Intro To Marketing Primer 158

Chapter 1: A general introduction to the subject guide

Chapter 1: A general introduction to the subject guide Welcome to the unit 141 Principles of marketing. As the title of the subject indicates, the emphasis in this guide is on the principles (that is, the models, theories, concepts, frameworks) rather than the practice, of marketing. The predominant theoretical insights will be drawn from several disciplines such as management, economics and psychology (although attention will also be paid to exclusively marketing-based concepts). Because of this focus, the applicability of what you will learn in this guide to many areas of marketing and management will be extremely high. The approach of this subject guide can be described as primarily deductive. This focus, of course, will come at a cost; that of ‘apparent’ realism. We say apparent because what people often call the ‘real world’ of marketing is also an apparent reality. Practitioners and many business school courses tend to lack rigour, and they claim that models and principles are never able to capture the complexities and the multi-dimensional nature of the marketing framework. This may be true only to the extent that ‘models’ or theoretical understanding can never tell you how to do your job as a marketing manager or consultant. Indeed, when one enters the world of work, long-term planning practically involves (at most) only a few months’ time horizon. But theoretical understandings of the world tend to have a longer shelf life. The value of a principles-based marketing course, or any theoretically grounded study, is how well it can explain the most important events and behaviours in a given field. The particular, the small, the ‘how to’ as opposed to the ‘why to’ – that is the job of intuition and ‘rule of thumb’ heuristic1 thinking and not the job of a university course of study. Having said that, there are some deficiencies with a programme of study that is solely devoted to abstract theory. As we said, a price is paid in terms of realism, but also in terms of internalisation. By internalisation we mean that students tend to forget what they learn once the course is finished if only abstract concepts are employed. That is why the subject guide and readings will often contain short cases in order to apply what has been learned. This application of marketing theory will take the form of minicases, activities and appropriate readings.

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‘Heuristic – enabling a person to discover or learn something for themselves; in computing, proceeding to a solution by trial and error or by rules that are only loosely defined’, Oxford Dictionary. (Oxford: Oxford University Press, 1999).

The structure of the guide This subject guide has three main areas of study: 1. A general introduction to marketing giving the historical foundations of the subject as well as the scope of what marketing is all about. 2. A focus on understanding consumer and buyer behaviour. This is an essential element, since the hallmark of marketing, as opposed to other management disciplines, is the belief in the sovereignty of the consumer and ultimate advisability of structuring managerial strategies around the end user. 3. A focus on the organisation and understanding its particular marketing behaviour.

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Principles of marketing

Aims and objectives This subject guide’s aim is to introduce you to the fundamental principles of marketing. Topics covered in the unit include: • origins of marketing theory and practice • consumer theory • product development • promotion strategy • pricing strategy • distribution strategy • marketing ethics and corporate social responsibility. The introductory and theoretical approach taken in this guide will enable you to gain a broad understanding of consumers and the marketing behaviour of firms, especially those operating in an international environment. Marketing can only be properly understood through the various disciplines that support it (i.e. economics, psychology, sociology and strategy). This subject guide will do its best to explore the relevance of these academic subjects to marketing. Throughout the guide, you are encouraged to question the limitations of marketing management and to suggest ways of overcoming its many problems. Through the use of short case studies, you will also be able to develop your practical skills by applying learned theories to real-world organisational problems.

Learning objectives The subject is ideally suited to those who wish to develop a sophisticated and critical understanding of marketing theory. Specifically, you will be expected to: • describe the behaviour of consumers from several perspectives, including an economic and psychological perspective • discuss the function and effect of advertising/promotion from both an organisational and market-wide perspective • describe the pricing behaviour of firms in an uncertain environment where information may be limited or wrong • develop a basic knowledge and ability to analyse the marketing behaviour of firms and consumers; and make predictions regarding such events as the success or failure of a new product launch or advertising campaign. These themes run throughout the unit. You will be expected to acquire a knowledge and critical understanding of these and other important themes as well as the sub-topics that form a part of each major theme.

Syllabus Exclusions: This subject has replaced 36 Marketing and may not be taken if a student is taking or has passed 36 Marketing. Part A. Understanding consumer and buyer behaviour 1. Overview of marketing: history and theoretical approaches used in marketing

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Chapter 1: A general introduction to the subject guide

2. Introduction to consumer and buyer behaviour 3. Introduction to market segmentation 4. Customer relationship marketing 5. Introduction to demand analysis and estimating market potential 6. Organisational buyer behaviour. Part B. Understanding organisational marketing behaviour 7. Introduction to promotion strategy 8. Branding and product development 9. Product life-cycle theory and competitor analysis 10.Introduction to pricing strategy 11.Introduction to placement/distribution analysis 12.The ethical, social and economic implications of organisational marketing behaviour.

Prerequisites If you are taking this unit as part of a BSc degree, the prerequisites are either: unit 10 Introduction to sociology or unit 21 Principles of sociology or unit 79 Elements of social and applied psychology or unit 02 Introduction to economics. Therefore this subject guide is written with the assumption that you have some background in one of the above three foundations of marketing (sociology, psychology or economics). In this subject guide you will find footnote references to some of the topics and concepts in units 21 Principles of sociology and 79 Elements of social and applied psychology, which relate to those being discussed here. These cross-references are not exhaustive and should not disadvantage you if you have not studied those units. However, we have mentioned the links so that you can see how your existing knowledge can help inform your study of this unit.

Reading advice There are many textbooks that cover most of the major themes related to the principles of marketing found in this guide. However, the Kotler and Armstrong (2004) text, listed under essential reading, is the book most often used in university programmes around the world. It also has the virtue of having a dedicated international edition and one of the longest print runs in academic history. As such, although our guide is structured thematically quite differently from the essential reading, all the chapters of the subject guide have corresponding ones in the textbook. Our subject guide is therefore a complement and not a substitute for this essential text.

Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761].

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Further reading At the start of each chapter we provide a list of relevant further reading; for your ease of reference we provide a full list here of all the further reading in the guide.

Books Adman, R. Morris Hite’s methods for winning the ad game. (Dallas, Tex.: E-Heart Press, 1988) [ISBN 0935014128]. Axelrod, R. The evolution of co-operation. (London: Penguin Books, 1990) [ISBN 0140124950]. Bauer, R.A. ‘Consumer behaviour as risk taking’ in Cox. D. (ed.) Risk taking and information handling. (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1967), pp. 22–33. Benioff, M. and K. Southwick Compassionate capitalism: how corporations can make doing good an integral part of doing well. (Franklin Lakes, NJ: Career Press, 2004) [ISBN 1564147142]. Berry, L.L. ‘Services marketing is different’ in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston, Mass.: Allyn and Bacon, 1991) [ISBN 0205129242]. Berry, L.L. and A. Parasuraman Marketing services. (New York: The Free Press, 1991) [ISBN 002903079X]. Blau, P.M. Exchange and power in social life. (New York: John Wiley, 1964). Brassington, F. and S. Pettitt Essentials of marketing. (Harlow: Prentice Hall, 2003) [ISBN 0273687859]. Cox, D.F. ‘Risk taking and information handling in consumer behaviour – an intensive study of two cases’ in Cox, D. (ed.) Risk taking and information handling. (Boston, Mass.: Harvard University Press, 1967), pp. 82–108. Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston: Allyn and Bacon, 1991) [ISBN 0205129242]. Frank, R. Luxury fever: money and happiness in an era of excess. (Princeton, NJ: Princeton University Press, 2000) [ISBN 0691070113]. Friedman, L. and T.R. Furey The channel advantage. (Oxford: Butterworth Heinemann, 1999) [ISBN 0750640987]. Galbraith, K. The affluent society. (London: Penguin, 1999) [ISBN 0140285199]. Jagpal, P. Marketing under uncertainty. (Oxford: Oxford University Press, 1999) [ISBN 0195125738]. Kay, J. ‘A model of product positioning’ in The foundations of corporate success. (Oxford: Oxford University Press, 1993) [ISBN 019828781X], pp. 242–50. Klein, Naomi No logo: no space, no choice, no jobs: taking aim at the brand bullies. (Toronto: A.A. Knopf Canada, 2000) [ISBN 067697130X]. Kotler, P., S.H. Ang, S.M. Leong and C.T. Tan Marketing management – an Asian perspective. (Singapore: Prentice Hall, 1996) [ISBN 0132548976]. Lambin, J. Market driven management: strategic and operational marketing. (Basingstoke: Macmillan Business, 2000) [ISBN 0333793188; 0333793196 (pbk)]. Levinson, J.C. Guerrilla advertising: cost-effective techniques for small-business success. (Boston: Houghton, 1994) [ISBN 0395687187]. Nagle, T. and R.K. Holden The strategy and tactics of pricing: a guide to growing more profitably. (Upper Saddle River, NJ: Prentice Hall, 2006) fourth edition [ISBN 0131856774]. Narus, J.A. and J.C. Anderson ‘Turn your industrial distributors into partners’ in Kotler, P. and K. Cox (eds) Marketing management and strategy: a reader. (Upper Saddle River, NJ: Prentice Hall International, 1988) [ISBN 013557653].

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Chapter 1: A general introduction to the subject guide Nevett, T. and R. Fullerton Historical perspectives in marketing. (Toronto: Lexington Books, 1988) [ISBN 0669169684]. Olson, J.C. ‘Cue utilisation in the quality perceptions process’ in Venkatesan, M. (ed.) Third annual conference of the association for consumer research. (Chicago: Association for Consumer Research 1972), pp. 167–79. Peter, J.P. and J.C. Olson Consumer behavior and marketing strategy. (New York: McGraw-Hill, 2005) seventh edition [ISBN 0072864877 (alk. paper) 0071111778 (international: alk. paper)]. Pindyck, R and D. Rubinfeld Microeconomics. (Upper Saddle River, NJ: Pearson/Prentice Hall, 2005) [ISBN 0131912070]. Puttnam, D. Movies and money. (New York: Knopf, 1998) [ISBN 067976741X] (pbk); 0679446648]. Rokeach, M. The nature of human values. (New York: The Free Press, 1973) [ISBN 0029267501]. Samuelson, P.A. Economics: an introductory analysis. (New York: McGraw-Hill, 1994) [ISBN 0070747415]. Stern, L.W. and T. Reve ‘Distribution channels as political economies: a framework for comparative analysis’ in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston, Mass.: Allyn and Bacon, 1991) [ISBN 0205129242 (pbk)]. Veblen, T. The theory of the leisure class. (New York: Random House, 1899, 2001) Modern Library Classics edition [ISBN 0375757872]. Williamson, O.E. Markets and hierarchies: analysis and antitrust implications. (New York: Free Press, 1975) [ISBN 0029347807 (pbk); 0029353602].

To help you read extensively, all external students have free access to the University of London External online library where you will find the full text or an abstract of some of the journal articles listed in this guide. You will need a username and password to access this resource. Details can be found in your Student Handbook or online at: www.external.shl.lon.ac.uk

Journal articles ‘Console wars’, The Economist, 20 June 2002. http://www.economist.com/business/displayStory.cfm?story_id=1189352 ‘Corporate social responsibility: two-faced capitalism’, The Economist, 22 January 2004. ‘Survey: corporate social responsibility’, The Economist, 20 January 2005. Beane, T.P. and D.M. Ennis (1987) ‘Market segmentation: a review’, European Journal of Marketing 21(5), pp. 20–42. Ben Porath, Y. ‘The F connection: families, friends and firms and the organisation of exchange’, Population and Review 6 (1980), pp. 1–30. Berry, L.L. ‘In services, what’s in a name?’, Harvard Business Review, September/October 1988, pp. 28–30. Bettman, J.R. ‘Perceived risk and its components: a model and empirical test’, Journal of Marketing Research 10 (1973), pp. 184–90. Bikhchandani, S., D. Hirshleifer and I. Welch ‘Learning from the behaviour of others: conformity, fads, and informational cascades’, Journal of Economic Perspectives, 12 (3), Summer 1998, pp. 151–70. Black, M. and D. Greer ‘Concentration and non-price competition in the recording industry’, Review of Industrial Organisation 3 (1987), pp. 13–37. Bourantas, D. ‘Avoiding dependence on suppliers and distributors’, Long Range Planning 22(3) 1989, pp. 140–49. Boze, B.V. ‘Selection of legal services: an investigation of perceived risk’, Journal of Professional Services Marketing 3(1) 1987, pp. 287–97. Coase, R. ‘The lighthouse in economics’, Journal of Law and Economics 17 (1974), pp. 357–76. Cothier, G., M. Christen and D. Soberman ‘Ford Ka, The market research problem’ 2003, INSEAD Case no. 503–084-1;

