15.1: Pricing Methods
15.1.1: Cost-Based Pricing
Cost-based pricing involves calculating the cost of the product, and then adding a percentage mark-up to determine price.
Learning Objective
Analyze the use of cost-plus pricing as a pricing method
Key Points
- Cost based pricing is the easiest way to calculate what a product should be priced at. This appears in two forms: full cost pricing and direct-cost pricing. Full cost pricing takes into consideration both variable, fixed costs and a % markup. Direct-cost pricing is variable costs plus a % markup.
- Cost-plus pricing is a pricing method used by companies to maximize their profits. The firms 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.
- Cost-plus pricing is used primarily because it is easy to calculate and requires little information.
Key Terms
- rate of return
-
Rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested.
- markups
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Markup is the difference between the cost of a good or service and its selling price. A markup is added on to the total cost incurred by the producer of a good or service in order to create a profit.
- variable cost
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the amount of resources used that changes with the change in volume of activity of an organization
Examples
- Cost-plus pricing is the simplest pricing method used by companies. It is primarily used because it is easy to calculate, requires little information, and allows them to maximize their profits. They first calculate the cost of the product, and then add a percentage mark-up. 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. 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.
- Information on demand and costs is not easily available, and managers have limited knowledge as far as demand and costs are concerned. This additional information is necessary to generate accurate estimates of marginal costs and revenues. However, the process of obtaining this additional information is expensive. Therefore, cost-plus pricing is often considered the most rational approach in maximizing profits because it relies on arbitrary costs and arbitrary markups.
Cost-plus pricing is the simplest pricing method. A firm calculates the cost of producing the product and adds on a percentage (profit) to that price to give the selling price. This appears in two forms: the first, full cost pricing, takes into consideration both variable and fixed costs and adds a % markup. The other is direct cost pricing, which is variable costs plus a % markup. The latter is only used in periods of high competition as this method usually leads to a loss in the long run.This method, although simple, does not take demand into account, and there is no way of determining if potential customers will purchase the product at the calculated price.
Cost-plus pricing is a method used by companies to maximize their profits. There are several varieties, but the common thread is that one first calculates the cost of the product, then adds a proportion of it as markup. 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. It is a way for companies to calculate how much profit they will make.
Cost-plus pricing is used primarily because it is easy to calculate and requires little information, therefore it is useful when information on demand and costs is not easily available. This additional information is necessary to generate accurate estimates of marginal costs and revenues. However, the process of obtaining this additional information is expensive. Therefore, cost-plus pricing is often considered the most rational approach in maximizing profits. This approach relies on arbitrary costs and arbitrary markups.
Cost-based Pricing
Cost-based pricing model
15.1.2: Demand-Based Pricing
Demand-based pricing uses consumer demand (and therefore perceived value) to set a price of a good or service.
Learning Objective
Compare various methods of price-setting
Key Points
- Demand-based pricing uses consumer demand (and therefore perceived value) to set a price of a good or service.
- Methods of demand-based pricing can include price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing.
- Pricing factors include manufacturing cost, market location, competition, market condition, and the quality of the product.
Key Terms
- yield management
-
The method of analyzing information to forecast market conditions and implications for the firm
- Price skimming
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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. It is a temporal version of price discrimination/yield management.
Examples
- Price skimming is a pricing strategy where initially a product price is set very high, but lowered over time. By using this pricing method, the firm can recover its sunk costs quickly (before competition lowers the market price). Price skimming is sometimes referred to as “riding down the demand curve.” By using this strategy, a company is able to capture consumer surplus. If done successfully, then in theory 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 the entire consumer surplus.
- Value based pricing (aka value optimized pricing) sets prices primarily on the perceived or estimated value to the customer (rather than on the cost of the product, the market price, competitors’ prices, or historical prices). The goal of value-based pricing is to align the price with the value of the product. Value-based pricing is based on the idea that a customer receiving high levels of value will pay a higher price compared to a customer receiving lower levels of value for the same product/service.
- Yield management is the process of understanding, anticipating and influencing consumer behavior. The purpose of it is to maximize profits from a fixed, perishable resource. Examples include airline seats or hotel rooms. This process involves strategic control of inventory in order to sell items to the correct customer at the correct time. Yield management can result in price discrimination. Yield management is a large revenue generator for several major industries (including airlines and hotels). The former Chairman and CEO of American Airlines, Robert Crandall, named this process “Yield Management” and said that it was “the single most important technical development in transportation management since we entered deregulation. “
- Psychological pricing (aka price ending) is a marketing practice based on the idea that certain price have a psychological impact. For example, items are typically priced at a point a little less than a round number ($2.99). The theory is that this causes demand to be greater than it would be if consumers were perfectly rational. In other words, because they see the 2 at the front of the price, they ignore that it is only 1 penny away from $3.
- Product bundling is a very common marketing strategy which involves offering several products for sale as a combined unit. It is common in the software business (Microsoft Office package), cable TV (basic cable, internet, phone), and food as well (burger, fries and a soda).
- When a company sets an initially low entry price (lower than the eventual market equilibrium price) to attract customers, they are engaging in penetration pricing. This strategy operates under the expectation that customers will switch to the new item because of its low price. Penetration pricing is used when the marketing objective is to increase market share/sales volume. It is not used to make short-term profit.
- Value based pricing (aka value optimized pricing) sets prices primarily on the perceived or estimated value to the customer (rather than on the cost of the product, the market price, competitors’ prices, or historical prices). The goal of value-based pricing is to align the price with the value of the product. Value-based pricing is based on the idea that a customer receiving high levels of value will pay a higher price compared to a customer receiving lower levels of value for the same product/service.
Demand-based pricing is any pricing method that uses consumer demand, based on perceived value, as the central element. These include: price skimming, price discrimination and yield management, price points, psychological pricing, bundle pricing, penetration pricing, price lining, value-based pricing, geo and premium pricing. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product.
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. It is a temporal version of price discrimination/yield management. It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price. Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus. 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 discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider.
Yield management is the process of understanding, anticipating and influencing consumer behavior in order to maximize yield or profits from a fixed, perishable resource, such as airline seats or hotel room reservations. As a specific, inventory-focused means of revenue management, yield management involves strategic control of inventory to sell it to the right customer at the right time for the right price. This process can result in price discrimination, where a firm charges customers consuming otherwise identical goods or services a different price for doing so. Yield management is a large revenue generator for several major industries; Robert Crandall, former Chairman and CEO of American Airlines, gave yield management its name and has called it “the single most important technical development in transportation management since we entered deregulation. “
Price points are prices at which demand for a given product is supposed to stay relatively high .
Demand-based Pricing
Illustration of price points, or concave-downward cusps on a demand curve (P is price; Q is quantity demanded; A, B, and C are the price points)
Psychological pricing or price ending 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 or £2.98. The theory is this drives demand greater than would be expected if consumers were perfectly rational. Psychological pricing is one cause of price points.
Product bundling is a marketing strategy that involves offering several products for sale as one combined product. This strategy is very common in the software business (e.g., bundle a word processor, a spreadsheet, and a database into a single office suite), in the cable television industry (e.g., basic cable in the United States generally offers many channels at one price), 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 or a compilation or an anthology.
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.
Value-based pricing, or value-optimized pricing is a business strategy. It sets prices primarily, but not exclusively, on the value, perceived or estimated, to the customer rather than on the cost of the product, the market price, competitors’ prices, or historical prices. The goal of value-based pricing is to align a price with the value delivered. It is based on the notion that a customer receiving high levels of value will pay a higher price than a customer receiving lower levels of value for the same product or service.
Geo (also called marketing geography or geomarketing) is a discipline within marketing analysis which uses geolocation (geographic information) in the process of planning and implementation of marketing activities. It can be used in any aspect of the marketing mix: the product, price, promotion, or place (geo targeting).
15.1.3: Competition-Based Pricing
Competitive-based pricing occurs when a company sets a price for its good based on what competitors are selling a similar product for.
Learning Objective
Explain the competitive-based pricing model
Key Points
- If competitors are pricing their products at a lower price, then it’s up to the company to either price their goods at a higher or lower price, all depending on what they want to achieve.
- One advantage of competitive-based pricing is that it avoids price competition that can damage the company.
- Potential disadvantages include that businesses may need to engage in other tactics to engage customers (if the price is not enough of an incentive).
- Another concern for companies is that this pricing method may barely cover production costs, resulting in low profits.
- Another concern for companies is that this pricing method may only cover production costs, resulting in low profits.
Key Term
- competitive-based pricing
-
Competitive-based pricing occurs when a company sets a price for its good based on what competitors are selling a similar product for.
Example
- Walmart is selling a face wash for $3.99. NuMart, who is looking to sell this product in the same area, also prices their product at $3.99 in order to capture market share. They will not receive higher profits per unit than Walmart with this pricing strategy, and will have to engage in marketing tactics to engage customers, since the price itself is not an incentive.
In economics, competition is the rivalry among sellers trying to achieve such goals as increasing profits, market share, and sales volume by varying the elements of the marketing mix: price, product, distribution, and promotion. Merriam-Webster defines competition in business as “the effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms. ” It was described by Adam Smith in The Wealth of Nations (1776) and later economists as allocating productive resources to their most highly-valued uses and encouraging efficiency. Smith and other classical economists before Cournot were referring to price and non-price rivalry among producers to sell their goods on best terms by the bidding of buyers, and not necessarily to a large number of sellers or to a market in final equilibrium.
Competitive-based pricing, or market-oriented pricing, involves setting a price based upon analysis and research compiled from the target market . With competition pricing, a firm will base what they charge on what other firms are charging. This means that marketers will set prices depending on the results from their research. For instance, if the competitors are pricing their products at a lower price, then it’s up to them to either price their goods at a higher or lower price, all depending on what the company wants to achieve.
Competitive Market Pricing
Status-quo pricing, also known as competition pricing, involves maintaining existing prices or basing prices on what other firms are charging.
One advantage of competitive-based pricing is that it avoids price competition that can damage the company. Disadvantages include that businesses have to attract customers in other ways, since the price will not grab the customer’s interest. The price may also barely cover production costs, resulting in low profits.
15.1.4: Break-Even Analysis
The break-even point (BEP) is the point where expenses and revenue intersect.
Learning Objective
Explain the break-even point (BEP)
Key Points
- At this point there is no loss or gain to the company. On a graph, it appears as the point where the cost and revenue curves intersect.
- In an instance when costs are linear, the break-even point is equal to the fixed costs divided by the contribution margin per unit.
- The break-even point is one of the simplest yet least used analytical tools in management. It helps to provide a dynamic view of the relationships between sales, costs and profits.
Key Terms
- price
-
The price is the amount a customer pays for the product.
- expense
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A spending or consuming. Often specifically an act of disbursing or spending funds.
Example
- If a business sells less than 200 units each month, it will record a loss. In the event it sells more, it will show a profit. Based off of this information, the business owners will need to determine if they can make and sell at least 200 tables a month. If they are not able to currently, adjusting other variables may help them reach this goal. For instance, reducing fixed costs (finding a building with cheaper rent), reducing variable costs (finding a cheaper supplier for table-making goods), and/or increasing the price of their tables. By performing any of these actions, the break-even point would be reduced, meaning that the owners do not need to sell as many tables in order to pay off fixed costs.
In Business Economics, specifically cost accounting, the break-even point (BEP) is the point at which cost (or expenses) and revenue are equal—there is no net loss or gain, i.e., one can “break even. ” No profit is achieved nor loss incurred, although opportunity costs are reconciled, and capital receives the risk-adjusted, expected return. Shown graphically, it is seen at the point where the total revenue and total cost curves meet. In the linear model, the break-even point is equal to the fixed costs divided by the contribution margin per unit .
Break-Even Analysis
This graphs depicts an example of a break-even point based on sales and total costs.
Example: Suppose that if a business sells fewer than 200 tables each month it will incur a loss, and if it sells more it will turn a profit. Given this scenario, the company’s business managers will need to compile information to determine if they can reasonably manufacture and sell 200 tables per month.
If they think they cannot sell that many, to ensure continued viability they might:
- Try reducing their fixed costs (e.g., by renegotiating rent, or by better controlling utility telephone bills or other costs)
- Try reducing their variable costs (the price paid for the tables by finding a new supplier)
- Consider increasing the selling price of their tables
Any of these would reduce the break-even point, meaning the business would not need to sell so many tables to ensure it could pay its fixed costs.
By inserting different prices into the formula, you will obtain a number of break-even points, one for each possible price point. If in the above example the firm changes the selling price for its product, say from $2 to $2.30, then it would have to sell only 589 units (1000/(2.3 – 0.6) = 589) to break even rather than 715.
Graphing these results can make them more clear. To do this, draw the total cost curve (TC in the diagram), showing total cost associated with each possible level of output; the fixed cost curve (FC), showing costs that do not vary with output level; and finally, the various total revenue lines (R1, R2, and R3), showing the total amount of revenue received at each output level given the chosen price point.
The break-even point is one of the simplest yet least used analytical tools in management. It helps provide a dynamic view of the relationships between sales, costs and profits. For an even clearer understanding, break-even sales can be expressed as a percentage of actual sales. By linking the percent to a point (during the week or month) that the percent of sales might occur, managers can glean when they might expect to break even.
15.2: Pricing Objectives
15.2.1: Profit Optimization
Firms utilize strategies such as price and promotional reduction to minimize cost, maximize revenue, and thereby optimize profits.
Learning Objective
Explain managerial methods of profit optimization
Key Points
- Firms can employ a number of methods to optimize profit including employing yield management and revenue optimization strategies.
- Yield optimization is the practice of using models to analyze data and information to forecast the best quantity of output a firm should produce to meet the total demand, thereby optimizing revenue.
