolete or nonfunctional after a certain period

obsolescence

The process of becoming obsolete, outmoded or out of date.

innovation

As used here, innovation describes an idea or product that is new to the company in question.

new product

a good or service that was previously not offered by the company

The marketplace is never static: it is dynamic and fast changing, and demand for products is constantly shifting as needs, wants, and technology all change. As a result, companies must always evaluate their existing product line and look for ways to ensure that it is up to date and in line with consumer desires. Continuous decisions must be made about whether new products should be added (and whether old products should be removed).

For instance, the graph in shows how an organization must establish a series of successful products if it wants to maintain a consistent stream of sales, or grow sales over time. As shown in the graph, no product lasts forever, and sales levels can fluctuate dramatically over time. This fictitious company has marketed eight different products over time.

Company Sales

Sales of individual products and total company sales for a fictitious company with multiple products.

In the past, four of these products have been deleted as they near obsolescence (the products labeled as A, B, C, and F). As a result, the sales level in the most current period depends upon the success of the remaining four products. If the firm has a goal to increase sales in the coming years, then it is imperative for that firm to introduce a new group of successful products.

Organizations invest a lot of money to create new products that perform effectively. Nonetheless, firms often struggle to convince people to try out these products, and to use them on a regular basis (and thus incorporate them into their habits and routines). For example, it took 18 years for microwave ovens to gain acceptance in Greece. The ultimate success of new products depends on consumers accepting them.

Innovation

‘Innovation’ is used here to describe an idea or product that is new to the company. A ‘continuous innovation’ introduces a new entrant into an existing category, and does not challenge established patterns of consumer behavior. An example of this is a new, technologically advanced cell phone. A ‘discontinuous innovation’ may alter existing consumption patterns, and even create new ones. For example, portable audio equipment has evolved from the radio, to the cassette tape player, to the compact disk player, and to the digital audio player – and now, to Cloud-based systems. Discontinuous innovation has the potential to radically shift consumer habits and thus create new demand for a whole category of products and services, but understandably entails more risk for the organization.

9.6.2: Strategy

A good NPDS can help organize research, prioritize customer needs, and reduce cost overruns, to ensure a smooth development process.

Learning Objective

Describe the three common approaches to strategically developing new products

Key Points

• Three common approaches to NPDS are user-centered design, flexible product development, and the phase-gate model. There are many other approaches used as well, and what approach to use depends on the nature of the management, the product, and the market.
• User-centered design emphasizes the wants, desires and limitations of the end-user in designing how to develop the product.
• Flexible product development emphasizes a flexible development process, instead of focusing on users as user-centered design does. By making the process as flexible as possible, necessary changes can take place very late in the development process with minimum disruption.
• The phase-gate model separates the different phases by using “gates”–at each gate, a steering committee uses all available information to decide whether to proceed with the development process or not.

Key Terms

flexible product development

A new product development strategy designed so that changes can be made late in the process without excessive disruption.

user-centered design

A new product development strategy where the needs of the end users are given the most attention.

Phase-gate model

A new product development strategy that is divided into phases, separated by gates.

New Product Development Strategy

A well thought out new product development strategy (NPDS) helps a company avoid wasting time and resources by helping to organize planning and research, understanding customer expectations, and accurately resourcing the project. By avoiding common errors such as overestimating the target market, incorrectly setting the price, and accruing higher than predicted costs, a NPDS helps the product to be developed and launched as planned.

The nature of the business and the product in question will determine the NPDS, and what steps need to be taken. Certain steps may be iterated as needed, and others may be eliminated. To speed up the process, many companies complete several steps at the same time (known as “time to market”). For some more complicated products, a large amount of uncertainty makes it impossible to plan the complete project before starting it, and thus a flexible approach is required.

There are many different ways to approaching NPDS. Some of the more common ways are described below.

User-Centered Design (UCD)

Here, the needs, wants and limitations of end users of a product are given a great deal of attention at each stage of the design process. The main element in this process is that user-centered design tries to optimize the product around how users can, want, or need to use the product, rather than forcing users to change their behaviors to accomodate the product.

Flexible Product Development

Flexible product development is the ability to make changes in the product being developed or in how it is developed, even relatively late in development, without being too disruptive. Flexibility is important because the development of a new product naturally involves change from what came before it. Change can be expected in what the customer wants and how the customer might use the product, in how competitors might respond, and in the new technologies being applied in the product or in its manufacturing process. The more innovative a new product is, the more likely it is that the development team will have to make changes during development.

Flexible development counteracts the tendencies of many contemporary management approaches to plan a project completely at its outset and discourage change thereafter. These include Six Sigma, which aims to drive variation out of a process; Lean, which acts to drive out waste; and traditional project management and phased development systems (including the popular Phase–gate model, discussed next), which encourage upfront planning and following the plan. Although these methodologies have strengths, their side effect is encouraging rigidity in a process that needs flexibility to be effective, especially for truly innovative products. Flexibility techniques must be used with discretion, for instance, only in the portions of a product likely to undergo change, in order to minimize potential disruptions, delays, and cost overruns.

Six Sigma

The symbol for Six Sigma, which is a contemporary management approach.

Phase-Gate Model

In a phase–gate model, also referred to as a phase–gate process, the process is divided into stages or phases, separated by gates. At each gate, the continuation of the process is decided by (typically) a manager or a steering committee. The decision is based on the information available at the time, including the business case, risk analysis, and availability of necessary resources (e.g., money, people with correct competencies). The phase–gate model may also be known as stage-limited commitment or creeping commitment.

9.6.3: Idea Generation

The success of product-driven companies is directly tied to new product development, which is generated through innovative ideas.

Learning Objective

Identify the five primary sources of product innovation

Key Points

• The five main sources of innovation are technological breakthough, non-technological development, environment, serendipity, and purposeful development.
• It is possible to create new ideas and new ways of producing products through non-technical means. This would involve using well-known business models and slightly modifying the production process to appear unique.
• The process of serendipity frequently occurs due to government funding of general and scientific research, causing technological and other spillovers into the commercial realm. These spill over effects generate new ideas for products that would have otherwise not been discovered.

Key Terms

Generation X

the generation of people born after the baby boom that followed World War II, especially those born in the 1960s and 1970s

SWOT Analysis

A structured planning method used to evaluate the strengths, weaknesses, opportunities, and threats involved in a project or in a business venture.

purposeful development

Innovation that occurs in response to a market need that existing product lines cannot satisfy.

Idea Generation

Ideas for new products can be obtained from basic research using a SWOT analysis. Market and consumer trends, R&D departments, competitors, focus groups, etc. may also be used to get an insight into new product lines or product features. New product innovations are responsible for employment, economic growth, technological process, and high standards of living. Innovation is crucial for the development of successful new products. Described below are different sources of innovation that lead to the generation of ideas for new products.

Sources of Innovation that Generate Ideas

While innovation is crucially important to any forward-thinking organization, developing and evaluating innovations is a challenge. Where do innovative ideas come from? Discussed below are five crucial sources of innovation: technical breakthrough, non-technical idea development, environment, serendipity, and purposeful development. These are discussed in turn below (see ).

Different Sources of Innovation

A summary of different sources of innovation, as described in this section. Being innovative is key to generating new ideas in product development.

A table to shows different sources of innovation (technical breakthrough, non-technical idea development, idea from environment, serendipity, and purposeful development).