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Principles of marketing http://www.ecch.cranfield.ac.uk Dahl, R.A. ‘The concept of power’, Behavioral Science 2, July 1957, pp. 201–15. Danneels, E. ‘Market segmentation: normative model versus business reality; an exploratory study of apparel retailing in Belgium’, European Journal of Marketing 30(6) 1996, pp. 36–51. Davis, H.L. ‘Service characteristics, consumer search and the classification of retail services’, Journal of Retailing 55(3) Fall 1979. Derbaix, C. ‘Perceived risk and risk relievers; an empirical investigation’, Journal of Economic Psychology 3 (1983), pp. 19–38. Dibb, S. ‘Market segmentation: strategies for success’, Marketing Intelligence and Planning 16(7) 1998, pp. 394–406. Dibb, S. and L. Simkin ‘Implementation problems in industrial market segmentation’, Industrial Marketing Management 23 (1994), pp. 55–63. Dibb, S. and P. Stern ‘Questioning the reliability of market segmentation techniques’, Omega – International Journal of Management Science 23(6) 1995, pp. 625–36. Durgee, J.F., G.C. O’Connor and R.W. Veryzer ‘Observations: translating values into product wants’, Journal of Advertising Research Nov/Dec 1996, pp. 90–9. El-Ansary, A.I. and L.W. Stern ‘Power measurement in the distribution channel’, Journal of Marketing Research 9, February 1972, pp. 47–52. Emerson, R.M. ‘Power dependence relations’, American Sociological Review 27(1962), pp. 31–40. Fishman, C. ‘The Wal-Mart you don’t know,’ FastCompany Magazine 77, December 2003; www.fastcompany.com/magazine/77/walmart.html Frazier, G.L., J.D. Gill and S.H. Kale ‘Dealer dependence and reciprocal actions in a channel of distribution in a developing country’, Journal of Marketing 53, January 1989, pp. 50–69. Gale, D. ‘What have we learned from social learning?’, European Economic Review 40(3–5), April 1996, pp. 617–28. Gaski, J.F. ‘The theory of power and conflict in channels of distribution’, Journal of Marketing 48, Summer 1984, pp. 9–29. Geanakoplos, J., M. Magill and M. Quinziil ‘Demography and the long-run predictability of the stock market’, Cowles Foundation Discussion Paper 1380 (August 2004); http://ideas.repec.org/p/cwl/cwldpp/1380.html Ghobadian, A., S. Speller and M. Jones ‘Service quality: concepts and models’, International Journal of Quality & Reliability Management, 11(9)(1994), pp. 43–66. Guseman, D.S. ‘Risk perception and risk reduction in consumer services’, in Donelly, J.H. and W.R. George (eds) Proceedings of American Marketing Association. (Chicago, IL: 1981), pp. 200–204. Halstead, D., C. Droge and M.B. Cooper ‘Product warranties and postpurchase service’, Journal of Services Marketing 7(1) 1993, pp. 33–40. Hanson, W.A. and Daniel S. Putler ‘Hits and misses: herd behavior and online product popularity’, Marketing Letters 7(4) 1996, pp. 297–305. Heide, J.B. and G. John ‘The role of dependence balancing in safeguarding transaction-specific assets in conventional channels’, Journal of Marketing 52(1), January 1988, pp. 20–35. Hirschman, A. ‘Rival interpretations of market society: civilizing, destructive, or feeble?’, Journal of Economic Literature 20 (1982): 1463–84. Holmstrom, B. and J. Roberts ‘The boundaries of the firm revisited’, Journal of Economic Perspectives, Volume 12(4) 1998, pp. 73–94. Hurst, E. and M. Aguiar ‘Consumption, expenditure and home production over the life cycle,’ University of Chicago, Department of Economics Working Paper (2004); http://www2.gsb.columbia.edu/divisions/finance/seminars/macro/fall04/ Hurst.pdf

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Chapter 1: A general introduction to the subject guide Johanson, J. and L.G. Mattson ‘Interorganisational relations in industrial systems: a network approach compared to a transaction approach’, International Studies of Management and Organisation 27(1) 1987, pp. 34–8. Joshi, A.W. and S.J. Arnold ‘The impact of buyer dependence on buyer opportunism in buyer-supplier relationships: the moderating role of relational norms’, Psychology and Marketing 14(8), December 1997, pp. 823–45. Liebenstein, H. ‘Bandwagon, snob and veblen effects’, Quarterly Journal of Economics 62 (1948), pp. 165–201. McDougall, G.H.G. ‘The intangibility of services: measurement and competitive perspectives’, Journal of Services Marketing 4(4), Fall 1990. Mitchell, V-W. ‘Buy-phase and buy-class effects on organisational risk perception and reduction in purchasing professional services’, Journal of Business and Industrial Marketing 13(6) 1998, pp. 461–78. Modigliani, F. ‘Life cycle, individual thrift, and the wealth of nations’, American Economic Review, 76 (1986), pp. 297–313. Modigliani, F. and R. Brumberg (1954) ‘Utility analysis and the consumption function: an interpretation of cross-section data’ in Kurihara, K. Postkeynesian economics. (New Brunswick, N.J.: Rutgers University Press, 1954 [OCoLC 273383]; (London: Routledge, 2003) [ISBN 0415313767]; facsimile reprint of 1955 edition. Porter, M. ‘How competitive forces shape strategy’, Harvard Business Review, March/April, 1979. Ring, P.S. and A.H. Van de Ven ‘Structuring Co-operative Relationships Between Organisations’, Strategic Management Journal 13 (1992), pp. 483–98. Salkever, A. ‘Byte of the apple,’ Business Week, 21 April 2004. Shimp, T.A. and W.O. Bearden ‘Warranty and other extrinsic cue effects on consumers’ risk perceptions’, Journal of Consumer Research 9(1) 1982, pp. 38–46. Simon, J.L. ‘Optimal allocation of space in retail advertisements and mailorder catalogues: theory and first-approximation decision rule’, International Journal of Advertising 2 (1983), pp. 123–129 (with Vithala Rao). Spekman, R.E. and D. Strauss ‘An exploratory investigation of a buyer’s concern for factors affecting more co-operative buyer-seller relationships’, Industrial Marketing and Purchasing 1(3) 1986, pp. 26–43. Van de Ven, A. ‘On the nature, formation, and maintenance of relations among organisations’, Administrative Science Quarterly 21, December 1976, pp. 598–621. Varian, H. ‘Differential pricing and efficiency,’ First Monday: The Internet Peer Reviewed Magazine 2 (1996); www.firstmonday.dk/issues/issue2/different/ Webster, F.E. and Y. Wind ‘A general model for understanding organisational buyer behaviour’, in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston: Allyn and Bacon, 1991) [ISBN 0205129242]. Williamson, O. ‘The economics of organisation: the transaction cost approach’, American Journal of Sociology 87(3) 1985, pp. 548–77. Williamson, O.E. ‘Transaction cost economics: the governance of contractual relations’, Journal of Law and Economics (1979), pp. 233–61. Wilson, D.F. ‘Why divide consumer and organisational buyer behaviour?’, European Journal of Marketing 34(7) 2000, pp. 780–96.

How to use the subject guide As noted earlier, the subject guide should be used as a guide to further reading and research as opposed to a replacement for it. In the essential reading section of every chapter, we identify at least one (and sometimes more) essential readings from the Kotler and Armstrong textbook. This, along with the guide, should form the backbone of your study. Apart from

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that, we encourage you to seek out other further readings and electronic sources such as web sites, which provide additional material of relevance to the subject. In order to succeed in the unit you should: 1. Read the guide and essential reading first. The order in which this is done is really up to you. The important thing is to realise that both are important. In some cases, there may be considerable overlap in content between the essential reading and the guide, while in other chapters of the guide, the material will deviate more considerably from the Kotler and Armstrong text. 2. Take note of areas of overlap, as these are obviously important. Also take note of areas where the guide and text do not overlap. Recognise that material in the guide which does not appear in the text and vice versa is important as well but may have less applicability or centrality to the course. 3. Take note of further reading and references listed in each chapter of the guide and follow up with information from electronic sources to gain a fuller appreciation of ideas and concepts which appear in each chapter of the guide and textbook. When you have finished doing your readings you should examine the learning outcomes in the subject guide and text and check to see if you have understood the material. Once that is done, make your own list of important topics and make sure that you have understood those as well.

Examination Important: the information and advice given in the following section are based on the examination structure used at the time this guide was written. Please note that subject guides may be used for several years. Because of this we strongly advise you to check both the current Regulations for relevant information about the examination, and the current Examiners’ reports where you should be advised of any forthcoming changes. You should also carefully check the rubric/instructions on the paper you actually sit and follow those instructions. The reports and examination papers, which you should use as part of your preparation for exams, are found on the External Programme’s web site at: www.londonexternal.ac.uk/studentarea/lse/exams.html. The reports are usually available on the web site several months before you receive the printed reports. They contain valuable information about how to approach the examination and you are strongly advised to read them carefully. The examination for this subject will be a three-hour written examination, in which candidates will be expected to answer four questions out of a total of eight. Sample examination questions are included at the end of each chapter and a sample examination paper is located at the end of the guide in Appendix 1. As will be evident upon inspection, the examination questions blend concrete definitional knowledge of the subject (you have to learn and recall what the concepts mean) along with analytical applicability (you have to know how to use the concepts you have learned). In answering any question it is important to utilise concepts from the subject guide, essential reading and further reading where applicable. However, what is more

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Chapter 1: A general introduction to the subject guide

important than a vast reservoir of accumulated knowledge is the quality of your arguments. Think of the material in this guide as offering supporting material for your own intelligence and informed opinions. We encourage you to take full advantage of the questions that appear at the end of every chapter in order to conduct self-testing. The ‘PRSQT’ method is of particular applicability in preparing for the examination in this course: 1. Preview the material you are about to read. 2. Read the material. 3. Go back and Study the material you have read by taking notes. 4. Create an inventory of Questions that may be relevant to the unit. 5. Test yourself with the questions you have assembled. We hope that this subject guide will enable you to enjoy the study of marketing and help you to refine your understanding of many topics that have an inordinate effect on the way we behave as consumers and how our market-oriented societies are structured.

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Chapter 2: An overview of marketing: history and theory

Chapter 2: An overview of marketing: history and theory Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761 (pbk)], Chapter 1.

Further reading Brassington, F. and S. Pettitt Essentials of marketing. (Harlow: Prentice Hall, 2003) [ISBN 0273687859 (pbk)]. Nevett, T. and R. Fullerton Historical perspectives in marketing. (Toronto: Lexington Books, 1988) [ISBN 0669169684]. Pindyck, R and D. Rubinfeld Microeconomics. (Upper Saddle River, NJ: Pearson/Prentice Hall, 2005) [ISBN 0131912070]. Porter, M. ‘How competitive forces shape strategy’, Harvard Business Review, March/April 1979.

Aims of the chapter The aims and objectives of this chapter are to: • show how and where the practice of marketing originated • help ground the study of marketing in its historical antecedents • identify which academic disciplines are the most important for the study of marketing.

Learning objectives By the end of this chapter and relevant reading, you should be able to: • explain what is meant by the ‘marketing framework’ • discuss the history of marketing theory and the marketing business orientation • describe how marketing fits into the traditional economic model of perfect competition • outline how marketing makes use of different theories used in other academic disciplines.

Useful web sites http://www.marketingpower.com/ This is the home of the American Marketing Association (AMA); the oldest marketing association of its kind. There are links to other affiliated marketing associations around the world.

Introduction Before we can start discussing marketing theories and concepts, it is useful to understand that marketing was (and to a large extent still is) a composite of a number of other academic disciplines. It is also important to understand where marketing originated and what its intellectual foundations are. In this chapter we will examine the emergence of

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marketing as a management discipline. In particular, we will examine how marketing fits into the traditional economic model of perfect competition. This will be followed by a discussion of the four main historical business orientations (production, product, selling and marketing) and how marketing fits into this. The chapter will conclude with an examination of marketing problems and how marketing students can draw upon different academic disciplines such as psychology and economics to solve them.

Definitions and a brief introduction to the history of marketing Let us begin with three definitions of marketing and then discuss the implications of those definitions in relation to traditional economic theory. Why should we compare marketing to economics? The main reason, among others, is that marketing was originally embedded in economics courses. After comparing marketing to economics we will go on to trace the history of marketing as an independent academic discipline within the field of management. There are many definitions of marketing. Here we present three of the most widely used versions from the inception of marketing to the present: 1. Marketing consists of those activities involved in the flow of goods and services from the point of production to the point of consumption. (1938, American Marketing Association) 2. Marketing is the process of planning and executing the conception, pricing, promotion and distribution of ideas, goods and services to create exchange and satisfy individual and organisational objectives. (1985, American Marketing Association) 3. Marketing is the management process that identifies, anticipates and supplies customer requirements efficiently and profitably. (UK Chartered Institute of Marketing, 2003) Activity Here is a question to ponder: What substantial differences exist between the first formal definition of marketing (i.e. the AMA’s 1938 definition) and the one the AMA provided nearly 50 years later in 1985? What explains the changes, if any, in the definition? Looking at the two most recent definitions of marketing, one sees that they agree on the following points: • Marketing is a management process. • Marketing is about giving customers what they want. • In the AMA version, marketing is about exchanges (i.e. of ideas, goods and services). • The AMA definition also describes the ways in which marketing can stimulate exchanges (i.e. through conception, pricing, promotion and distribution). Further information about these definitions can be found in Brassington and Pettitt (2003). 1

A brief history of marketing theory You may wonder why a history of marketing is of interest in the context of more recent developments. To paraphrase Joseph Schumpeter (1883–1950),1 in order to be a well-grounded social scientist, one needs a

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Joseph Schumpeter (1883–1950) was a well-known economist who developed and popularised a version of business cycle theory based on punctuated spurts of technological advances that is now accepted by economists of the evolutionary school of economics.

Chapter 2: An overview of marketing: history and theory

command of four disciplines (economics, statistics, maths and history). However, if forced to choose one, Schumpeter always claimed he would have chosen history. A proper historical account of ‘marketing’ would begin with early capitalism and sociological theories of the growth of consumerist culture. However, that is a bit beyond the scope of this chapter. Instead, we will briefly trace the growth and emergence of the marketing framework, which began in the 1900s when marketing began to divorce itself from its founding discipline of economics. We will then go on to show why some marketers argue that the marketing framework is the most ‘advanced’ of all business orientations. The development of marketing thought can be divided into four eras: • First era: Classical school (1900–50): These theories focused on aggregate market behaviour and were concentrated on the use of traditional economics and sociology to understand market-driven phenomena. • Second era: Managerial marketing (1950–75): This era began in marketing departments within the newly formed managerial or business schools, which focused their attention on individual behaviour, but continued their reliance on borrowing techniques from other social sciences. • Third era: Behavioural marketing schools (1965–present): These schools have borrowed from different branches, mostly psychology, in an effort to gain even greater insight into individual consumer and organisational behaviour. • Fourth era: Adaptive/strategic marketing school (1980–present): This school returned to a more economic focus. It was strongly influenced by Michael Porter and his five-forces model and the paradigm of competitive advantage.2 Advances in economic strategy and game theory also influenced the growth of the strategic marketing school. It is interesting to note that most marketing courses only appeared in university course curricula in the early 1970s. A very nice and more detailed description of these eras can be found in Nevett and Fullerton (1988).

