Marketing: Just the Basics PDF

TARUN DEWAN Marketing: Just the Basics ã : Tarun Dewan  Contents PREFACE 7 PART1:THEBASICS 8 1.INTRODUCTION 9 Origins...

TARUN DEWAN Marketing: Just the Basics ã : Tarun Dewan  Contents PREFACE 7 PART1:THEBASICS 8 1.INTRODUCTION 9 Origins 9 Utility and Marketing 14 The Central Idea in Marketing 15 What do Marketers Do? 17 2.THECONSUMER 22 The Black Box 24 Consumer Characteristics 25 Consumer Decision Process 28 Organisational Buyer Behaviour 30 Is That All ? 31 3.THECOMPANY 33 Resource Based Perspective 33 Positioning Perspective 34 Configurational Perspective 37 SWOT Analysis 37 4.THECOMPETITION 40 Who are our Competitors 40 How is our Competition Structured 41 5.STPANDMARKETINGRESEARCH 44 Segmentation 44 Targeting 45 Positioning 46 Tools 47 Factor Analysis 49 Cluster Analysis 49 Discriminant Analysis 49 Perceptual Maps 50 Summary 53 6.PRODUCT 55  Types of Products 56 Consumer Goods 56 Industrial Goods 57 Durable and Non-Durable goods 57 New Products 57 The Product Life Cycle 60 Diffusion of Innovation 61 7.PRICE 65 Cost-Plus Pricing 65 Breakeven Analysis 70 Value Based Pricing 71 Competition Based Pricing 74 Conclusion 75 8.PLACE 77 Channels 77 Functions 78 Control 80 Conclusion 81 9.PROMOTION 83 What’s “Promotion” 83 Integrated Marketing Communications (IMC) 84 5 M’s 85 Mission 85 Money 86 Message 86 Media 87 Measurement 90 Conclusion 90 Preface This book is of use to the Marketing student who does not wish to read through multiple examples and stories, but prefers a concise reference for basic concepts. TD Toronto The Basics  1 Chapter 1. Introduction What is the “story” behind the “Fine art of Storytelling “? W e have all heard, countless times, the phrase "Marketing is Everywhere", or "Marketing is all around us!". Perhaps we have also had an uncle point out that "Half the world lives by selling something and the other half by buying it." So what is the omnipresent beast? Where did it come from? Did it originate in a primordial big bang or did it evolve through successive Darwinian mutations? Is it true (as my father maintains to this day) that Marketing is "...the fine art of Storytelling”? The answers to these (and other – including the title!) questions lie within the pages of this book. Hopefully this journey will be a pleasant and worthwhile one Origins Marketing is about buying and selling - and buying and selling are as old as the end of "Barter". Barter had the inconvenience of requiring a "double coincidence of wants. (If Jim had an extra copy of "Titanic", but needed "Kill Bill", he needed to find someone who not only had a spare copy of "Kill Bill", but also needed "Titanic"). What was required was something that could be used to “store” value – Jim could then exchange Titanic with the first person who came along and wanted it for a “credit”; and then whenever he found someone willing to part with Kill Bill he 9 could transfer the stored value. Using "credits" (or Money!) to trade marks the origins of Marketing. We can look back quite far into history thanks to Herodotus (the "Father of History" - his notes are the oldest record of events in his past). He wrote about the Lydians (who lived about 3000 years ago in modern day Turkey) as being the first people he knew of to use gold and silver coins. Ok. So there is now trade and hence marketing (people grow/build things others need, set prices, go to a “market”, shout out their wares). What do people think about it? Aristotle (around 2400 years ago) thought (essentially) that marketers were useless parasites. We still hear echoes of this thought today when people speak of pushy salespersons, telemarketers and large advertising budgets that translate into higher costs for consumers. Thankfully (for readers of this book) this view may not be without a counter point. Plato, for example, had a more constructive view of things. If we put his ideas into contemporary terminology, he proposed that with division of labour came a separation between producer and consumer. Also, it turned out that some people were better at bridging this gap - Marketing Intermediaries! Lets now skip forward almost a thousand years to about the 13th century. St. Thomas Aquinas (a Dominican monk) wrote mainly about church related issues like social policy and philosophy. Views about marketing cropped up in his writing, though, and it turns out that his thoughts anticipated our version of the Utilities of Marketing. (Marketing: What is it good for?) We'll talk more about these utilities of marketing, but for now suffice to say that these are the value provided by marketing. We make another jump - this time to the early 20th century when marketing role in creating utility and providing satisfaction begins to be better understood. Robert Bartels (History of Marketing Thought) places the first use of the term "Marketing" to "about 1910". Finally in about the 1950's the concept of Marketing Management evolved - again more on that later. Many textbooks speak of the evolution of marketing from the 50's onwards in terms of the "Production Era" ("if we build it they will come", "a good product will sell itself" - companies don't have to do anything as long as they can build a good product), the "Sales Era" ("Sell what we 10 have". Creative advertising and selling will overcome consumers resistance and convince them to buy) "Marketing Era" ("The consumer is king! Find a need and fill it." "Whatever the consumer wants, we do.") and the "Relationship Era" (our customers are our best assets - build a relationship with the customer.). Now it is important to note that these 'eras' may not have occurred exactly in that order, or even successively. In fact you will find that these situations may all still be found today - with some companies adopting one or the other! We are at the point now that we recognize that the most money is made when both the company and the customers are happy. Marketing thought has formalized some basic principles. Most of these are key building blocks. This book is mostly about understanding the "basics". These "basics" are things that endure - they will keep you from making "basic" mistakes. Surprisingly these mistakes occur very frequently - the "Dot Com Bust" is an example of poor attention to the "basics". The focus (for many) in the heady days of the Internet boom a few years ago was not satisfying consumer needs, but "what are the cool things we can do with this new technology". This abandonment of a marketing basic (marketing is driven by consumer needs), led to trouble for the entire industry. Those who do not learn from history are doomed to repeat it. Hopefully, by the end of this book you will know enough about marketing to avoid basic errors! So what is this subject we are talking about? The American Marketing Association in 1937 defined Marketing as follows: Definition: Marketing (AMA 1937) Marketing is the business activities involved in the flow of goods and services from production to consumption This definition focusses on the ‘Place” or distribution function of Marketing and not much else. Things did evolve over the years, though. 11 In 1985, the AMA agreed on the following definition of marketing: Definition: Marketing (AMA 1985) Marketing is the process of planning and executing the conception, pricing, promotion, and distribution of ideas, goods, and services to create exchanges that satisfy individual and organizational objectives This is quite a powerful definition, and could potentially answer most of the questions we posed earlier as well as hold the key to many of the “basic” mistakes we warned against. First, this definition highlights the 4 P’s – Product, Price, Place and Promotion. (Distribution is referred to as “Place”; otherwise it would be the 3 Ps and a D!). These are the 4 decision variables, or controllables available to the Marketing manager. Marketing decisions and plans are choices involving the 4 Ps. Second, this definition explicitly categorizes Marketing as a “process” (something ongoing and continuous) rather than as a task. Third, this definition lists the elements of exchange. These could be physical products like cars, soap or milk (goods), or things other people do for us like bring food to our table, provide legal/medical expert advice, or help while looking for the best MP3 player (services), or an abstract concept like a different way of doing things or quitting smoking/drinking and driving etc. (ideas) Fourth, this definition emphasizes that a Marketing exchange must be a win-win. Both the parties involved (consumer and producer) must get something out of it. Taking without giving something of value in return is not Marketing. Good Marketers are those who understand all elements of this definition well – and perhaps the most important element of this definition is the fourth one – there must be something of “value” for all participants in a Marketing exchange. 12 In September 2004, the AMA agreed on a new and updated definition of Marketing. Definition: Marketing (AMA 2004) Marketing is an organizational function and a set of processes for creating, communicating and delivering value to customers and for managing customer relationships in ways that benefit the organization and its stakeholders. As you can see, the basic elements of the definition remain the same. Marketing is not just an organizational function (something that a “Marketing department” might do in a firm), but more than that – it is a “set of processes”. The newer definition continues to explicitly recognize that “benefit” to the organization and its stakeholders comes from “delivering value” to customers. What is new in the definition is the explicit recognition of “customer relationships” i.e. the concept that marketers do not simply engage in one-off transactions, but look at the longer term and at building ongoing relationships. Most recently, in July 2013, the AMA agreed on the current definition of Marketing. Definition: Marketing (AMA 2013) Marketing is the activity, set of institutions, and processes for creating communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large. Once again, the basic elements continue to be the same and value to the society has been added. So, by definition, Marketing as activity must create value. What is the value that Marketing provides? We will use the economic term “Utility” (value from satisfying a need). 