Technical Breakthroughs

Technical breakthroughs refer to product innovations that result from technical developments. New brands that have emerged from this process include MP3 players, GPS navigation devices, and cell phones. Technological breakthroughs are often born in R&D departments or through government funding of research, which ultimately lends itself to commercial uses.

Non-technical Development

This approach involves finding a niche in the market without making radical changes to the basic product category (i.e., in terms of the underlying technology). “Build a Bear Workshop” provides a good example of this style of innovation: Unlike other conventional stuffed animal manufacturers, the Build a Bear Workshop allows customers to choose their bear’s body, sound, clothing, stuffing, and heart. For example, a customer can choose a lower-priced paper heart with their wish, or they can invest in a higher-priced electronic heart. After customers make choices, they then observe the production process in the shop. In this way, customers create their own custom-designed toy. This business model does not rely on developing new technology, but a modified production process and a unique idea that draws the consumer in.

Environment

Certain ideas developed in one environment or geographical location have the potential to do well when imported into new environments. Good examples of this style of innovation are Wal-mart in China and IKEA in the United States–ideas that proved a big hit outside of the cultures that they were traditionally employed in. Large-retail stores are now achieving success in Asian nations, through importing the idea of economies of scale, which in turn enable one-stop shopping and lower prices. Similarly, IKEA achieved great success in the United States through importing the idea of a warehouse-type retail setting from Europe.

Serendipity

Serendipity plays a role in product innovation. The word serendipity derives from “serendip,” which means “Sri Lanka” in Persian. The fairy tale, The Three Princes of Serendip, tells the story of three men who continuously discover something that is completely unrelated to what they originally set out to find. Thus, the term “serendipity” describes a situation where one accidentally discovers something fortunate, while looking for something else entirely. For example, penicillin was discovered quite by accident when Alexander Fleming discovered that a mold contaminating one of his experiments possessed powerful antibacterial properties. While not exactly a strategy that can be purposefully conducted by companies attempting to come up with a specific product, the process of serendipity frequently occurs due to government funding of general and scientific research, causing technological and other spillovers into the commercial realm.

Purposeful Development

Purposeful development occurs when there is a strong need for certain goods or services. As Plato once said, “Necessity is the mother of invention.” In other words, this type of innovation occurs when existing product lines cannot satisfy current needs or current demand. As a result, organizations are willing to invest considerable funds to create a successful innovation. Thus, purposeful development occurs when there is a need that requires satisfaction, as opposed to when demand creation is required for a new product for which there is no initial desire in the marketplace. A good example of purposeful development is the heavy investment that pharmaceutical firms make to discover new prescription drugs.

9.6.4: Screening

During screening, the company evaluates whether to devote further resources to the development of a product at various stage gates.

Learning Objective

Discuss the benefits and shortcomings of product screening

Key Points

• The company must ask itself a number of questions, such as whether there is a potential market for the product, whether the product will meet the demands of the consumer base, and whether the product can be profitable.
• Two major risks arise during screening: an unviable product may be admitted to the next stage, and a potentially successful product may be rejected.
• Products are often rated on a scale from poor to good on a variety of different criteria in order to determine their viability. This process is taken a step further by assigning weights to the criteria, so as to give more importance to factors considered crucial for a product’s success.

Key Term

screening

A step in the product development process where products are evaluated according to a certain set of criteria on whether they will be successful in the marketplace.

Screening

It is important for businesses to continually devise new products, as products do not last forever. While there are millions of products available to consumers, many more products do not make it to market at all. As it is expensive to bring a product to market, products go through a product development process where they are evaluated at every stage before they are brought to commercialization. For example, of the 5,000 drug ideas that go through the screening process of the Federal Drug Administration, only 10 end up getting approved, and of these only 3 become profitable. With an average cost of $1 billion to bring a drug to market, it would take several billion in sales to recoup the cost .

Screening

This figure illustrates the long process it takes for a drug to enter the market.

Screening Objectives

The objective of the screening stage is to eliminate unsound concepts prior to devoting resources to them. The screeners should ask several questions: Will the customer in the target market benefit from the product? What is the size and growth forecast of the target market? What is the current or expected competitive pressure for the product idea? Is it technically feasible to manufacture the product? Will the product be profitable when manufactured and delivered to the customer at the target price? By answering these questions, the company can get a better idea of the likelihood of a product becoming a commercial success.

The screening step is a critical part of the new product development process. Product ideas that do not meet the organization’s objectives should be rejected. Two problems that may arise during the screening stage are the acceptance of a poor product idea, and the rejection of a viable product idea. In the former case, money and effort are wasted in subsequent stages until the product idea is abandoned. In the latter case, a potential winner never sees the market.

Screening Techniques

There are two common techniques for screening new product ideas. Both involve the comparison of a potential product idea against the criteria for acceptable new products. The first technique is a simple checklist. For example, new product ideas can be rated on a scale ranging from very good to poor, in respect to factors such as value added, sales volume, patent protection, and effect on present products. Unfortunately, it is often very challenging for evaluators to define what is fair or poor in any given category. Also, this system does not address the issue of the time and expense associated with each idea, nor does it provide instructions with regard to the scores.

The second technique goes beyond the first in that the criteria are assigned weights based on their importance. These scores are then multiplied by their respective weights and added to yield a total score for the new product idea.

9.6.5: Concept Testing

Concept testing is important for evaluating consumer responses to a product before market introduction.

Learning Objective

Explain concept testing, its disadvantages, and alternative methods used to evaluate consumer behavior toward new concepts

Key Points

• Concept testing can also be useful in altering existing attitudes towards existing products in the market.
• Concept testing uses qualitative and quantitative methods. Concept generation portions of concept testing are generally qualitative, while evaluations, positioning, and product/concept tests are usually quantitative.
• Traditional methods of concept testing faced many shortfalls, including not providing consistent information on the ranking of consumer preferences. However, newer methods are alleviating such issues and providing more useful information.

Key Term

concept testing

The process of evaluating consumer response to a product idea prior to the introduction of the product to the market.

Concept testing

Concept testing is the process of using quantitative and qualitative methods to evaluate consumer response to a product idea prior to the introduction of a product to the market. It is a vital part of the idea screening stage of new product development. It can also be used to generate communication designed to alter consumer attitudes toward existing products. These methods involve the evaluation by consumers of product concepts having certain rational benefits, such as “a detergent that removes stains but is gentle on fabrics,” or non-rational benefits, such as “a shampoo that lets you be yourself.” Concept testing is often performed using field surveys, personal interviews and focus groups, in combination with various quantitative methods.

Focus Group

Using focus groups to generate user feedback is one method used to perform concept testing.

The concept generation portions of concept testing are generally qualitative. Advertising professionals create concepts and communications of these concepts for evaluation by consumers, on the basis of consumer surveys and other market research, or on the basis of their own experience as to which concepts they believe represent product ideas that are worthwhile in the consumer market.

The quantitative portions of concept testing procedures have generally been placed in three categories: (1) concept evaluations, where concepts representing product ideas are presented to consumers in verbal or visual form and then quantitatively evaluated by consumers by indicating degrees of purchase intent, likelihood of trial, etc., (2) positioning, which is concept evaluation wherein concepts positioned in the same functional product class are evaluated together, and (3) product/concept tests, where consumers first evaluate a concept, then the corresponding product, and the results are compared.