History of business orientations: the triumph of marketing? Having described the evolution of marketing theory, we will now look at a brief account of the emergence of the current ‘marketing framework’, which has come to dominate certain industries and markets. There are four main business orientations, each of which has emerged as a response to evolutions in the marketplace. If I were to ask the question: ‘What kind of a firm do you work for?’, the answer is likely to be one of these four orientations: • Production: Here the focus is on producing more, selling high volumes, controlling costs and production efficiency. The firm which pioneered this orientation is Ford in the early 1900s, with its adoption of assembly line manufacturing and a standardised product, the Model T, which was famously available in any colour ‘as long as it’s black’! (See Mini-case 2.1.) • Product: This orientation moves away from standardised products

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Michael Porter suggests that the key to success in business often has a lot to do with being in the right industry. There are five forces, according to Porter, that determine whether or not a certain industry is able to achieve sustained competitive advantage for its firms (by competitive advantage we mean higher than average market-wide profits). The five forces are: (1) Threat of new entrants (some industries are harder to enter than others); (2) Bargaining power of suppliers (suppliers with low bargaining power are good for business); (3) Bargaining power of buyers (buyers with weak bargaining power are more favourable to the business); (4) Threat of substitute products (the more substitutes, the weaker the sustained competitive advantage in an industry will be); and finally (5) Intensity of rivalry among competitors (it is pretty obvious that it is unwise to enter an industry that is already hugely competitive). See Porter (1979).

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and focuses on improving quality. The assumption is that customers want a better quality version of the same thing, and are prepared to pay a premium for a differentiated product. This approach was first adopted by General Motors (GM) in the 1930s, which gained market share from Ford in the 1930s by offering customers a diversified product line (see Mini-case 2.1). • Selling: The selling orientation, as the name suggests, focuses on aggressive sales and promotion to sell whatever the organisation wants to make or distribute. Here the sellers’ needs come first, and products are ‘pushed’, under the assumption that if the price is low enough, customers will buy the product whether they like it or not. Examples of this orientation include firms that use door-to-door salesmen to distribute encyclopedias or vacuum cleaners (this orientation is also nicely portrayed in the 1988 Hollywood movie Tin Men and more recently in Boiler Room (1999) which depicts financial industry salesmen trying to convince prospective investors to buy stock over the phone). • Marketing: The marketing orientation is the most advanced orientation according to marketing founders such as Phillip Kotler. They feel this way because marketing, unlike other orientations, focuses on the end user by first defining customer needs and then developing offerings that deliver what the customer wants. In this approach, customers and their needs come first. Can you think of a company that uses this orientation? Mini-case 2.1: Henry Ford vs Alfred Sloan: A contrast of business orientations Before Henry Ford (1863–1947) first started to produce automobiles in 1905, they were very much a luxury item. Ford’s dream was to ‘democratise’ cars, by making them affordable. To achieve this ambition, his big innovation was to create a simple car, produced in a streamlined production process. Ford’s pioneering vision was to regiment the production process. He placed the emphasis on achieving productivity improvements and leveraging economies of scale. The gains made were substantial: in 1913 it took 12 hours to manufacture a Model T car, but by the following year this had been reduced to a mere 96 minutes, thanks to the introduction of the moving assembly line. This increase in productivity allowed Ford to reduce the price from over $800 in 1908 to under $450 in 1914. This allowed a much wider segment of the population to purchase a car, radically changing American society and business. Volumes also increased dramatically in that period, from just over 10,000 cars in 1908 to over 730,000 in 1916 (for $360). Ford also had a radical social agenda. In 1914, when the average weekly wage was around $11 a week, he introduced a $5 wage for an eight-hour day for his workers. This not only motivated his workers, but also put cars within their economic reach. Ford’s approach is characteristic of the production orientation: strong focus on efficient production of a simple, optimised product. By the 1920s Ford was by far the leading car manufacturer in America, but it was soon to be outdone by its rival General Motors. How did this come about? When Alfred Sloan (1875–1966) became head of GM in 1925, he felt that there was a need for a new development in the car market, which was suffering from saturation and technological obsolescence. His solution to this problem was to introduce the concept of ‘planned obsolescence’ and an emphasis on a diverse product range and product styling, exemplified by annual model facelifts. His assumption was that customers would become too dissatisfied with their ‘old’ car, and would want to trade up to a newer and more expensive model before their current cars had reached the end of their useful life. This tapped into the ebullient mood of the 1920s’ boom years, and customers jumped on the possibility of differentiating themselves through their car.

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Chapter 2: An overview of marketing: history and theory

In 1928 Ford had lost its position as market leader, and by 1936 GM had a market share of 43 per cent of the US market, while Ford claimed only 22 per cent. GM retained its leadership until 1986. By allowing its customers to choose from a wide variety of models, and emphasising design rather than engineering, GM was one of the pioneers of the product orientation. Activity In addition to the Ford vs GM case, try to think of other examples of companies for each of the business orientations listed above (i.e. production, product, selling and marketing).

How does the modern definition of marketing fit into traditional economic theory? If one thinks of the conventional starting point in neo-classical economic theory, there would be no pressing need to study something called marketing. Why? Let us begin with some key assumptions of the competitive framework, starting with the firm and the products they sell: • First, we have many small firms x (x , i = 1…n), each taking a price as i given. The demand curve facing every firm is perfectly elastic. This means that individual decisions concerning production have no effect on the market price for the good in question. In other words, they are homogeneous firms that accept what the market gives them. They have no power to shape their market environment. • Second, we have a homogenous product (either real or perceived that way by consumers). The decision for the firm amounts only to produce at the point where marginal cost equals marginal revenue (MC = MR = P). The total supply in the market is merely the summation of the individual supply curves of each firm. Graphically it would look something like Figure 2.1. Supply=MC

P AC

p=MR=Demand

Q

Figure 2.1: Price and demand conditions facing individual firm (x) So far we have just sketched out (in a very fast and loose fashion) the basic behaviour of a perfectly competitive firm in a perfectly competitive market. At this stage, however, it may be useful to clarify exactly what we mean by a perfectly competitive market and how this relates to the marketing framework. More rigorously, the theory of perfect competition rests on the following four assumptions: 1. Price taking: Both consumers and firms do not affect the price – or stated another way, both consumers and producers believe (correctly) that their decisions will not affect the price. 2. Product homogeneity: Products are undifferentiated, therefore consumers consider only price when choosing where to buy from. This means that any firm that tries to raise its price will lose all sales.

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Principles of marketing

3. Perfect information: Consumers have perfect information about their preferences, their income levels, the prices they face, and the quality of goods they purchase. Likewise, firms have perfect information about costs, prices and technology. This means that there is little scope for promotion policies as all information is known. 4. Perfect mobility of resources: Firms can freely enter an industry if making a profit, or exit if losing money. This means that firms have few extra resources to devote to marketing efforts. Thus, in a perfectly competitive environment, the following three key points, or theorems, emerge for marketing theory: • Theorem 1: Because of the law of ‘one price’, in a competitive market price is not a strategic marketing tool for the individual firm. • Theorem 2: Equally, price and product development are not important marketing tools when a firm operates in an industry with undifferentiated products. • Theorem 3: With perfect information, no gains can be had from informative promotion or formal advertising. There is an obvious symmetry here, in that these three theorems fall out of the first three assumptions of competitive markets. The answer, therefore, to the question that started off this section is that ‘marketing does not fit into traditional economic theory in the sense that the perfectly competitive view of markets seems to rule out most marketing activities’. Where it does fit, it only fits in rather tangentially in that the most important strategic tools, pricing and promotion, become irrelevant marketing channels when markets approach perfect competition. Activity Empirically, are there examples of where the above statement is true? In other words, do we observe markets (at a geographic or industrial level) where high degrees of competition and low levels of marketing (pricing and promotion) behaviour prevail?

Where does economic theory leave us? Given that marketing exists and given that firms devote huge amounts of money to the marketing of their goods and services, we need to ask ourselves the following: ‘What theory or economic model is consistent with what firms do in practice?’ This question will be explored in further chapters when we break the competitive assumptions of neo-classical economic theory and examine a world which contains heterogeneous firms and consumers, differentiated products, imperfect competition and information, uncertainty, risk or social networks, and other non-economic social considerations. In other words, a world that more closely resembles the one we live in. Indeed, by breaking these competitive assumptions, we will be able to answer questions such as: ‘Why in 1995, did management gurus Treacy and Wiersema secretly purchase 50,000 copies of their own business strategy book The Discipline of market leaders from stores across the United States?’ (Hint: Ask yourselves what is an important driver of book sales?)

Other academic disciplines and marketing Marketing is not itself a unitary theoretical discipline. Rather, it is a framework drawing from many different academic disciplines. Though its roots are in industrial economics, it is actually a composite of three major

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Chapter 2: An overview of marketing: history and theory

academic disciplines: economics, psychology and management. Each theoretical approach has its specific contribution to areas of marketing relevance which are summarised in Table 2.1. Academic discipline

Area of marketing relevance

Economics

Price theory and strategy Economic behaviour Applied game theory

Psychology

Consumer behaviour Advertising messages Social psychology

Management

Segmentation strategy Demand analysis General management strategy

Table 2.1: Academic disciplines and marketing

Marketing problems ‘Real world’ marketing problems involve all three disciplines in varying degrees and proportions. A marketing practitioner has to decide which academic discipline is most relevant to the problem at hand. Marketing problems can essentially be divided into four groups: • Operational marketing problems involve working with existing opportunities, for example by targeting the product to a specific segment of consumers. • Analytical marketing problems are related to the market structure in which a firm operates, and its effects on the firm’s marketing approach. • Normative marketing problems are those which concern themselves with how things ‘should be’. An example of this is the emergence of corporate social responsibility and ethical marketing (‘no logo’ movement). • Strategic marketing problems involve evaluating the needs of customers and evaluating how the company can provide a solution to this need. Each problem requires a different set of academic approaches. It takes time to develop the requisite skills as a marketing analyst or practitioner to know when to use which approach to solve a given problem. In some cases, even defining what the problem is requires experience and subtle knowledge of the problem at hand.

Looking ahead: the marketing framework and the ultimate aim of production We end this chapter on a rather philosophical note. What is the ultimate aim of marketing or of any form of production? The ultimate aim of production is not the production of goods and services, nor the satisfaction of a narrow set of consumer preferences, but rather ‘the production of free human beings associated with one another in terms of equality’. This was Adam Smith’s (1723–1790) definition in the Wealth of nations (1776).

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We mention this in passing because there is a group of marketing scholars and practitioners who believe in something similar called ‘social or ethical marketing’ and this is one of their ultimate aims. They believe the marketing orientation, with its focus on the end user and the solving of problems for people, can achieve a better society. In the next part of the subject guide we will begin our study of consumer behaviour, but first in Chapter 3 we will place the theory of consumer behaviour in the context of the overall marketing framework and environment adopted in this subject guide.

Summary Modern definitions of marketing identify it as a management process that involves the identification and anticipation of customer requirements. The development of marketing can be divided into four eras. When marketing began as a widespread practice, at the start of the twentieth century, the main focus was on aggregate market behaviour. In the 1950s, the focus shifted towards individual customer behaviour. In the 1960s, psychology was added to the traditional social scientific ‘tool box’ in an attempt to gain greater insight into individual consumer behaviour and into the behavioural decisions of organisations. The focus of later theories returned to the aggregate level and the paradigm of competitive advantage as well as the strategic decision-making of firms. Most businesses can be classified into four main business orientations that evolved in response to changes in technology and society. These were: 1. Production, which focuses on production efficiency and high volumes. 2. Product, which provides a wider choice to the customer. 3. Selling, where aggressive sales techniques are used to ‘push’ the product to the client. 4. Marketing, where customer needs are defined before a product which can satisfy the needs is produced. As we saw, according to the traditional model of perfect competition, marketing should not exist (or at least most marketing functions such as pricing and promotion would have no real effects). Indeed, it follows from the assumptions of the model that due to the absence of differentiated products, the firm cannot employ price or promotion as strategic tools. It thus becomes clear that it is more interesting to examine marketing under a different economic assumption (i.e. models of imperfect competition, which are not as restrictive as the neo-classical theory of perfect competition). Marketing is not in itself an abstract theory; rather, it draws on tools developed in a variety of other disciplines, such as economics, psychology and management, to solve various marketing problems. These problems can be divided into those which deal with the company’s existing opportunities, those which relate to the market environment in which the firm operates, those which influence the firm’s overall image, and finally, those which are concerned with identifying a strategy for the future.

A reminder of your learning outcomes By the end of this chapter and relevant reading, you should be able to: • explain what is meant by the ‘marketing framework’ • discuss the history of marketing theory and the marketing business orientation

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Chapter 2: An overview of marketing: history and theory

• describe how marketing fits into the traditional economic model of perfect competition • outline how marketing makes use of different theories used in other academic disciplines.

Sample examination questions 1. Discuss the origins of marketing as an academic discipline and the use it makes of other disciplines’ techniques. 2. Explain why marketing is not required in a perfectly competitive economy. 3. Why do some marketing experts believe that marketing is the most advanced business orientation? Do you agree with their assessment? 4. Do the marketing theorems derived from the application of competitive economic theory to modern marketing imply that marketing is totally irrelevant to the firm or industry? Can you think of an industry where firms operate in perfect competition, yet marketing activities like promotion or price differentiation still take place?

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Chapter 3: The marketing environment and a game theory perspective on competition

Chapter 3: The marketing environment and a game theory perspective on competition Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapter 4.

Further reading Axelrod, R. The evolution of co-operation. (London: Penguin Books, 1990) [ISBN 0140124950].

Aims of the chapter The aims of this chapter are: • to identify the different elements of the marketing environment • to distinguish between those elements • to describe some of the elements • to introduce you to some aspects of game theory.

Learning objectives By the end of this chapter and the relevant reading, you should be able to: • distinguish between the micro and macroenvironment of a firm • describe how the different elements of the micro and macroenvironment affect firms’ marketing activities • distinguish between zero-sum and non-zero-sum games and the implications for competitive behaviour • explain the different methods firms can use to elicit co-operation.