13 Utility and Marketing The Four Utilities provided by Marketing Utility is anything of value. The following are the four utilities provided by marketing: 1. Form – the physical attributes of a product. It is the substance of the product itself. Form utility comes from both Marketing and Production areas. The marketing area provides the framework for what the production people are going to build. Form involves the product design and packaging that helps us to make a final decision on purchasing the item. It tells us the answer for whether we should manufacture only black cars or other colors such as blue or green. 2. Time – The utility of having access to the product at the right time – Marketing activities include: warehousing, inventory planning, and delivery – all of which impact when we get the product to the customers and the availability of the items. 3. Place - this involves getting the product from the dealership to the consumer’s house. This can involve distribution or store location. 4. Possession – This involves the consumer actually owning the product. It is the utility created in owning a car after purchase (getting your name registered on the title), or when grocery products are bagged and handed to the customer/you. 14  Form Product Design, Packaging Possession Place Transactions, Transfer of Utility Distribution, Store Location Ownership Time Inventory Mgmt, Warehouses, Delivery FIGURE 1.1 Utility and Marketing Actions The Central Idea in Marketing Marketing is driven by the satisfaction of Consumer Needs A lot of what we do as marketers (some would argue, “all” that we do as marketers…) is centered on the consumer. 15  Economic Forces Product Competitive Forces Social and Legal Forces Price Consumer Place Promotion Technological Forces FIGURE 1.2 The Central Idea in Marketing This is quite appropriate as the money flows from the consumer to the producer. Even if we “follow the money”, the focus of our attention needs to be firmly centered on the consumer. More “basic” mistakes occur due to a lack of understanding of this simple idea than any other Marketing concept. Very simply, Marketers have just two basic tasks: To discover consumer needs and to satisfy them. 16  Marketers First Task Discover Consumer Needs Marketers Second Task Satisfy Consumer Needs Everything that we as Marketers do involves the first or second task in one way or the other. In fact, if an activity does not involve the first or second task, it is generally not a marketing activity. The satisfying of consumers needs is done through appropriate choices involving the Marketing Mix (the 4 P’s). What do Marketers Do? Marketing is not just the 4 P’s We all know that Marketing is not just Sales. Marketing is the process of determining customer wants and then developing a product to satisfy that need and still yield a satisfactory product. This is, as we have seen a Customer-Centric approach. Selling, on the other hand, is producing a product and then trying to persuade customers to purchase it. This is a Product-centric approach. Marketers need to understand Market Orientation (putting the needs and wants of the target market first and then deciding a cost effective approach to providing the product/service). The school of Marketing Management thought views Marketing mostly as involving tactical and strategic decisions involving the 4 Ps. This school does follow the Central Idea concept and links coordinated marketing activities and a customer orientation directly to customer satisfaction and from there to organizational success. If we add a couple of more things to this concept, we can get a very good idea of What Marketers Do. 17  3 C’s STP Customer Segmentation Competition Targeting Company Positioning 4P’s Product Place Price Promotion FIGURE 1.3 What do Marketer’s Do? This book is structured around Figure 1.3. The 3C- STP – 4P framework offers a much broader strategic understanding of Marketing than the classical Marketing Management school of thought that focuses just on the 4P’s. This represents key parts of Figure 1.2 that Marketers incorporate into practice. A Marketing manager may, usefully, begin with an analysis of the 3Cs and in the process understand the marketing problem well. During the Segmentation, Targeting and Positioning phase, the manager decides what subset of the entire population she will address, and finally with the 4P’s she will have a solution for the problem. I advocate this framework for addressing most Marketing problems. Marketing as a field borrows from many disciplines. The two major influences on Marketing are Economics and Psychology. A lot of things you will see in this book can be traced to one or the other of these. The field of marketing also has substantial rules and process involved in order to be effective. There is a distinct system behind marketing: rules 18 behind pricing, rules behind designing a better product; rules behind promotion, rules the govern channels, and rules about how to distribute products. It should also be noted that both profit and not-for-profit businesses need effective and targeted marketing activities to achieve success. Marketing means adopting a customer focus for the organization, which means keeping the customer's needs in mind at all times. This may not result in making immediate sales, but will ultimately increase longevity and profitability of the relationships the company has with its customers. Remember that in order to be successfully customer-centric, one must always keep in mind what the customer's requirements are. Anyone doubting the importance of marketing should think about this: marketing is the ONLY revenue-producing activity for a firm. Other departments, like finance for example, may play with money but they are not generating any money for the company directly. The only way money is coming into the business is through marketing activities. Marketing is therefore everywhere and it is valuable to understand why advertisements have certain messages. Marketing helps to communicate product attributes and benefits to consumers to allow consumers to make informed choices. For example, marketing helps you when: you buy a pair of shoes by informing yourself of the various options you have, as well as emphasizing styles, colours, prices etc. you apply for a job by getting to know what a company is 'all about' - do you want to work with this firm? you open a new bank account by targeting specific accounts to your particular needs (through demographic/psychographic analysis) when you watch TV: if you understand how marketing works, you have a better appreciation for the types of ads you see on TV, and why those particular ads are out there. The confusion with marketing often arises from the different perspectives that marketers and customers may have. For all of of us, our experiences as customers are a really big part of our "take" on Marketing. As students (and practitioners) of Marketing, however, the perspective is different. We have to take off our "customer" hat to appreciate the Marketing Managers 19 viewpoint. Our experiences as customers do help even when we have the Marketer's hat on as a guide to what customers think, but we have to force ourselves to remember that there are many, many different kinds of customers out there and generalizing from our own experience may often not be appropriate Marketing is everywhere, and we hope that by the end of this book, you will have a good handle on the Basics of Marketing. The object here is not to make you a Marketing expert (that would several books and several courses !) , but to introduce you to the field and provide you with a good enough road map that helps you avoid some major pitfalls. Happy Trails! 20 NOTES 21  2 Chapter 2. The Consumer Understanding the focus of our attention. W hy do wish to understand consumers ? As we have seen in Chapter 1, the center of attention for Marketers is the consumer. If an element is so important for our field, we had better spend some time on it! Consumer Behaviour "is the study of human consumption, which entails the acquisition, usage, and disposition of goods, services, events, and ideas." Consumer behaviour focuses on the satisfaction of goals, desires, and needs of the consumer. The study of consumer behaviour should not be overlooked because it is this area of study that allows marketers to be better prepared to fulfill the needs and wants of consumers. If marketers can understand consumer behaviour, they can answer questions like these: How does the consumer come to a purchase decision? Is it random or is there a process? 22  What motivates and makes consumers happy/upset? How can you fulfill their needs? Many people look at consumer behaviour as a way to manipulate various consumers. This field of study is not about manipulation!! It is about understanding consumer needs well enough to be able to answer them. On a more practical front, here are some implications for the 4 P’s: Product o What products do consumers use now? o What benefits do consumers want from this product? Promotion o What promotion appeal would influence consumers to purchase and use our product? o What advertising claims would be more effective for our product? o We will talk about different types of appeals, and the circumstances under which they work. Pricing o How important is price to consumers in various target product? o What effects will a price change have on purchase behaviour? o As marketers we could figure out price just by observing consumers o If we change price, we could figure out consumers’ sensitivity to price o If demand drops, should we increase the price? Place (distribution) o Where do consumers buy this product? (For example: Majority of consumers buy milk more at grocery stores, than at convenience stores ) o Would a different distribution system change consumers’ purchasing behaviour? 