Shortcomings of Traditional Concept Testing

Traditional systems of concept testing generally failed to provide a systematic, proven way of showing consumer preference of one concept over another. The relative importance of the factors responsible for or governing why consumers, markets and market segments reacted differently to concepts presented to them in the concept tests were not demonstrated. Thus, communication of the concept was generally left to the creativity of the advertising agency, with no systematic quantitative method known or employed that could identify the criteria on which consumer choices were made (at least, not with any real accuracy).

Moore and William (1982), in a literature survey and review of concept testing methodology, point out that concept tests have failed to account for changes between the concept tested and the communication describing the benefits of the product which embodies the concept. The paper reports that “no amount of improvement in current concept testing practices can remedy these problems. ” This is reflective of the fact that none of the traditional methods provided a quantitative means for ascertaining the relative importance of the underlying criteria of concept choices as a means for identifying the visual and verbal expressions of the concepts which best communicate the benefits sought by the consumer. Nor did the traditional methods quantify the relationships between concepts and existing products offered in the same consumer market. The ability of a method to ameliorate or overcome the above shortcomings would provide substantial improvement in communication of the concepts identified in testing and offered to the market as a product.

One such method is conjoint analysis and another is choice modeling. In addition, with online retailing becoming increasingly prominent, many online respondents are also online consumers. Thus, they are able to easily place themselves in the mindset of a consumer looking to buy goods or services. Since the arrival of these methods, market researchers have been able to make better, more accurate, suggestions to their clients regarding the decision to move forward, revise, or start over with a product concept. Online choice modeling, for example, can produce detailed econometric models of demand for various attributes of the new product such as feature, packaging and price.

9.6.6: Business Analysis

The output of the business analysis stage is a prediction about whether the product is likely to be profitable or not if ultimately produced.

Learning Objective

Demonstrate knowledge of the components included in the business analysis stage of product development

Key Points

• The first step in the business analysis process is to examine the likely demand for the product, as well as possible licensing of technologies associated with the product.
• A cost appraisal is also carried out, which involves looking at development costs, management costs, operating costs, set-up costs, and marketing costs.
• Based on the above costs, as well as the level of competition and customer feedback, a selling price and break-even point can be identified.

Key Term

Fourt-Woodlock equation

a market research tool to describe the total volume of consumer product purchases per year based on households which initially make trial purchases of the product and those households which make a repeat purchase within the first year.

Business Analysis

After the initial screening stage, the number of viable proposals available to progress to the next stage will have decreased significantly. However, before the company begins the development of prototypes, there is one more evaluation process that must take place, and this is the business analysis stage. In this stage, additional information is gathered on the remaining innovations in order to decide whether the significant costs that development will require are justified .

Business Analysis

Financial ratio analysis allows an observer to put data provided by a company in context. The observer can gauge the strength of different aspects of the company’s operations.

Stacks of gold coins.

The primary focus of the business analysis stage is to determine whether the product idea will ultimately be profitable or not. However, while this is the primary consideration, it is not the only consideration. Social and environmental issues are frequently considered as well, particularly if there are certain regulations that the company must adhere to in these realms.

The first step in the business analysis process is to examine the projected demand for the product. While the major source of revenue would be product sales, another possible significant source of revenue is the licensing of the technology generated as a byproduct of the given product. Clearly this is not applicable to all products, but for certain classes of products, this can be a very significant source of income .

A complete cost appraisal is also necessary as part of the business analysis. As you can expect, it is difficult to anticipate all the costs that will be involved in product development. However, the following cost items are typical:

• Expected development cost, including both technical and marketing R&D
• Expected set-up costs (production, equipment, distribution)
• Operating costs that account for possible economies of scale and learning curves
• Marketing costs, especially promotion and distribution
• Management cost

Based on these costs, the business analysis stage will estimate the likely selling price. This figure will also depend on the level of competition, as well as customer feedback. Sales volumes must also be estimated based on the size of the market (using, for instance, the Fourt-Woodlock equation). Ultimately, profitability and the estimated break-even point can be derived. Customers base buying decisions on a personal value equation where the value is calculated by weighing the cost versus the benefits. This relates to the viability and feasibility of products that companies are considering to add to their line.

9.6.7: Development

Development involves setting product specifications as well as testing the product with intended customer groups to gauge their reaction.

Learning Objective

Describe the steps involved in the technical and marketing development stages of new product development

Key Points

• Technical development involves creating a prototype to develop exact product specifications.
• The technical development stage also involves getting a good idea for the different methods and costs of making the product in a factory setting.
• The concept test is usually the first stage for the marketing department during the development stage. In addition to the product, elements such as packaging and labeling can also be tested with potential consumers.

Key Terms

development stage

The stage where prototypes are created, and questions of production and marketing are asked.

development

the complete process of bringing a new product to market

Development

Once a potential product has passed the screening and business analysis stages, it goes onto the technical and marketing development stage. This stage includes identifying the target market and the decision maker in the purchasing process, determining what features must be incorporated into the product and the most cost-effective way to produce it, and establishing what the actual cost of production will be.

Technical Development

Technical development involves two steps. The first is the applied laboratory research required to develop exact product specifications. The goal of this research is to construct a prototype model of the product that can be subjected to further study. Once the prototype has been created, manufacturing methods research can be undertaken to plan the best way of making the product in commercial quantities under normal manufacturing conditions. This is an extremely important step, because there is a significant distinction between what an engineer can assemble in a laboratory and what a worker can produce in a factory.

Prototype

A company develops a prototype in order to conduct further testing on a potential product.

A Toyota car prototype on display.

Testing Process

While the laboratory technicians are working on the prototype, the marketing department is responsible for testing the new product with its intended consumers and developing the other elements of the marketing mix.

Concept Test

The testing process usually begins with the concept test. The product concept is a synthesis or a description of a product idea that reflects the core element of the proposed product. For example, a consumer focus group might be assembled and the interview session might begin with the question: “How about something that would do this?”

Consumer Testing

The second aspect of market development involves consumer testing of the product idea. This activity usually follows the construction of the prototype or limited production models. Various kinds of consumer preference can be conducted. The product itself can be exposed to consumer taste or use tests. Packaging, labeling, and other elements in the mix can be similarly studied.

9.6.8: Test Marketing

Test marketing is the final stage before commercialization, and is where all the elements of the marketing plan are tested.

Learning Objective

Discuss the requirements that must be satisfied to conduct successful test marketing of new products and distinguish test marketing from initial product testing

Key Points

• Initial product testing and test marketing are very different. The former involves providing consumers with the test product, and giving them an incentive to participate. The latter involves all the elements of the marketing plan, in a real-world setting meant to simulate the broader market.
• There are risks in test marketing, such as high initial marketing costs, the potential to lose customer goodwill before the official launch, and giving competitors the opportunity to quickly copy the product.
• Variables in the test marketing process include the selection and number of test cities, as well as the ideal sample size to use.

Key Term

test marketing

The stage where all the variables in the marketing plan, as well as the product characteristics, are tested in a real-world setting.

Test Marketing

This is the final step before commercialization. The objective of the this marketing phase is to test all the variables in the marketing plan, including different elements and characteristics of the product. This stage represents the launching of the total marketing program, albeit on a limited basis.

Three questions can be answered through test marketing:

• Is the overall workability of the marketing plan realized as planned?
• Do alternative allocations of the budget need to be evaluated?
• Can we determine whether users are being inspired to switch from their previous brands to the new one, and whether repeat purchases are taking place?