- Optimization attempts to take information on a firm’s operating constraints, market demand, and factors influencing these to find the optimal selling prices and optimal production quantities for a firm’s goods.
- Revenue optimization is the mathematical process of finding the highest possible revenue a firm can make, using quadratic equations.
Key Terms
- Revenue optimization
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A method of finding the best possible combination of output and price level to give the most possible revenue.
- revenue
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the total income received from a given source
- yield management
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The analysis of qualitative and quantitative information on factors driving demand for a good in order to forecast the most profitable production decisions for a firm.
Example
- Hypothetically, a lemonade stand may engage in yield management. Reviewing historical sales records in the neighborhood, looking up the weather forecasts, noting the hours of highest traffic in the area and other factors that may affect sales can help determine how many ingredients to purchase and how much lemonade to make.
Traditional profit optimization includes methods for reduction of pricing, promotional, and markdown losses.
Yield management can help firms optimize profits. Firms that engage in yield management usually do so via computer yield management systems, and periodically review transactions for goods or services already supplied as well as those being supplied in the future. They may also review information (including statistics) about events (known future events such as holidays, or unexpected past events such as terrorist attacks), competitive information (including prices), seasonal patterns, and other pertinent factors affecting sales. The models use market segment and price point to forecast total demand for all products or services they provide. Since total demand normally exceeds what the particular firm can produce in that period, the models attempt to optimize the firm’s outputs to maximize revenue. This optimization seeks to address key questions, such as: “Given our operating constraints, what is the best mix of products and/or services for us to produce and sell in the period; and at what prices do we sell those products and/or services to generate the highest expected revenue? ” Optimization can help the firm adjust prices and allocate capacity among market segments to maximize expected revenues. This can be done at different levels:
- By goods (such as a seat on a flight or a seat at an opera production)
- By group of goods (such as the entire opera house or all seats on a flight)
- By market (such as sales from Seattle and Minneapolis for a flight via Seattle-Minneapolis-Boston)
- Overall (such as on all routes of an airline, or on all seats during an opera production season)
Revenue optimization is a method of determining ‘optimal’ profits or expenditures, and can be related to quadratics, as the vertex of a parabola can illustrate the point where the ‘maximum’ revenue can be attained. Revenue optimization requires finding the x-intercepts and vertex, which can be done utilizing the quadratic formula (x-intercepts), and completing the square (vertex/ maximum). By finding these, one can then determine the highest or lowest cost and where the costs and quantities must lie in accordance to the vertex. This method is effective for maximizing profits for companies and families, as it can ensure the highest profit for sales and the lowest amounts for expenditures.
Optimization
Optimization point at x1, x2.
15.2.2: Return on Investment
Return on investment (ROI) is one way of considering profits in relation to capital invested.
Learning Objective
Explain the effect of marketing on return on investment (ROI)
Key Points
- 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.
- The purpose of the “return on investment” metric is to measure per-period rates of return on dollars invested in an economic entity.
- Return on investment (%) = Net profit ($) / Investment ($) × 100; or: Return on investment = (gain from investment – cost of investment) / cost of investment.
- Interest on a second (or refinanced) loan may increase, and loan fees may be charged, both of which can reduce the ROI when the new numbers are used in the ROI equation.
Key Terms
- profits
-
Collective form of profit.
- return on investment
-
One way of considering profits in relation to capital invested.
Example
- Suppose a lemonade stand wanted to use a yield management method. They could look at historical pricing and sales performance of past lemonade stands in the neighborhood, and traffic patterns in the area. At what time of day are more people (possible customers) outside? And what about the weather (does lemonade sell better in sunny or rainy weather)? All this information can give the lemonade entrepreneurs a better idea of how much to make and how much to charge.
Return on Investment
Return on investment (ROI) is one way of considering profits in relation to capital invested. Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how ‘investment’ is defined .
Assets
Return on assets (ROA), return on net assets (RONA), return on capital (ROC) and return on invested capital (ROIC) are similar measures with variations on how ‘investment’ is defined.
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.
In a survey of nearly 200 senior marketing managers, 77 percent responded that they found the “return on investment” metric very useful.
Purpose
The purpose of the “return on investment” metric is to measure per-period rates of return on dollars invested in an economic entity. ROI and related metrics (ROA, ROC, RONA and ROIC) provide a snapshot of profitability adjusted for the size of the investment assets tied up in the enterprise. Marketing decisions have obvious potential connection to the numerator of ROI (profits), 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. ROI is often compared to expected (or required) rates of return on dollars invested.
Construction
For a single-period review, just divide the return (net profit) by the resources that were committed (investment):
Return on investment (%) = Net profit ($) / Investment ($) × 100
or
Return on investment = (gain from investment – cost of investment) / cost of investment
Problems in Calculating ROI
Complications in calculating ROI can occur when a real estate property is refinanced, or a second mortgage is taken out. For example, interest on a second (or refinanced) loan may increase or loan fees may be charged. Both of these factors can reduce the ROI when the new numbers are used in the ROI equation. There may also be an increase in maintenance costs and property taxes, or an increase in utility rates if the owner of a residential rental or commercial property pays these expenses.
Complex calculations may also be required for property bought with an adjustable rate mortgage (ARM) with a variable escalating rate charged annually through the duration of the loan. (To know more about ARM, check out: Mortgages: Fixed-Rate Versus Adjustable-Rate. )
15.2.3: Market Share
Market share is an indicator of how well a firm is doing against its competitors and can often be influenced through pricing.
Learning Objective
Explain the importance of market share
Key Points
- Market share, usually measured as a percentage of a market’s total revenue captured by a single entity, is a key indicator of market competitiveness.
- Managers can use market share data to evaluate a firm’s overall performance, market demand, market growth, and customer preference trends.
- Market share is measured by looking at a firm’s sales revenue as a percentage of the total market revenue.
Key Term
- Market Share
-
The percentage amount of a market captured by a single firm
Example
- For a very basic example, let’s look at the market for baubles. Suppose there are 1000 total baubles sold in the U.S. per year for $1 each. If company A sold 600 of those baubles, they have 60% of the market share.
Market share is the percentage of a market (defined in terms of either units or revenue) accounted for by a specific entity.
Market share is a key indicator of market competitiveness—that is, how well a firm is doing in terms of its competition. This metric, supplemented by changes in sales revenue, helps managers evaluate both primary and selective demand in their market. 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.
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 macroenvironmental variables, such as the state of the economy or changes in tax policy. However, increasing market share may be dangerous for makers of fungible hazardous products, particularly products sold into the United States market, where they may be subject to market share liability.
Although market share is likely the single most important marketing metric, there is no generally acknowledged best method for calculating it. This is unfortunate as different methods may yield not only different computations of market share at a given moment but also widely divergent trends over time. The reasons for these disparities include variations in the lenses through which share is viewed (units versus dollars), where in the channel the measurements are taken (shipments from manufacturers versus consumer purchases), market definition (scope of the competitive universe), and measurement error.
Market Share
Mobile phone market share in Q3 2008
15.2.4: Demanding a Premium
Firms can engage in premium pricing by keeping the price of their good artificially higher than the benchmark price.
Learning Objective
Explain why business owners sometimes price at a premium
Key Points
- Premium pricing is used to maximize profit in areas where customers are happy to pay more, where there are no substitutes for the product, where there are barriers to entering the market, or when the seller cannot save on costs by producing at a high volume.
- More expensive items are perceived to be of better quality or have a better reputation by virtue of their price.
- Luxury has a psychological association with price premium pricing.
Key Terms
- prestige
-
The quality of how good the reputation of something or someone is.
- Price premium
-
The percentage by which a product’s selling price exceeds a benchmark price.
Example
- Brands like Pepsi or Coke can price their goods at a premium, charging more than a generic soda brand due to its brand name.
Pricing strategies for products or services encompass three main ways to improve profits. The business owner can cut costs or 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.
Premium Pricing
Premium pricing is the practice of keeping the price of a product or service artificially high in order to encourage favorable perceptions among buyers, based solely on the price. The practice is intended to exploit the (not necessarily justifiable) tendency for buyers to assume that expensive items enjoy an exceptional reputation or represent exceptional quality and distinction . A premium pricing strategy involves setting the price of a product higher than similar products . This strategy is sometimes also called skim pricing because it is an attempt to “skim the cream” off the top of the market. It is used to maximize profit in areas where customers are happy to pay more, where there are no substitutes for the product, where there are barriers to entering the market, or when the seller cannot save on costs by producing at a high volume. It is also called image pricing or prestige pricing.
Premium-Priced Good
Gold mined from different sources demand different premiums.
Mercedes Benz SLR McLaren
Mercedes Benz executes a premium pricing strategy.
Luxury has a psychological association with price premium pricing. The implication for marketing is that consumers are willing to pay more for certain goods and not for others. To the marketer, it means creating a brand equity or value for which the consumer is willing to pay extra. Marketers view luxury as the main factor differentiating a brand in a product category.
15.2.5: Status-Quo Pricing of Existing Products
Status quo pricing is the practice of maintaining current price levels that other firms are charging.
Learning Objective
Compare Nagle and Holden’s nine laws of price sensitivity with status-quo pricing
Key Points
- Pricing strategies for products or services encompass three main ways to improve profits. These are that the business owner can cut costs or sell more, or find more profit with a better pricing strategy.
- Merely raising prices is not always the answer, especially in a poor economy. 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.
- Status-quo pricing advantages: Avoids price competition that can damage the company. Disadvantages: Because the price may not grab the customer’s interest, businesses may have to attract customers in other ways. Also, these prices may barely cover production costs, resulting in low profits.
Key Term
- status-quo pricing
-
The practice of pricing goods such that the current market price level is maintained.
Pricing strategies for products or services encompass three main methods of improving profits: the business owner can cut costs, sell more, or implement a better pricing strategy. When costs are already at their lowest and increasing sales becomes difficult, adopting a better pricing strategy may be a key option for staying viable.
However, merely raising prices is not always the best solution, particularly in poorer economies. Many businesses fold because as a result of pricing themselves out of the marketplace. On the other hand, many business and sales staff leave “money on the table”. One strategy does not fit all, so adopting a pricing strategy is a learning curve—studying the needs and behaviors of customers and clients is essential.
Nine Laws of Price Sensitivity and Consumer Psychology
In their book The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden outline nine “laws”—factors they say influence how a consumer perceives a given price, and how price-sensitive they may be with respect to different purchase decisions.
- Reference Price Effect: 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, occasion, or other factors.
- 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.
- 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.
- Price-Quality Effect: Buyers are less sensitive to price the more 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.
- Expenditure Effect: Buyers are more price sensitive when the expense accounts for a large percentage of buyers’ available income or budget.
- End-Benefit Effect: This effect refers to the relationship of a given purchase to a larger overall benefit, and is divided into two parts. The first, derived demand, referes to buying sensitivity relative to the price of the end benefit; the more sensitive they will be to the prices of those products that contribute to that benefit. The second, price proportion cost refers to the percent of the total cost of the end benefit accounted for by a given component that helps produce the end benefit (e.g., CPU and PCs). The smaller the given components share of the total cost of the end benefit, the less sensitive buyers will be to the component’s price.
- Shared-cost Effect: The smaller the portion of the purchase price buyers must pay for themselves, the less price sensitive they will be.
- 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.
- 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.
Status-quo Pricing
Status-quo pricing, also known as competition pricing, involves maintaining existing prices (status quo) or basing prices on the prices of competitor firms .
Competitive Market Pricing
Status-quo pricing, also known as competition pricing, involves maintaining existing prices or basing prices on what other firms are charging.
Advantages: Avoids price competition that can damage the company.
Disadvantages: Because the price will not grab the customer’s interest, businesses must attract customers in other ways. Also, these prices may barley cover production costs, resulting in low profits.
15.3: Pricing Strategies
15.3.1: New Product
Penetration and skimming are two strategies employed in pricing new products.
Learning Objective
Compare penetration and skimming as two strategies for setting a price level
Key Points
- Penetration pricing in the introductory stage of a new product’s life cycle involves accepting a lower profit margin and pricing relatively low.
- Price skimming involves setting the price relatively high to generate a high profit margin.
- A premium product generally supports a skimming strategy.
Key Terms
- pull strategy
-
communication not demanded by the buyer
- Price skimming
-
This involves the top part of the demand curve. The price is set relatively high to generate a high profit margin, and sales are limited to those buyers willing to pay a premium to get the new product.
- Penetration pricing
-
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.
- push strategy
-
communication demanded by the buyer
With a totally new product, competition does not exist or is minimal. What price level should be set in such cases? Two general strategies are most common: penetration and skimming. Penetration pricing in the introductory stage of a new product’s life cycle involves accepting a lower profit margin and pricing relatively low. Such a strategy should generate greater sales and establish the new product in the market more quickly. Price skimming involves the top part of the demand curve. Price is set relatively high to generate a high profit margin, and sales are limited to those buyers willing to pay a premium to get the new product.
Price Skimming
Video game systems, such as the Sony PS3, usually employ the classic new product pricing strategy, known as skimming.
Which strategy is best depends on a number of factors. 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. A skimming strategy is most appropriate when the opposite conditions exist. A premium product generally supports a skimming strategy. In this case, “premium” doesn’t 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 $500 ticket for the World Series or an $80,000 price tag for a limited-production sports car. 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.
15.3.2: Differential
Differential pricing exists when sales of identical goods or services are transacted at different prices from the same provider.
Learning Objective
Analyze the situations in which price differentiation works
Key Points
- Product heterogeneity, market frictions, or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for differential pricing to different consumers, even in fully competitive retail or industrial markets.
- Price differentiation requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors.
- There are two conditions that must be met if a price differentiation scheme is to work. First, the firm must be able to identify market segments by their price elasticity of demand. Second, the firm must be able to enforce the scheme.