Useful web sites http://www.tutor2u.net/economics/content/topics/monopoly/game_theory. htm This site has a diagram illustrating the prisoners’ dilemma.

Introduction This chapter has two parts. In the first part we will look at the marketing environment, both the micro and macroenvironments. In the second part we will look in more detail at how game theory can be used to understand the interactions between competitors. This chapter focuses on the environmental factors which affect the marketing activities of organisations. Such factors include demographic changes, changes in fashions, changes in consumption due to economic development and political changes. How marketers cope with such changes is also covered. Another important theme that runs throughout this course

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is the fact that marketers have to be aware of changes that take place in the marketing environment, since these can have a major impact on how marketers change and evolve their own marketing strategies. You should note that while this chapter and the accompanying material in Kotler and Armstrong (2004) draw attention to specific aspects of the political, economic, social and technological environments, these are all dynamic areas and for examination purposes you need to have your own examples that illustrate, for example, how specific changes in the economic environment have had an influence on marketers. Clearly there is a similarity in concepts and their study in this chapter will repay when you reach the end of the course. Finally, you should remember that study of the marketing environment is important insofar as the environment can have an important impact on the activities of marketers. For this reason this topic has important, though often unstated, links with the other topics in this course. You should be aware that examination questions on any of the other topics may require you to have an awareness of the issues addressed in this topic.

Types of environment Companies interact with two types of environment: the ‘microenvironment’ and the ‘macroenvironment’. The microenvironment comprises the company’s suppliers, customers, marketing intermediaries and competitors. The macroenvironment is made up of wider forces which affect demand for a company’s goods. These forces include demographics, economics, nature, technology, politics and culture.

The microenvironment1 The microenvironment consists of five major factors: 1. The marketer’s ‘internal environment’ (i.e. its own management structure). 2. The ‘marketing channel’ used by the firm (for example, its suppliers). 3. The markets in which the firm may be selling (these may be consumer, producer, reseller, government or international markets). 4. The firm’s competitors (also contained in the ‘internal environment’). 5. Those groups of people who have an interest in the marketer’s ability to achieve their objectives. As well as obvious groups such as shareholders, interested publics can also include local interest groups who may have concerns about the marketer’s impact on the environment or on local employment. The characteristics of the firm’s internal environment affect its ability to serve its customers.

The macroenvironment Demographics The demographic environment itself is affected by changes in the mix of age groups in the population. If the population becomes older, this will lead to rising demand for products and services consumed by older people and a similar fall in demand for products consumed by younger people. The development of ethnic markets can also be relevant. In a number of countries, the ethnic mix of consumers is changing due to immigration and other factors. This will be reflected in changing demands for various goods not only from the specific ethnic group but from other consumers whose

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1

Those of you who studied Principles of sociology should recall the coverage of ‘Elements of organisations’. That topic considered the role of ‘missions and goals’; these are an important element of the internal environment for an organisation. For example, the mission of an organisation explains what the organisation is about and what different stakeholders can expect from it.

Chapter 3: The marketing environment and a game theory perspective on competition

tastes have been affected by them. Furthermore, as ethnic groups emigrate to other countries, their own tastes can affect those of consumers in the host nation (e.g. Asian foods are now sold within UK supermarkets). The demographic environment is also affected by the level of education in a country, since changes in education have an impact on the wealth of a nation and the tastes of its people. The lifestyles of a population also have an impact on the macroenvironment facing marketers. In Western countries there has been a growth in households made up of single people; a large proportion of women go out to work. This has resulted in an increase in the sales of convenience foods. There are also more couples whose children have grown up and left home. Such couples have more disposable income to spend on luxuries, holidays and home improvements. Economics The economic environment is important to marketers because it affects the amount of money people have to spend on products and services. One of the components of the economic environment is the distribution of income. Economies around the world not only vary in their absolute or total level of wealth but also how their wealth is spread within the population. For example, poor countries may be classified either as those which have a highly unequal spread of wealth or those where it is more evenly shared. The former group of countries may be markets for luxury goods, despite the level of poverty. In contrast, the second type of country may be more attractive to marketers of inexpensive goods for the mass market. Consumers around the world differ in the extent to which they save money and the use they make of credit facilities. A high propensity to save will result in a lower propensity to consume. However, these patterns will also have a secondary effect on the overall macroeconomy of a nation. A country where people have a high propensity to save is likely to be characterised by low interest rates, which will affect industry’s borrowing costs. The economic problems faced by some countries have meant that some international marketers cannot be paid in hard currency. To make sales, therefore, they have had to barter their products. An example of this is the barter of Pepsi-Cola for Russian vodka by the Pepsi company and the old Soviet government. Nature This is important to marketers insofar as it is the source of many raw materials and fluctuation in supply can affect the prices paid for purchases. Furthermore, the increasing cost of some raw materials has meant that recycling of some materials, such as aluminium, has become economic. There is increasing pressure from public opinion as to the sources of raw materials and their effect on the natural environment. Paper manufacturers have had to pay attention to sourcing pulp from renewable forests, where trees are replanted to make up for those which have been felled. There is also pressure on them not to use chemicals and bleaches in their processing of paper. The increased cost of energy is also having an effect on the types of products which appeal to consumers. For example, in some countries there is a trend towards small cars and products which save energy. Due to developments in technology, it is possible for manufacturers and consumers to cause less damage to the environment. Various European

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Principles of marketing

countries encourage the use of catalytic converters in cars to reduce the levels of poisonous gases which are emitted into the atmosphere. Technology2 Technological developments offer marketers both opportunities and threats. While firms can offer customers a wider array of advanced products, changes in technology also mean that there may be more than one technical solution to a customer’s needs. Where a market converges towards one technological standard, there can be problems for marketers who had promoted an alternative standard. An example of such a situation was illustrated by the fight between two alternative video formats: VHS (promoted by JVC) and Betamax (promoted by Sony). While Sony’s technology was considered superior, most other manufacturers adopted the VHS format and ultimately Sony stopped selling Betamax video recorders and switched to making those using the VHS format. Today there is a similar struggle between suppliers of different types of hi-fi equipment.

2

Those of you who have studied Principles of sociology will recall the argument between modernists and post-modernists. The latter argue that the information explosion of recent years has not led to increasing conformity, as the modernists have argued, but it has led to an increase in diversity and choice. This highlights the issue that there can be considerable debate about the impact of changes in technology on society.

Increased technological development accelerates the speed of obsolescence. Marketers have to consider how their product may need to be developed over time if it is to remain competitive. For example, Apple Computer gained an advantage over IBM and IBM-compatibles through the use of its Graphic User Interface (GUI), which meant that the users can manipulate pictures on the computer screen rather than use complex commands. This made it much easier to use than IBM personal computers. However, the introduction by Microsoft of Windows meant that IBM users could also have a pictorial display on their screens; this reduced Apple’s advantage. To regain the advantage Apple introduced a new computer chip (PowerPC) which was supposed to be faster than the Pentium chip used by IBM. Technological developments affect how people work and do business. For example, the falling cost of telecommunications coupled with their increased sophistication has meant that it is possible for individuals to work away from the office. In the future this could lead to lower usage of transportation systems. Furthermore, the falling cost of technology has meant that many more small firms can function in areas such as publishing and film production, which used to be the domain of large organisations. In a number of countries this has resulted in the establishment of small firms in these areas. The risks from technological changes have meant that firms are increasingly entering into ‘strategic alliances’ with customers, suppliers and even competitors. Indeed, there has been an increasing emphasis on open, longterm relationships, based on trust between customers and suppliers. This is expected to help in the development of products and the management of technological risks. Politics3 Marketers are influenced by the regulatory environment. This has implications for their obligations to customers and the wider public. Customers are increasingly able to seek redress for faulty products and those who live near manufacturing plants are able to claim compensation for pollution. The political environment around the world has recently favoured the privatisation of public companies. Such companies have also been able to compete more freely in the private sector. Political changes in Eastern Europe have also meant that these markets are now open to marketers from around the world.

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3

Those of you who have studied Principles of sociology will recall the points made about the size of transnational corporations and the impact that they can have on people. Indeed, some are argued to be more powerful than some nation states.

Chapter 3: The marketing environment and a game theory perspective on competition

Culture4

4

People’s opinions and tastes are shaped by the society in which they live. It should be noted that societies are not made up of homogeneous populations. They contain sub-cultures, which are beliefs and values shared by smaller groups of people. Such groups may arise out of a common race, religion, social activity or hobby. Sub-cultures are important to marketers insofar as they may have different consumption habits from the rest of the population. The following are some aspects of culture which influence people’s consumption: the ‘core’ culture is that set of values which is handed down from generation to generation and which is reinforced by social institutions such as schools and places of worship. Core values are likely to be strongly held and it may be difficult for marketers to promote a message which runs counter to them. More susceptible to change are secondary values, as people’s opinions are influenced by the media, role models and changing tastes. Chapter 5 of Kotler and Armstrong (2004) ends with a discussion of how marketers can respond to the marketing environment. That is an important issue which is significant for examination purposes and you should pay attention to it.

Those of you who have studied Principles of sociology will recall the discussion about globalisation. One of the definitions put forward in that course highlighted that as a result of globalisation the constraints of geography on culture recede and people act accordingly. Following that argument, if globalisation is taking place, it will have an impact on the cultural environment. You should also recall the coverage given to ‘religion’ and how this can influence behaviour. Specifically, the course mentioned that substantive definitions of religion are based on religious beliefs – in terms of a marketing context such beliefs can drive consumption behaviour.

Figure 3.1 shows the different elements of the macro and micro environments and also shows that the marketing organisation (represented by the marketing mix) is directly influenced by the microenvironment and that both are influenced by the macroenvironment. Demographics Technology competitors

customers Economics

management

External Environment suppliers

strategies & objectives

Internal Environment

Culture public

other departments Politics marketing intermediaries Nature

Figure 3.1: Macro and micro environment Activity Choose an industry about which you can get information from either newspapers or books. Using Figure 3.1, describe any political, economic, social and technological changes taking place which will affect the demand for the products/services produced by that industry. Then explain what impact this is having on the marketing activities of the firms in that industry. Where possible collect relevant statistics and collect details of the source of the information. The examples you use and the sources of information can be either local or international. An example for using the above figure is as follows; it is based on an extract from http://www.foodanddrinkeurope.com/news/ng.asp?n=62404-indian-packaged-foods-ethnic/ ‘Average annual growth in consumer spending on ethnic packaged foods in Europe has been running at 14 per cent since 1999 – a rate far higher than 5 per cent in the US. Food formulators could delve deeper into Chinese offerings, with the report showing that Chinese food is the leading pre-packaged ethnic cuisine, popular across all of Europe, even where Chinese immigration is relatively low. “This reflects Chinese food's relative ease of

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Principles of marketing

consumption: it is not heavily spiced and it often features familiar ingredients," comments Band.’5 The marketing impact of this information would be on producers of ethnic cooking ingredients, whose forecasts of sales could take into account the news of a healthy and growing market.

Introduction to game theory Game theory can be useful in helping marketers understand the external environment, particularly the way in which firms can deal with competitors. It uses the metaphor of a game to describe this situation, and the participants are referred to as players. In our marketing context, game theory’s usual references to players will instead be companies, and the possible gain will be in terms of profits or sales. A game may consist of a single set of decisions, or a round, or it may consist of many rounds. Although such games cannot reflect all aspects of real life, they can give managers useful insights into the strategies that may work in the real world and an understanding of why some courses of action may be more effective than others. The assumptions made by game theory are as follows: • Players are self-interested in that they try to maximise their own payoff from the game. • Players are rational – they can calculate pay-offs correctly and will select the ones that maximise individual reward. • The optimum decision for a player will depend on how the other player(s) will react and, therefore, it requires a dynamic and interactive approach to strategic decision-making. In a marketing context, the objective is to identify marketers’ optimal decisions under conditions of uncertainty and interdependence. Games consist of the following characteristics and conditions, which are known to the firms involved: • a defined set of possible courses of action for the firms • identifiable preferences of each firm among the possible outcomes of the game • relationships whereby outcomes are determined by firms’ choice. Firms within a game choose strategies by rationally examining available information, and by considering the actions open to them, the expected pay-offs and their expectations of other players’ decisions. The resulting equilibrium is the combination of best strategies for each player. In this section, we shall consider some of the basic models and then show how they can be used in actual marketing situations.

The basic models First, we discuss the basic models and concepts of game theory. We explore their relevance to marketing in the next section. The prisoners’ dilemma Two prisoners are accused of committing a robbery together. They are held in separate cells and cannot talk to each other. If one confesses to the robbery and the other does not, the one who confesses is released, and the other receives a five-year sentence. If both confess, they receive three-year sentences. If neither confesses, they receive one-year sentences for a lesser crime.

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5

John Band, consumer markets analyst at Datamonitor.