23 The Black Box The key to understanding consumers is first recognizing our limitations. We are attempting not only to understand what goes on in one person’s mind (a huge, complicated, and as yet mostly unsolved task) but also how different things go on in different people’s minds (so even if you know what one person is thinking, you may not know anything about what thousands of other people are thinking). I like to think of this problem as a “Black Box” problem. (Figure 2.1) INPUTS (Controllable) 4P’s Product Place Price Customer’s Promotion Black Box OUTPUTS Decisions Product Choice Uncontrollable Brand Choice Store choice Influences Purchase Timing Mood/Attitude Purchase Amount Psychological/Personal Social/Cultural FIGURE 2.1 The Consumer’s Black Box Since, we do not yet possess the tools to get inside a consumer’s head, we have to make do with the best we can do. This involves looking at the 24 relationship between Inputs and Outputs in figure 2.1 and based on that inferring what is going on in the Customer’s Black box. To make our life more exciting, it is not even as “simple” as that – There are many influences on the consumer unrelated to our “Marketing” inputs. Things like the consumer’s mood, his/her friends and a host of other influences that we (as marketers) have no control over – and that we cannot even observe in most cases ! We will look at the effect of the 4P’s on the consumer’s decision later on in the book. This chapter will look at the Uncontrollable (from the Marketing Managers point of view) Influences. There are two aspects to this: 1. What are the Characteristics of the consumer and what are their building blocks 2. What are the processes going on in the consumer’s minds, or what is the Consumer Decision Process Consumer Characteristics Consumer characteristics are what make up the individual consumer. These can be classified into Cultural, Social, Personal and Psychological influences. Culture is made up of values and forms of expression. Social influences include reference groups, family members, role models etc. A person’s age, income, location etc. (“Demographics”) are also generally linked to different types of behaviour. Note how we word this: Cultural and social forces influence the consumer. However, where a person lives or her age may not necessarily influence her choices in a causal manner, but we may be able to discover correlations with behaviour. For example, the demand for retirement communities does go up with age and the “warmth” of the location ! On the Psychological front, there are many influences on the consumer that are of interest to marketers. The questions we ask are: What motivates people to behave a particular way ? (to buy/not buy, to look for cheaper 25 prices, to prefer certain stores etc.). An important model about motivation is “Maslow’s Hierarchy of needs: Self Actualization Esteem Needs Social Needs Safety/Security Needs Physiological Needs FIGURE 2.2 Maslow’s Hierarchy of Needs The idea here is that there is a “hierarchy of needs that people are motivated to satisfy. Some needs come before others and must be satisfied before motivation to satisfy a “higher” need kicks in. I like to think of a caveman in pre-historic times as a story to help understand the Hierarchy of needs. Our ancient homo-sapien wakes up in the morning and his first thought is for his basic (physiological) needs. He does his morning thing and then hunts for food and water. After much exertion (the hunger clearly motivates him to give his best), he brings down his prey and proceeds to fill his belly. (Step 1 !). As he lays happily on his rock, full and satiated, with his basic needs met for the present, his thoughts turn to the next day – It would be nice to have food for tomorrow as well ! – and to make sure the hyenas don’t make off with the remainder of the kill. He promptly gets up and with more exertion (motivated no doubt, by the thought of his hungry stomach the following day) he drags the rest of the 26 meat into his cave to protect it. It might pass through his mind, that the local lions might be hungry as well. Let us imagine our hairy friend a few weeks later. He has found a big dead mammoth and has managed to store all the meat in his cave. He has also figured out that if he lights a fire outside his cave, the lions and hyenas can’t get to him or his stock of food. (step 2 !) Now when he lounges around in front of his cave, he doesn’t have to worry about his next meal, or his safety. He now wishes he could share his wonderful story of the ingenious way he dragged the mammoth’s meat back to his cave with someone. Not seeing anyone close by, he is again motivated to wander the woods searching for others like him – He is getting to be quite the social animal ! (Step 3). If we return to him many moons later, we find him seated around a fire with a bunch of Neanderthals having a whale of a time. But amidst all the happy grunting, his brow furrows (more than it usually does) as he tries to get the rest of his buddies to think really, really well of him. Our caveman, it turns out needs the respect of his friends! (Step 4). When (and if) he becomes “chief”, he is held in high regard by the others and now he occupies himself with weight issues like the meaning of life and fulfillment. He is up to Step 5 ! You can see how at each stage our protagonist was motivated by a particular type of need, once that need was satisfied, he became motivated by a higher level need. There are three more “basic” ideas of human behaviour we need to keep in mind as marketers: 1. Perception. The Sensation à Attention à Interpretation model underlies perception. It is important to remember that Interpretation (which often differs among consumers) is key to perception. 2. Psychological Learning The model here is: Stimuli à Response à Reinforcement à Response This model is also called Operant Conditioning. 27 3. Persuasion We can influence attitudes through the use of marketing inputs Marketing Process Results Inputs Source Attention Belief Change Message Comprehension Attitude Change Recipient Acceptance Behaviour Change Media Retention FIGURE 2.3 Persuasion Consumer Decision Process The second part of understanding consumers is trying to get a handle on the “process” of decision making. It is generally agreed that the consumer decision process can be divided into 5 stages: 1. Problem Recognition This is the recognition of an unsatisfied need or want. “Needs” are basic forces that motivate a person to something, while “Wants” are manifestation of needs or objects that will satisfy needs. (I may need a car, but want a Ferrari!). Both can be triggered by internal stimuli (like hunger) or external stimuli (like a nice display in a store, an ad or the smell of fresh baked bread in a bakery). Involvement will influence the likelihood of internal and external triggers. Further, the motivation (the drive that stimulates or generates behaviour) could be Utilitarian (Rational) or Ego-expressive (Emotional). 2. Information Search 28 Once an unfulfilled need or want has been identified, the consumer looks (both in her memory and externally) for information to help in the decision process. Often the information search does not involve all possible ways of fulfilling the need, but a much smaller set of options, which is often different for each consumer. To explain this better, we can use the following three “sets”: Total Set: The set of all alternative available to the consumer Awareness Set: The subset of options the consumer is aware of Consideration Set: The even smaller subset of options the consumer seriously considers. The average size of consideration sets is about 6 – 7. There are, of course, times when the consumer may not go through the full decision process and may make an “Impulse” Buy. This is a purchase with little or no advance planning. To put this in perspective, it is known that only about 31 % of grocery shoppers use shopping lists ! As marketers, stores try to induce impulse buying with in-store displays, loss- leader items (i.e. items priced very low) placed for store traffic, or sample food in the store. 3. Alternative Evaluation As we shall see in Chapter 4, in the minds of consumers, products are “bundles of attributes”. Each attribute (a particular part of the product that satisfies something for the consumer) of the product has it’s own benefit. The consumer compares different alternatives either based on prior attitudes stored in memory, simple heuristics (thumb rules like variety seeking, habit, dissonance reduction etc) or more complex decision rules that may involve tradeoffs of different attributes. 4. Purchase Decision In the end the final decision is based on the information search and alternative evaluation. However, situational issues are important – the display of a particular type of Orange Juice may result in a purchase. As 29 marketers we try and figure out the patterns of behaviour – “Overall, what will the average consumer (or most consumers) do when we change one or more of the 4 Ps?” 5. Post Purchase Behaviour The transaction and the process does not end with a purchase. There are “after-effects”. The consequences of satisfaction are Repeat purchase and word of mouth communication. Dissatisfaction would not be good for the company. On average a dissatisfied consumer spreads bad word of mouth to 11 others. It is also 5 times more expensive, on average, to get a new customer than it is to keep an existing one. Post purchase evaluation is generally based on expectations and performance. If the product performs better than expectations, we get a satisfied consumer, and if not, a dissatisfied one. “Post purchase Dissonance” is the term used to describe the state of anxiety or tension caused by the difficulty of choosing from among several alternatives. (“Did I do the right thing ? Did I get a good deal? Should I have waited ? Did I get ripped off ?). No decision is perfect, so some dissonance is always to be expected. As marketers we try and reduce dissonance as much as we can. Dissonance increases with the dollar value of the purchase, the similarity between selected items and rejected items and the relative importance of the decision. To reduce dissonance, consumers avoid information favourable to the unselected alternative and seek information favourable to the selected alternative. To reduce post purchase dissonance, companies reassure buyers through advertising and personal selling, provide return policies, and provide post purchase service and support. The idea is to make the consumer feel good about the choice they have made. Consumers may not always follow the exact decision process outlined above. In many cases some steps are skipped (for example with low- involvement products). However, breaking up the process into the 5 stages helps us as marketers focus on the appropriate action required to satisfy the consumer’s needs. Organisational Buyer Behaviour So far we have talked about the individual consumer. When our customer is a business/company instead of an individual consumer, things are a little different. The organization is still composed of individuals, but they act 30 together based on some norms. A company buyer may have reporting/justification issues to deal with, or internal company priorities to keep track of. The interplay of these elements makes organizational buyer behaviour just a little bit more complex. So long as we keep this in mind, we can fruitfully apply the basic principles of marketing in a “B2B” context as well, quite effectively. Is That All ? This is not even close to being all about Consumer Behaviour. This is a field that spans hundreds of articles, books and other scholarly work every year. Even for this book, however, we are not done. We will have consumer behaviour discussions in the chapters on Price, Product and Promotion. It makes more sense to deal with behaviour issues related to price in the chapter on price and the issues related to Promotion in the promotion chapter. This way it will be easier to link the understanding of consumer behaviour directly with the Marketing implication. The behaviour issues we have discussed in this chapter are “broad” items that apply to all areas of marketing! 