Key Term
- arbitrage
-
Any market activity in which a commodity is bought and then sold quickly, for a profit which substantially exceeds the transaction cost
Price differentiation, or price discrimination, exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (re-selling) to prevent arbitrage, price differentials can only be a feature of monopolistic and oligopolistic markets, where market power can be exercised. However, 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 differentiation 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. The boundary set up by the marketer to keep segments separate is referred to as a rate fence. Price differentiation is thus very common in services where resale is not possible, such as airlines and movie theaters.
Price differentiation 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 with cream) 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.
There are two conditions that must be met if a price differentiation scheme is to work. First, the firm must be able to identify market segments by their price elasticity of demand. Second, the firm must be able to enforce the scheme. For example, airlines routinely engage in price differentiation 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 conditions that would be difficult for the average business traveler to meet.
Price Differentiation
The airline industry implements price differentiation schemes.
15.3.3: Psychological Pricing
Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact.
Learning Objective
Apply the discipline of psychology to pricing
Key Points
- Psychology is an academic and applied discipline that involves the scientific study of mental functions and behaviors.
- While psychological knowledge is often applied to the assessment and treatment of mental health problems, it is also directed towards understanding and solving problems in many different spheres of human activity.
- Psychological pricing can be used to increase the perceived value of a product as well.
Key Term
- psychological pricing
-
Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact.
Psychological
Psychology is an academic and applied discipline that involves the scientific study of mental functions and behaviors. Psychology has the immediate goal of understanding individuals and groups by both establishing general principles and researching specific cases and, by many accounts, ultimately aims to benefit society. In this field, a professional practitioner or researcher is called a psychologist, and can be classified as a social, behavioral, or cognitive scientist. Psychologists attempt to understand the role of mental functions in individual and social behavior, while also exploring the physiological and neurobiological processes that underlie certain cognitive functions and behaviors.
While psychological knowledge is often applied to the assessment and treatment of mental health problems, it is also directed towards understanding and solving problems in many different spheres of human activity. The majority of psychologists are involved in some kind of therapeutic role, practicing in clinical, counseling, or school settings. Many do scientific research on a wide range of topics related to mental processes and behavior, and typically work in university psychology departments or teach in other academic settings (e.g., medical schools or hospitals). Some are employed in industrial and organizational settings, or in other areas such as human development and aging, sports, health, and the media, as well as in forensic investigation and other aspects of law.
Psychological pricing or price ending 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, such as $19.99 or £2.98. The theory is that this drives demand greater than would be expected if consumers were perfectly rational.
Psychological pricing can be used to the perceived value of a product up as well. By charging $350 for designer jeans, retailers are at times able to create more demand for the product than if they were priced at $19.99 for example.
Stop & Shop Price Cruncher
A British Stop & Shop ad from the 1994 holiday season, informing consumers what they would save on the purchase of each item.
15.3.4: Product Line
Product lining is the marketing strategy of offering several related products for sale as individual units.
Learning Objective
Explain the strategies of creating a product line
Key Points
- Line extensions strategies involve adding goods related to the initial product, whose purchase or use is keyed to the product.
- 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.
- Line-filling strategies occur when a void in the existing product line has not been filled or a new void has developed due to the activities of competitors or the request of consumers.
- Line-pruning strategies involve the process of getting rid of products that no longer contribute to company profits.
Key Terms
- product line
-
a series of several related goods or services for sale as individual units
- line vulnerability
-
the percentage of sales or profits that are derived from only a few products in the line.
- product mix
-
the number of different categories and lines of goods or services offered by a company
- line depth
-
the number of subcategories a product category has.
- line consistency
-
how closely related the products that make up the line are.
Product lining is the marketing strategy of offering several related products for sale as individual units. A product line can comprise related products of various sizes, types, colors, qualities, or prices. Line depth refers to the number of subcategories a category has. Line consistency refers to how closely related the products that make up the line are. Line vulnerability refers to the percentage of sales or profits that are derived from only a few products in the line. The number of different categories of a company is referred to as width of product mix. The total number of products sold in all lines is referred to as length of product mix. If a line of products is sold with the same brand name, this is referred to as family branding.
Walmart Exterior
Large companies, such as Walmart, often have product lines that cover a wide variety of similar or related needs.
Variables to Consider When Selecting a Product Line Strategy
There are two basic strategies for dealing with whether the company will attempt to carry every conceivable product needed and wanted by the consumer or whether they will carry selected items. The first is a full-line strategy while the second is called a limited line strategy. Few full-line manufacturers attempt to provide items for every conceivable market niche. And few limited-line manufacturers would refuse to add an item if the demand were great enough. Each strategy has its advantages and disadvantages.
Line extensions strategies involve adding goods related to the initial product, whose purchase or use is keyed to the product. For example, a computer company may provide an extensive selection of software to be used with its primary hardware. This strategy not only increases sales volume, it also strengthens the manufacturer’s name association with the owner of the basic equipment and offers dealers a broader line. These added items tend to be similar to existing brands with no innovations. They also have certain risks. Often the company may not have a high level of expertise with either producing or marketing these related products. Excessive costs, inferior products, and the loss of goodwill with distributors and customers are all possible deleterious outcomes.
There is also a strong possibility that such a product decision could create conflict within the channel of distribution. In the computer example just described, this company may have entered the software business over the strong objection of their long-term supplier of software. If their venture into the software business fails, re-establishing a positive relationship with this supplier could be quite difficult. 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.
Line-filling strategies occur when a void in the existing product line has not been filled or a new void has developed due to the activities of competitors or the request of consumers. Before considering such a strategy, several key questions should be answered:
- Can the new product support itself?
- Will it cannibalize existing products?
- Will existing outlets be willing to stock it?
- Will competitors fill the gap if we don’t?
- What will happen if we don’t act?
Assuming a firm decides to fill out its product line further, there are several ways of implementing this decision.
Ways to Implement the Filling Out of a Product Line
- Product proliferation: The introduction of new varieties of the initial product or products that are similar.
- Brand extension: Strong brand preference allows the company to introduce the related product under the brand umbrella.
- Private branding: Producing and distributing a related product under the brand of a distributor or other producers.
In addition to the demand of consumers or pressures from competitors, there are other legitimate reasons to engage in these tactics. First, the additional products may have a greater appeal and serve a greater customer base than did the original product. Second, the additional product or brand can create excitement both for the manufacturer and distributor. Third, shelf space taken by the new product means it cannot be used by competitors. Finally, the danger of the original product becoming outmoded is hedged.
Yet, there is serious risk that must be considered as well. Unless there are markets for the proliferations that will expand the brand’s share, the newer forms will cannibalize the original product and depress profits. Line-pruning strategies involve the process of getting rid of products that no longer contribute to company profits. A simple fact of marketing is that sooner or later a product will decline in demand and require pruning.
15.3.5: Promotions
Promotional pricing means temporarily reducing the price of an established product in order to increase interest in customers.
Learning Objective
Explain why and how marketers use promotion
Key Points
- Promotion is one of the market mix elements, and a term used frequently in marketing.
- Fundamentally, however, there are three basic objectives of promotion: to present information to consumers as well as others, to increase demand, and to differentiate a product.
- Promotional pricing often involves reducing prices to unsustainably low levels. In some cases, products and services may be sold at or below cost.
Key Term
- Promotional pricing
-
The temporary reduction of the price of an established product in order to increase interest in customers.
Promotion is one of the market mix elements, and a term used frequently in marketing. Fundamentally, there are three basic objectives of promotion:
- To present information to consumers as well as others.
- To increase demand.
- To differentiate a product.
There are different ways to promote a product in different areas of media. Promoters use internet advertisement, special events, endorsements, and newspapers to advertise their product. Many times with the purchase of a product there is an incentive like discounts, free items, or a contest. This is to increase the sales of a given product.
Promotional Pricing
Promotional pricing means temporarily reducing the price of an established product in order to increase interest in customers. This is sometimes done because the sales of the product are falling and the firm wants to renew customer’s interest in it. Or perhaps the product has gone out of fashion, and the firm wants to clear their stock (e.g., sales on last season’s clothes).
Promotional pricing often involves reducing prices to unsustainably low levels. In some cases, products and services may be sold at or below cost. A buy-one-get-one-free scheme may even be used. When this is done, interest in goods can be greatly increased, meaning sales are also likely to increase dramatically.
This technique may be used by retailers or producers alike. When it is used by retailers, the goal is generally to attract attention to the business and to attract regular customers. When the technique is used by producers, the goal is generally to attract customers to a product or brand and to encourage brand loyalty.
Quaker Oats man
A Quaker Oats promotion at a Publix grocery store.
15.4: Pricing Products
15.4.1: The Meaning of Price
Price is both the money someone charges for a good or service and what the consumer is willing to give up to receive a good or service.
Learning Objective
Differentiate between cost, customer’s view of price, and society’s view of price
Key Points
- When you ask about the cost of a good or service, you’re really asking how much you will have to give up in order to get it.
- For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.
- Viewing price from the customer’s perspective helps define value — the most important basis for creating a competitive advantage.
- There are two different ways to look at the role price plays in a society; rational man and irrational man.
Key Term
- value
-
The degree of importance you give to something.
Examples
- Wedding photographers frequently charge thousands of dollars for a wedding, be it a large, opulent event, or a small scale affair. Unlike Louis Vuitton, most wedding photographers are individuals working from home, or small studios, and so charging a high price is not purely about protecting the brand, or about the cost of the equipment (although there is certainly a high initial cost to starting out). Rather, it is about the need that customers have to capture these memories. Because the customer feels there is value in having a good wedding photographer, they are willing to pay prices that are not related to the cost.
- Louis Vuitton is a designer of luxury goods such as handbags, luggage, watches, etc. The company has been criticised for burning unsold merchandise, rather than putting them back on the market at discounted prices. This action is defended by saying that it must be done in order to maintain the value of the brand – if discounted items enter the market place, the brand value would fall.
What does a Price Convey
Buying something means paying a price. But what exactly is “price? “
- Price is the money someone charges for a good or service. For example, an item of clothing will cost a certain amount of money. Or a computer specialist will charge a certain amount of money for fixing your computer.
- Price is also that which you, a consumer, has to give up in order to receive a product or service. Price does not necessarily always mean money. Bartering is when you exchange goods or services in return for goods or services. For example, I teach you English in exchange for you teaching me about graphic design. In that case, I give up my time and knowledge.
Even though the question, “How much? ” could be phrased as “How much does it cost? ” price and cost are two different things. Whereas the price of a product is what you, the consumer has to pay to obtain it, the cost is what the business pays to make it. When you ask about the cost of a good or service, you’re really asking how much will you have to give up to get it.
Different Perspectives on Price
The perception of price differs based on the perspective from which it is beign viewed.
Louis Vuitton
Louis Vuitton sells luxury designer goods such as these suitcases. If Louis Vuitton merchandise was offered at low prices it might significantly undermine the brand value, much of which is based upon exclusivity.
The Customer’s View
A customer can either be the ultimate user of the finished product or a business that purchases components of the finished product. It is the customer that seeks to satisfy a need or set of needs through the purchase of a particular product or set of products. Consequently, the customer uses several criteria to determine how much they are willing to expend, or the price they are willing to pay, in order to satisfy these needs. Ideally, the customer would like to pay as little as possible.
For the business to increase value, it can either increase the perceived benefits or reduce the perceived costs. Both of these elements should be considered elements of price.
To a certain extent, perceived benefits are the opposite of perceived costs. For example, playing a premium price is compensated for by having this exquisite work of art displayed in one’s home. Other possible perceived benefits directly related to the price-value equations are:
- Status
- Convenience
- The deal
- Brand
- Quality
- Choice
Many of these benefits tend to overlap. For instance, a Mercedes Benz E750 is a very high-status brand name and possesses superb quality. This makes it worth the USD 100,000 price tag. Further, if one can negotiate a deal reducing the price by USD 15,000, that would be his incentive to purchase. Likewise, someone living in an isolated mountain community is willing to pay substantially more for groceries at a local store than drive 78 miles (25.53 kilometers) to the nearest Safeway. That person is also willing to sacrifice choice for greater convenience.
Increasing these perceived benefits are represented by a recently coined term, value-added. Providing value-added elements to the product has become a popular strategic alternative.
Perceived costs include the actual dollar amount printed on the product, plus a host of additional factors. As noted, perceived costs are the mirror-opposite of the benefits. When finding a gas station that is selling its highest grade for USD 0.06 less per gallon, the customer must consider the 16 mile (25.75 kilometer) drive to get there, the long line, the fact that the middle grade is not available, and heavy traffic. Therefore, inconvenience, limited choice, and poor service are possible perceived costs. Other common perceived costs include risk of making a mistake, related costs, lost opportunity, and unexpected consequences.
Ultimately, it is beneficial to view price from the customer’s perspective because it helps define value — the most important basis for creating a competitive advantage.
Society’s View
Price, at least in dollars and cents, has been the historical view of value. Derived from a bartering system (exchanging goods of equal value), the monetary system of each society provides a more convient way to purchase goods and accumulate wealth. Price has also become a variable society employs to control its economic health. Price can be inclusive or exclusive. In many countries, such as Russia, China, and South Africa, high prices for products such as food, health care, housing, and automobiles, means that most of the population is excluded from purchase. In contrast, countries such as Denmark, Germany, and Great Britain charge little for health care and consequently make it available to all.
There are two different ways to look at the role price plays in a society; rational man and irrational man. The former is the primary assumption underlying economic theory, and suggests that the results of price manipulation are predictable. The latter role for price acknowledges that man’s response to price is sometimes unpredictable and pretesting price manipulation is a necessary task.