Chapter 3: The marketing environment and a game theory perspective on competition

Each player will identify the rational self-interested decision that gives the best pay-off no matter what the other player decides to do. It is relatively easy to show that, under these assumptions, the best decision for each prisoner (the dominant strategy) is to confess. The importance of the prisoners’ dilemma game lies in showing how independent decision-making can lead to inferior results for the players, since the optimal strategy for both would be not to confess. However, each prisoner may feel that if they followed this strategy and the other person confessed, they would end up being worse off. In such cases, collective or co-operative decisions are more effective from the players’ point of view. The model highlights how individuals can actually become worse off when they pursue self-interested decision-making. The lessons from this game are very wide-ranging, and they can be applied to many areas of marketing. • Price control. If all firms competing in a particular market cooperate to maintain prices at a high level, knowing that their competitors will do so, overall profitability is maximised. But if one firm decides to drop prices (this is called defecting) to increase its market share, its rivals will have to follow suit, so reducing the overall profitability of the industry. • Product development. If all firms competing in a particular market co-operate to develop new standards, for example in mobile phones, the ability of any individual company to differentiate its offering is reduced; however, the benefits brought about by the collaboration mean that the new standard can sell to many more people and thereby become accepted. • See also http://www.dmnews.com/cms/dm-news/database-marketing/ 34403.html for a discussion of how game theory can be an important consideration in direct marketing. The example given is important not just in the direct marketing context discussed but also in a wider range of situations where a firm can be releasing products that compete with each other (e.g. a firm that makes many different brands of breakfast cereal). Activity Give some examples of ‘standards’ that have helped competitors in an industry. Answer The following web site gives an example of how standards can be commercially important: http://www.udel.edu/alex/dictionary.html#sta In summary it explains how alliance-forming in the video market by JVC enabled the company to have its standard VHS format accepted, even though the competitor format developed by Sony was widely considered to be technically superior. The tragedy of the commons In this game farmers keep their cattle in a field (a common). At the start of the game farmers agree that they should each only keep one cow there, since too many cows will eat all the grass. Nevertheless, each farmer’s goal is to maximise the selling weight of the cow at the end of the season, so they will each have an incentive to make themselves better off at the expense of the other farmers. But if every farmer does this, the land will become overgrazed and each cow will weigh less than it would have done if everyone had stuck to the original arrangement. The tragedy of the commons is that the dominant strategy to maximise the common good is not the same as that to maximise the individual good.

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The tragedy can only be avoided by government intervention through regulation – to restrain overuse. There are other means of ensuring cooperation, without coercion, and government regulation does not always achieve the desired outcome. There are lots of examples of this in the commercial world, especially in developing countries where people pursue their personal interests without regard for the long-term pay-off for everyone and where governments may be too weak to impose regulations that people have to follow. In contrast, there are countries where the laws may seem restrictive to others, but the benefit is that the gains for the wider community are maximised. Activity Identify current examples of the tragedy of the commons. What measures have or could be taken to ensure that the outcome comes closer to maximising the common good? Commentary Planning and building laws restrict the ability of individuals and firms to build their homes and shops however they like. The restriction on the rights of individuals, however, means that the wider community is able to gain from better planned towns and cities. Where shops adhere to such laws the shopping experience can be more rewarding than situations where people have been able to expand their businesses however they like.

Zero-sum games Zero-sum games are those where one player’s gains can only be at the expense of the others. Certain types of examinations are examples of a zerosum game. In such examinations there are only a limited proportion of firsts and upper seconds. If one candidate gains a first, it means that there is one fewer first-class result available for the other players (or students). In marketing the competition for market share can be seen as a zero-sum game: if one firm wins a 30 per cent share of a market, there is less for everyone else.

Non-zero-sum games Non-zero-sum games (which are also known as positive-sum games) are those in which the total combined score of the players can vary, depending on the different combinations of moves they make. This means that if people co-operate they can all gain. Activity Are the prisoners’ dilemma and the tragedy of the commons, zero-sum games or nonzero-sum? Answer The prisoners’ dilemma and the tragedy of the commons, and the examples of their application, are all non-zero-sum games, which is why co-operation can evolve. Other examples of non-zero-sum games include the following: • When firms launched mp3 players, people knew very little about the technology. However, the advertising and promotional efforts of the different competitors meant that consumers were educated about the benefits of the new format. As a result of their combined activities the firms were able to increase the rate of expansion of the market than

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Chapter 3: The marketing environment and a game theory perspective on competition

would have been the case if they had been operating alone and as a result all firms gained. • The introduction of new technology may be seen by firms as zero-sum in the short term, since all that happens is that they lose sales of existing older products. But if it leads to increased market share and accelerated growth, it can become non-zero-sum. • In international marketing, regional trade agreements lower trade barriers, thereby increasing competition for firms in individual countries. But economic growth in all countries will be stimulated as a result of the change and all companies stand to benefit. Three further points need to be made: 1. Zero-sum games are win–lose, and offer no benefit from co-operation. 2. The status of a game can vary according to how the players are defined. Thus co-operation between competing stores to maintain prices will be seen as non-zero-sum for the participating stores. But if the players are expanded to include the buying public, the game will be zero-sum – the increased profit to the stores will be at the expense of higher prices to the customers. It is essential, therefore, to be clear about the boundaries of the ‘game’ that you are analysing and take into account the different players who are involved. 3. There may be time-lags in the generation of benefits, which means that for some of the players even a non-zero-sum game may appear as zero-sum in the short term. For example, regulation of the advertising industry may bring long-term benefits (as firms who make false claims for their products are forced to stop) but will be seen as a zero-sum game by advertisers in the short term.

Co-operative games Zero-sum games are always going to be non-co-operative: win–lose offers no opportunity for mutual benefit to be derived by co-operation. Non-zerosum games, on the other hand, offer the participants potential benefits from co-operation. The challenge is how to establish the conditions and processes whereby co-operation can be achieved. It is possible to establish co-operation in various ways. The first, and most obvious, is through direct communication between the parties. The advantages of collusion to oligopolistic suppliers are obvious, matched by the equally obvious disadvantages to the paying public. Most countries have enacted legislation against collusion, prohibiting cartels among companies. Even where direct communication is not possible, however, co-operation can be established through reciprocity and a pattern of behaviour. Axelrod (1990) identifies four principles that can make for an effective strategy – being: • nice • retaliatory • forgiving • clear. Niceness prevents a player from getting into unnecessary trouble. Retaliation discourages the other side from persisting whenever defection is tried. Forgiveness helps restore mutual co-operation. And being clear makes

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Principles of marketing

it obvious to the other companies which strategy a firm is adopting and this can help develop long-term co-operation. Eliciting co-operation can be achieved through the following methods: Enlarge the shadow of the future…Mutual co-operation can be stable if the future is sufficiently important relative to the present. This is because the players can use an implicit threat of retaliation against the other’s defection – if the interaction will last long enough to make the threat effective…There are two basic ways of doing this: by making the interactions more durable, and by making them more frequent…Durability of an interaction can help not only lovers, but enemies. The most striking illustration of this point was the way the live-and-let-live system developed during the trench warfare of World War I…The same small units of troops would be in contact with each other over extended periods of time. They knew their interactions would continue because no one was going anywhere…This prolonged interaction allows patterns of co-operation which are based on reciprocity to be worth trying and allows them to become established. Another way to enlarge the shadow of the future is to make the interactions more frequent. In such a case the next interaction occurs sooner, and hence the next move looms larger than it otherwise would…frequent interactions promote stable cooperation. (Axelrod, 1990, pp. 126–30)

As well as enlarging the shadow of the future, Axelrod suggests that participants should base their code of practice for interactions on reciprocity (an eye for an eye, rather than turning the other cheek). Retaliation should be proportional but immediate, so that there is no chance for the opponent to receive false signals about the willingness to respond to defection. Reciprocity can actually help not only oneself, but others as well. It helps others by making it hard for exploitative strategies to survive. And not only does it help others, but it asks no more for oneself than it is willing to concede to others. A strategy based on reciprocity can allow the other player to get the reward for mutual co-operation, which is the same payoff it gets for itself when both strategies are doing their best. A further tactic for establishing co-operation can be to make your strategy very clear to other player(s) from the start. An example used to illustrate this is the game of ‘chicken’ (Axelrod, 1990). Two cars are driving fast towards each other along a one-lane road with one passing space in the middle. The driver who turns into the passing space loses (the chicken). To be sure of winning, one driver should lock the steering straight ahead, take off the steering wheel and throw it obviously out of the window. This will ensure that the other driver gives way! This shows a benefit of making your strategy clear in advance. It is referred to as signalling and it is widely used by commercial organisations to make their competitors aware of their intentions without actively colluding (which can be illegal in many countries). As we can see from the above discussion, effective co-operation depends on the direct or indirect exchange of signals among players. Signals are more likely to be given – and therefore co-operation is more likely to be achieved – in a game with multiple rounds. In such games firms can develop and signal a pattern of behaviour. This analysis can be used to understand why relationship marketing can be effective.

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Chapter 3: The marketing environment and a game theory perspective on competition

There are some situations in which, strategically, it may still be in one party’s interests to reject co-operation, even in a non-zero-sum game; for example, where there is a large disparity in size or strength among the players and the benefits of co-operation are spread unevenly among the players. In a price war, for example, if one store has 80 per cent of the market and the other 20 per cent, informal collusion to avoid price competition will bring four times the benefit to the larger player. This will reinforce the market strength of the larger player and place the smaller company at an ever-increasing disadvantage, leading eventually to its elimination. In this situation the smaller company may choose not to cooperate, and it will continue to cut prices even though it knows that the larger company will retaliate since the cost of this price war will be four times greater for the larger company. Who the long-term winner will be will depend on the relative resources available to each.

Summary The firm is affected by both its microenvironment and the macroenvironment. The characteristics of the marketer’s microenvironment affect its ability to serve its customers. The macroenvironment comprises the wider societal forces which determine the opportunities and threats facing a firm. Game theory presents a number of models which show how it may pay competitors to co-operate and/or cheat on each other. These models help to identify the characteristics of situations when these different strategies may be relatively effective. Game theory also presents various ideas as to how firms can try and increase the possibility of co-operation.

A reminder of your learning outcomes By the end of this chapter and the relevant reading, you should be able to: • distinguish between the micro and macroenvironment of a firm • describe how the different elements of the micro and macroenvironment affect firms’ marketing activities • distinguish between zero-sum and non-zero-sum games and the implications for competitive behaviour • explain the different methods firms can use to elicit co-operation.

Sample examination question 1. What are the main components of the microenvironment of marketing? With respect to each of these components identify the major questions that the marketer should be asking him/herself when carrying out an audit of the microenvironment.

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Chapter 4: An introduction to consumer behaviour

Chapter 4: An introduction to consumer behaviour Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761 (pbk)], Chapter 6.

Further reading Geanakoplos, J., M. Magill and M. Quinziil ‘Demography and the long-run predictability of the stock market’, Cowles Foundation Discussion Paper 1380 (August 2004); http://ideas.repec.org/p/cwl/cwldpp/1380.html Hurst, E. and M. Aguiar ‘Consumption, expenditure and home production over the life cycle’, University of Chicago, Department of Economics Working Paper (2004); http://www2.gsb.columbia.edu/divisions/finance/ seminars/macro/fall04/Hurst.pdf Modigliani, F. ‘Life cycle, individual thrift, and the wealth of nations’, American Economic Review, 76 (1986), pp. 297–313. Modigliani, F. and R. Brumberg ‘Utility analysis and the consumption function: an interpretation of cross-section data’ in Kurihara, K.K. (ed.) PostKeynesian economics. (New Brunswick, NJ: Rutgers University Press, 1954) [OCoLC 273383], pp. 388–436; also (London: Routledge, 2003) [ISBN 0415313767]; facsimile reprint of 1955 Allen and Unwin edition. Peter, J.P. and J.C. Olson Consumer behavior and marketing strategy. (New York: McGraw-Hill, 2005) seventh edition [ISBN 0072864877 (alk. paper); ISBN 0071111778 (international: alk. paper)].

Aims of the chapter The aims of this chapter are to: • explain why the study of consumer behaviour is so central to the marketing framework • convince you of the importance of understanding buyer behaviour from a multi-dimensional perspective • present the various psychological and economic theories of how consumers make their choices.

Learning objectives By the end of this chapter and relevant reading, you should be able to: • understand why the study of consumer behaviour is so important to marketing • explain why economics differs from social psychology in its explanation of consumer behaviour • identify the different stages of a consumer’s life cycle and its relation to consumer behaviour • discuss the differences between cognitive and behavioural theories of consumer behaviour • identify the types of consumer behaviour based on the concepts of setting, involvement and perceived brand differences.

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Useful web sites http://www.consumerpsychologist.com/ The site contains a useful listing of many consumer behaviour web sites.

Introduction In a sense, everything an organisation does (whether it is a private forprofit enterprise, a non-profit entity, or a governmental organisation) hinges on the assumptions it makes about people – both the people that are employed and the people served by the organisation. In marketing we tend to think only of the profit-making private sector, but whether they want to admit it or not, governmental organisations and non-profit organisations also engage in marketing exercises. The goal of marketing is determining wants and satisfying them, and this essentially is what government services are about as well. So, the importance of knowing how people will behave is tantamount to knowing the ‘secret to organisational success’. So let us begin with the simplest description of consumer behaviour. Consumer behaviour is simply the individual purchasing and/or consuming decision of an individual – and/or household – who buys goods and services for personal consumption (Kotler and Armstrong, 2004, p. 178). That purchase can be the consumption of a good or service in the marketplace or can even include the purchase of a stock and other investment decisions as well. This good or service can be either publicly supplied or privately produced by the organisation. Consumer behaviour can be modelled from a number of perspectives. As pointed out by Kotler and Armstrong (2004, p. 179), consumer purchases are influenced by forces such as: • cultural: the set of basic values, perceptions, wants and behaviours learned by an individual from being a member of society • social: the influences of social factors such as the consumer’s relation to small groups, family and social roles • individual: the characteristics of the individual such as the consumer’s age, economic situation and occupation • psychological: the motivation, perception and beliefs and attitudes of the consumer. Clearly there is some overlap between these four categories, as a person’s attitudes may be dependent on the age or economic situation that the person is in; or the other way around; a person’s attitudes and motivation may affect personal factors such as occupation and economic situation. But to the extent that the overlap is not perfect, such a broad-based perspective on consumer behaviour will tend to provide a more accurate portrayal of why consumers make the purchase decisions they do.1 It is not our intention in this brief introduction to explain each of the factors affecting consumer behaviour in great detail, as the Kotler and Armstrong text does a very good job of this already. Rather (as we did in Chapter 2 with the theory of perfect competition) we will start by presenting a relatively stylised economic interpretation of consumer behaviour and then we’ll see what implications this has for the marketing decisions of an organisation. We will then contrast this economic version with the social and psychological approaches.