31 NOTES 32  3 Chapter 3. The Company Who are we ? A ccording to Day and Wensley (“Handbook of Marketing”), three theories of the firm are of particular use in understanding the nature of the company and the marketing area. These are: 1. Resource Based Perspective 2. Positioning Perspective 3. Configuration Perspective Resource Based Perspective This theory argues that companies seek sustainable competitive advantages. These are a “bundle” of resources available to the company that may be better or worse than competitors. Resources can be divided, broadly into Assets and Capabilities. Assets include not only capital items like factories and production equipment, but also advantages like brand equity, relationships, consumer lists etc. 33 Capabilities are the “complex bundles of skills and accumulated knowledge exercised through organizational processes that enable firms to coordinate activities and carry on learning how to perform these activities better.” (Day and Wensley, Handbook of Marketing). Capabilities are not just about skills and technical expertise that the company’s employees have, it is also about the processes within the company that keep track of an effectively store and use these skills. When the whole is greater than the sum of it’s parts, it is generally due to good managerial systems and norms in the company. Positioning Perspective This perspective is best understood in terms of the 3-4-5 framework. Each element of this framework provides a way of positioning or classifying a company (or a part of it). It is useful to understand where a company stands, because depending on how where we fit in this classification scheme, a different strategy might be called for. This involves the following: 3 Generic Strategies Michael Porter identified the three generic strategies that companies might position themselves as: Focus: The company chooses to find a niche and focuses on it Cost: The company chooses to compete on costs and strives to achieve efficiencies on this dimension Differentiation: The company uses differentiation as a competitive tool. (we are better, safer, smaller, quicker etc.). This sets the company’s positioning against competitors. 34 4 Contexts The Boston Consulting group Growth share identifies four contexts into which individual business units may be classified based on industry attractiveness (Market Growth Rate – how much potential the industry has) and how well we are doing in relation to our competition (Relative Market Share). Each business unit is represented on this grid. The size of each unit represents the volume of business associated with it. High Question Marks Market Growth Rate Stars Dogs Cash Cows Low Low High Relative Market Share FIGURE 3.1 The Boston Consulting Group (BCG) Growth-Share Matrix The 4 "contexts" are the four ways one can classify individual business units (products), i.e. Question Marks, Stars, Dogs and Cash Cows, based on the Market Growth rate and Relative Market Share. 35 So, a product that has a high market share (for "our" brand) in a market that is stagnant or declining, is a "Cash Cow" - such a product would probably no require excessive promotional spending (because it's future is not particularly good even though the present is pretty profitable), and would be a good candidate for "harvesting" (getting as much profit out of it as possible before it declines). "Dogs" are products that are not doing well (low market share) in poor markets. The products probably need to be divested (discontinued!). "Stars" are products that are doing well in good markets. They generally require lots of attention, but are good for profits. Eventually (because of the Product Life Cycle) stars become cash cows. "Question Marks" are just that - they may become stars or dogs 5 Forces of Industry Attractiveness Michael Porter (him again !) has identified Five Forces which determine industry attractiveness. Both Buyer and Supplier power make an industry less attractive from the perspective of the company, because it means the company itself has lesser “power” vis-à-vis it’s external contacts. Industry competitors determine how much competition the company has to deal with and the threat of new entrants (or, barriers to entry) determine how easy it is for new competitors to emerge. It is also important to keep track of not only competition within the industry the company operates, but also keep track of other products which may be substitutes for ours. (Remember the focus on “Consumer Needs” instead of on products ? – this implies that all other products which satisfy the consumer need that we are targeting are our competition). 36  Threat of New Entrants Supplier Buyer Power Power Industry Attractiveness Industry Threat of Competitors Substitutes FIGURE 3.2 Michael Porter’s 5-Forces of Industry Attractiveness Configurational Perspective This perspective deals with the internal organization of the company and it’s boundaries (i.e. the nature of it’s links with other entities). The way a company is structured (both internally and externally is an important determinant of what it can and cannot do. For example “make or buy” decisions are generally determined by the cost of doing something within the company or outsourcing. SWOT Analysis SWOT Analysis (Strengths – Weaknesses – Opportunities – Threats) is a very simple, but powerful tool for collecting information on the company and summarizing the classification approaches of the 3-4-5 framework. 37  Internal External + Strengths Opportunities - Weaknesses Threats Items (“facts”) are classified along the Positive (“Good for us”) and Negative (“Bad for us”) dimension as well as along the Internal (“Controllable”) and External (“Uncontrollable”) dimension. It is easy then to see not only the internal issues of the 3 generic strategies or the 4 contexts (BCG) , but also the external issues of the 5 forces (Porter). The most important contribution of SWOT analysis is that it helps managers to sift through all the information available (generally the information and data available for decision making is far in excess of what is actually required) and pick the relevant items. SWOT analysis helps managers weed out the irrelevant “facts” (pieces of information that don’t affect the decision making) and focus in on the key issues. The classification into Internal/External and +/- helps keep track of what type of action is required in each instance. Strengths are generally things that the company can highlight and build on, as well as use as competitive advantages or selling tools. Weaknesses need to be either improved, or ways must be found that help overcome them. Opportunities need to be taken advantage of and threats must be watched out for. These techniques help us understand the Company related issues that we need to keep track of in developing Marketing plans. 38 NOTES 39  4 Chapter 4. The Competition What are we up against ? N o matter how well we analyse ourselves and our consumers, we will generally, not get our marketing right unless we take into account how our competition is structured and how their actions impact us. There are two main issues of concern here: 1. What is our Market ? (Who are our Competitors) and 2. How is our Market structured? (How is our competition organized) Who are our Competitors One has to be careful in defining “our market” – Shocker (Marketing Handbook) says that a Market can be defined in terms of a product by “..identifying the set of ‘product’ alternatives or competitors which are sufficiently consequential to a firm that they need monitoring. For many applications a “Product-Market” can be thought of as the totality of product alternatives that could be actively considered for purchase or use by at least some minimal percentage of people for whom such purchase or 40 use is relevant.” The definition of a Product-Market is critical because when we try to get measures of competitive intensity, the results could vary greatly depending on the particular set of products we have classified as “our market”. So, Coke might view just Pepsi as a competitor, but it may be argued that Coke’s competitors also include all other “pop” drinks, not just colas. In fact, there is also an argument for treating all grocery store beverages as competitors for Coke. Clearly in each case, Coke’s market share would be different as would our inferences on intensity of competition. Defining a ‘market’ through a product has pitfalls. Theodore Levitt (“Marketing Myopia”, Harvard Business Review) argued many years ago that it is better to define a Market by the “Needs” served. This makes sure that marketers do not get “short-sighted” (myopic) and complacent about their competition. In the example of Coke, above, it makes sense, then to consider Coke’s competition to be all ‘soft’ beverages. It is important to not only focus on current competitors but also “potential” competitors (those whose products might be able to satisfy the same consumer needs as our product In the STP chapter, later in this book we will see some “spatial” models of representing competition (Perceptual Maps). These models are built based on attribute differences, and since they are generated using needs based data, are quite a good tool for representing “our market”. Measuring inter-product competition, then becomes about either a) Cross – Elasticity (the effect of changes in a competitors marketing actions on our market performance) or b) Substitutability (“if customers regard the products as interchangeable for some relevant purpose(s)”) How is our Competition Structured We can look at this from the industry perspective. Economic theory presents us with 4 main types of industry structures based on differing competitive characteristics. The four classifications differ on two dimensions : 1. The number of Sellers and 2. The degree of product differentiation (how different the products are). Monopoly is the structure that exists when there is just one main producer/seller of a particular product or service. (at least in some area). 