In the end, the test market should include an estimate of sales, market share, and financial performance over the life of the product.

Initial product testing versus test marketing

Initial product testing and test marketing are not the same. Product testing is totally initiated by the producer: he or she selects the sample of people, provides the consumer with the test product, and offers the consumer some sort of incentive to participate.

Test marketing, on the other hand, is distinguished by the fact that the test cities represent the national market. The consumer must make the decision herself, must pay his or her own money, and the test product must compete with the existing products in the actual marketing environment. For these and other reasons, a market test is meant to serve as an accurate simulation of the national market and serves as a method for reducing risk. It should enhance the new product’s probability of success and allow for final adjustment in the marketing mix before the product is introduced on a large scale.

Risks

Test marketing is not without inherent risks. First, there are substantial costs in buying the necessary productive capacity needed to manufacture the product or locating manufacturers willing to make limited runs. There are also promotional costs, particularly advertising and personal selling . Although not always easy to identify, there are indirect costs as well. For example, the money used to test market could be used for other activities. The risk of losing consumer goodwill through the testing of an inferior product is also very real. Finally, engaging in a test-market might allow competitors to become aware of the new product and quickly copy it.

Test Marketing

Aggressive promotion in a limited geographical area is often a key element of the test marketing phase.

A Red Bull mini truck that’s used for test marketing.

Because of the special expertise needed to conduct test markets and the associated expenses, most manufacturers employ independent marketing research agencies with highly-trained project directors, statisticians, psychologists, and field supervisors. Such a firm would assist the product manager in making the remaining test market decisions.

Variables

• Selection of test market cities: these cities should reflect the norms for the new product in such areas as advertising, competition, distribution system, and product usage.
• Number of test cities: should be based on the number of variations considered (i.e. vary price, package, or promotion), representativeness, and cost.
• Sample size determination: the number of stores used should be adequate to represent the total market.

Even after all the test results are in, adjustments in the product are still made. Additional testing may be required, or the product may be deleted if it does not perform well during this stage, or if it becomes apparent that the product is not likely to become a commercial success.

9.6.9: Commercialization

Commercialization the process of launching a new product; it may involve heavy promotion and filling the distribution networks with the product.

Learning Objective

Describe the three steps that must be implemented during the commercialization of new products

Key Points

• The timing of the launch should coincide with a good economic situation to maximize sales. Cannibalization of existing products should be avoided, and the product should only be launched when no further improvements are foreseeable.
• Companies must decide which location(s) to launch, depending on their target markets, capabilities, and marketing strategy.
• By targeting the primary consumer group (which includes innovators, early adopters, and opinion leaders), the company can ensure adoption by other buyers in the market place during the product growth period.

Key Term

commercialization

The process of introducing a new product into the market.

At last the product is ready to go. It has survived the development process and it is now on the way to commercial success (if all goes well, that is!). ‘Commercialization’ is the process or cycle of introducing a new product or production method into the market. In this stage, the product is launched, advertisements and promotional activity begins and increases heavily, and the distribution pipeline is filled with the product. The actual launch of a new product is the final stage of new product development, and the one where the most money will have to be spent for advertising, sales promotion, and other marketing efforts.

The commercialization process

Commercialization of a product will only take place, if the following three issues are satisfied:

• Timing of launch: When facing the danger of cannibalizing the sales of the company’s other products, if the product can be improved further, or if the economy is down, the launch should be delayed.
• Launch location: It can be in a single location, one or several regions, a national or the international market. This decision will be strongly influenced by the company’s resources, in terms of capital, managerial confidence and operational capacities. Smaller companies usually launch in attractive cities or regions, while larger companies enter a national market at once. Global roll outs are generally only undertaken by multinational conglomerates, since they have the necessary size and make use of international distribution systems (e.g., Unilever, Procter & Gamble). Other multinationals use the “lead-country” strategy: introducing the new product in one country/region at a time.
• Target consumers: The primary target consumer group will have been identified earlier by research and test marketing. This primary consumer group should consist of innovators, early adopters, heavy users and/or opinion leaders. This will ensure adoption by other buyers in the market place during the product growth period.

The company has to decide on an action plan for introducing the product by implementing the above decisions. It has to develop a viable marketing-mix and create a respective marketing budget. When a plan is in place for each of these three issues, then the commercialization process may begin .

Launching a New Product

Whenever Apple launches a new product, there are crowds outside waiting to get their hands on the new product.

9.6.10: Success and Failure: Strategies to Improve Success

Marketers must learn from their own previous failures, and others’ failures, to ensure that they are successful for the next product launch.

Learning Objective

Describe how market structure and business model, culture and communication, political and regulatory, and product/service factors impact a company’s market success and failure

Key Points

• Four areas that marketers must pay attention to in order to maximize the chances of success are: (a) market structure and business model; (b) cultural and communication; (c) politics and regulation; and (d) product/service failure.
• Companies must align their business model to the structure of the market that the product is entering. No business model will work in all situations, and so it must be altered appropriately.
• Any product will run up against certain cultural factors. By understanding these, and avoiding problems (or even making use of such factors), companies can increase their chances of success.
• Companies must be aware of all legal regulations as well as potential political issues that may arise from the release of their product, and act accordingly to negate such issues.

Key Term

cultural factors

Differences in cultures (be they national or corporate cultures) that managers must pay attention to in order to ensure success.

Example

• As we saw in the case study, Wal-Mart came up against all these factors when attempting to launch in Germany. With a finer appreciation of these potential issues, and a plan to counteract them, it would have had more success in the country.

Success and Failure

A product fails when it does not meet the objectives that were established before its release. The following case study describes Wal-Mart’s failure to enter the German market, and highlights many of the problems faced by marketers in making a successful product. By learning from the failures of others (and their own prior failures), marketers may learn how to succeed in future. For a summary of the reasons why products fail as applied to the Wal-Mart case.

Wal-Mart’s Failure in Germany

Marketers face many challenges when making and introducing a successful product.

A chart that summarizes a case study of why Wal-Mart failed in Germany.

Wal-Mart case study

Wal-Mart is the world’s biggest food retailer. In some nations, it is a great success. However, it has failed in some countries (e.g. Germany, South Korea). Here, we will describe Wal-Mart’s failure in Germany, and use its experiences there to illustrate some key principles relating to product failure and deletion.

There is fierce competition in the German grocery industry, and thus, low profitability in the food retail sector; profit margins range from 0.5-1%. The main feature of Wal-Mart’s business model is to continuously cut costs and so offer lower prices than its competitors. Wal-Mart also continuously pressures its suppliers to cut costs.

In 1997-1998, Wal-Mart acquired over 95 stores from existing German supermarket chains, making it the fourth biggest supermarket operator in Germany. The objective was to expand to 500 stores. However, Wal-Mart never grew from the original 95 stores. By 2007, it was bought out by one of Germany’s largest retail groups. Ultimately, Wal-Mart left the German market with a loss of one billion dollars before tax.

There are four key issues related to Wal-Mart’s failure in Germany: (a) market structure and business model; (b) cultural and communication; (c) politics and regulation; and (d) product/service failure.

Market structure and business model

A retailer that wants to follow Wal-Mart’s strategy of low prices needs to expand rapidly. In Germany, there were not enough appropriate locations to support such expansion. Wal-Mart did not build their own stores, but took over existing supermarkets that had a completely different business model – they were very small and had a limited range of goods. They were also located far apart, which resulted in high logistical costs.