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1

Those of you who have studied Elements of social and applied psychology will recall that Stockdale (2005) deals with ‘attitudes’. This is an important topic in marketing, specifically in terms of consumer behaviour and also for understanding the differences between consumers in different countries; indeed the link between attitudes and culture is discussed in more depth in Section 9.8 of Stockdale. The uni-dimensional model described by Stockdale (2005) refers to attitude as: ‘a general enduring positive or negative feeling about a person, object or issue’.

Chapter 4: An introduction to consumer behaviour

Activity Before we give you the analytical tools of economics, think about why the following countries differ in their consumption or purchase of leisure (leisure as defined by the average number of paid days off) and in their tolerance for differing personal income tax rates (these are the top marginal tax brackets, meaning the rate charged to the highest level of earnings). Days off

Tax rates

France

32

70

Germany

28

65

Netherlands

27

55

United Kingdom

13

44

Canada

12

49

United States

10

32

The numbers are illustrative rather than accurate descriptions of what occurs in each country, but are in congruence with the reality that continental Europeans pay higher taxes but have more time off than in North America.

Tastes and constraints in explaining differences or changes in behaviour Traditionally, economists (if asked) would explain consumer behaviour in three steps: 1. The first step is to examine consumer preferences (easier said than done). For practical purposes this just means what a consumer would theoretically prefer disregarding prices and income. 2. The second step is to acknowledge that consumers do in fact face budget constraints that restrict the quantities or amounts of goods and services that can be consumed. 3. The third step is to put consumer preferences and budget constraints together to determine choices. Economists accomplish this last trick by assuming that people maximise their satisfaction by combining a set of goods and services. Graphically they are able to represent this via the use of indifference curves2 and budget lines3 as depicted in Figure 4.1. The point A, at which the indifference curve touches or is tangent to the budget line (the point of tangency) is where our theoretical consumer apportions his consumption of goods X and Y.

2

An indifference curve represents combinations of two goods that provide equal levels of satisfaction for the consumer.

3

Budget lines map the maximum amount of consumption possible based on the price and quantities of each product consumed.

X

Indifference curve

A

Budget line

Y

Figure 4.1: Indifference curve and budget line

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Principles of marketing

There are also economic assumptions made purely about consumer preferences that need to be stated to make the approach more complete. These are that: • individuals are able to make choices and rank their preferences for different goods and services • individuals are rational in the choices they make • more is preferred to less • additional units consumed provide less additional satisfaction relative to previous units consumed (the more you have of a particular good, the less satisfaction you receive with additional consumption of that same good). As with the theory of perfect competition, we can arrive at several theorems of consumer behaviour, but we will just draw your attention to one of the key assumptions about the psychology of consumers that you should be aware of (the fourth bullet point above), which is known as the principle of diminishing marginal rate of substitution. Put simply, it states that as more and more of one good, service or attribute is consumed, we would expect that a consumer would prefer to give up fewer and fewer units of a second product to get additional amounts of the first. So as we move along the indifference curve and as the consumption of one good increases, the consumer’s desire for still more should diminish. Thus he/she should be willing to give up less and less of good X to obtain additional Y. This assumption is what gives the indifference curve its bowllike shape. Activity Where does this principle break down? In other words, are there cases where the enjoyment increases as we consume more of a good or service in question? And what are the reasons why?

So what implications can we draw from this simple view of consumer behaviour? Remember that marketers are presumably interested in two things: why consumer choices differ across consuming agents (this could be between two people, or the average consumption patterns of two consumer segments or even two nations); and changes in the consumption behaviour of the same consumer over time (again, a person or groups of persons with similar consumption patterns). The reason why these consumption patterns may differ, based on the economic model presented above, is based on two things: preferences (sometimes referred to simply as tastes by economists) and/or constraints (typically budget-related but there can also be physical, geographic and even social constraints that economists would consider binding). Based on these two reasons, economists typically argue that models where constraints differ are the more interesting cases since these are more likely to be measurable by a researcher and subject to observable change. What happens to tastes and preferences (the psychology of the consumer) is often hard to determine and therefore not theoretically of interest to mainstream economists since it is very hard to test these theories with large-scale empirical data that economists normally have access to. • Model 1: Consumer behaviour is some function of tastes and constraints. In this model both are variable.

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Chapter 4: An introduction to consumer behaviour

• Model 2: Consumer behaviour is some function of tastes and constraints. In this model only constraints are variable. Economists think that they can explain most consumer behaviour in terms of Model 2 and more precisely looking at constraints in terms of prices and income. They even translate non-economic constraints into costs. This has important implications for marketing (as seen in the case below). Two famous economists, Gary Becker and George Stigler, have even argued that ‘tastes neither change capriciously nor differ importantly between people’. This is a pretty radical statement, but is it accurate?

Stability of tastes and the economic explanation of custom and tradition In many cases we observe stable behaviour that we attribute to cultural factors. For example, for as long as anyone can remember, consumption of wine has been higher in France than in Germany, where beer is consumed more than wine. What explains this and other national differences? The ‘common sense’ answer would be that there is a custom of beer consumption in Germany and a custom of wine consumption in France. But to prove this assertion, we need to prove that prices and incomes (the environment) have not remained stable. In other words, only when we observe stable behaviour in the face of prolonged or severe changes in the environment can we then say that custom or tradition are important factors in determining choices. The economic answer to stable patterns of consumer behaviour relies on the cost (price) of decision-making. The making of a decision is costly, because in order to make a decision one requires information, and the information must be analysed. Therefore, the price of a good or service has to incorporate the cost of search as well as the market price. When a temporary change takes place in the environment, perhaps in price or in income, it generally may not pay to disinvest in the knowledge or skills that one has acquired. As a result, behaviour will appear stable in the face of temporary changes and will reinforce the popular perception that culture is the causal factor. So returning to our example of wine and beer consumption in France and Germany, is it tradition or some other constraint that is at work? And more importantly, what use can this debate have to marketing departments? It could be argued that in France people have more information about the quality of wine than beer, and consequently they will not switch to beer without: a. a huge increase in information (translation for marketers: huge advertising campaign) b. a large drop in the market price of beer to counteract the information search costs.4 Now what about ‘permanent or long-lasting changes’ in the environment, for example the shift to a market economy in the former Soviet Union? Typically, one observes a heterogeneous response. The younger generation usually responds to these changes to a greater extent than older persons. Why? The popular press account is that young persons are more readily seduced away from old customs by the glitter of the Western environment. In the economic interpretation, it has nothing to do with fickle or immutable taste differences between old and young; rather it has to do with the cost to older persons of disinvesting in the knowledge of how to do things under the old environment. The older one is, the fewer years one has to collect the

4

When consumers are prompted to search for more information about a product or service. Information search can be costly in terms of time or the purchase of some market research (e.g. the purchase of a consumer reports magazine).

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returns from investments in certain patterns of behaviour. Young persons on the other hand are not so encumbered, not because they are more flexible or adaptable to changes in the environment; they simply have a greater incentive to invest in new knowledge and new skills. Activity What implications does the above view of consumer behaviour have for former nonmarket economies intent on instilling the virtues of the ‘market’ upon their populations? Should they: a) Engage in a highly visible and expensive advertising campaign aimed at everyone over 40 extolling the virtues of the capitalist system? b) Use that same money and invest it in subsidies for training programmes, or rent subsidies/controls so as to lower the transition cost of deregulation, increases in state pensions, etc.? What would have a bigger impact on people’s commitment to the new regime? A more trivial application (or confirmation) of this theory is the discounts given to senior citizens for bus travel or the cinema. If preferences really differed, then there would be no need to lower the price of cinema tickets if you were over 65 years of age. What you would do is produce films that catered to that group, or you would engage in publicity campaigns aimed at changing their attitudes. Instead, the price cuts apply to all films but are targeted to a consumer group less likely to step out of the house. This particular economic view of consumer behaviour has very powerful implications. It says that we are the same – old or young, non-market or Western. What differs is the incentive we have to behave in a certain way or consume a certain good. So, let us move back once again to an interesting application that we discussed earlier.

What explains different national consumption of holidays? Having given you a few of the analytical tools, we want you to think once again about why these countries differ in their consumption or purchase of leisure (leisure as defined by the average number of paid days off) and in their tolerance for differing tax rates: Days off

Tax rates

France

32

70

Germany

28

65

Netherlands

27

55

United Kingdom

13

44

Canada

12

49

United States

10

32

Table 4.1: National consumption of holidays Holidays can be seen to be some function of: • institutions (law, political parties, unions) • preferences (custom, ideology) • prices (taxes, incomes). You may retort that it is legislation that differs in these countries. And we would say, then why does the legislation differ? Presumably legislation, in a democratic society, is based on the collective choices of voters. So why have voters in continental Europe chosen to elect governments that promise increases in statutory minimum holidays, and why have voters in North

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Chapter 4: An introduction to consumer behaviour

America and the Anglo-American world more generally, chosen the opposite? Well, it is simply a matter of tastes and constraints (or what is perceived as a constraint). The simple answer would be that Europeans prefer leisure more than AngloAmericans do. In the parlance of economics, we may say that they have a greater taste for holidays. The answer preferred by economists would be that leisure is more ‘expensive’ in the Anglo-American world and therefore workers take fewer days off. By ‘expensive’ we don’t mean that the price of theme parks or resorts is higher. What we mean by price is really the cost of taking time off work. In Europe, leisure is cheaper, because work is more expensive. What do we mean when we say that work is more expensive? Well, income tax rates are higher in continental Europe, making the time off work less expensive. Voters in those countries may feel that pressing for changes in more days off is easier than pressing for more tax breaks. Conversely, in the US, pressing for legislative changes to statutory minimum days off is more difficult so they instead press governments for more tax cuts. What economists would argue, using the tools of economic consumer behaviour, is that taxes and days off are two possible choices for voters, in the same way that consumers face choices over goods and services. However, the economist does not necessarily think voters in these countries are inherently different. Perhaps Americans would like to ‘consume’ 32 days of holidays and perhaps Germans would like to pay only a 32 per cent marginal tax rate? However, what is preventing voters (consumers) in either system are the differing constraints faced in both countries. So graphically the first and second answers would be as shown in Figure 4.2a and 4.2b.

WD

Figure 4.2a: Same constraints; different preferences

US

EU T

WD

Figure 4.2b: Same preferences; different ‘prices’

US

EU T So the subtler and less intuitive answer would be that taxes and holidays are trade-offs. They are not complements but are substitutes. And in Europe people find it easier to press for working-day reductions, and to pay for those they tolerate larger tax rates from their elected officials. But taking that same European and placing him/her in America, one would assume that they would be pressing for tax relief at the expense of lower holidays.

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Age and consumer behaviour over the life cycle The life-cycle view of consumer behaviour is closely linked to economics, although like any theory about individual behaviour, it has to make some assumptions about human psychology. In this respect, the life-cycle model of consumer behaviour is quite ubiquitous and appears in economics, marketing and gerontology. Each discipline has a slightly different interpretation of the life-cycle model. Below we review what the life-cycle model has to say regarding consumption and activity patterns as we age. The first formal use of the life-cycle model in economics stemmed from a puzzle regarding income and consumption. In macroeconomic data sets, consumption and income seemed to rise at a fixed or constant rate. That is, for every $1 increase in national income a fixed portion (e.g. 70 cents) would be directed into consumption. The problem for economists occurred when they examined data at the microeconomic level (i.e. at the level of the individual). Individual and household consumption appeared more or less constant and did not vary with income in the same way. One of the answers to this puzzle was provided by Modigliani and Brumberg (1954) with their life-cycle theory. Empirically, the life-cycle theory predicts that the consumption and saving behaviour of an individual has less to do with current income and more to do with age, material status and other socioeconomic conditions during various stages of the individual’s life. From the saving side, the life-cycle hypothesis posits that saving is negative for the young, positive for middle-aged households and negative for the retired, so that wealth should be hump-shaped (Modigliani 1954, p. 406).5 The idea motivating this model is that people have distinct financial needs at different periods of their life, typically borrowing when young, paying back the loans and then saving for retirement when middle-aged and reducing savings during retirement. Shares (along with other financial assets such as real estate and bonds) are vehicles for the savings of those preparing for their retirement. It seems plausible therefore that a large middle-aged cohort seeking to save for retirement will push up the prices of financial services and these securities, and that the prices will be depressed in periods when the middle-aged cohort is small. A recent paper by Geanakapolos et al. (2004) finds that this is indeed the case for the United States. Another strand of the life-cycle literature examines consumer behaviour from the perspective of the opportunity costs of time and time-use decisions. Specifically, this research stream addresses the well-documented fact that expenditure and labour supply are also hump-shaped over the life cycle. This means that consumer expenditure rises, peaks and then declines as we age. This hump is present even when economists control for changing family composition. As noted by economists, household consumption is the output of combining market activities and expenditure with time spent in home production. To the extent that the relative price of time increases with age (as we gain labour market experience and wages rise, it costs us more to enjoy leisure), individuals will substitute money spent on market goods for time by undertaking less home production and by searching (shopping) less intensively for cheaper goods and services. In a recent paper by Hurst and Aguiar (2004), it is shown that the large differences in prices paid across households for identical consumption of goods in the same metropolitan area at any given point in time, corresponds directly with the household’s opportunity cost of time. For example, the authors – using UPC code6 data that uniquely identifies a good – find that middle-aged households (with high wages and lots of family commitments) pay 16 per cent higher prices for the same goods and services than 24-year-olds and 8 per cent higher prices than

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5

This just means that if graphed, the pattern of savings for an individual would look like an inverted U with respect to age.

6 UPC stands for universal price code, which is simply the number and barcode that identifies an individual consumer product.