41 The product is clearly unique and cannot be substituted. Mostly, because of monopoly power, marketing effort is minimal. Oligopoly is the structure where there are only a few main large competitors who produce similar products. Marketing effort consists mostly of trying to find attributes along which each competitor can attempt to seek a leadership position. Monopolistic Competition is the structure where many competitors exist, but they are able to differentiate their products. Marketing effort is directed at differentiation and finding market segments which are not served by competitors. Pure Competition is an idealized structure that involves a large number of producers/sellers with the same, undifferentiated product or service. In market structures that approach pure competition, there may not be any competition on the product (same), price (same) or even promotion (nothing distinctive to communicate). Mostly, place (distribution) becomes important. Knowing the Market we are operating in and it’s structure is vital in creating the right Marketing mix (4 Ps) as we shall see in the next few chapters ! 42 NOTES 43  5 Chapter 5. STP and Marketing Research Dealing with Differences W e know that consumers come in all different shapes and sizes. Everyone is different. However we also know that many consumers share similar needs. STP (Segmentation, Targeting and Positioning) is the process of looking for and finding these “groups” (or segments) of consumers and designing marketing strategies to take advantage of this grouping Segmentation Different Customers want different things (product), are able to pay different prices, have different information sources (promotion) and buy at different places (geographic, demographic). Essentially, these are the 4 P’s. Marketers must try to understand their consumer. However, developing a different marketing program for each customer is extremely expensive. Segmentation allows a marketer to identify and group people that behave similarly. An example of this is the Internet. Certain on-line companies have tailored or personalized their website to individual users. Finally, marketers can then position their products to fit their target market segment. 44  Definition: Segmentation: Segmentation is the process of dividing the total heterogeneous market for a product or service into several segments, each of which tends to be homogeneous in some significant aspects. Example - Air Travel - One company serving many segments Business/Executive: Inflexible; price insensitive. Small number of people, but travel often. Leisure Traveler/Student: Flexible; very price sensitive (other methods of travel--e.g., bus, car, train--are feasible; travel may not be essential). Very large segment. Comfort Travelers: Comfort (e.g., space, food) important; willing to pay. Small segment. Requirements for effective segmentation Profitability must be sustainable over time. Measurability with accessible data is very important. The segment must be accessible through existing distribution, advertising, etc. For the ODI case analysis there should have been a section in the report on the different ways to communicate (trade magazines) with the selected target market. More requirements for effective segmentation Good segments are also Homogenous (similar needs and desires within segments) and mutually exclusive (different needs and desires among segments). The essence of segmentation is that there are differences across but similarities within different groups of consumers. Targeting Once we have identified groups of consumers with similar needs, we need to choose, which of these we will target. 45 Factors that need to be considered when selecting Target Markets (Big Picture): Target segments should be compatible with the organization’s goals and image The market opportunity represented by the segment must match the company’s resources The segment must represent an opportunity to generate enough sales to generate a profit The company should select target segments where it can enjoy a competitive advantage Positioning Positioning relates to the use of various marketing techniques and marketing-mix variables to create the image or perception that will best fit with what the company wishes to be known for. According to Lillien and Rangaswamy (Marketing Engineering), “Positioning involves designing an offering so that the target segment members perceive it in a distinct and valued way relative to competitors.” ( There are three main ways to position a product: (again according to Lillien and Rangaswamy): 1. Unique (“Only product/service with ---”) 2. Difference (“More than twice the [feature] vs. [competitor]”) 3. Similarities (“Same functionality as [competitor]; lower price”) This is closely related to establishing a Brand. Positioning may be done on Attributes (low price, safer car, bigger screen etc.), Benefit (better for your skin, saves money etc.), Usage Situations, or Product Class. 46 Tools There are four main tools we use for STP. Factor Analysis Cluster Analysis Discriminant Analysis Perceptual Maps. We are now in the realm of Marketing Research. Any activity that involves, collecting, analyzing or interpreting market information is Marketing Research. One of the most common methods of collecting information is to ask what they feel/think/believe about something and what/when they will do something about it. (The other main way of collecting information is to observe what people actually do) Often the amount of information that is collected or available may be huge. Let us use the example of Digital Cameras. Here are some questions we may ask potential consumers: On a scale of 1- 7 (1 Not important, 7: Very important), please rate how important each of the following attributes are in your decision to buy a digital camera: 1. Size 2. Mega pixels 3. Optical Zoom 4. Digital Zoom 5. Movie Clip capability 6. LCD size 7. Weight (including batteries) 8. Bundled software 9. Image Stabilisation 10. White Balance override 11. Manual Focus 12. Storage media type 13. Price 47 We will also ask potential consumers how they rate the following brands (again on a 7 point scale; 1: Poor, 7: Excellent) on each of the above attributes: Canon, Nikon, Minolta Here is a sample data we might collect from this exercise. Each number in a cell represents the average from all the respondents: Attribute Ratings Attribute Importance Canon Nikon Minolta 1. Size 4 6 5 4 2. Mega pixels 6 6 6 4 3. Optical Zoom 4 4 5 6 4. Digital Zoom 3 5 5 5 5. Movie Clip capability 7 6 3 4 6. LCD size 5 2 4 6 7. Weight (incl. batteries) 5 6 5 4 8. Bundled software 2 6 2 3 9. Image Stabilisation 1 3 2 5 10. White Balance 1 4 2 1 11. Manual Focus 3 7 4 5 12. Storage Media type 4 6 3 2 13. Price 7 4 5 3 As you can surmise, there is a table like the one above for every respondent. Different respondents will have different responses to both the Attribute Importance question, but also the Brand Rating question. So, what can we do with this information we have collected ? Let’s see how we can use the Market Research tools we mentioned earlier with the data we have collected. 48 Factor Analysis It turns out that all the 13 attributes listed above are not necessary to analyse digital cameras. Factor Analysis is a mathematical technique that looks at all the responses from all the respondents and finds that most respondents who think that (for example) White Balance is an important attribute also think that Image Stabilisation is important. What this means is that we can use fewer attributes to describe digital cameras. (We can “merge” some of the attributes – White Balance and Image Stabilisation can be merged into an attribute called “Professional Features” – In fact, factor analysis may reveal that Manual Focus and Storage Media Type can also be merged into the “Professional Features” attribute). The purpose of Factor Analysis is data reduction. We can proceed with much fewer attributes. (If you look at websites which rate and compare digital cameras, you will find upwards of 30 attributes that are used – Factor analysis would be a very useful tool to reduce the attributes to a more manageable number without losing important information. Cluster Analysis We will also find that there are patterns among the responses of different groups of consumers. We might find that there is a group of consumers that rates Mega pixels and Professional features very highly, but rate LCD size and price low. (these could be professional photographers who need the best equipment and may not be too price sensitive). We might also discover another group that rates size and price very highly, but not any of the other attributes. (these could be people who are not technically advanced, but want a simple small camera). Cluster Analysis is the mathematical tool that looks for and finds these groups of respondents. Cluster Analysis is thus the tool used for Segmentation. Note also, that we are segmenting consumers based on “Needs Variables” (i.e. attributes of the product, or items that represent the needs of the consumers). These variables are called “Bases variables”. We are not segmenting consumers based on their income, or age etc. Discriminant Analysis The next issue is identifying these groups. We want to link these groupings to something observable (like age, income, magazines read etc.) These are