15.4.2: Impacts of Supply and Demand on Pricing
The supply and demand model states that the price of a good will be the level where the quantity demanded equals the quantity supplied.
Learning Objective
Apply the concept of supply and demand to price determination
Key Points
- In the supply and demand model of price determination, there is never a surplus or shortage of goods at the equilibrium level. The market always settles at the point where supply equals demand.
- If demand increases (decreases) and supply is unchanged, then it leads to a higher (lower) equilibrium price and quantity.
- If supply increases (decreases) and demand is unchanged, then it leads to a lower (higher) equilibrium price and higher (lower) quantity.
- If a price for a particular product goes up and the customer is aware of all relevant information, demand will be reduced for that product.
- Demand-oriented pricing focuses on the nature of the demand curve for the product or service being priced.
Key Terms
- Supply and demand model
-
An economic model of price determination in a market.
- demand-oriented pricing
-
A pricing model focused on the nature of the demand curve for the product or service being priced.
- demand curve
-
An economic model showing the quantity demanded at various price levels.
Example
- Suppose the equilibrium price of burgers is $10, and 200 widgets are eaten every day in a particular town. A sudden outbreak of mad cow disease leads to people not wanting to eat burgers at all–demand drops. Now, only 50 burgers are eaten per day. As a result of the fall in demand, price drops as well (while the actual quantities of demand and supply will depend on the shape of the demand and supply curves, for the sake of example, let’s say the price drops to $4).
Supply, Demand, and Pricing
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.
The four basic laws of supply and demand are:
- If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
- If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
- If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
- If supply decreases and demand remains unchanged, then it leads to higher equilibrium price and lower quantity.
Equilibrium is defined as the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves. Market equilibrium is a situation in a market when the price is such that the quantity that consumers wish to demand is correctly balanced by the quantity that firms wish to supply.
Economics assumes that the consumer is a rational decision maker and has perfect information. Therefore, if a price for a particular product goes up and the customer is aware of all relevant information, demand will be reduced for that product. Should price decline, demand would increase. That is, the quantity demanded typically rises causing a downward sloping demand curve. A demand curve shows the quantity demanded at various price levels.
Price affected by supply and demand
The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.
As a seller changes the price requested to a lower level, the product or service may become an attractive use of financial resources to a larger number of buyers, thus, expanding the total market for the item. This total market demand by all buyers for a product type (not just for the company’s own brand name) is called “primary demand. ” Additionally, a lower price may cause buyers to shift purchases from competitors, assuming that the competitors do not meet the lower price. If primary demand does not expand and competitors meet the lower price, the result will be lower total revenue for all sellers.
Demand-oriented pricing focuses on the nature of the demand curve for the product or service being priced. The nature of the demand curve is influenced largely by the structure of the industry in which a firm competes. That is, if a firm operates in an industry that is extremely competitive, price may be used to some strategic advantage in acquiring and maintaining market share. On the other hand, if the firm operates in an environment with a few dominant players, the range in which price can vary may be minimal.
15.5: New Product Development
15.5.1: Innovation
Innovation is the creation of better, more effective products, processes, services, or technologies.
Learning Objective
Subdivide the innovation process in to sources, goals, failures, and diffusion
Key Points
- Innovation is defined in this context as the development of better products or services.
- In business and economics, innovation is the catalyst to growth. With rapid advancements in transportation and communications over the past few decades, the old-world concepts of factor endowments and comparative advantage, which focused on an area’s unique inputs, are outmoded for today’s economy.
- In the organizational context, innovation may be linked to positive changes in efficiency, productivity, quality, competitiveness, market share, and others. All organizations can innovate, including hospitals, universities, and local governments.
Key Term
- innovation
-
The creation of better or more effective products, processes, services, technologies, or ideas that are not readily available but will soon be.
Example
- Innovations in the method of iron production catalyzed the Industrial Revolution of the nineteenth century.
In business and economics, innovation is the catalyst to growth. With rapid advancements in transportation and communications over the past few decades, the old-world concepts of factor endowments and comparative advantage, which focused on an area’s unique inputs, are outmoded for today’s global economy.
Organizations
In the organizational context, innovation may be linked to positive changes in efficiency, productivity, quality, competitiveness, market share, and others. All organizations can innovate, including hospitals, universities, and local governments.
Sources of Innovation
The famous robotics engineer Joseph F. Engelberger asserts that innovations require only three things: (1) A recognized need; (2) competent people with relevant technology; (3) financial support.
The Kline Chain-linked model of innovation places emphasis on potential market needs as drivers of the innovation process, and describes the complex and often iterative feedback loops between marketing, design, manufacturing, and research and development (R&D). Innovation by businesses is achieved in many ways, with much attention now given to formal research and development for “breakthrough innovations. ” R&D helps spur on patents and other scientific innovations that lead to productive growth in such areas as industry, medicine, engineering, and government. Yet, innovations can be developed by less formal on-the-job modifications of practice, through exchange and combination of professional experience and by many other routes. The more radical and revolutionary innovations tend to emerge from R&D, while more incremental innovations may emerge from practice—but there are many exceptions to each of these trends. An important innovation factor includes customers buying products or using services. As a result, firms may incorporate users in focus groups (user-centered approach), work closely with so-called lead users (lead user approach) or users might adapt their products themselves.
Goals and Failures
Programs of organizational innovation are typically tightly linked to organizational goals and objectives, to the business plan, and to market competitive positioning. One driver for innovation programs in corporations is to achieve growth objectives. A survey across a large number of manufacturing and services organizations found that systematic programs of organizational innovation are most frequently driven by (ranked in decreasing order of popularity): Improved quality, creation of new markets, extension of the product, range, reduced labor costs, improved production processes, reduced materials, reduced environmental damage, replacement of products/services, reduced energy consumption, and conformance to regulations. These goals vary between improvements to products, processes and services and dispel a popular myth that innovation deals mainly with new product development. Most of the goals could apply to any organization, be it a manufacturing facility, marketing firm, hospital or local government. Whether innovation goals are successfully achieved depends greatly on the environment prevailing in the firm. Conversely, failure can develop in programs of innovations. The causes of failure have been widely researched and can vary considerably. Some causes will be external to the organization and outside its influence of control while others will be internal and ultimately within the control of the organization. Internal causes of failure can be divided into causes associated with the cultural infrastructure and causes associated with the innovation process itself. Common causes of failure within the innovation process in most organizations can be distilled into five types: (1) Poor goal definition; (2) poor alignment of actions to goals; (3) poor participation in teams; (4) poor monitoring of results; (5) poor communication and access to information.
Diffusion of Innovations
Once innovation occurs, innovations may be spread from the innovator to other individuals and groups. This process has been proposed that the life cycle of innovations can be described using the “S-curve’ or diffusion curve. The S-curve maps growth of revenue or productivity against time. In the early stage of a particular innovation, growth is relatively slow as the new product establishes itself. At some point customers begin to demand and the product growth increases more rapidly. New incremental innovations or changes to the product allow growth to continue. Toward the end of its life cycle growth slows and may even begin to decline. In the later stages, no amount of new investment in that product will yield a normal rate of return.
Innovative companies will typically be working on new innovations that will eventually replace older ones. Successive S-curves will come along to replace older ones and continue to drive growth upwards . The S-curve derives from an assumption that new products are likely to have “product life” (i.e. a start-up phase, a rapid increase in revenue and eventual decline). In fact the great majority of innovations never get off the bottom of the curve, and never produce normal returns.
Technological Innovation Chart
In the figure above the first curve shows a current technology. The second shows an emerging technology that currently yields lower growth but will eventually overtake current technology and lead to even greater levels of growth.
15.5.2: New Product Ideas
New product ideas can generate from existing frustrations using a certain product, or a desire to do something better or more simply.
Learning Objective
Explain the front-end process of new product development (NPD) and the characteristics of a SWOT analysis
Key Points
- Most new product ideas come from experiences, like frustrations with an existing product.
- There are two parallel paths involved in the NPD process: one involves the idea generation, product design and detail engineering; the other involves market research and marketing analysis.
- Lots of ideas are generated about the new product. Out of these ideas many are implemented. The ideas are generated in many forms. There are many factors responsible for generation of an idea.
Key Terms
- life cycle
-
The useful life of a product or system; the developmental history of an individual or group in society.
- SWOT Analysis
-
a structured planning method used to evaluate the strengths, weaknesses, opportunities, and threats involved in a project or in a business venture
- product life cycle
-
the stages that a good or service goes through from when it is first introduced to when it is taken off the market
Example
- Airbnb.com, which has been wildly successful, started when their founders needed to generate $100 in order to pay their rent. A conference in a nearby town prompted them to rent out air mattresses in their apartment. They realized might have a good business idea.
In business and engineering, new product development (NPD) is the complete process of bringing a new product to market. A product is a set of benefits offered for exchange. It can be tangible (something physical you can touch) or intangible (like a service, experience, or belief). There are two parallel paths involved in the NPD process: idea generation, including product design and detail engineering; and market research and marketing analysis. Companies typically see new product development as the first stage in generating and commercializing a new product within the overall strategic process of product life cycle management, used to maintain or grow their market share.
Ideas for new products can be obtained from basic research using SWOT analysis: Strengths, Weaknesses, Opportunities & Threats. Many methods may be used to gain insight into new product lines or product features, including:
SWOT Analysis
Here is an example of the SWOT analysis matrix.
- Market and consumer trends
- Research and development
- Competitors
- Focus groups and trade shows
- Employees and corporate spies
- Salespeople
- Ethnographic discovery methods (searching for user patterns and habits)
Five Different Front-End Elements
- Opportunity identification: Large or incremental business and technological chances are identified in a relatively structured way. Using the guidelines established here, resources are allocated to new projects, leading to a structured New Product & Process Development or NPPD strategy.
- Opportunity analysis: This element translates identified opportunities into implications for the business and technology specific context of the company. This element focuses on aligning ideas to target customer groups, and can include market studies and/or technical trials and research.
- Idea genesis: The evolutionary and iterative process of progressing an initial idea from birth to maturation into a tangible idea. This process can occur internally or externally (e.g., a supplier offering a new material or technology, or a customer presenting an unusual request.
- Idea selection: The decision to pursue an idea is determined by analyzing its potential business value.
- Concept and technology development: During this part of the front-end, the business case is developed based on estimates of the total available market, customer needs, investment requirements, competition analysis and project uncertainty. Some organizations consider this the first stage of the NPPD process
15.5.3: Following a Product Development Process
Product development is idea generation, screening, business analysis, technical development, manufacturing, testing, and commercialization.
Learning Objective
Outline the several stages in new product development
Key Points
- Ideas for new products can be obtained from customers (employing user innovation), the company’s research and development department, competitors, focus groups, employees, salespeople, and more.
- The object of idea screening is to eliminate unsound concepts prior to devoting resources to them.
- The focus of the business analysis is primarily on profits, but other considerations, such as social responsibilities, may also be involved.
- Manufacturing planning must consider how to secure the availability of required funds, facilities, and personnel at the intended time, as well as the methods of coordinating this effort.
- Test marketing is the final step before commercialization; the objective is to test all the variabilites in the marketing plan including elements of the product.
Key Term
- Focus Group
-
A group of people, sampled from a larger population, interviewed in open session for market research or political analysis
New Product Development Process
There are several stages in the new product development process–not always followed in order:
Idea Generation
Generating new product ideas is a creative task that requires a specific way of thinking. Ideas for new products can be obtained from customers (employing user innovation), the company’s R&D department, competitors, focus groups, employees, sales people, corporate spies, trade shows, or through a policy of Open Innovation. Formal idea generating techniques include attribute listing, forced relationships, brainstorming, morphological analysis, and problem analysis.
Idea Screening
The second step in the product development process is screening. It is a critical part of the development activity. The object is to eliminate unsound concepts prior to devoting resources to them. The screeners must ask at least three questions:
- Will the customer in the target market benefit from the product?
- Is it technically feasible to manufacture the product?
- Will the product be profitable when manufactured and delivered to the customer at the target price?
Business Analysis
After the various product ideas survive their initial screening, very few viable proposals will remain. Before the development of prototypes can be decided upon, however, a further evaluation will be conducted to gather additional information on these remaining ideas in order to justify the enormous costs required. The focus of the business analysis is primarily on profits, but other considerations, such as social responsibilities, may also be involved. Management must:
- Estimate the likely selling price based upon competition and customer feedback.
- Estimate sales volume based upon size of market.
- Estimate profitability and the break even point.
Technical and Marketing Development
A product that has passed the screening and business analysis stages is ready for technical and marketing 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 factory worker can produce.
Prototypes
One step in the product development process is technical development.
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. They must ask the following questions:
- Who is the target market, and who is the decision maker in the purchasing process?
- What product features must the product incorporate?
- What benefits will the product provide?
- How will consumers react to the product?
- How will the product be produced most cost effectively?
- What will it cost to produce it?
Marketers must then prove feasibility through a virtual computer-aided rendering and rapid prototyping, and test the concept by asking a sample of prospective customers what they think of the idea.
Manufacturing Planning
Assuming that the product has cleared the technical and marketing development stage, the manufacturing department is asked to prepare plans for producing it. The plan begins with an appraisal of the existing production plant and the necessary tooling required to achieve the most economical production. Compromise between attractiveness and economy is often necessary. Finally, manufacturing planning must consider how to secure the availability of required funds, facilities, and personnel at the intended time, as well as the methods of coordinating this effort.
Marketing Planning
It is at this point that the product planner must prepare a complete marketing plan–one that starts with a statement of objectives and ends with the fusion of product, distribution, promotion, and pricing into an integrated program of marketing action.
Test Marketing
Test marketing is the final step before commercialization; the objective is to test all the variabilites in the marketing plan including elements of the product.