Chapter 4: An introduction to consumer behaviour

66-year-olds. The data suggests that a doubling of shopping frequency (i.e. more time spent searching for the lowest price) lowers the purchase price of a good by 15 per cent. From this, the authors impute an opportunity cost of time for shoppers. Not surprisingly, the cost of time peaks in middle-age, and is roughly 35 per cent higher than that of retirees. This model has particular relevance for time-use over the life cycle. In particular, older consumers shop more frequently and also spend more time on each trip. Time spent in home production is therefore driven by two agerelated forces: home production needs, such as children, and the opportunity cost of time. The authors find that both forces explain the pattern in the data: home production needs drive the peak found in home production in the late 1930s, while declining opportunity costs of time explain the increase in home production starting in the late 1950s. A final strand in the literature looks at the stages in the life cycle and links these to the generic needs of the consumer. A generic need is an inherent need of physical or social life. These needs are generic in the sense that they tell us when an individual is likely to move from public transportation to the purchase of a car or from the rental to the purchase of a house (this happens at a fairly predictable stage in someone’s life, i.e. mid-twenties for cars and early-thirties for homes). The model, of course, cannot predict the colour or the make of the car chosen, but despite this limitation, the life-cycle needs of an individual (household) are useful in predicting which sectors may witness demographic induced growth and what sectors may face demographicrelated challenges.

Stages in the consumer’s life cycle The household is typically segmented into four stages. The average age for first marriage in the United Kingdom is 24.4 for females and 26.5 for men (similar patterns hold in the United States and many other countries). This changes depending on level of education (i.e. the higher educated tend to marry later than the national average) but we can use this as our benchmark. Stage one therefore includes households in their twenties, usually without children. Whether married or not, young groups are more likely to rent than to own, spend more money than other groups on cinema tickets, take away food, beer and clothes. Stage two, which includes households in their thirties and forties, typically involves children and brings with it changes in lifestyle and consumption. Household needs increase and commensurate with this, spending increases on baby clothes, furniture and televisions, and television viewing on children’s programming increases. Noisy restaurants and fast food are chosen instead of quiet, expensive dinners. This is a time of high debt; households are borrowing for their car, home and other family purchases. In stage three, the household is now middle-aged and here the typical portrait begins to diverge. There are middle-aged married couples with children in their late teens or early twenties experiencing high costs of higher education and car insurance. Middle-aged singles without children may have many of the same needs as married households, but tend to live in condominiums or smaller homes. Some middle-aged stage-three households may also be sandwiched between support for children as well as ageing parents. This group typically demands household cleaning services or other types of time-saving services. Stage-three households with no children have higher travel expenditures, enjoy luxury items and may take up gambling, golf and spa treatments.

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Principles of marketing

In stage four, older married and singles are typically in the 65 and older group. If in good health, the consumption patterns of young retirees are quite distinct from older retirees. Young retirees are heavy travellers and supporters of culture. As people are living longer and healthier, the age range of the actively retired keeps getting pushed upwards. In the later years, regardless of health status, estate planning, rearranging insurance, health care, assisted living and retirement homes become important. As frequently noted by gerontologists, this is a good reason to separate stage four into at least two distinct groups.

The social-psychological approach to consumer buyer behaviour Let us begin with the simplest contrast between economic and socialpsychological views. In the economic view, one assumes that consumers have fixed preferences, are self-interested in that they feel better or worse only depending on what they do rather than on the outcomes of others. Sometimes economists even use a utility function to show how simple their model of human behaviour is: U (x, y) where x and y represent a bundle of goods/services. Consumers gain more utility U whenever they consume more of x and y. The trick for the firm is merely to supply the consumers with what they want. The social-psychology view assumes that consumers are not exclusively selfinterested in that the utility function encompasses many things including other consumer goods and that preferences may change over time such that the firm might induce purchases by ‘socialising’ consumers. A firm might try to influence preferences in order to achieve the goal of increasing sales. In the economic view, that goal is achieved normally through price cuts. In short, there is a sharp contrast in explaining consumer behaviour through the extrinsic motives such as prices and costs (assumed by economists) and the intrinsic motives such as preferences and attitudes (assumed by social psychologists). It may make sense to enhance the economic view with the socialpsychology view by using (broad-minded) utility-maximisation models, but this is not standard as social psychologists talk about personalities and the self (not ‘preferences’) and the process of self-creation, through socialisation, in order to explain people’s choices.

The socialisation process There are three basic feedback loops that social psychologists use to explain not just consumer behaviour but human behaviour more generally. These models are nicely represented using diagrams developed by James Montgomery of the University of Wisconsin. There is the basic feedback loop where the numbers refer to the causal ordering, as shown in Figure 4.3 opposite. This is where a person has a well-defined self-concept or personality,7 and makes choices and undertakes actions based on this set of psychological characteristics (Kotler and Armstrong, 2004, p. 191). The attributions8 are the reinforcing part of the feedback process, and these usually can be both external and internal, meaning that they are either made by a third person observing some action or by the person undertaking the action. For instance, if a person is aggressively competitive,

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7

The distinguishing personal psychological characteristics that lead to relatively consistent and lasting predictions of an individual’s responses to their environment.

8

Attributions are the causal explanations people use to explain behaviour either of themselves or of others.

Chapter 4: An introduction to consumer behaviour

attributions

(1) self-concept

(2) actions

Figure 4.3: Basic feedback loop is this because of the kind of person he/she is, or is the person reacting to situational pressures? If a student fails a test, does s/he have low ability, or is the test unfair? In both examples, the questions concern the causes of observed behaviour and the answers of interest are those given by the person and external observers because these can serve to reinforce or to change the self-concept. In the realm of consumer theory this model states that if I am consistently observed buying Starbucks coffee, when there are other coffee choices available to me, then I am more than likely buying the coffee because I am a ‘Starbucks lover’. However, if I regularly buy coffee from Starbucks, but the nearest competing coffee chain is one hour away, then there are two possible attributions: I like Starbucks or I actually prefer another coffee but can’t be bothered to drive an hour to get it. There are also alternative specifications of the above feedback loop such as dissonance theory. This is where people take actions and only later construct reasons for their actions (see Figure 4.4).

rationalisations/self-attributions

(2) self-concept

(1) actions

Figure 4.4: Dissonance theory feedback loop Here the personality or self-concept is solidified after the action is taken. There is quite a bit of experimental evidence suggesting that individuals often attempt to justify past effort/actions, effectively changing their current self-concept. This internal justification occurs especially when there is no fixed external justification. Consumers often face this kind of dissonance after making a high-involvement purchase (see below) decision, where there are no a priori differences in the brands (for more see Kotler and Armstrong 2004, p. 197). Finally, there is the case where culture and social forces can play a big role on the individual’s personality and actions. This is where the self-concept is actually the result of a set of social roles or norms (see Figure 4.5).

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attributions

(2) actions

(3) self-concept

(1) social norms Figure 4.5: Influence of social pressures on the feedback loop Here social factors are very important determinants in individual actions and ultimately shape behaviour and personality. Take for example our discussion earlier about French wine drinkers and German beer drinkers. In this model, in each society there are social pressures that induce actions, usually early on in life, which solidify later on through the life course and become personality traits and preferences that are hard to dislodge. This is perhaps why marketers spend such an inordinate amount of time and energy trying to target advertisements to the young rather than to the old, because in a sense their self-concepts are already set while those of the young can still be influenced.

A cognitive versus behavioural approach to consumer decision-making Now we will look at the psychological model (as opposed to the socialpsychological approach seen above) of consumer decision-making. It involves two concepts (the environment and the cognitive process) which are not all that dissimilar from the ‘constraints and taste’ approach of consumer theory in economics. Psychological explanations of consumer behaviour, which emphasise environmental factors, are called behavioural or habitual explanations. Theories that emphasise internal mental processes are called cognitive explanations. You can see in Table 4.2 that the behavioural approach is quite close to the strict economic interpretation with its emphasis on external factors (constraints); whereas the cognitive approach has a closer resemblance with a new branch of economics that is called quasirational economics, which attempts to integrate the ways in which consumers process information into economic models. Positions and assumptions

Behavioural approach

Cognitive approach

Emphasis on explaining

Observable behaviour

Mental constructs

Role of environment

Predominant controlling variable

One influence among many

Role of cognitive factors

Mediators

Predominant controlling variables

View of freedom and discretion

All behaviour is controlled by environmental factors

Humans are autonomous, independent agents of action

Table 4.2: Comparison of behavioural and cognitive approaches Table created using data from Kotler and Armstrong (2004, p.197)

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Several points need to be raised regarding this rather simple classification system. Notice the resemblance between the behavioural approach and the constraints-based approach of economists like Becker and Stigler. Second, in this division we can see that the behavioural approach is akin to saying that ‘actions speak louder than words’. Third, one can think of situations, experiments and examples of consumer behaviour that confirm both views. So how do we arrive at a way of making these concepts measurable in order to better understand how to implement marketing strategy? The psychological model after all is aimed at explaining consumer behaviour (brand loyalty, choices, etc.). Cognitive approaches emphasise how people store, process and use information and how they create beliefs and form attitudes and values. Behavioural approaches really look at observable associations between behaviours and their environmental stimuli.

Mechanisms of behavioural/habitual explanation Let us begin with how behavioural explanations work. The classic work in this field was Pavlov and his explanation of salivation in his pet dog. Salivation is an innate response to the smell of food. Pavlov rang a bell every time the dog was fed the food. Over time the dog came to associate the bell with the smell of food – so when Pavlov stopped pairing the bell with the food, the dog still salivated. The bell became what is called a discriminative stimulus in the environment. The above is an example of classical conditioning, which can be defined as a process by which a previously neutral stimulus (the bell), by being paired with an unconscious stimulus (food) comes to elicit a response (salivation) very similar to the response originally elicited by the unconditioned stimulus. Operant conditioning differs from classical conditioning because the operant behaviours are elicited because of stimuli elicited after the behaviour has taken place. Marketers use this information of human behaviour in designing fixed ratio schemes (for example, a pizza chain gives a free pizza after 10 purchases; a coffee shop stamps a card each time you come in and then the tenth time you get a free coffee, etc.).

Applications of behavioural and cognitive principles in marketing Types of buying behaviour Buying behaviour differs greatly for different types of products and services. Table 4.3 shows types of consumer-buying behaviour based on a buyer’s involvement and the perceived differences among brands. Involvement Differences in brand

High

Low

Significant differences between brands

Complex buying behaviour (cognitive process)

Variety-seeking buying behaviour (primarily behavioural with some cognitive)

Few differences between brands

Dissonance-reducing Habitual buying behaviour buying behaviour (behavioural process) (primarily cognitive with some behavioural)

Table 4.3: Types of buying behaviour

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Complex buying behaviour results from situations where involvement is high and where there is a high degree of perceived difference amongst the products that one has to choose from. The involvement may arise from uncertainty of the product’s quality and/or a high price or a number of other factors such as personal factors related to whether the product’s image and whether the needs it serves are congruent with a consumer’s self-image, values and needs. Also, the more socially visible a product is, the greater the involvement. Once in this situation, a consumer will attempt to learn about a product and then assimilate the information into beliefs about the product’s quality and possible benefits. This type of behaviour is cognitive in nature and marketers must usually respond with promotion that is information rich (i.e. using print media with long copy). Dissonance-reducing buying behaviour is normally associated with products that are risky, purchased infrequently or expensive (making them high-involvement goods) but where there is little perceived difference amongst brands. Consumers may shop around for the best price but buy relatively quickly and often can be affected by environmental (behavioural) factors such as convenience. After the purchase, however, the consumer might experience post-purchase dissonance, believing that there was actually something better on the market. So this type of behaviour represents a mix of cognitive and behavioural factors. Habitual buying behaviour occurs under conditions of low consumer involvement and little significant brand differences. In these cases, often for goods that are purchased frequently (e.g. toothpaste), behaviour does not pass through the standard cognitive process of belief–attitude–behaviour formation. Instead, consumers passively receive information as they watch television or surf the Internet. Unconscious advertising repetition creates familiarity, which often translates into a brand purchase at the moment the consumer is deciding which brand to buy. This is almost pure behavioural decision-making and hence advertising tends to be focused on classical conditioning, in which buyers are taught to identify a certain product by a single symbol repeatedly attached to it. Variety-seeking buying behaviour occurs in situations where there are low-involvement purchases but significant differences in brands. In this situation, rather than engage in lengthy pre-purchase surveys, consumers, if curious about a new brand or dissatisfied with the product choice, engage in switching to another brand. In such situations the advertising approach differs across firms. Market leaders often want to encourage habituation and therefore employ conditioning strategies, whereas challenger firms rely instead on inducing consumers to switch and instead employ more cognitive approaches and appeal to consumers on the basis of reasons for making the switch (see Chapter 11 for the case of Apple’s switch campaign).

The case of advertising: cognitive versus behavioural approaches Why does so much advertising contain so little information about a product? One classic case was the Benetton advertising campaign of 1999, in which convicts were depicted on death row in posters and print advertisements. Why did Benetton do this? Clearly this wasn’t about information dissemination. It was about creating discriminative stimuli rather than giving information to customers about the quality or style of the clothes. This type of behaviour modification is commonly done by advertising the brand and pairing it with something else that consumers

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regard as positive – beer with nice music, toilet paper with a pleasant landscape. Over time consumers come to associate these positive elements with the product. In the Benetton case, the company was trying to align itself with the values of consumers who opposed the death penalty. Certain advertising media are better at this than others. Film, television and the Internet are all multi-sensual media. They are better because they appeal to more than one sense at a time (this is how you get pairing). It is much harder to pair when it appeals to only one or two senses. The concepts of setting and involvement displayed in Table 4.4 may help us understand when the two views are most appropriate. Setting refers to the environmental control available to a consumer in a given purchasing decision. When a consumer is inside a supermarket we say that this setting is closed because the firm has almost complete control of the environment – from the music, temperature, arrangement and size of the store. In an open setting, consumers have more control of the variables such as when making investment choices on a Sunday afternoon in the kitchen. Involvement, as we saw before, refers to the state of awareness that motivates consumers to seek out, attend to, and think about product information prior to purchase. When involvement is low, advertising tends to be highly persuasive. Combining both setting and involvement, we gain an appreciation for what kind of psychological approach is most effective in advertising. Open situations with high involvement rely more on cognitive features of advertising techniques (information and comparison shopping) whereas in low-involvement situations with open setting, the advertising relies on persuasive ads with some cognitive element (e.g. ads with clever situations that offer comedy and intellect). Setting Involvement

Closed

Open

High

Behavioural advertising with some informative content

Cognitive advertising with substantial informative content

Low

Behavioural persuasive advertising

Cognitive persuasive advertising

Table 4.4: Advertising as a function of involvement and setting

A reminder of your learning outcomes By the end of this chapter and relevant reading, you should be able to: • discuss why the study of consumer behaviour is so important to marketing • explain why economics differs from social psychology in its explanation of consumer behaviour • identify the different stages of a consumer’s life cycle and its relation to consumer behaviour • discuss the differences between cognitive and behavioural theories of consumer behaviour • identify the types of consumer behaviour based on the concepts of setting, involvement and perceived brand differences.