called “descriptor variables” and are used to identify and target 49 (reach) different segments of consumers. The mathematical technique that lets us link groupings of consumers with descriptor variables is called Discriminant Analysis. We might, thus, discover that of the two groups we identified through cluster analysis, the first is composed mostly of people in the age group of 35 – 55 with an income of between $70,000 to $90,000 and the second group is mostly people in the age group of 15 – 40 with an income range of $50,000 to $70,000. We may also discover that the first group watches mostly the news on TV, but the second group watches mostly reality shows. This would help us a great deal in terms of being able to target ads for the first group during news shows, and for the second group during reality shows. As you may have guessed, if we used a survey to collect data on our respondents earlier, we would also have needed to ask them the appropriate questions about their gender, income, magazine preference, age, address etc. Perceptual Maps Based on the data we have collected in our digital camera example, we can get an idea of what our average consumer thinks of us. This is the Position we occupy in the consumer’s mind. It may not necessarily be what we want it to be, or even what we think it should be. For example, we might produce a really safe car (based on our tests), but consumers may think of it as “unsafe” if there are negative news stories about it. Perceptual Maps represent the information we have gathered in a visual manner to make it easier to interpret. A “Snake Plot” is the simple, traditional way to “see” the differences (in the average consumer’s mind) among the three brands of digital cameras. 1 2 3 4 5 6 7 1. Size 2. Mega pixels 3. Optical Zoom 4. Digital Zoom 50 5. Movie Clip capability 6. LCD size 7. Weight (incl. batteries) 8. Bundled software 9. Image Stabilisation 10. White Balance 11. Manual Focus 12. Storage Media type 13. Price = Canon = Nikon = Minolta FIGURE 5.1 Snake Plot This information can be further simplified (as we did in Factor Analysis) and reduced to two main dimensions as in Perceptual Map. Figure 3.2 represents the simplification of several dimensions into two dimensions: Simple – Advanced and Low price – High Price. The lines with arrows (“vectors”) represent each attribute. The attributes that have a higher correlation with each other are “closer” (i.e. more consumers think alike on them). The length of the lines represent the importance of the attribute in the consumer’s mind. 51  Manual Focus Image Stabilisation Advanced White Balance Mega pixels Software Low Price High Price Price Optical Digital Zoom Zoom LCD Size Simple FIGURE 5.2 Perceptual Map with attributes Now that we have seen how to “condense” several attributes into two main attributes, we can see what the consumers think of the three digital camera brands in a way that is easy to understand and interpret. (Figure 3.3) (Please note that this example is constructed with “made up data” and is not truly representative of the digital camera marketplace) 52  Advanced Canon Minolta Low Price High Price Nikon Simple FIGURE 5.3 Perceptual Map with Digital Camera Brands We can now visualize our brand’s positioning relative to other brands. We can find “empty” areas of the map to target, and we can see what parts of the map have more intense competition (and potentially avoid them). Summary So, we use Factor Analysis to reduce data to a manageable size. Then we use Cluster Analysis to Segment consumers. Next, we use Discriminant Analysis to identify and hence Target consumers, and finally we use Perceptual Maps to help Position our product offering – and that’s STP ! 53 NOTES 54  6 Chapter 6. Product What do we have to offer ? W hat is a Product ? The Marketing definition in Chapter 1 provides a simple answer: A product is a good service or idea. If we expand this idea we can say that a Product is a good, service or idea consisting of a bundle of tangible and intangible attributes that satisfies consumers’ needs and is received (by consumers) in exchange for money or some other unit of value. This idea is a little different from what people have thought of in terms of “Product” in the past. (a Product hasn’t always been thought of as being a service or idea). The product is, in essence, anything of value that can be exchanged for a price. This is another example of the centrality of the exchange concept to Marketing. Thus, for a product to be a product in the marketing sense, there has to be a form of exchange. Products also incorporate both tangible (physical) and intangible (perceived, felt, experienced) attributes. Products embody, not just the physical or measurable characteristics of an item, but also how consumers ‘feel’ about it. We’ll talk more about this perception/feeling issue when we discuss branding. 55 Types of Products It is useful to classify products into different types. The two main classifications are Consumer vs. Industrial goods and Durable vs. Non- durable goods. Consumer Goods Consumer goods are goods purchased by the ultimate consumer (i.e. user). These can be further classified as follows: Convenience Goods These are goods that are purchased frequently and involve minimal shopping effort. (E.g. Milk, chewing gum, pop etc.). These goods are generally inexpensive and can be bought at many different types of stores. Consumers in this category are not particularly brand loyal, will accept substitutes and are often price conscious. Marketers focus on building awareness of their brands, and recognize that easy availability is very important in determining sales. Shopping Goods Shopping goods are more expensive than convenience goods and require effort deliberation and thought before purchase decision are made. These goods are purchased infrequently, and can be bought only at particular types of stores. Consumers generally go through all five stages of the consumer decision process when buying these goods. They are often high involvement items like cars, or electronics and consumers are brand conscious. Marketers focus on differentiating their brands from competitors. Specialty Goods Specialty goods are usually very expensive and can only be purchased at a very limited number of stores. (e.g. Mont Blanc pens, Harley Davidson Motorcycles, Vintage cars). Availability is not important here, but rather exclusiveness is sought after. Marketers stress the uniqueness and status of their brand. 56 Unsought Goods These goods are not characterized by price or availability. They are generally purchased very infrequently. Consumers generally do not go looking for these products. (e.g. Life insurance, Education Bonds, Anti- smoking aids etc.). Marketers emphasize awareness, because it is the key to educating the consumer to buy their product. Industrial Goods Industrial goods are not purchased by the ultimate consumer, but by other producers who then manufacture consumer goods (or other industrial products). These goods assist in providing products for resale and are bought by companies to be put into production to be used in the manufacturing other goods. The sale of industrial goods is the result of derived demand. The demand for these products comes from the demand for the final consumer good. The demand for bicycle wheels is derived from the demand for bicycles. Durable and Non-Durable goods Durable goods last over an extended period and are therefore purchased only infrequently (like cars, laptop computers, washing machines etc.). Non-Durables (or “consumables”) (e.g.: batteries, cereal, pencils) are used up in one or a few uses and must be purchased again and again. Printers and printer cartridges are also good examples of Durable and Non-Durable goods. This classification is important because it indicates to the marketer the behaviour of consumers for the two types of goods. In one case, consumers have to be encouraged to repeatedly keep buying the consumable, and in the other the message must reach the consumer mostly at the point in time when the consumer is considering buying a durable item. New Products Launching a new product is one of the most important and riskiest things that a company does. By some estimates 80 % of new products fail. From a business perspective this sounds pretty grim considering that new product launches cost several hundred million dollars. What can marketers (and they are the ones ultimately responsible for new product 57 introductions) do about this ? Can the failure rate be reduced ? Let’s see why new products fail. New products typically fail due to some (or all) of the following reasons: Poor Concept (No one wants it ! It doesn’t satisfy any consumer needs) Inadequate selection and targeting. (The wrong consumers are being targeted) Inadequate differentiation (The new product is perceived as very similar to existing products and doesn’t provide any reason for consumers to switch) Marketing Mix Issues: § Poor Execution § Poor Quality § Bad Timing (too early, too little, too late) § No access to buyers (distribution weakness) From the perspective of this book, these seem to be fairly obvious, “basic” and avoidable errors. We have highlighted the primacy of consumer’s needs, so the new product would be expected (in the hands of a competent marketer) to satisfy some consumer needs. We would also expect (given a basic understanding of STP) that a new product would go through sufficient research to find and target appropriate consumer segments, as well as be launched in an area of the market that differentiates it from competitors. As we will see in succeeding chapters, there are some simple ideas to be kept in mind to ensure good execution on the 4 Ps. Please do remember, however, that this book just presents the basics; there are a host of details that need to be worked out when making real life decisions that we don’t go into. We can go back once again to the Marketing concept of satisfying consumer needs to look for ways of making sure that the new product does not fail. There are many techniques and processes that different 58 companies use for new product development. Most of them involve creative ways of keeping track of new opportunities, and some process for idea generation (both from consumers and employees) and screening, as well as development. In terms of opportunities, a firm has four main options (Figure 6.1) Existing New Products Products Existing Market Product Markets Penetration Development New Market Markets Development Diversification FIGURE 6.1 Options for Expansion A key element of the new product development process is the tradeoffs amongst attributes. If we ascertain the consumers’ ideal products, we would find that there are many attributes that consumers want more and more of. (for example: Price. All consumers would prefer price to be as low as possible). The ideal product thus, would be mostly something very impractical. However, if we provide consumers with tradeoffs possibilities (e.g.: You can have a larger TV, but you have to pay more, or you can have a larger room in a hotel, but it won’t have free internet), we can get a much more useful picture of what attribute levels the new product should have. Conjoint Analysis is a technique that elicits this trade-off information from consumers. It involves having consumers make choices between alternative combinations of different attribute levels. This lets us figure out, for example, how much consumers are willing to pay for extra cheese on pizza, or what they are willing to give up for a cheaper printer. 