Commercialization (often considered post-NPD)
At last, the product is ready to go. It has survived the development process, and it is now on the way to commercial success. How can it be guided to that marketing success? It is the purpose of the lifecycle marketing plan to answer this question. Such a complete marketing program will, of course, involve additional decisions about distribution, promotion, and pricing.
15.5.4: Screening
Idea screening attempts to eliminate unsound product concepts prior to devoting resources to them.
Learning Objective
Explain how product developers use a simple checklist and assign weights of importance in order to best screen ideas
Key Points
- If a poor product idea is allowed to pass the screening state, it wastes effort and money in subsequent stages until it is later abandoned. However, the possibility of screening out a worthwhile idea is even more serious.
- The first technique of screening is a simple checklist. For example, new product ideas can be rated on a scale ranging from very good to poor.
- A second technique goes beyond the first, in which criteria are assigned importance weights, with products rated on a point scale measuring product compatibility.
- New product criteria include value added, sales volume, patent protection and affect on present products.
Key Terms
- patent
-
A declaration issued by a government agency declaring someone the inventor of a new invention and having the privilege of stopping others from making, using or selling the claimed invention; a letter patent.
- idea screening
-
the process of testing concepts and eliminating unsound ones
Idea screening is an early step in the new product development process and is a critical part of the development activity. If a poor product idea is allowed to pass the screening state, it wastes effort and money in subsequent stages until it is later abandoned. However, the possibility of screening out a worthwhile idea is even more serious, There are two common techniques for screening new product ideas. Both involve the comparison of a potential product idea against criteria of 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 by such criteria as value added, sales volume, patent protection and affect on present products. Unfortunately, it is quite difficult for raters to define what is fair or poor. In addition, the rating system does not address the issue of the time and expense associated with each idea, nor does it instruct with regard to scores. A second technique goes beyond the first, in which criteria are assigned importance weights, with products rated on a point scale measuring product compatibility. These scores are then multiplied by their respective weights and added to yield a total score for the new product idea.
In summary:
The object 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 market segment / target market?
- What is the current or expected competitive pressure for the product idea?
- What are the industry sales and market trends the product idea is based on?
- Is it technically feasible to manufacture the product?
- Will the product be profitable when manufactured and delivered to the customer at the target price?
Product Screening
Before introducing the iPad to market, Apple had to go through a process of screening in order to conclude the new product would be a worthwhile investment.
15.5.5: Analysis
The focus of the business analysis is primarily on profits, but other considerations such as social responsibilities may also be involved.
Learning Objective
Explain the business analysis stage of new product development
Key Points
- Before the development of prototypes can be decided upon, a further evaluation will be conducted to gather additional information on these remaining ideas in order to justify the enormous costs.
- The first step in the business analysis is to examine the projected demand. This would include two major sources of revenue: The sales of the product and the sales or license of the technology developed for or generated as a by-product of the given product.
- A complete cost appraisal is also necessary as a part of the business analysis.
- The Fourt-Woodlock equation is 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.
Key Terms
- learning curve
-
An experience or graphic representation of progress in learning measured against the time required to achieve mastery of something.
- economies of scale
-
The characteristics of a production process in which an increase in the scale of the firm causes a decrease in the long-run average cost of each unit.
After the various product ideas survive their initial screen, very few viable proposals will remain. Before the development of prototypes can be decided upon, however, a further evaluation will be conducted to gather additional information on these remaining ideas in order to justify the enormous costs. The focus of the business analysis is primarily on profits, but other considerations such as social responsibilities may also be involved. The first step in the business analysis is to examine the projected demand. This would include two major sources of revenue: The sales of the product and the sales or license of the technology developed for or generated as a by-product of the given product. A complete cost appraisal is also necessary as a part of the business analysis. It is difficult to anticipate all the costs that will be involved in product development, but the following cost items are typical:
- Expected development cost, including both technical and marketing research and development.
- Expected set-up costs. These can include production, manufacturing equipment, distribution, etc.
- Operating costs that account for possible economies of scale and learning curves.
- Marketing costs, especially promotion and distribution.
- Management costs.
Other necessary steps in business analysis include:
- Estimating the likely selling price based upon competition and customer feedback.
- Estimating sales volume based upon the size of the target market and such tools as the Fourt-Woodlock equation.
- Estimating profitability and the break-even point.
The Fourt-Woodlock equation is 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. Since it includes the effects of initial trial and repeat rates, the equation is useful in new product development .
The Fourt-Woodlock Equation
The left-hand-side of the equation is the volume of purchases per unit time (usually taken to be one year). On the right-hand-side, the first parentheses describes trial volume, and the second describes repeat volume. HH is the total number of households in the geographic area of projection, and TR (“trial rate”) is the percentage of those households which will purchase the product for the first time in a given time period. TU (“trial units”) is the number of units purchased on this first purchase occasion. MR is “measured repeat,” or the percentage of those who tried the product who will purchase it at least one more time within the first year of the product’s launch. RR is the repeats per repeater ( the number of repeat purchases within that same year). RU is the number of repeat units purchased on each repeat event.
15.5.6: Testing
The objective of testing is to test all the variabilites in the marketing plan, including elements of the product.
Learning Objective
Compare and contrast initial product testing and test marketing
Key Points
- 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.
- In test marketing, the consumer must make the decision him- or herself, must pay using his or her money, and the test product must compete with the existing products in the actual marketing environment.
- 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.
Key Terms
- marketing mix
-
The marketing mix is a business tool used in marketing products. The marketing mix is often crucial when determining a product or brand’s unique selling point and is often synonymous with the four Ps: price, product, promotion, and place.
- Market Share
-
Percentage of some market held by a company.
Example
- In this stage, one of the best things you can do as an entrepreneur is find cheap easy ways to test the market for your product. One way to do that might be spending $50 on Facebook or Google ads, before you even go and build a product.
Testing is the final step before commercialization. The objective is to test all the variabilites in the marketing plan including elements of the product. Test marketing represents an actual launching of the total marketing program, but on a limited basis.
Three general issues are addressed through test marketing. First, the overall workability of the marketing plan is assessed. Second, alternative allocations of the budget are evaluated. Third, whether the new product is inspiring users to switch from other brands is determined. In the end, the test market should include an estimate of sales, market share, and financial performance over the life of the product.
Product Testing
This is a photo of a temperature and humidity chamber used to simulate transport, warehouse environments, and shelf life conditions of a packaged product.
Initial product testing and test marketing are not the same. Product testing is totally initiated by the producer. He or she selects a 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 should represent the national market. The consumer must make the decision him- or herself, must pay with his or her 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 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.
However, running a test marketing simulation has inherent risks. First, there are substantial costs in buying the necessary plant and machinery 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; in other words, there is an opportunity cost. There is also a risk of losing consumer goodwill through the testing of an inferior product. Finally, engaging in a test market might allow competitors to become aware of a new product and quickly copy it.
Because of the special expertise needed to conduct test markets and take on associated expenses, most manufacturers employ independent marketing research agencies with highly trained project directors, statisticians, psychologists, and field supervisors. Such firms assist the product manager in making the remaining test market decisions. These include:
- Duration of testing: the product should be tested long enough to account for market factors to even out, allow for repeat purchases, and account for deficiencies in any other elements in the new product (three to six months of testing may be sufficient for a frequently purchased and rapidly consumed convenience item).
- Selection of test market cities: the test market 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., 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 discontinued.
15.5.7: Commercialization
Once a product is ready to take to market, commercialization involves key decisions about distribution, promotion, and pricing.
Learning Objective
Outline the basics of commercialization
Key Points
- 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.
- Commercialization of a product will only take place if the following three questions can be answered: When is the appropriate time to introduce the product? Where is the appropriate market to launch the product? To whom will the product be targeted primarily?
- The company has to decide on an action plan for introducing the product by implementing the above decisions.
Key Term
- marketing mix
-
The marketing mix is a business tool used in marketing products. The marketing mix is often crucial when determining a product or brand’s unique selling point and is often synonymous with the four Ps: price, product, promotion, and place.
Commercialization is the process or cycle of introducing a new product or production method into the market . This 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. Commercialization is often confused with sales, marketing or business development. The commercialization process has three key aspects:
Commercialization
Bringing new products to market will require creative marketing techniques to achieve success like Red Bull did by creating mascot automobiles.
- It is essential to look at many ideas to get one or two products or businesses that can be sustained long-term. This is often known as the funnel.
- Commercialization is a stage-wise process, and each stage has its own key goals and milestones.
- It is vital to involve key stakeholders early on, including customers.
Commercialization of a product will only take place if the following three questions can be answered:
- When is the appropriate time to introduce the product? 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.
- Where is the appropriate market to launch the product? It can be in a single location, in several regions, or it might be more appropriate for a national or 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 all 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. Other multinationals use the “lead-country” strategy by introducing the new product in one country/region at a time.
- To whom will the product be targeted primarily? These primary consumer groups should consist of innovators, early adopters, heavy users and/or opinion leaders. This will ensure adoption by other buyers in the marketplace during the product growth period.
The company has to decide on an action plan for introducing the product by thinking about the questions above and making informed decisions. It has to develop a viable marketing mix and create a respective marketing budget.
15.6: Product Strategy
15.6.1: Developing Products
Organizations assess the current market for new product opportunities and, when potentially profitable, develop new product prototypes to test feasibility of production.
Learning Objective
Outline the steps involved in new product development, understanding the logic behind them
Key Points
- Product development is the process of identifying consumer needs within a market and innovating towards developing a product to fulfill those needs.
- Internal and external factors impacting production and demand should all be considered during the product development period.
- The eight steps of Koen provide useful context on how organizations develop products. Market research, brainstorming, screening, prototyping, testing, process engineering, and distribution are all key phases in development.
- Another useful concept is the idea of a minimum viable product (MVP). Due to the cost of mass production and perfecting a product, MVP allows rapid prototyping and testing to ensure a demand exists.
Key Terms
- scale
-
To grow and expand rapidly.
- conceptualizing
-
To conceive an idea for something.
New Product Opportunities
The process of identifying consumer needs within a market, and innovating towards developing a product to fulfill those needs, is referred to as new product development. When developing new products, the most important thing to keep in mind is that the product itself must successfully fill an existing need in the market, transforming a market opportunity into a tangible and marketable product.
Cost, time of development, price points, ability to scale, distribution, legalities, and competition should all be considered during the product development period. Through assessing the opportunity, risks, costs and external environment, organizations can ensure they focus on developing and investing in the products with the highest potential.
How To Develop Products
There are a number of useful frameworks for product development and product design, each of which focus on a full process of identifying market needs, ideating upon solutions, conceptualizing these solutions, and ultimately prototyping the new product for testing. One of the more well-known approaches is called eight stages of Koen:
Eight Stages of Koen
- Idea generation – Using market research, SWOT assessments, industry trends, trade shows, and data gathering techniques, organizations identify the existing opportunities in the market. Ideas to fill these consumer needs are brainstormed. When brainstorming, any and all ideas are valid and should be considered thoroughly.
- Idea screening – Once all of the ideas are on the board, the screening process can begin. Screening revolves around identifying which products best align with the target market and the need being filled, along with the technical feasibility and potential profitability of producing it.
- Idea development and testing – In this phase, the organization focuses on identifying marketing and engineering needs for production. The idea, concept, and brand identity of the new product should be considered, and technical aspects such as patents, features, and cost saving should be considered. 3D printing is an excellent advantage for prototyping as well, and consumers can be invited to test 3D printed models of the product.
- Business analysis – At this point, estimated selling prices, volume and profitability should be projected, researched, and confirmed.
- Beta testing and market testing – After producing and testing the prototype, an organization can now package and send this to small focus groups, trade shows and user testing sessions. This initial run through will allow comments from real consumers and criticisms to be addressed before mass marketing.
- Technical implementation – Assuming the beta testing goes well, the technical aspects of larger scale manufacturing must be organized. This includes building in quality management, resource estimations, technical spec sheets, engineering planning, department scheduling, sourcing, logistics, and all the other various inputs specific products may need for production.
- Commercialization – The product is finally ready for commercialization. At this point, the organization can officially launch the product, advertise, fill distribution pipelines, and refine the process.
- New product pricing – Once the product has been on the shelves for a some time, sufficient data can be collected to identify the financial impacts of this new product. Differentiating between segments, price points, consumer groups, and competitive markets can yield useful strategic information for the firm.
Pyramid of Production Systems
Refining production for a new product requires consideration of a variety of factors, including productivity, quality, economics, flexibility, and sustainability.
Through executing these eight steps, organizations can effectively mitigate risk while capturing new and interesting opportunities in the external markets.
Minimum Viable Product
Another useful concept to learn in regards to product development is referred to as the minimum viable product (MVP). A minimum viable product is the least investment of time and resources required to bring the product to market for testing. Often an MVP project will be developed rapidly and distributed in one or two locales, representative of the general market population. This mitigates risk and exposure while ensuring the organization can confirm the demand for a given product at a given price point.
15.6.2: Developing Services
Service products are offered by a wide variety of industries such as barbers, travel agencies, and consulting firms.
Learning Objective
Explain how services are a key aspect of the goods industry
Key Points
- It is important to remember that all products – whether they are goods, services, blankets, diapers, or plate glass – possess peculiarities that require adjustments in the marketing effort.
- Behind every product is a series of supporting services, such as warranties and money-back guarantees.
- An industrial customer might be keenly interested in related services such as prompt delivery, reliable price quotations, credit, test facilities, demonstration capabilities, liberal return policies, engineering expertise, and so forth.
Key Term
- credit
-
A privilege of delayed payment extended to a buyer or borrower on the seller’s or lender’s belief that what is given will be repaid.