With their strategy of “everyday low prices,” Wal-Mart is very successful in the United States and elsewhere. However, due to the extreme competition, Germans are accustomed to the low prices that are offered by numerous discount supermarket chains. For this reason, Wal-Mart’s low price strategy did not create sufficient competitive advantage.

Culture

and communication

When products are introduced, it is important to consider cultural factors. Wal-Mart decided to operate its German locations from the UK. Thus, its “corporate language” was English. However, many of the older German Wal-Mart managers did not speak English. Some managers did not stay on after the Wal-Mart acquisition. Key business connections were lost, which resulted in the loss of major suppliers. It would have been far better to retain and communicate effectively with the German managers who had know-how about the local market.

Politics and regulation

Wal-Mart’s managers violated German laws repeatedly, simply because they were unfamiliar to them. For example, Wal-Mart always stays union-free, but Germany has a history of strong, politically powerful unions. Ver.di, one of Germany’s biggest unions, sued the company for failing to publish key financial statements in 1999 and 2000. A fine, as well as much negative press, harmed Wal-Mart’s reputation.

After its expansion strategy failed, Wal-Mart began a price war to drive small competitors out of business. One part of the price war was to introduce a private label called “Smart Brand” and sell most of these products below manufacturing costs. The reaction of many competitors was also to decrease their prices, which led to a profit setback for the entire industry. Finally, the Federal Cartel Office interceded and stopped the price war.

Product/service failure

Good customer service, combined with low prices, could have been a new market niche in Germany. One part of Wal-Mart’s customer service program was to ensure someone was always there to help. However, customer reaction was negative, because customers who normally do their grocery shopping in discount supermarket chains are used to self-service. They found this annoying, and it did not create a reputation for providing good customer service.

Conclusion

Wal-Mart tried to apply its U.S. success formula in an unmodified manner to the German market. As a result, they didn’t have sufficient knowledge about the market structure and key cultural / political issues. In addition, structural factors prevented Wal-Mart from fully implementing its successful business model. The final outcome was that it had to abandon its offerings in Germany. Had Wal-Mart paid careful attention to these issues prior to entering the German market, it could have had a very different outcome.

9.7: Differentiating Factors in Product Design

9.7.1: Quality

Consumers place a value on quality; therefore high quality products may be able to win share and/or command a price premium.

Learning Objective

Identify the attribute of quality at the design stage as a differentiating factor

Key Points

• Quality is considered a non-functional requirement in product design, affecting the execution and evolution of a product.
• The five aspects of quality in a business context include producing, checking, controlling, managing, and assuring quality in products and services.
• Manufacturers often view quality as a driver for productivity, increased revenues, and technological advances.

Key Terms

extensibility

A quality of design that takes possible future advances into consideration and attempts to accommodate them.

ISO

The ISO is the International Organization for Standardization.

conformance

The act of conforming; conformity.

Quality

Quality in business, engineering, and manufacturing has a pragmatic interpretation as the non-inferiority or superiority of something; it is also defined as fitness for purpose. Product quality can vary depending on perception and is considered somewhat subjective since it may be understood differently by different people. When it comes to quality in product design, manufacturers might measure how well products conform to certain requirements or the level of accuracy in products and services following production. Consumers may focus on product features and how well the product compares to competing brands in the marketplace. Support personnel may measure quality in the degree that a product is reliable, maintainable, or sustainable.

Improving Product Quality

Improving product quality in businesses can lead to better productivity and more innovation.

Quality is considered a non-functional requirement in engineering, affecting the execution and evolution of a product. Product qualities can be divided into two main categories:

• Execution qualities, such as security and usability.
• Evolution qualities, such as testability, maintainability, extensibility, portability, and scalability.

Product Quality in Business

During the 1960s, the U.S. military, aerospace, and nuclear industries developed the original versions of the Quality Management System Standards (eventually merged to ISO 9001). These standards were established to produce better products on a consistent basis, while focusing on production, conformance, and quality control mechanisms. Within areas such as product design and manufacturing, five main aspects of quality fall under this scheme. They include:

1. Producing – providing a product or service.
2. Checking – confirming that a product or service has been produced correctly.
3. Quality Control – controlling a process to ensure that the outcomes are predictable.
4. Quality Management – directing an organization so that it improves its performance through analysis and innovation.
5. Quality Assurance – obtaining confirmation (usually from the purchaser or a third-party) that a product or service will be satisfactory.

Managing quality is fundamental to any activity, particularly in the design and manufacturing of consumer and industrial goods. For manufacturers of products, it is commonly stated that “quality drives productivity.” Better productivity is viewed in direct correlation to increased revenues, employee opportunities, and technological advances. Thus, businesses must have a clear understanding of all aspects of product quality, measure product performance, and adapt their market strategy for longevity and growth.

9.7.2: Design and Feature Set

Premium features and design may help differentiate a product to earn it share or a price premium in the marketplace.

Learning Objective

Outline the concept of design and feature sets as differentiating factors in product design

Key Points

• During product design, companies must consider factors such as cost, producibility, quality, performance, reliability, serviceability, and user features.
• Companies must be cognizant of feature creep, which is the ongoing expansion or addition of new features in a product.
• Product design teams can control feature creep by setting strict limits for allowable features or limiting features in some product versions.
• Once products reach the stage of maximum functionality, manufacturers face the choice of adding extraneous functions, sometimes at the cost of efficiency.

Key Terms

feature creep

The tendency of a design project or product cycle to accumulate more and more features or details, rather than to be completed and released at a more basic level.

serviceability

The property of being serviceable, of being useful for some function.

Design and Feature Set

In systems engineering, a requirement (often referred to as a functional requirement) can be a description of what a system must do. Another type of requirement specifies something about the system itself, and how well it performs its functions. Such requirements are often called non-functional requirements, performance requirements. or quality of service requirements. Examples of such requirements include usability, availability, reliability, supportability, testability, and maintainability. These requirements define the characteristics or features of the desired product during the design process .

Product Features

Features must meet usability and reliability requirements before being built into products and systems.

Product Design Process

Product design involves developing a device, assembly, or system into an item for sale using a production manufacturing process. During product design, engineers and designers must consider factors such as cost, producibility, quality, performance, reliability, serviceability, and user features. A product must go through the design and development of its mechanical, electronics, and software components before transitioning to manufacturing for mass production.

For example, the development of digital cameras would include defining the feature set; designing the optics, as well as the mechanical and ergonomic aspects of the packaging; developing the electronics that control the various components; and developing the software that allows users to view and manipulate photos, store them to memory, and download to them to a computer.

Dangers Of Feature Creep

Customer demand for particular features or functionality can result in products tailored to very specific, niche markets. However, manufacturers must be cognizant of feature creep, which is the ongoing expansion or addition of new features in a product. Although providing consumers more useful or desirable products and increasing sales are priorities for most businesses, extra features going beyond product function can result in over-complication.

Once products reach the stage of maximum functionality, manufacturers face the choice of adding extraneous functions, sometimes at the cost of efficiency. On the other hand, the manufacturer must deal with ignoring older versions at the cost of being perceived by the market as stagnant or dated. Nevertheless, introducing a bloated feature set can move the product or system beyond its initial goals, increasing production costs and schedule overruns. Introducing too many requirements into a feature set has often been blamed for endangering and even killing products and projects.