59 The Product Life Cycle This is a key concept in understanding products. Every product has a life cycle from “birth” to “death”. Figure 6.2 shows the general shape of Sales over time for any product. Introduction Growth Growth Decline Sales Time FIGURE 6.2: Product Life Cycle Individual products may have variations on the shape of the Product Life Cycle (PLC). Fads (products that quickly become popular, but then just as quickly fade away) have a very narrow peak. Some products have life cycles that are done in a few weeks or a few months. Others (e.g. Ketchup) have product life cycles that can last several decades During the Introduction stage, the product has just been introduced into the market and customers are not quite familiar with the product yet. Due mostly to start up costs, Research and Development costs that go into every new product, the company is generally losing money in this stage. 60 There is usually not much competition and the company focuses on building awareness. The Growth phase marks the point where sales begin to “take off”. This generally happens once a threshold of awareness is crossed. There is, by this time, more competition and the company must continue to inform potential customers about their competitive advantages. Sales of the product eventually begin to peak and level off. This is the Maturity stage. The company’s profits also peak around this time. The company now focuses on defending it’s market share and reminding consumers of the value of the product and it’s differentiation from competition. Eventually, the sales of the product begin to drop in the Decline stage and the profits for the firm fall as well. At the decline stage, the firm will generally “Harvest” the product and eventually delete it from their product line (stop manufacturing it). Diffusion of Innovation The shape of the PLC is linked to how quickly a new product or idea (innovation) spreads (diffuses) amongst the population. Figure 6.3 illustrates a typical curve representing the adoption of a new product. The figure shows the different categories of consumers who adopt the new product at different speeds. Innovators are motivated by being pioneers and buying the “latest and greatest” product. This really small group is more inclined to pay a higher price for the new product. They are often referred to as being at the “bleeding edge”. Innovators have a high tolerance or risk. The Early Adopters are a slightly larger group who also value trying something new, but are not as informed about new products as Innovators. As you can see from Figure 6.3, Early Adopters are still well ahead of the curve. Marketers have realized that a skimming (high) pricing strategy works well for both these groups because of their willingness to pay higher prices. A skimming price strategy has the advantage of recouping costs quicker, but it does slow the diffusion process. The Majority of consumes buy the new product when there are enough others who have already tried it and the “bugs” have been discovered and fixed. This group has an average tolerance of risk and is generally price sensitive. Finally the Late Adopters (sometimes referred 61 to as Laggards) are the last segment of the market to adopt the new product. This group is extremely risk-averse and want a competitive price. % Adoption Majority Time Innovators Late Adopters Early Adopters FIGURE 6.3: Diffusion of Innovation and different categories of Adopters Certain characteristics of an innovation may serve to improve or detract from its chances of adoption by consumers (and the time frame over which adoption takes place). These are: It’s perceived complexity. (the more complex the product is viewed as, the slower consumers adopt) It’s compatibility in use with present behaviour patterns and complementary products. (A product that is more similar in use to existing behaviour, the faster it will spread) 62  The ease with which it’s features (and especially it’s benefits) can be observed and communicated. (the easier this is, the easier it is for word of mouth to occur and spread the message – and the adoption – faster) The degree of risk – physical, financial and social – attached to adoption of the innovation in preference to existing products or procedures (the higher the perceived risk of buying the new product, the bigger the barrier to quick adoption. For example the higher the price, the slower the adoption curve) The extent to which the innovation can be tried on a limited basis before being adopted on a large scale, permanent basis. (Easy trial reduces the risk of buying something new and hence helps faster adoption) Diffusion is different from person to person depending on his/her definition of perceived risk. Faster diffusion occurs if the marketer can communicate benefits that are of value to the consumer. The final thing to keep in mind is that typically consumers go through the following stages in the adoption process: Awareness –> Knowledge -> Evaluation –> Trial -> Adoption Each of these stages has it’s own “Diffusion Curve” and it is important to remember that each curve influences the succeeding ones. So, if the spread of awareness is slow, the other parts are automatically slowed down and the final adoption is also slow. 63 NOTES 64  7 Chapter 7. Price What do we want in return for our offering ? P rice is the value exchanged by the consumer for a product. This is often (but not always) a monetary value. From the perspective of the firm, Price is a key decision variable because it determines the inflow of revenue. There are three main approaches to setting price, each corresponding to one of the 3C’s from Chapter 1. Cost-Plus Pricing (Company) Competitive Parity Pricing (Competition) Value Based Pricing (Customer) Let us look at each in turn: Cost-Plus Pricing To begin this section we need to remind ourselves of some basic concepts from Economics. The “Demand Curve” describes the relationship between price and the quantity demanded (or, the number of units 65 consumers will buy at that price). In keeping with the idea that if price increases, fewer units will be bought, the demand curve is generally downward sloping. Figure 7.1 shows a simplified demand curve. (It is simplified because it is assumed that there is a linear – the simplest mathematical form – relationship between quantity demanded and price.) 60 Total Revenue 40 P* 20 Demand Curve Price 0 0 10 20 Q* 30 40 50 60 -20 -40 Marginal Revenue -60 Quantity FIGURE 7.1: Demand Curve In this case, the relationship can also be represented by the equation: Q = 50 - P (7.1) This is a scenario where, when the Price is $1, 49 units of the good are purchased/sold. When the Price is $ 48, 2 units are demanded etc. Table 7.1 lists the various combinations. The revenue that the firm generates is the price it charges times the quantity demanded (or the quantity sold – for simplicity we will assume these are the same). In equation form: 66  TR = P.Q (7.2) Table 7.1 also shows the Total Revenue (TR) for our example. Total Marginal Total Marginal Price Quantity Revenue Revenue Price Quantity Revenue Revenue 50 0 0 50 24 26 624 -2 49 1 49 48 23 27 621 -4 48 2 96 46 22 28 616 -6 47 3 141 44 21 29 609 -8 46 4 184 42 20 30 600 -10 45 5 225 40 19 31 589 -12 44 6 264 38 18 32 576 -14 43 7 301 36 17 33 561 -16 42 8 336 34 16 34 544 -18 41 9 369 32 15 35 525 -20 40 10 400 30 14 36 504 -22 39 11 429 28 13 37 481 -24 38 12 456 26 12 38 456 -26 37 13 481 24 11 39 429 -28 36 14 504 22 10 40 400 -30 35 15 525 20 9 41 369 -32 34 16 544 18 8 42 336 -34 33 17 561 16 7 43 301 -36 32 18 576 14 6 44 264 -38 31 19 589 12 5 45 225 -40 30 20 600 10 4 46 184 -42 29 21 609 8 3 47 141 -44 28 22 616 6 2 48 96 -46 27 23 621 4 1 49 49 -48 26 24 624 2 0 50 0 -50 25 25 625 0 TABLE 7.1: Demand Curve Example If you look at Figure 7.1 (or Table 7.1), you can see that as the price drops, the quantity demanded increases and the Total Revenue increases as well. However, a point is reached where the price is low enough that even 67 though the quantity demanded keeps increasing, the Total Revenue starts to drop. On inspection, you can see that Total Revenue is highest when P*= 25 and Q* = 25. This is the Optimal Point to price at. Table 7.1 also shows something called Marginal Revenue. Marginal Revenue (MR) is the additional revenue from increasing the quantity sold by 1 unit. In equation form: d MR = TR (7.3) dQ d Þ MR = PQ dQ d Þ MR = (50 - Q )Q dQ Þ MR = 50 - 2Q (7.4) You can see (from either Figure 7.1 or Table 7.1) that the optimal price we found earlier corresponds to the point where MR = 0. This just means that we can keep lowering the price and increasing quantity demanded till there is no additional revenue from selling more. So far so good. But we have not considered Costs. It does cost the company to produce the product and get it to the consumer. Costs can be broken up into Fixed Costs (i.e. the costs that are independent of the number of units produced) and Variable Costs (costs that increase with the number of units produced – In general, if you can break up a cost into a per-unit charge for marketing purposes, you can treat it as a variable cost). As with Revenue, we can describe