Example
- The price of your merchandise or service tells the customer a lot about what they can expect from your business. This is why in some instances, salons and other services are able to charge a premium. Although they are delivering a product/service that is similar to competitors, the higher price suggests theirs has greater value.
Service products are reflected by a wide variety of industries: utilities, barbers, travel agencies, health spas, consulting firms, medical care and banking, to name but a few. They account for nearly 50% of the average consumer’s total expenditures, 70% of the jobs, and two-thirds of the GNP. Clearly, the service sector is large and is growing. It is important to remember that all products—whether they are goods, services, blankets, diapers, or plate glass—possess peculiarities that require adjustments in the marketing effort. However, offering an exceptional product at the right price, through the most accessible channels, promoted extensively and accurately, should work for any type of product.
Service Development
Dog walking is a service industry that has developed in recent years.
Moreover, behind every product is a series of supporting services, such as warranties and money-back guarantees. In many instances, such services may be as important as the product itself. In fact, at times it is difficult to separate the associated services from the product features. Consequently, companies must constantly monitor the services offered by the company and its competitors. Based on the results of data-gathering devices such as customer surveys, consumer complaints, and suggestion boxes, the product manager can determine the types of services to offer, the form the service will take, and the price charged.
An industrial customer might be keenly interested in related services such as prompt delivery, reliable price quotations, credit, test facilities, demonstration capabilities, liberal return policies, engineering expertise, and so forth. Although there are a wide range of supportive services, the following are most prevalent:
- Credit and financing: With the increased acceptance of debt by the consumer, offering credit and/or financing has become an important part of the total product. For certain market segments and certain products, the availability of credit may make the difference between buying or not buying the product.
- Warranty: There are several types of durable products, retail stores, and even service products where warranties are expected. These warranties can provide a wide array of restitution, with a very limited warranty at one end of the continuum and extended warranties at the other.
- Money-back guarantees: The ultimate warranty is the money-back guarantee. To the customer, a money-back guarantee reduces risk almost totally. There are certain market segments (e.g., low risk takers) that perceive this service as very important. Obviously this service is effective only if the product is superior and the product will be returned by only a few people.
- Delivery, installation, and training: Firms that sell products that tend to be physically cumbersome or located far from the customer might consider delivery to be an integral part of the new product. Very few major appliance stores, lumber yards, or furniture stores could survive without provisions for this service. Similarly, there are products that are quite complicated and/or very technical, and whose average consumer could neither learn how to install or use it without assistance from the manufacturer. Both professional and home computer companies have been forced to provide such services.
15.6.3: Classifying Consumer Products
Consumer products can be classified as convenience, shopping, or specialty goods.
Learning Objective
Categorize consumer product into three groups: convenience, shopping, specialty
Key Points
- A convenience good is one that requires a minimum amount of effort on the part of the consumer.
- Goods that consumers want to be able to compare, such as automobiles, appliances, and homes,are categorized as shopping goods.
- Specialty goods are products so unique that consumers will go to any lengths to seek out and purchase them.
Key Terms
- wholesaler
-
a person or company that sells goods wholesale is a middleman that buys its merchandise from a third party supplier and resells the merchandise to retail businesses or the end consumer. A wholesaler normally does not sell to other wholesalers.
- reseller
-
a company or individual that purchases goods or services with the intention of reselling them rather than consuming or using them
Examples
- In its online product catalog, retailer Sears divides its products into “departments”, then presents products to potential shoppers according to (1) function or (2) brand. Each product has a Sears item-number and a manufacturer’s model-number. Sears uses the departments and product groupings with the intention of helping customers browse products by function or brand within a traditional Raj department-store structure.
- Intangible Data Products can further be classified into Virtual Digital Goods (“VDG”) that are virtually located on a computer OS and accessible to users as conventional file types, such as JPG and MP3 files. Open Source Code, GNU Linux, or even Android, may manipulate and/or convert base Virtual Digital Goods (“VDG”) into process-oriented Real Digital Goods (“RDG”), as part of an application process or manufactured service that may be viewed on Personal Data Assistant (“PDA”) or other hand-held tangible devices or OS computer.
Classifying Consumer Products
A classification long used in marketing separates products targeted at consumers into three groups:
- Convenience
- Shopping
- And specialty
Convenience Goods
A convenience good is one that requires a minimum amount of effort on the part of the consumer. Extensive distribution is the primary marketing strategy. The product must be available in every conceivable outlet and must be easily accessible in these outlets. Vending machines typically dispense convenience goods, as do automatic teller machines. These products are usually of low unit value, they are highly standardized, and, frequently, they are nationally advertised. Yet, the key is to convince resellers (i.e., wholesalers and retailers) to carry the product. If the product is not available when, where, and in a form desirable by the consumer, the convenience product will fail. From the consumer’s perspective, little time, planning, or effort go into buying convenience goods. Consequently, marketers must establish a high level of brand awareness and recognition. This is accomplished through extensive mass advertising; sales promotion devices, such as coupons and point-of-purchase displays; and effective packaging. The fact that many of our product purchases are often on impulse is evidence that these strategies work. Availability is also important. Consumers have come to expect a wide spectrum of products to be conveniently located at their local supermarkets, ranging from packaged goods used daily (e.g., bread and soft drinks) to products purchased rarely or in an emergency, such as snow shovels, carpet cleaners, and flowers.
Convenience Goods
Convenience goods are typically found in convenience stores, such as the one pictured here.
Shopping Goods
In contrast, consumers want to be able to compare products categorized as shopping goods. Automobiles, appliances, furniture, and homes are in this group. Shoppers are willing to go to some lengths to compare values, and, therefore, these goods need not be distributed so widely. Although many shopping goods are nationally advertised, often, it is the ability of the retailer to differentiate itself that creates the sale. The differentiation could be equated with a strong brand name, such as Sears Roebuck, effective merchandising, aggressive personal selling, or the availability of credit. Discounting, or promotional price-cutting, is a characteristic of many shopping goods because of retailers’ desire to provide attractive shopping values. In the end, product turn over is slower, and retailers have a great deal of their capital tied-up in inventory. This, combined with the necessity to price discount and provide exceptional service, means that retailers expect strong support from manufacturers with shopping goods.
Specialty Goods
Specialty goods represent the third product classification. From the consumer’s perspective, these products are so unique that they will go to any lengths to seek out and purchase them. Almost without exception, price is not a principle factor affecting the sales of specialty goods. Although these products may be custom-made (e.g., a hairpiece) or one-of-a-kind (e.g., a statue), it is also possible that the marketer has been very successful in differentiating the product in the mind of the consumer. Crisco shortening, for instance, may be a unique product in the mind of a consumer, and the consumer would pay any price for it. Such a consumer would not accept a substitute and would be willing to go to another store or put off their pie baking until the product arrives. Another example might be the strong attachment some people feel toward a particular hair stylist or barber. A person may wait a long time for that individual and might even move with that person to another hair salon. It is generally desirable for a marketer to lift the product from the shopping to the specialty class. With the exception of price cutting, the entire range of marketing activities are required to accomplish this goal.
15.6.4: Classifying Business Products
Business products are goods or services that are sold to other businesses rather than to end-consumers.
Learning Objective
Explain the different marketing strategies of various types of indistrial goods
Key Points
- Forests, mines, and quarries provide extractiveproducts to producers.
- Manufactured products are those that have undergone some processing. Semi-manufactured goods are raw materials that have received some processing but require more before they are useful to the purchaser.
- Parts are manufactured items that are ready to be incorporated into other products.
- Process machinery (sometimes called installations) refers to major pieces of equipment used in the manufacture of other goods.
- Equipment is made up of portable factory equipment (e.g., fork lift trucks, fire extinguishers) and office equipment (e.g., computers, copier machines).
- Supplies and service do not enter the finished product at all, but are nevertheless consumed in conjunction with making the product.
Key Terms
- lathe
-
A machine tool used to shape a piece of material, or workpiece, by rotating the workpiece against a cutting tool.
- process
-
A series of events to produce a result, especially as contrasted to product.
Although consumer products are more familiar to most individuals, business and industrial goods represent very important product categories as well. In the case of some manufacturers, business products are their entire focus. Industrial products can either be categorized from the perspective of the producer and how they shop for the product, or the perspective of the manufacturer and how they are produced and how much they cost. The latter criteria offers a more insightful classification for industrial products.
Forests, mines, and quarries provide extractive products to producers. Although there are some farm products that are ready for consumption when they leave the farm, most farm and other extractive products require some processing before purchase by the consumer. A useful way to divide extractive products is into farm products and natural products, since they are marketed in slightly different ways.
Extractive Products
Quarries are examples of business that provide extractive products for other businesses.
Manufactured products are those that have undergone some processing. The demands for manufactured industrial goods are usually derived from the demands for ultimate consumer goods. There are a number of specific types of manufactured industrial goods.
Semi-manufactured goods are raw materials that have received some processing but require more before they are useful to the purchaser. Lumber and crude oil are examples of these types of products. Since these products tend to be standardized, there is a strong emphasis on price and vendor reliability.
Parts are manufactured items that are ready to be incorporated into other products. For instance, the motors that go into lawn mowers and steering wheels on new cars are carefully assembled when they arrive at the manufacturing plant. Since products such as these are usually ordered well in advance and in large quantities, price and service are the two most important marketing considerations.
Process machinery (sometimes called installations) refers to major pieces of equipment used in the manufacture of other goods. This category would include the physical plant of a manufacturer (boilers, lathes, blast furnaces, elevators, and conveyor systems). The marketing process would incorporate the efforts of a professional sales force, supported by engineers and technicians, and a tremendous amount of personalized service.
Equipment is made up of portable factory equipment (e.g., fork lift trucks, fire extinguishers) and office equipment (e.g., computers, copier machines). Although these products do not contribute directly to the physical product, they do aid in the production process. These products may be sold directly from the manufacturer to the user, or a middleman can be used in geographically dispersed markets. The marketing strategy employs a wide range of activities, including product quality and features, price, service, vendor deals, and promotion.
Supplies and service do not enter the finished product at all, but are nevertheless consumed in conjunction with making the product. Supplies would include paper, pencils, brooms, soap, etc. These products are normally purchased as convenience products with a minimum of effort and evaluation. Business services include maintenance (e,g., office cleaning), repairs (e.g., plumbing), and advisory (e.g., legal). Because the need for services tends to be unpredictable, they are often contracted for a relatively long period of time.
15.6.5: Marketing Classes of Products
Products can be classified based on consumer versus industrial goods and goods versus services.
Learning Objective
Categorize products into consumer goods, industrial goods, goods, services
Key Points
- When we purchase products for our own consumption with no intention of selling these products to others, we are referring to consumer goods.
- Industrial goods are purchased by an individual or organization in order to modify them or simply distribute them to the ultimate consumer in order to make a profit or meet some other objective.
- Consumer goods can be classified as convenience, shopping, or specialty goods.
- Service products are characterized as being intangible, produced and consumed simultaneously, lacking standardization, and having high buyer involvement.
- 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 United States, with the exception of products obtained directly from the producer, all products are sold through resellers. Since resellers operate under unique business characteristics, they must be approached carefully. Producers are always cognizant of the fact that successful marketing to resellers is just as important as successful marketing to consumers.
Key Terms
- intangible
-
incapable of being perceived by the senses; incorporeal
- Consumer
-
Someone who acquires goods or services for direct use or ownership rather than for resale or use in production and manufacturing.
- marketing
-
The promotion, distribution and selling of a product or service; includes market research and advertising.
Example
- Industrial market example: A steel mill might purchase computer software, pencils, and flooring as part of the operation and maintenance of its business. Likewise, a refrigerator manufacturer might purchase sheets of steel, wiring, and shelving in order to produce its final product. These purchases occur in the industrial market. Evidence suggests that industrial markets function differently from consumer markets, and that the buying process is particularly different.
The two most commonly used methods of classifying products are: (1) Consumer goods versus industrial goods, and (2) goods products (i.e., durables and non-durables) versus service products.
Consumer Goods and Industrial Goods
The traditional classification of products is to dichotomize all products as being either consumer goods or industrial goods. When we purchase products for our own consumption with no intention of selling these products to others, we are referring to consumer goods . Conversely, industrial goods are purchased by an individual or an organization in order to modify them or simply distribute them to the ultimate consumer in order to make a profit or meet some other objective.
Olympus Camera
This Olympus camera is considered to be a consumer good.
Classification of Consumer Goods
A classification long used in marketing separates products targeted at consumers into three groups: (1) Convenience goods, (2) shopping goods and (3) specialty goods.
A convenience good is one that requires a minimum amount of effort on the part of the consumer. Extensive distribution is the primary marketing strategy. The product must be available in every conceivable outlet and must be easily accessible in these outlets. These products are usually of low unit value, they are highly standardized, and frequently they are nationally advertised.
Consumers desire to compare products categorized as shopping goods. Automobiles, appliances, furniture, and homes are in this group. Shoppers are willing to go to some lengths to compare values; therefore, these goods need not be distributed so widely. Although many shopping goods are nationally advertised, often it is the ability of the retailer to differentiate itself that creates the sale. Discounting, or promotional price-cutting, is a characteristic of many shopping goods because of retailers’ desire to provide attractive shopping values.
Specialty goods represent the third product classification. From the consumer’s perspective, these products are so unique that they will go to any lengths to seek out and purchase them. Almost without exception, price is not a principle factor affecting the sales of specialty goods.
Classification of Industrial Goods
Although consumer products are more familiar to most readers, industrial goods represent a very important product category. For some manufacturers, industrial goods are the only product sold. The methods of industrial marketing are somewhat more specialized. Industrial products can either be categorized from the perspective of the producer and how they shop for the product, or the perspective of the manufacturer and how they are produced and how much they cost. The latter criteria offers a more insightful classification for industrial products.