Another major cause of feature creep might be a compromise from a committee which decides to implement multiple, different viewpoints in the same product. As more features are added to support each viewpoint, it might be necessary to have cross-conversion features between the multiple viewpoints, further complicating the total features.

Feature Control In Product Design

To control the number of product features during the design phase, manufacturers set strict limits for allowable features and multiple variations. Excess features are removed or delayed until the later delivery phases of the project. Quality control is also maintained through multiple variations of products, where features are kept limited in some versions. Because the ever-growing, ever-expanding addition of new features might exceed available resources, a minimal “basic” version of a product can be maintained separately to ensure operation in smaller operating environments.

Other companies might use the “80/20 Rule”, where more basic product variations might support the needs of about “80%” of the users. Thus, the bulk of end-users are not subjected to the complexity (or extra expense) of features requested by the remaining 20% of users. These extra features are still available, but may be available in only select versions of the products.

9.7.3: Support and Help

Excellent customer service can help differentiate a product or brand and may lead to increased brand loyalty over time.

Learning Objective

Examine the role of support and help programs as a differentiating factor in product design

Key Points

• Today, most major telecommunications, IT and electronic companies run virtual support and help desks to provide user assistance around the world.
• Virtual product support allows organizations to optimize their overall IT support process and gain competitive advantages when it comes to delivering quick and efficient technical support.
• Companies, especially larger organizations, often offer internal technical support and help desk services to their staff for computer-related problems.
• In addition to virtual help desks, product support and help services are delivered via email, toll-free numbers, or at physical locations.

Key Term

extranet

A private computer network that uses Internet protocols and can be accessed by authorized individuals via the Internet.

Support and Help

Rapid globalization and expansion of technology are quickly making geography irrelevant; eliminating time constraints for customer support and help functions in organizations. Moreover, as more people telecommute from home and work from remote locations, internal information technology (IT) administrators must spend more time troubleshooting and fixing employees’ problems.

Customer Support

In today’s interconnected world, product support and help services are delivered through multiple channels.

An illustration that shows how companies have tried to streamline the customer support process.

This increased demand for technical services requires IT support organizations to be more agile in diagnosing and resolving product issues. Today, most major telecommunications, IT and electronic companies run virtual support and help desks to provide user assistance around the world. As a result, these organizations are able to optimize their overall IT support process and gain competitive advantages when it comes to delivering quick and efficient technical support.

The Role of Product Support and Help Services

Users of mobile phones, televisions, computers, software products, and other electronic or mechanical goods will occasionally need product support services. This service is usually offered in the form of a help desk that acts as an information and assistance resource. Product support professionals attempt to help users solve specific problems with a product—rather than providing training, customization, or other support services.

Most companies offer either free customer support or charge for premium customer support and help services. Companies, especially larger organizations, offer internal technical support and help desk services to their staff for computer-related problems.

Types of Product Support and Help Services

The Internet serves as a primary source for freely available product support. Virtual help desks, which allow organizations to virtually deploy IT technicians on demand to support users can efficiently manage and allocate organizational resources. Product support personnel can access any computer to provide support despite the end users’ or technicians’ location.

Some companies develop extranet sites, or customer websites that allow users to log calls and report incidents. Virtual help desks access these systems through support sessions where they can diagnose and fix computer issues quickly. This eliminates in-person customer service calls and ineffective phone-only tech support sessions, making the help desk more efficient.

However, many organizations still offer support services via email and toll-free numbers. Some companies also offer live support at physical stores and locations. Nevertheless, the Internet has allowed for a new form of product support to develop. Some online communities, which are moderated by product users, have emerged to give support where manufacturer support is lacking. These experienced users may provide advice and assistance with problems, or offer work-arounds to fellow users unable to find solutions on their own or through the vendor.

9.7.4: Deletion

Product deletion, either through product replacement or product elimination, results when products fail to meet company expectations.

Learning Objective

Illustrate the reasons for and the impact of product deletion

Key Points

• Companies are increasingly under pressure to evaluate their existing product line and make continuous decisions about adding new products or deleting existing ones.
• In addition to weak sales and profit, brands delete products that fail to align with marketing strategies or that demonstrate an unfavorable market outlook.
• Product failure rates vary by industry, but it is estimated that failure rates for new packaged goods range anywhere from 75% to 90%.

Key Term

revenue stream

A revenue stream is a method that a company, organization, or individual uses to collect money—often automated—from users of their product or service. In essence, it is a method of earning money and a way to protect it.

Example

• Coca-Cola Vanilla is the limited relaunch of the formerly produced Vanilla Coke soft drink from the early 2000s to compete with Pepsi Vanilla. Doubt was cast over the future of Vanilla Coke and its splinter beverages when the company announced the 2004 sales figures: 35 million unit cases in North America compared to 90 million in 2002; Vanilla Diet Coke dropped from 23 million unit cases in its inaugural year (2003) to 13 in 2004. On November 3, 2005, The Coca-Cola Company announced that Vanilla Coke and its diet counterpart would be discontinued in the United Kingdom and Ireland by early 2006. A day later, it was announced that it would be phased out in North America by the end of 2005.

Deletion

The twenty-first century marketplace is dynamic, fast-changing, and increasingly fickle. More and more businesses realize that no product lasts forever, and that sales levels can fluctuate dramatically over time. As a result, companies are under pressure to evaluate their existing product line and to make continuous decisions about adding new products or deleting existing ones. Brands must task their engineering and design teams to produce successful products that generate a consistent stream of sales for both short-term profit and long-term survival. An organization must establish a series of successful products, if that organization wants to maintain a consistent stream of sales or else grow sales over time. One reason for this pattern is the product life cycle. No product lasts forever, and sales levels can fluctuate dramatically over time.

Factors in Product Deletion

Deletion is the process of removing products that perform below market expectations or fail to meet company objectives. Deletion results in either product replacement or product elimination. Product deletion requires the company to evaluate its entire product mix and pinpoint where organizational resources can be allocated elsewhere to generate consistent revenue streams.

In addition to weak sales and profit, brands delete products that fail to align with marketing strategies, or that demonstrate an unfavorable market outlook. Market trends and consumer tastes often dictate whether products perform well in the long-term or taper off as a passing fad. However, factors including a company’s business model, culture (or local tastes), government politics and/or regulations, and product malfunction can all contribute to the removal of a product.

Failure rates of products vary by industry. Despite significant investment in product development and market research, it is estimated that failure rates for new packaged goods range anywhere from 75% to rates as high as 90% (source: catalinamarketing.com). When considering “innovative” new products, Harvard Professor John T. Gourville estimates that approximately half of all such products fail.

Business Impact of Product Deletion

Once a company eliminates a product from its offering, the brand must decide whether its goal is to maintain or increase sales. To maintain revenues, the company must continue investing in its remaining products and ensure they are competitively positioned in the marketplace. However, if the company seeks to increase sales in the near future, then it must introduce a new group of successful products to generate additional revenue.

Coca-Cola Vanilla

Coca-Cola Vanilla was the limited relaunch of Vanilla Coke from the early 2000s to compete with Pepsi Vanilla. It was phased out in North America by the end of 2005 due to low sales.

9.7.5: Organizational Requirements for Product Development and Management

Product development combined with product marketing make up the product management function within an organization.