the concept of Marginal Cost as the cost of producing one additional unit. In our example, we had obtained the optimal price without looking at cost. Now let us add Marginal Cost to the mix (Figure 7.2). The Marginal cost curve is generally either flat or downward sloping. A downward sloping Marginal Cost curve simply reflects the learning curve and economies of scale. As the firm produces more and more units, it gets better at doing so and can produce more efficiently (cheaper). Also, sometimes producing a larger quantity can be cheaper per unit. For this example, let us assume that: MC = 30 - Q (7.5) 68  60 40 Price Demand Curve P* Marginal Cost 20 Marginal Revenue 0 0 10 20 30 40 50 60 Q* Quantity FIGURE 7.2: Demand Curve with Marginal Cost In Figure 7.2, the area between the Marginal Cost cure and the Marginal Revenue curve represents the “gain” from producing an additional unit. Clearly, we should increase the quantity upto the point where MR=MC. Beyond (to the right) of this point, the cost of producing the next unit is higher than the revenue we would generate from it, so it is not worthwhile. This gives us a better idea of the optimal price to charge. From the figure, we can see that that the point where MR = MC corresponds to P* = 30 and Q* = 20. We can also see this in equation form below: MR = MC Þ 50 - 2Q = 30 - Q (From Equation 7.4 and 7.5) Þ Q* = 20 Þ P* = 50 - Q = 30 69  (7.6) Breakeven Analysis So far, we have taken into account the demand curve as well as the marginal cost of producing the product. Let us now look at the optimal price from the point of view of Profit. This will include consideration of Variable Costs as well as Fixed Costs. The analysis is quite simple, yet incredibly powerful (Figure 7.3 illustrates the Breakeven Point graphically). Higher Profit Area Total Revenue Curve Total Revenue and Cost Total Cost Curve Break-Even Point Loss Area Total Variable Costs Total Fixed Costs 0 More Units of Production (Quantity) FIGURE 7.3: Breakeven Analysis In terms of equations: Profit = P = Total Revenue – Total Cost (7.7) Total Revenue = Price x Quantity 70 And, Total Cost = Fixed Cost + (Unit Variable Cost x Quantity) So, Equation 7.7 becomes: P = P.Q - ( FC + Q.VC ) (7.8) Þ P = Q( P - VC ) - FC This is where the concept of Breakeven point comes in. The Breakeven point is the Quantity we need to produce to just recover our costs. It is the quantity below which we make a loss and above which we make a profit. So, to obtain the Breakeven Point (BEP), we need to find the Quantity that leads to a zero profit : (Q* = BEP) P=0 Þ Q * ( P - VC ) - FC = 0 Þ Q * ( P - VC ) = FC (7.9) FC Þ Q* = ( P - VC ) Equation 7.9 is the Breakeven Point Equation and shows that the BEP is the quantity at which the Fixed Costs are covered by the “Contribution” (P-VC). You will notice that we need to know the price before we can calculate the Breakeven Point. So, how does this help us determine price ? The power of Breakeven Analysis is that we can calculate the BEP for many different levels of price and potentially many different cost scenarios as well, to see the effect of price levels on profitability. In conclusion, Breakeven Analysis provides us with a simple tool to incorporate costs (both variable and fixed) into the pricing decisions and let’s us evaluate many different scenarios to pick the best one. Value Based Pricing Value based or Demand based pricing looks at the Price decision not from the internal perspective of how to recover costs, but from the point of view 71 that the purpose of price is to capture the perceived value of the product in the minds of the consumer. At one level, this can be characterized as charging “what the market will bear” (what the market is willing to pay) and at another level it can be seen as focusing on the value we are offering the consumers. (something we have recommended throughout this book). The basis for this approach to pricing is to use the customers’ perception of value, rather than the company’s cost. Once we determine the price we wish to charge, we can work backwards to create the appropriate cost structure. To better understand value based pricing we will have to switch our focus from economic theory to more behavioural characterizations. One example of this switch is the difference between Reservation Price and Reference Price. Reservation Price is an economic term that is defined as the highest price a consumer is willing to pay. In light of the fairly standard Rational Utility Assumption of economics (i.e. that consumers on average behave rationally and will choose options that objectively maximize their benefit). Reservation price is the same as the customer’s perception of the value of the product. In other words, the customer will not pay more for a product than what she perceives to be it’s value/benefit to her. Reference Price on the other hand is a more behavioural concept and the literature offers several ways to define it. It can be thought of as either one or a combination of the following: Fair Price Frequently Charged Price Last Price Paid Price of Brand usually bought Average price for similar products Expected future price Typical discounted price Another important idea that can be better understood by looking at the behavioural aspect of things is Price Sensitivity. (like the economic 72 concept of Price Elasticity). The availability of alternatives, perceived substitutes, reference points, switching costs etc. all contribute to the level of price sensitivity. Sometimes, consumers may perceive higher prices to be a signal of quality and therefore would not be very price sensitive. Overall, we know that the economic assumption of the rational consumer is not true all the time. Often we see others (and sometimes ourselves) do things that may not be completely rational. For example people tend to buy more when an item is “on Sale” regardless of whether the item is actually any cheaper or not. More people will also buy a product for (say) $49.99 than will buy the product at $50.00, even though (rationally) there is only a negligible 1 cent difference. Daniel Kahneman and Amos Tversky studied some of the breakdowns of rational behaviour and proposed “Prospect Theory” to account for some of the deviations. Their work has had such a profound impact on Economic theory that in 2002, Daniel Kahneman won the Nobel Prize in Economics for “bridging economics and psychology”. (Amos Tversky passed away in 19996 and the Nobel committee does not award prizes posthumously). Prospect theory says that consumer response to gains vs. losses is asymmetric. This means that consumers value gains and losses differently. In fact it turns out that “losses loom larger than gains”. A classic example to illustrate this idea is the following scenario: Say someone told you that you had won $10,000. You would be pretty happy. (You have a gain and value it). Now suppose that this was a mistake and you are told that you really did not win (this is the “loss”). Since you are now exactly where you were to begin with, (you haven’t gained anything or lost anything overall) you should be just as content as you were before this whole thing began. Or at least that is what a “Rational” person would feel. However, the “let down” from “not winning” the money is bigger than the “boost” from winning it and you end up less happy than you were to begin with ! An important component of prospect theory is that we evaluate losses and gains relative to a (subjective) reference point. (so something that is a large gain to one person may be a small gain to another. This “framing” effect means that how a particular issue is framed or presented can determine how it is viewed. A store advertising a new brand by placing it right next to a very expensive brand can better convince customers that the new 73 brand is a good value than by placing it right next to a low price alternative. This also explains the “On Sale” phenomenon. The price we pay for a product is a “loss” from the consumers perspective. However, if we present a $80 watch as a $100 watch at a 20 % discount, consumers will be attracted by the seeming “gain”. Marketers should also try and frame purchases (i.e. the price paid) as gains denied rather than losses. Further, the marginal utility of gains is decreasing, which means that (for example) $10 is worth more to the person with nothing in their pocket than the person with $1000 in their pocket. This further implies that two distinct gains of $10 will perceived as better than a one time gain of $20. If you have seen Ron Popeuil sell knife sets on TV, you will see him separating gains as well: “You can have 2 knives for three easy payments of $13.33”, he says. “But wait ! There’s more !! I will give you 3 knives for the same three easy payments of $13.33 !”. “But wait ! There’s more !! I will give you 2 more knives – so 5 knives for the same three easy payments of $13.33 !”… and so on till he is selling you 21 (!) knives all for “three easy payments of $13.33 !” Two losses, on the other hand are worse than one combined loss. So as a marketer, it is better to raise your price in one big jump, rather than gradually, in many steps. The lesson from all this is that perceptions of price often don’t follow strict economic models of utility. Knowing how his works can help marketers understand consumer reactions to price and set prices effectively. Competition Based Pricing Pricing in the face of competition is like a “game”. (hence the term “Game Theory” for the field of study that looks at competitive strategy and won John Nash the Nobel prize in economics in 1994). Often someone wins and someone loses. (typically the item being won or lost is market share). If you lower your price, competitors are likely to lower their prices as well. This can lead to price wars which are typically bad for both participants and generally worse for the company with the higher market share. Strategically, when fixing price you do need to anticipate competitor response and account for it. 74 Conclusion So, where does all this leave us overall. Cost analysis typically gives us a “floor” or minimum price we need to charge to meet our costs. Value analysis gives us a “ceiling” or maximum price our customer will be willing to pay. Between these two extremes is where (based on competitive and behavioural considerations) is where we will actually