Forests, mines, and quarries provide extractive products to producers. Most extractive products require some processing before purchase by the consumer. Manufactured products are those that have undergone some processing. The demand for manufactured industrial goods are usually derived from the demand for ultimate consumer goods.
Goods Versus Services
Service products are reflected by a wide variety of industries—utilities, barbers, travel agencies, health spas, consulting firms, medical facilities and banks are but a few. They account for nearly 50 percent of the average consumer’s total expenditures and 70 percent of jobs. Like goods products, service products are quite heterogeneous. Nevertheless, there are several characteristics that are generalized to service products.
Intangible: With the purchase of a good, one has something that can be seen, touched, tasted, worn or displayed. This is not true with a service. Although one pays money and consumes the service, there is nothing tangible to show for it.
Simultaneous Production and Consumption: Service products are characterized as those that are being consumed at the same time they are being produced. In contrast, goods products are produced, stored, and then consumed. A result of this characteristic is that the provider of the service is often present when consumption takes place.
Little Standardization: Because service products are so closely related to the people providing the service, ensuring the same level of satisfaction from time to time is quite difficult.
High Buyer Involvement: With many service products, the purchaser may provide a great deal of input into the final form of the product. For example, in the case of a cruise, a good travel agent would provide a large selection of brochures and pamphlets describing the various cruise locations, options provided in terms of cabin location and size, islands visited, food, entertainment, prices, and whether there are facilities for children.
It should be noted that these four characteristics associated with service products vary in intensity from product to product. In fact, service products are best viewed as being on a continuum in respect to these four characteristics.
15.6.6: Using a Product Life Cycle Framework
Evidence suggests that every product goes through a lifecycle with different phases of sales and profits.
Learning Objective
Explain the five stages of the product life cycle
Key Points
- A company has to be good at both developing new products and managing them in the face of changing tastes, technologies, and competition.
- It should be noted that the predictive capabilities of the product lifecycle are dependent upon several factors, both controllable and uncontrollable, and that no two companies may follow the same exact pattern or produce the same results.
- Some argue that the competitive situation is the single most important factor influencing the duration of height of a product lifecycle curve.
- Almost all new products can expect fewer than 5, 10, or 15 years of market protection.
- Usually the improvements brought about by non-product tactics are relatively short-lived, and basic alterations to product offerings provide longer benefits.
Key Terms
- patent
-
A declaration issued by a government agency declaring someone the inventor of a new invention and having the privilege of stopping others from making, using or selling the claimed invention; a letter patent.
- distinctiveness
-
Something which distinguishes something from anything else
- obsolete
-
no longer in use; gone into disuse; disused or neglected (often by preference for something newer, which replaces the subject).
Example
- Product life-cycle predictions are dependent upon controllable and uncontrollable factors. For example, differences in the competitive situation during each of these stages may dictate different marketing approaches.
The Product Lifecycle
A company has to be good at both developing new products and managing them in the face of changing tastes, technologies, and competition. Evidence suggests that every product goes through a lifecycle with different phases of sales and profits. As such, the manager must find new products to replace those that are in the declining stage of the product lifecycle and learn how to manage products optimally as they move from one stage to the next. The five stages of the product life cycle and their components can be defined as follows:
- Product development: the period during which new product ideas are generated, operationalized, and tested prior to commercialization.
- Introduction: the period during which a new product is introduced. Initial distribution is obtained and promotion is obtained.
- Growth: the period during which the product is accepted by consumers and the trade. Initial distribution is expanded, promotion is increased, repeat orders from initial buyers are obtained, and word-of-mouth advertising leads to more and more new users.
- Maturity: the period during which competition becomes serious. Towards the end of this period, competitors’ products cut deeply into the company’s market position.
- Decline: the product becomes obsolete and its competitive disadvantage result in decline in sales and, eventually, deletion.
It should be noted that the predictive capabilities of the product lifecycle are dependent upon several factors, both controllable and uncontrollable, and that no two companies may follow the same exact pattern or produce the same results. For example, differences in the competitive situation during each of these stages may dictate different marketing approaches. Some argue that the competitive situation is the single most important factor influencing the duration of height of a product lifecycle curve. A useful way of looking at this phenomenon is in terms of competitive distinctiveness.
Product Lifecycle
The product lifecycle.
Often, new products may, upon introduction, realistically expect a long period of lasting distinctiveness or market protection—through such factors as secrecy, patent protection, and the time and cash required to develop competitive products. However, almost all new products can expect fewer than 5, 10, or 15 years of market protection.
Of course, changes in other elements of the marketing mix may also affect the performance of the product during its lifecycle. For example, a vigorous promotional program or a dramatic lowering of price may improve the sales picture in the decline period, at least temporarily. The black-and-white TV market illustrated this point. Usually the improvements brought about by non-product tactics are relatively short-lived, and basic alterations to product offerings provide longer benefits. Whether one accepts the S-shaped curve as a valid product-sales pattern or as a pattern that holds only for some products (but not for others), the product lifecycle concept can still be very useful. It offers a framework for dealing systematically with product management issues and activities. Thus, the marketer must be cognizant of the generalizations that apply to a given product as it moves through the various stages. This process begins with product development and ends with the deletion (discontinuation) of the product.
15.7: Product Packaging and Branding
15.7.1: A Brief Definition of Brand
A brand refers to a name, term, symbol, or any other type of feature that defines or identifies a seller’s product or service.
Learning Objective
Explain the history and importance of branding
Key Points
- The word “brand” is derived from the Old Norse brand meaning “to burn,” which refers to the practice of producers burning their mark (or brand) onto their products.
- During the Industrial Revolution, the production of many household items, such as soap, was moved from local communities to centralized factories where they were branded with a logo or insignia, extending the meaning of “brand” to that of trademark.
- All of a brand’s elements (i.e., logo, color, shape, letters, images) work as a psychological trigger or stimulus that causes an association to all other thoughts we have about a brand.
- Brands provide external cues to taste, design, performance, quality, value, and prestige if they are developed and managed properly.
- Brands convey positive or negative messages about a product. They also indicated the company or service to the consumer, which is a direct result of past advertising, promotion, and product reputation.
- A brand can convey up to six levels of meaning: Attributes, Benefits, Values, Culture, Personality and User.
Key Term
- brand
-
A name, symbol, logo, or other item used to distinguish a product, service, or its provider.
Example
- Campbell Soup, Coca-Cola, Juicy Fruit gum, Aunt Jemima, and Quaker Oats were among the first products to be “branded. “
Defining a Brand
A brand consists of any name, term, design, style, words, symbols or any other feature that distinguishes the goods and services of one seller from another. A brand also distinguishes one product from another in the eyes of the customer. All of its elements (i.e., logo, color, shape, letters, images) work as a psychological trigger or stimulus that causes an association to all other thoughts we have about this brand. Tunes, celebrities, and catchphrases are also oftentimes considered brands.
Coca-Cola Brand Logo
The Coca-Cola logo is an example of a widely-recognized trademark and global brand.
History
The word “brand” is derived from the Old Norse ‘brand’ meaning “to burn,” which refers to the practice of producers burning their mark (or brand) onto their products. Italians are considered among the first to use brands in the form of watermarks on paper in the 1200s. However, in mass-marketing, this concept originated in the 19th century with the introduction of packaged goods.
During the Industrial Revolution, the production of many household items, such as soap, was moved from local communities to centralized factories to be mass-produced and sold to the wider market. Illiteracy was still prevalent and packing crates were handled by stevedores who couldn’t read. Factories branded their logo or insignia on the barrels used and the logo of the companies to which the cargo was being shipped. This allowed the products to be delivered to the proper location. The meaning of “brand” extended to that of the trademark symbol, and communicated to retailers and their customers that mass produced products should be trusted as much as local competitors. Campbell Soup, Coca-Cola , Juicy Fruit gum, Aunt Jemima, and Quaker Oats were among the first U.S. products to be “branded. “
Connotations
A successful brand can create and sustain a strong, positive, and lasting impression in the mind of a consumer. Brands provide external cues to taste, design, performance, quality, value and prestige if they are developed and managed properly. Brands convey positive or negative messages about a product, along with indicating the company or service to the consumer, which is a direct result of past advertising, promotion, and product reputation.
A brand can convey up to six levels of meaning:
- Attributes: The Mercedes-Benz brand, for example, suggests expensive, well-built, well-engineered, durable, high-prestige automobiles.
- Benefits: attributes must be translated into functional and emotional benefits.
- Values: Mercedes stands for high performance, safety, and prestige.
- Culture: Mercedes represents German culture, organized, efficient, high quality.
- Personality: the brand projects a certain personality.
- User: the brand suggests the kind of consumer who buys and uses the product.
15.7.2: Brand Categories
Similar goods and services are classified in brand categories.
Learning Objective
Define a brand
Key Points
- Brand categories, or generic classification of products, group similar goods and services.
- A brand is a name, term, design, symbol, or any other feature that identifies one seller’s good or service as distinct from those of other sellers.
- Brand awareness refers to the customer’s ability to recall and recognize the brand under different conditions, using memory associations to link to the brand name, logo, jingles, and so forth.
Key Terms
- Brand Equity
-
the value of having a well-known name, logo, or other identifier
- Brand categories
-
A generic classification of products or services.
Example
- Coke, Pepsi, Sprite, and all other soda brand products fall into the same brand category of soft drinks.
Brand Categories
A brand is a name, term, design, symbol, or any other feature that identifies one seller’s good or service as distinct from those of other sellers.
Branding began as a functional marketing tool. Italians are considered among thefirst to use brands in the form of watermarks on paper in the 1200s. People in the Middle Ages were illiterate. Medieval guilds — candle makers, goldsmiths,cobblers; carpenters, painters and masons; bakers and fishmongers — created symbols to be etched or stamped into their work, products or crates which represented and certified the quality of a guild’s work.
Brand categories are generic classifications of products or services. Similar and competing products (or services) all fall into the same brand category. For example, all the different perfumes fall into the brand category of perfume because they all satisfy the same consumer need.
Brand awareness refers to the customer’s ability to recall and recognize the brand under different conditions, using memory associations to link to the brand name, logo, jingles, and so forth. It consists of both brand recognition and brand recall. It helps the customers understand to which product or service category the particular brand belongs and what products and services are sold under the brand name. It also ensures that customers know which of their needs are satisfied by the brand through its products (Keller). Brand awareness is of critical importance, since customers will not consider your brand if they are not aware of it .
Brand logo
Brand awareness refers to thecustomer’s ability to recall and recognize the brand under different conditions,using memory associations to link to the brand name, logo, jingles, and so forth.
There are various levels of brand awareness that require different levels and combinations of brand recognition and recall. Top-of-Mind is the goal of most companies. Top-of-Mind Awareness occurs when your brand is what pops into a consumer’s mind when asked to name brands in a product category. For example, when someone is asked to name a type of facial tissue, the common answer is Kleenex, which is a top-of-mind brand. Aided Awareness occurs when a consumer is shown or reads a list of brands, and expresses familiarity with your brand only after they hear or see it as a type of memory aid. Strategic Awareness occurs when your brand is not only top-of-mind to consumers, but also has distinctive qualities that stick out to consumers as making it better than the other brands in your market. The distinctions that set your product apart from the competition are also known as the Unique Selling Points or USP.
15.7.3: The Benefits of a Good Brand
Good branding gives a company several advantages including establishing a positive reputation and building an image attractive to consumers.
Learning Objective
Explain the components of a strong brand
Key Points
- Branding develops an image of a company’s products in the minds of consumers, attributing goods with certain unique qualities or characteristics that, if done effectively, are attractive to the target audience.
- A brand widely known in the market has brand recognition and builds up positive sentiment which further strengthens the company position amongst competitors.
- Benefits of a strong brand include: being able to command higher prices, speeding up new product acceptance, enabling market share penetration by advertising, and resisting price erosion.
Key Terms
- good
-
an object produced for market
- brand image
-
The set of emotional and sensory perceptions a consumer associates with a particular product or service in their mental construct of a brand.
Example
- Disney has brand recognition worldwide; its castle logo with Walt Disney’s signature, as well as its characters (like Mickey Mouse) are instantly recognizable.
Benefits of a Strong Brand
A brand is the personality that identifies a product, service or company (name, term, sign, symbol, design, or combination thereof); it also represents a relationship to key constituencies: customers, staff, partners, investors etc. Proper branding can yield higher product sales, and higher sales of products associated with the brand (or brand association). For example, a a customer who loves Pillsbury biscuits (and trusts the brand) is more likely to try other products the company offers, such as chocolate chip cookies.
Some people distinguish the psychological aspect of brand associations (e.g., thoughts, feelings, perceptions, images, experiences, beliefs, attitudes, etc.) that become tied to the brand from the experiential aspect—the sum of all points of contact with the brand, otherwise known as brand experience. Brand experience is a brand’s action perceived by a person. The psychological aspect, sometimes referred to as the brand image, is a symbolic construct created within the minds of people, consisting of all the information and expectations associated with a product, service, or company providing them .
Brands
Good branding gives a company several advantages, including establishing a positive reputation and building an image attractive to consumers.
The branding process seeks to develop or align the expectations behind the brand experience, creating an impression that a product or service associated with a brand possesses certain qualities or characteristics that set it apart from other (e.g., competitor) products or services. A brand is therefore one of the most valuable elements in an advertising theme, as it demonstrates the uniqueness of what the brand owner is able to offer in the marketplace. Orientation of the whole organization towards its brand is called brand orientation. Brand orientation is developed in response to market intelligence. Brand strength analysis describes efforts to determine the strength a brand has compared with its competitors. The art of creating and maintaining a brand is called brand management.