Learning Objective

Construct the relationship between product development and product management

Key Points

• Product management spans many activities, from strategic to tactical, and can be shared by other roles, such as product engineering.
• Many interpretations exist for product management roles and functions and vary depending on company size, history and industry.
• Product management often serves an interdisciplinary role, bridging gaps within the company between engineering-oriented teams and commercially oriented teams.
• To facilitate the launch and marketing of new products, product management teams may perform tasks, including research and competitive intelligence, and sales training.

Key Term

lifecycle

the stages through which a product or its category bypass, from its introduction to the marketing, growth, maturity to its decline or reduction in demand in the market.

Organizational Requirements for Product Development and Management

Product management is an organizational lifecycle function within a company dealing with the planning, forecasting, or marketing of a product or products at all stages of the product lifecycle. Product development – the process of bringing new products to the marketplace – combined with product marketing, make up the product management function that oversees the launch of a company’s new products.

Product Launch

Some organizations set up product management teams so that they intersect between marketing and engineering activities.

Product management spans many activities, from strategic to tactical, and varies based on the organizational structure of the company. Product management can be a function separate on its own, or fall under marketing or engineering.

Functional Requirements of Product Management

Depending on the company size and history, product management has a variety of functions and roles, and can be shared across different departments, such as product development or engineering. A product manager investigates, selects, and develops one or more tangible products for an organization. However, product management also deals with intangible products, such as music, information, and services. Many interpretations exist for product management roles and functions and vary depending on company size, history, and industry.

The Intersection between Product Management, Product Development and Marketing

Frequently there is Profit and Loss (P&L) responsibility as a key metric for evaluating product management performance. In some companies, the product management function is the hub of many other business activities around the development and launch of a product. In other organizations, product management is one of several things that need to occur to successfully launch, monitor, and manage a product. Product management often serves an interdisciplinary role, bridging gaps within the company between different sets of expertise.

This intersection most commonly happens between engineering-oriented teams and commercially-oriented teams. Often, product management professionals serve as the middlemen between product development and engineering and marketing and sales teams. They often translate business objectives set for a product by marketing or sales into engineering requirements for product development. Conversely, the product management team may work to explain the finished product’s capabilities and limitations to marketing and sales professionals. This constant exchange between technical and business teams ensures that product benefits and features are accurately communicated to target audiences.

To facilitate this communication process, product management teams will perform activities including customer research, competitive intelligence, industry analysis, and competitive analysis. Likewise, product management works closely with marketing distributing messages, training sales people, developing market strategies, and communicating messages through advertising and public relations channels.

9.8: The Spread of New Products

9.8.1: The Diffusion of Innovation

The diffusion of innovation theory seeks to explain how, why, and at what rate new ideas and technology spread through cultures.

Learning Objective

List the four main elements that influence the spread of new ideas and technologies

Key Points

• Everett Rogers, a professor of rural sociology, popularized the theory in his 1962 book Diffusion of Innovations.
• Four main elements that influence the spread of a new idea are the innovation, communication channels, time, and the social system.
• Diffusion of innovations manifests itself in different ways in various cultures and fields and is highly subjective to the type of adopters and innovation decision process.
• Marketers are particularly interested in the diffusion process as it determines the success and failure of any new product introduced in the market.

Key Term

innovation

As used here, innovation describes an idea or product that is new to the company in question.

The Diffusion of Innovation

The diffusion of innovation is a theory that seeks to explain how, why, and at what rate new ideas and technology spread through cultures. The origins of the diffusion of innovation theory are varied and span multiple disciplines. Everett Rogers, a professor of rural sociology, popularized the theory in his 1962 book Diffusion of Innovations. He said diffusion is the process by which an innovation is communicated through certain channels over time among the members of a social system. Rogers synthesized research from over 508 diffusion studies and produced a theory for the adoption of innovations among individuals and organizations. Rogers (1962) espoused the theory that there are four main elements that influence the spread of a new idea:

1. The innovation – According to Rogers, an innovation is “an idea, practice, or object that is perceived as new by an individual or other unit of adoption.”
2. Communication channels – These are “the means by which messages get from one individual to another.”
3. Time – Rogers wrote that “the innovation-decision period is the length of time required to pass through the innovation-decision process. The rate of adoption is the relative speed with which an innovation is adopted by members of a social system.”
4. Social system – According to Rogers, a social system is “a set of interrelated units that are engaged in joint problem solving to accomplish a common goal.”

Diffusion of innovations manifest themselves in different ways in various cultures and fields and is highly subjective to the type of adopters and innovation decision process. Marketers are particularly interested in the diffusion process as it determines the success and failure of any new product introduced in the market. They usually look forward to procuring the largest amount of adoption within the shortest period of time. Thus, it is quite important for a marketer to understand the diffusion process so as to ensure proper management of the spread of the new product or service.

Market Share

With successive groups of consumers adopting the new technology (shown in blue), its market share (yellow) will eventually reach the saturation level.

9.8.2: The Rate of Adoption

The rate of adoption is defined as the relative speed with which members of a social system adopt an innovation.

Learning Objective

Discuss the factors leading to adoption of an innovation, and the strategies for making innovation sustainable

Key Points

• Critical mass is the point within the adoption curve that enough individuals have adopted an innovation such that that the continued adoption of the innovation is self-sustaining.
• The adoption process is an individual phenomenon the describes the series of stages an individual undergoes from first hearing about a product to finally adopting it.
• The diffusion process essentially encompasses the adoption process of several individuals over time.

Key Terms

intrinsic

Innate, inherent, inseparable from the thing itself, essential.

critical mass

A quantity or amount required to trigger a phenomenon.

The Rate Of Adoption

The rate of adoption is defined as the relative speed with which members of a social system adopt an innovation. It is usually measured by the length of time required for a certain percentage of the members of a social system to adopt an innovation. Within the rate of adoption there is a point at which an innovation reaches critical mass. Critical mass is the time in the adoption curve when enough individuals have adopted an innovation so that the continued adoption of the innovation is self-sustaining. Everett Rogers outlines several strategies to help an innovation reach this stage:

Diffusion of Innovation

This graph shows the innovation curve and the tipping point, or critical mass.

1. Have an innovation adopted by a highly respected individual within a social network, creating an instinctive desire for a specific innovation.
2. Inject an innovation into a group of individuals who would readily use an innovation.
3. Provide positive reactions and benefits for early adopters of an innovation.

The adoption process is an individual phenomenon describing the series of stages an individual undergoes from first hearing about a product to finally adopting it. On the other hand, the diffusion process signifies a group of phenomena, which suggests how an innovation spreads among consumers. Overall, the diffusion process essentially encompasses the adoption process of several individuals over time.

Five Adoption Factors

Rogers defines several intrinsic characteristics of innovations that influence an individual’s decision to adopt or reject an innovation:

1. Relative Advantage: How improved an innovation is over the previous generation.
2. Compatibility: The level of compatibility that an innovation has to be assimilated into an individual’s life.
3. Complexity or Simplicity: If the innovation is perceived as complicated or difficult to use, an individual is unlikely to adopt it.
4. Trialability: How easily an innovation may be experimented. If a user is able to test an innovation, the individual will be more likely to adopt it.
5. Observability: The extent that an innovation is visible to others. An innovation that is more visible will drive communication among the individual’s peers and personal networks, and will in turn, create more positive or negative reactions.