Careful brand management seeks to make the product or services appealing and/or relevant to the target audience. Brands should reflect more than mere differential of product cost versus selling price. They should represent the sum of all valuable qualities of a product to the consumer.
A brand which is widely known in the marketplace acquires brand recognition. When brand recognition builds to the point of a critical mass of positive sentiment in the marketplace, it is said to have achieved brand franchise. Brand recognition is most successful when a brand is recognized independent of the company’s name, but rather through visual signifiers like logos, slogans, and colors. For example, Disney has been successful branding with their particular script font, originally created for Walt Disney’s “signature” logo, and which it now uses in the logo for the website GO.com.
Consumers may view branding as an aspect of products or services, as it often serves to denote certain attractive qualities or characteristics. From the perspective of brand owners, branded products or services also command higher prices. Where two products resemble each other, but one of the products has no associated branding (such as a generic, store-branded product), people may often select the more expensive branded product on the basis of the quality or reputation of the brand or brand owner. Benefits of good brand recognition include facilitating of new product acceptance, enabling market share penetration by advertising, and resisting price erosion.
15.7.4: Developing a Brand
Developing a brand successfully requires a company to analyze the characteristics and values a customer base desires.
Learning Objective
Explain how companies can develop their brand
Key Points
- Brands have intrinsic attributes (functional characteristics and design of the products) and extrinsic attributes (packaging, pricing, marketing tactics) that develops the brand image and personality.
- A well-developed brand creates value beyond the actual product.
- Every design shown and communication made to the consumer are related to branding.
Key Terms
- advertising
-
communication whose purpose is to influence potential customers about products and services.
- marketing
-
Marketing is the process of communicating the value of a product or service to customers.
Examples
- Extrinsic attributes of a brand include Oreo cookie packaging, celebrity spokespersons, and marketing slogans.
- Extrinsic attributes of a brand include oreo cookie packaging, celebrity spokespersons, and marketing slogans.
Developing a Brand
The goal when developing a brand is to create value. You do that by emulating the characteristics and values that your customers desire. Branding is present throughout everything your company touches—it is not just a logo. Every design shown and communication made to the consumer are examples of branding.
Branding Attributes
Brands have intrinsic and extrinsic attributes. Intrinsic attributes refer to functional characteristics of the brand: its shape, performance, and physical capacity (e.g. Gillette razors shave unwanted hair and are able to do so more closely than most products in their product class because of their curved shape). Should any of these attributes be changed, they will not function in the same way or be the same product.
Examples of extrinsic attributes are features like the price of the Gillette razors, their packaging, the Gillette brand name, and mechanisms that enable consumers to form associations that give meaning to the brand. For example, it can appear more desirable because David Beckham, who is a brand himself, advertizes it.
Some refer to a brand’s function as the creation and communication of a multidimensional character of a product—one that is not easily copied and damaged by competitors’ efforts.
Brands have different elements, namely brand personality (functional abilities), brand skill (its fundamental traits—e.g. Chanel No 5 is seen as sexy) and brand relationships (with buyers) or brand magic. These elements are what give the brand added value.
Marketing and advertising are about selling your products and services. Branding is about selling everything associated with your organization . The consumer perception of brands is brand knowledge: brand awareness, recognition and recall, and brand image denote how consumers perceive a brand based on quality and attitudes towards it and what stays in their memory.
Branding
Branding is about selling everything associated with your organization.
This suggests that brand associations are anything linked in memory to a brand. “The essence of branding is promising and delivering” (Low and Lamb Jr, 2000). The successful organizations realize that the employees are influential to brand strategy. Aaker referred to studies using different methods and larger samples, which point out that “consumers noted for high-preference brands, 82% related to employee behavior; for low-preference brands, 90% related to influence of employee behavior (attitudes, competence, and personalization of the service).” Therefore, a part of brand strategy must focus on building brand association among employees at all levels. “If the employees are aligned with the brand strategy, including the promise, then they will deliver a consistent expression of the brand to their customers at every touch point.”
Brand Development Index or (BDI) measures the relative sales strength of a brand within a specific market (e.g. Pepsi brand in 10 – 50 year olds). It is a measure of the relative sales strength of a given brand in a specific market area.
15.7.5: Brand Management Strategies
Through effective brand management, organizations can build a loyal following of engaged consumers.
Learning Objective
Assess the variety of brand management strategies companies employ, and identify the potential advantages and disadvantages of each one
Key Points
- Brand management can enable high levels of awareness, engagement, retention and loyalty from users, which translates into significant organizational value.
- There are a wide variety of brand management strategies, each of which has some pros and cons organizations will want to consider on a case by case basis.
- Some examples of brand management strategies include iconic branding, individual branding, multi-product branding, sub-branding, and co-branding.
- Modern day branding incorporates a number of new tactics that organizations must be aware of to succeed. The social media landscape empowers companies to engage with consumers in a meaningful way (if properly managed).
- Through understanding both the organization’s culture and the target market(s), organizations must make informed strategic and tactical decisions regarding how to build a brand.
Key Terms
- engagement
-
In marketing, this is the degree to which individuals follow, discuss, comment on, and participate with a brand.
- loyalty
-
In business, this is a customer’s propensity to buy from the same organization again as a result of a meaningful brand relationship.
- retention
-
In general, this is the process of remembering something. In business, however, it refers to the ability of an organization to keep its current customers.
Brand management is a wide and varied study of the various approaches organizations can take to maximize consumer awareness, engagement, retention, and loyalty. Brand management strategies are constantly evolving, and the various potential distribution channels between organizations and their consumers is also rapidly changing. The rise of social networks is an incredible opportunity for meaningful engagement with current and prospective customers, and free outlets like Youtube enable viral distribution of assets for virtually no cost (indeed, sometime for a profit!).
The reason for brand management is relatively simple. Through creating a lasting impression and meaningful relationship with users, organizations can retain customers and create brand loyalty. Brand loyalty simply means that customers, when making a purchase to fulfill a given need, will default to their brand of choice. Brand of choice is something every organization wants to be, as the cost of maintaining loyal customers is much lower than the cost of acquiring new ones.
Brand Management Strategies
Loyal customers are cheaper, and happy customers are likely to talk about the company in a positive light. As a result, building brand is a key to success in an enormous number of industries. There are many approaches to this, both traditional and modern, and understanding both the strategy and the potential tactical channels available is integral to making smart branding decisions:
- Individual Branding – This has proven highly beneficial for a number of large organizations that offer a wide variety of goods. Proctor and Gamble (P&G) is a classic example of this working successfully. P&G own the brands Dawn, Joy, Crest, Scope, Gain, Tide, Fixodent, Pepto-Bismol, Swiffer, Ivory, Olay, Old Spice, and the list goes on and on. Many of these products actually compete head to head. This strategy allows minimal risk of the parent company being hurt by an individual brand, and allows a sense of competition between brands. It also allows P&G to capture a variety of demographics simultaneously by positioning each brand to large consumer groups.
- Multi-product Branding – The inverse of individual branding in some ways, multi-product branding allows companies like Samsung, Apple, Sony, and Virgin to focus consumer loyalty on the broader parent brand. Through doing so, all investments in branding boost the brand across all product spheres. This creates some efficiency in promoting brand, but also attaches all of the risk and positioning to that one single brand name.
- Sub-branding – Something of a cross between individual and multi-product branding, sub-branding allows an organization to create relatively large sub-brands for given product groups. A good example is Honda and Acura, one is positioned in a higher price bracket yet both are Honda.
- Co-branding – As the name suggests, often companies collaborate on projects and pursue branding together. For example, Bose is often co-branded with various vehicle manufacturers. Similarly, Google is often co-branded with Samsung products. This allows each organization to benefit from each other’s loyal consumer base.
- Iconic Branding (Attitude) – A bit less clear than the strategies above, iconic branding is all about building a persona. This persona tends to arise through stories, establishing a counter-culture, and building a community. Nike’s brand is iconic, for example. By promoting the ‘Just Do It’ mentality, they sell a perspective alongside their products. Red Bull takes a similar approach, going so far as to sponsor amazing feats of athleticism and daring to demonstrate the values they represent. This type of branding is complex and extremely difficult to accomplish, but can build a powerful and loyal following.
Tactics and Developments in Brand Management
Social media has changed the landscape for branding, and at this point encompasses a critical and necessary series of channels to leverage when pursuing any of the above branding strategies. Distributing messaging and displaying the core values of the organization is both easier and more difficult than ever. In just a click of a button, organizations can make a huge impression on the general public. However, the digital landscape is noisy; being heard can be extremely challenging.
Along similar lines is social proofing. Companies like Amazon offer consumers the ability to rate a product or service, which ultimately establishes a brand quality level many others consumers will trust and see as more objective. Social proofing can have an enormous impact on the perception of an organizations brand.
Brand Touch-point Wheel
As a supplement to the various strategies listed above, these touch-points indicate where the tactics of these strategies will come into play. Understanding where the organization will be in direct communication with a prospective consumer is imperative to ensuring messaging is clean, consistent, and clear across the board.
15.7.6: Packaging and Labeling
Packaging refers to the physical appearance of a product when a consumer sees it, and labels are an informative component of packaging.
Learning Objective
Explain the important features of packaging
Key Points
- The role of packaging in marketing has become quite significant as it is one of the ways companies can get consumers to notice products.
- A common use of packaging is marketing. The packaging and labels can be used by marketers to encourage potential buyers to purchase the product.
- Packaging is also used for convenience and information transmission. Packages and labels communicate how to use, transport, recycle, or dispose of the package or product.
- Labels serve to capture the attention of shoppers as well as provide useful information regarding the product.
- Labels are attached on the product package to provide information such as manufacturer of the product, date of manufacture, date of expiry, its ingredients, how to use the product, and its handling.
Key Term
- Packaging
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Physical appearance of a good prepared for retail sale
Example
- The packaging of perfumes, for instance, attempts to appeal to the sensibilities of its target consumer. For instance, a perfume geared towards younger females may have colorful, feminine packaging, but a perfume for older professional women may have more subdued and sophisticated packaging.
Packaging
With the increased importance placed on self-service marketing, the role of packaging is becoming quite significant. For example, in a typical supermarket a shopper passes about 600 items per minute, or one item every tenth of a second. Thus, the only way to get some consumers to notice the product is through displays, shelf hangers, tear-off coupon blocks, other point-of-purchase devices, and, last but not least, effective packages. Considering the importance placed on the package, it is not surprising that a great deal of research is spent on motivational research, color testing, psychological manipulation, and so forth, in order to ascertain how the majority of consumers will react to a new package. Based on the results of this research, past experience, and the current and anticipated decisions of competitors, the marketer will initially determine the primary role of the package relative to the product. Should it include quality, safety, distinction, affordability, convenience, or aesthetic beauty?
Various Packaging Designs, including labeling
Packaging refers to the physical appearance of a product when a consumer sees it, and labels are an informative component of packaging.
Common uses of packaging include:
- Physical protection: The objects enclosed in the package may require protection from, among other things, mechanical shock, vibration, electrostatic discharge, compression, temperature, etc.
- Information transmission: Packages and labels communicate how to use, transport, recycle, or dispose of the package or product. With pharmaceuticals, food, medical, and chemical products, some types of information are required by governments. Some packages and labels also are used for track and trace purposes.
- Marketing: The packaging and labels can be used by marketers to encourage potential buyers to purchase the product. Package graphic design and physical design have been important and constantly evolving phenomenon for several decades. Marketing communications and graphic design are applied to the surface of the package and (in many cases) the point of sale display, examples of which are shown here:.
- Convenience: Packages can have features that add convenience in distribution, handling, stacking, display, sale, opening, re-closing, use, dispensing, reuse, recycling, and ease of disposal.
- Barrier protection: A barrier from oxygen, water vapor, dust, etc., is often required. Permeation is a critical factor in design. Some packages contain desiccants or oxygen absorbency to help extend shelf life. Modified atmospheres or controlled atmospheres are also maintained in some food packages. Keeping the contents clean, fresh, sterile and safe for the intended shelf life is a primary function.
- Security: Packaging can play an important role in reducing the security risks of shipment. Packages can be made with improved tamper resistance to deter tampering and also can have tamper-evident features to help indicate tampering. Packages can be engineered to help reduce the risks of package pilferage.
Labeling
A label is a carrier of information about the product. The attached label provides customers with information to aid their purchase decision or help improve the experience of using the product. Labels can include:
- Care and use of the product
- Recipes or suggestions
- Ingredients or nutritional information
- Product guarantees
- Manufacturer name and address
- Weight statements
- Sell by date and expiration dates
- Warnings
Symbols Used in Labels
Many types of symbols for package labeling are nationally and internationally standardized. For consumer packaging, symbols exist for product certifications, trademarks, and proof of purchase. Some requirements and symbols exist to communicate aspects of consumer use and safety. For example, the estimated sign notes conformance to EU weights and measures accuracy regulations. Examples of environmental and recycling symbols include the recycling symbol, the resin identification code, and the “green dot.”
Labeling Laws
In some countries, many products, including food and pharmaceuticals, are required by law to contain certain labels such as ingredients, nutritional information, or usage warning information (FDA). For example, a law label is a legally required tag or label on new items describing the fabric and filling regulating the United States mattress, upholstery, and stuffed article industry. The purpose of the law label is to inform the consumer of the hidden contents, or “filling materials” inside bedding & furniture products. Laws requiring these tags were passed in the United States to inform consumers as to whether the stuffed article they were buying contained new or recycled materials. The recycling logo,, needed to be displayed on the label. The Fair Packaging and Labeling Act (FPLA) is a law that applies to labels on many consumer products that states the products identity, the company that manufactures it, and the net quantity of contents.
Labels Indicating Recycled Material
Laws were passed in the United States to inform consumers as to whether the stuffed articles they were buying contained new or recycled materials.