9.8.3: Stages of Adopters

The stages of adopters for the diffusion of innovation include knowledge, persuasion, decision, implementation, and confirmation.

Learning Objective

Describe the five stages detailed in Everett Rogers’ adoption process

Key Points

• Diffusion occurs through a series of communication channels over a period of time among the members of a similar social system.
• An individual might reject an innovation at any time during or after the adoption process.
• Previous terminology for the stages of adopters included awareness, interest, evaluation, trial, and adoption.

Key Terms

social system

The interaction of at least two personal systems or two persons acting in their own roles.

diffusion

The act of diffusing or dispersing something, or the property of being diffused or dispersed; dispersion.

Stages of Adopters

Diffusion of an innovation occurs through a five–step process. This process is a type of decision-making. It occurs through a series of communication channels over a period of time among the members of a similar social system. Everett Rogers categorizes the five stages (steps) of adopters as:

1. Awareness
2. Interest
3. Evaluation
4. Trial
5. Adoption

An individual might reject an innovation at any time during or after the adoption process. In later editions of The Diffusion of Innovations, Rogers changes the terminology of the five stages to: knowledge, persuasion, decision, implementation, and confirmation. However the descriptions of the categories have remained similar throughout the editions. The five stages of the adoption process are:

1. Knowledge: In this stage the individual is first exposed to an innovation but lacks information about that innovation. During this stage of the process the individual has not been inspired to find more information about the new idea.
2. Persuasion: In this stage, the individual is interested in the innovation and actively seeks information and details about it.
3. Decision: In this stage, the individual takes the concepts of change (switching cost), weighs the advantages and disadvantages of using the innovation, and decides whether to adopt or reject the innovation. Due to the individualistic nature of this stage, Rogers notes that it is the most difficult stage to acquire empirical evidence.
4. Implementation: In this stage, the individual employs the innovation to a varying degree depending on the situation. During this stage the individual determines the usefulness of the innovation and may search for further information about it.
5. Confirmation: Although the name of this stage may be misleading, in this stage, the individual finalizes his or her decision to continue using the innovation and may end up using it to its fullest potential.

Stages of Diffusion

There are five stages of the diffusion of innovation.

A chart that shows the five stages of decision innovation process – knowledge, persuasion, decision (reject or accept), implementation, and confirmation.

9.8.4: Applying the Diffusion of Innovation Theory

In applying the diffusion of innovation theory, it is important to understand potential adopters and their decision-making process.

Learning Objective

Illustrate how the diffusion of innovation theory influences consumer adoption of products and services

Key Points

• Important factors in decision making include whether the decision is made freely and implemented voluntarily, and who makes the decision.
• Opinion leadership tends to be organized into a hierarchy within a society, with each level having the most influence over other members in the same level, and on those in the level below it.
• Public consequences refer to the impact of an innovation on those other than the actor, while private consequences refer to the impact on the actor itself.
• Direct costs of the diffusion of innovation are usually related to financial uncertainty and the economic state of the actor. Indirect costs may be social, such as social conflict caused by innovation.

Key Terms

horizontal conflict

channel conflict between intermediaries at the same level within a channel

hierarchy

Any group of objects ranked so that every one but the topmost is subordinate to a specified one above it.

vertical conflict

psychological tension or anxiety between two alternatives that are not simply different, but where one is genuinely higher than the other

Applying the Diffusion Of Innovation Theory

In applying the diffusion of innovation theory, it is important to understand potential adopters and their decision-making process. Important factors in decision making include who makes the decision, and whether the decision is made freely and implemented voluntarily. Based on these considerations, three types of innovation decisions have been identified:

1. Optional innovation decision: This is made by an individual who is in some way distinguished from others in a social system.
2. Collective innovation decision: This is made collectively by all individuals of a social system.
3. Authority innovation decision: This is made for the entire social system by a few individuals in positions of influence or power.

There are categories of adopters that serve as a classification of individuals within a social system on the basis of innovativeness. According to Everett Rogers , these categories include:

Categories of Adopters

Categories of innovation adopters include innovators, early adopters, early majority, late majority, and laggards.

A chart that shows that innovators are the first category of adopters.

1. Innovators: Innovators are the first individuals to adopt an innovation. Innovators are willing to take risks, youngest in age, have the highest social class, have great financial liquidity, are very social, and have the closest contact to scientific sources and interaction with other innovators. Risk tolerance has them adopting technologies which may ultimately fail, though their financial resources help them absorb these failures.
2. Early adopters: This is the second fastest category of individuals who adopt an innovation. These individuals have the highest degree of opinion leadership among the other adopter categories. Early adopters are typically younger in age, have a higher social status, have more financial liquidity, possess an advanced education, and are more socially forward than late adopters. They are more discrete in adoption choices than innovators, as they realize that judicious choice of adoption will help them maintain a central communication position.
3. Early majority: Individuals in this category adopt an innovation after a varying degree of time. This time of adoption is significantly longer than with the innovators and early adopters. The early majority tends to be slower in the adoption process, has above average social status, has contact with early adopters, and seldom holds positions of opinion leadership in a system.
4. Late majority: Individuals in this category will adopt an innovation after the average member of the society does. These individuals approach an innovation with a high degree of skepticism. The late majority typically has below average social status, has very little financial liquidity, shares contact with others in the late majority and the early majority, and has very little opinion leadership.
5. Laggards: Individuals in this category are the last to adopt an innovation. Unlike some of the previous categories, individuals in this category show little to no opinion leadership. Laggards typically tend to be focused on “traditions”, are likely to have the lowest social status, have the lowest financial liquidity, be the oldest of all other adopters, and are in contact with only family and close friends.

Research done in the early 1950s at the University of Chicago attempted to assess the cost-effectiveness of broadcast advertising on the diffusion of new products and services. The findings were that opinion leadership tended to be organized into a hierarchy within a society, with each level having most influence over other members in the same level, and on those in the next level below it. The lowest levels were generally larger in numbers, and tended to coincide with various demographic attributes that might be targeted by mass advertising. However, the study found that direct word of mouth were far more influential than broadcast messages, which were only effective if they reinforced the direct influences. This led to the conclusion that advertising was best targeted, if possible, on those next in line to adopt, and not on those not yet reached by the chain of influence.

Consequences Of Adoption

There are both positive and negative outcomes when an individual or organization chooses to adopt a particular innovation. In her article, “Integrating Models of Diffusion of Innovations,” Barbara Wejnert details two categories for consequences: public and private. Public consequences refer to the impact of an innovation on those other than the actor, while private consequences refer to the impact on the actor itself. Public consequences are usually concerned with issues of societal well-being, while private consequences are usually concerned with the improvement of quality of life or the reform of social structures.

Benefits Versus Costs

The benefits of an innovation obviously refer to the positive consequences, while the costs refer to the negative. Direct costs are usually related to financial uncertainty and the economic state of the actor. Indirect costs may be social, such as social conflict caused by innovation.

8.4: Inputs to Pricing Decisions

8.4.1: Marginal Analysis

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

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

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

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

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.

7.4: Types of International Business

7.4.1: Countertrade

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

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

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

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

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

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

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

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

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

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

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.

6.4: Service Quality

6.4.1: Customer Feedback

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

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

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

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).

5.4: The Business Buying Decision Process

5.4.1: Decision-Making Units

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

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

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

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

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

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

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

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.

4.4: Market Segmentation

4.4.1: What Are Markets

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

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

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