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Sample examination questions 1. Under what conditions will consumers seek out a great deal of information about a product before purchasing it? 2. What kind of advertising techniques are habitual buying behaviours associated with? 3. Which consumer, a younger or older one, would you predict to be the target of more behavioural advertising? Explain your choice.

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Chapter 5: Introduction to market segmentation

Chapter 5: Introduction to market segmentation Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761 (pbk)], Chapter 8.

Further reading Beane, T.P. and D.M. Ennis ‘Market Segmentation: a review’, European Journal of Marketing 21(5)(1987), pp. 20–42. Cothier, G., M. Christen and D. Soberman ‘Ford Ka, the market research problem’ 2003, INSEAD Case no. 503-084-1; http://www.ecch.cranfield.ac.uk Danneels, E. ‘Market segmentation: normative model versus business reality; an exploratory study of apparel retailing in Belgium’, European Journal of Marketing 30(6) 1996, pp. 36–51. Dibb, S. ‘Market segmentation: strategies for success’, Marketing Intelligence and Planning 16(7) 1998, pp. 394–406. Dibb, S. and L. Simkin ‘Implementation problems in industrial market segmentation’, Industrial Marketing Management 23 (1994), pp. 55–63. Dibb, S. and P. Stern ‘Questioning the reliability of market segmentation techniques’, Omega – International Journal of Management Science 23(6) 1995, pp. 625–36. Kay, J. ‘A model of product positioning’ in The foundations of corporate success. (Oxford: Oxford University Press, 1993) [ISBN 019828781X], pp. 242–50.

Aims of the chapter The aims and objectives of this chapter are: • to explain why firms undertake segmentation, targeting and positioning (STP) • to describe the segmentation, targeting and positioning process • to discuss some of the arguments surrounding STP.

Learning objectives By the end of this chapter and the relevant reading, you should be able to: • understand the possible usefulness of segmentation, targeting and positioning to marketing managers • explain the STP process • critically evaluate the arguments in favour of STP and the criticisms levelled against it.

Useful web site http://en.wikipedia.org/wiki/Market_segment This site has a brief and useful overview to the topic; hyperlinks help explain some of the technical terms associated with this topic.

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Introduction In this chapter we will look at the link between marketing orientation and market segmentation. We will start with an examination of what marketing orientation involves and why marketing texts recommend its usage. We will explain the segmentation, targeting and positioning (STP) process and conclude this chapter by considering some of the criticisms levelled at market segmentation – specifically that it is much more difficult to put into practice than is suggested by theory and that there are some problems underlying the theory. You should note that the recommended text (Kotler and Armstrong) tends to follow a normative approach to these topics; specifically it focuses on how managers should undertake STP. For the purposes of this course such an understanding is not going to be sufficient. We have taken a critical approach to this topic and expect you to be able to understand and explain the criticisms levelled against it. Understanding the criticisms and being able to explain and evaluate them against the benefits of STP is going to be more challenging than simply understanding the process of STP and you should be aware that the examination may well require more than simply understanding the process.

Market segmentation – the relevance for marketoriented organisations In Chapter 2 of this subject guide we described the different orientations that firms can follow. In this chapter we will complete that discussion by looking at the assumptions underlying the different orientations. Table 5.1 PRODUCTION

PRODUCT

SALES

Assumptions regarding market conditions

There is a lack of supply.

There is a lack of quality products.

Oversupply/lack of demand requires additional sales effort.

Assumptions regarding buyer behaviour

Customers are not concerned about product quality or variety.

Customers are not aware of the possibilities for the product class.

They need to be pushed into buying.

Situations when effective

When there is a lack of supply – customers will buy whatever is available.

In high-technology businesses where there is an asymmetry of information between buyer and seller.

When buyers’ behaviour is characterised by inertia.

Situations when ineffective

When customers have a choice – they will want quality and variety.

When marketers come to regard themselves in the business of making a particular product and not fulfilling a particular want.

Where focus on selling leads marketers to sell whatever they have rather than consider customers’ wants.

+ Marketing Develop product and then undertake market research.

Sell products which people want to buy, but accompany with heavy sales pitch.

Combinations of orientations

Table 5.1: Marketing orientations compared

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shows the different assumptions made about the market and consumer behaviour by firms that follow the different orientations. If you look at the second column of this table, the production-oriented firm assumes that there is a lack of supply; it is because of this assumption that its focus is to produce as much as possible. There are obvious examples of markets around the world where this assumption holds and the behaviour of some marketers is evidence of a production orientation. The airline market is a case in point. Some airlines flying between developed countries to destinations in developing countries know that demand for seats is very high (from people wishing to return ‘home’ to see their families). The number of competitors on these routes is sometimes limited and such airlines know that they do not need to even attempt to provide a good service; all they need to do to fill seats is to ensure that they have enough aircraft flying. Contrast this with the London to New York route, which is extremely competitive, with customers having the choice of a number of airlines. In such a situation, where supply exceeds demand, a marketing orientation is more likely. If you look at the second box in the first column of Table 5.1 you will see that as a result of market conditions it is possible to make assumptions about buyer behaviour. Where supply is limited, customers cannot afford to be choosy and may not be able to consider quality or variety. Rows three and four are important for practical purposes because they identify the situations when the different orientations may be effective and ineffective. You should also pay attention to the last row in the table. This shows that it is possible for firms to display a combination of orientations. Looking at the practices of firms in real life it is often difficult to see if there are any MARKETING

SOCIETAL

Oversupply/lack of demand can be overcome if you take into account needs and wants.

As well as products which satisfy needs and wants should also consider wider issues – in their own right.

Customers prefer products which cater for their needs and wants and if this is done they may come back. Will need less sales effort.

Customers will buy from marketers with concerns for wider environmental issues. This will also win favour with government.

Where customers have a choice and will prefer those products which cater most closely to their needs.

Where there is pressure to look after the environment and other social issues.

Where customers are unable to identify their needs and wants. Where there is a lack of production capability and customers will buy anything.

Where there is no pressure from customers/ government and no long-term benefits and the costs outweigh the benefits.

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that are wholly oriented one way or another. Some aspects of their activities suggest one orientation, other characteristics of their activities suggest another. This is why we argue that firms can have combinations of orientations. The argument presented in the last row of the third column is that some firms may combine elements of the product orientation with the marketing orientation. For example, product development may be undertaken as a result of innovation by the firm’s engineers (without prior market research). However, prior to launch the product may be tested amongst customers. Activity Write down examples of firms which in your experience follow the different orientations. Then write down which elements of consumer buyer behaviour or characteristics of the market have encouraged the firms to follow a specific orientation. You should read the details of the other orientations and consider the advantages and disadvantages of each. You should note that it has been argued that a marketing orientation can lead to problems for marketers since it may lead to them focusing on customers’ perceptions of what is required and for many industries this may lead to cosmetic changes to a product.

Importance of segmentation Businesses from all industry sectors use market segmentation in their marketing and strategic planning. Customer needs are becoming increasingly diverse. These needs can no longer be satisfied by a mass marketing approach. Businesses can cope with this diversity by grouping customers with similar requirements and buying behaviour into segments. Choices about which segments are the most appropriate to serve can then be made, thus making the best of finite resources. (Dibb, 1998, p. 394)

The importance of market segmentation is reflected in the definition of what constitutes a segment. A market segment has been defined as: ‘a group of present or potential customers with some common characteristic that is relevant in explaining and predicting their response to a supplier’s stimuli’. Segmentation is about finding some common characteristic about a group of customers which could help predict how they will react to the marketer’s advertising, pricing, distribution, etc. Common characteristics can be important because, taken as a whole, customers tend to be ‘heterogeneous’ in terms of their wants and preferences. (‘Heterogeneous’ means that customers are different.) Therefore, if we are able to find out that certain groups of potential customers will react in the same way to our marketing efforts, we will be better able to control those marketing efforts to ensure that a particular group of people react in a positive way (i.e. make a purchase and come back for more). Specifically, we could tailor our marketing efforts to ensure that the needs of that specific group of people are satisfied. Of course it is important that they have a characteristic in common, otherwise we would not be able to identify the relevant groups. Overall, market segmentation is important because it can be a means of increasing sales and profitability. According to Beane and Ennis (1987), market segmentation is done for two reasons: to look for new product opportunities or areas which may be receptive to current product

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repositioning, and to create improved advertising messages by gaining a better understanding of one’s customers. This distinction is important. In the first instance the firm is segmenting the market before it has entered it and will use information about segments in order to develop specific elements of the marketing mix and indeed to decide which segments should be focused on. In the second instance the marketer looks at an existing customer base and sees which basis for segmenting groups of customers may be most effective for predicting their behaviour. Elements of the marketing mix are then designed to appeal to specific segments. In this chapter, the notion ‘normative segmentation model’ refers to the conventional segmentation–targeting–positioning sequence that is presented in most textbooks in marketing and retailing. The segmentation model is labelled normative because of its prescriptive nature; it suggests that practitioners should go about their business in a certain way (Danneels, 1996).

Market segmentation, targeting and positioning A ‘market segment’ is a large group of identifiable customers. A ‘niche’ is a more narrowly defined group of customers who may seek a specific combination of benefits. No company can serve all the customers in a particular market. Firms recognise that their competitors can be better placed to serve the needs of some customers. For this reason firms have to segment, target and position (STP) their products. However, this approach is not always used by marketers. Mass marketing is used by marketers to try to sell to all segments of the marketplace, regardless of the differences in customers’ needs. Over the years there has been a shift away from mass marketing. An early development was ‘product-variety marketing’, which emphasised the importance of providing customers with variety and differences in the specifications of products. With recent emphasis on target marketing, the marketers should distinguish between market segments and target one or more of them.

Market segmentation There are three steps to target marketing: 1. Distinct groups of customers are identified and profiled. 2. Market targeting involves selecting one or more market segments which are to be entered. 3. Market positioning involves establishing and communicating producers’ benefits to target customers in selected markets. While at the extreme each buyer could be seen as a separate market, segmentation of a market can be undertaken according to the following differences in customers’ characteristics: • wants • purchasing power • geographical location • buying attitudes • buying practices. Using one of the above as an example, if individuals differ in their wants according to income, the marketer may split the market into income groups. The degree to which a firm customises marketing depends on the

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numbers of customers and their importance to the marketer. Manufacturers of aircraft engines, for example, tailor their products for each individual customer. They find it profitable to do this because of the large size of each individual order. However, manufacturers of cheap cars would not find it profitable to spend a great deal of time meeting the needs of individual customers. But they may segment their customers into large groups; for example, according to the continent in which they live. Geographic segmentation relies on the notion that customer wants vary according to their geographic location. As well as differences in a customer’s culture there are other ways in which geographically distinct customers vary. The market power of customers can be different and for this reason marketers may charge different prices according to the country in which sales are being made on what can be exactly the same product. For example, the Scandinavian airline SAS charges higher prices for flights from Scandinavia rather than to Scandinavia, because passengers who fly to Scandinavia have a wider range of carriers to choose from. There can also be a difference in the nature and degree of government regulation. As a result of such a difference, the price of fax machines in France is 50 per cent higher than in the UK. Customer tastes can also vary and as a result products which are considered to be commodity purchases in some countries can be regarded as prestige goods in others. Stella Artois beer is a premium product in the UK but not in Germany or Belgium. The above examples are also useful insofar as they show how marketers can use segmentation not only to improve customer welfare but also to improve profits.

Problems in implementing segmentation There are a variety of reasons why firms may not segment their markets using the bases referred to above. This section deals with some of the shortcomings with the normative view of segmentation, explains what may happen in real life and the reasons why. In real life marketers may identify segments but instead of their being developed on the basis of distinctive needs, the segments may be developed on bases for which a marketing programme can be undertaken. The market divisions may be based on product criteria rather than reflecting distinctive customer needs. In many cases these groupings do not consist of customers with homogeneous needs and buying behaviour. In the corporate banking sector, some banks divide their customer base in terms of turnover and/or size criteria. This is despite the fact that these businesses talk about the resultant groupings as if they are genuine customer segments; in practice they may fail to delineate between customers in terms of product requirements and buying behaviour. Segments may also be developed on an unsystematic basis, through marketers’ intuition and as a result of customer requests. Also the basis of implementation may not be chosen because it is the most appropriate, but rather because of such factors as the ease of implementation. It should be noted that there can be a dichotomy between the most statistically valid segments and those segments for which an effective marketing programme can be developed.

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There is a distinction between a sectorised view of the market and a segmented view. A sectorised view is one which is based on product criteria rather than on the needs of customers. The latter is a perspective which marketers may prefer to use because it is convenient and easy. Dibb and Simkin (1994) argue that a company’s structure, distribution systems and sales force may limit the practicability of segmentation; they also point out that companies adopt an ad hoc approach to segmentation; for example, they may be motivated by customer requests and the costs of identifying segments may be prohibitive. Industry norms may also limit the extent to which segmentation can be undertaken effectively. The UK car market represents a sectorised view of the market, which is (or has been) segmented by marketers into ‘small’, ‘lower medium’, ‘upper medium’ and ‘large’; these segments may not actually correspond to specific targeted groups of buyers but may reflect a convenient means of dividing up the market. Also in this instance, if the entire car market is geared towards producing and selling products for these sectors it may be difficult for one manufacturer to go against the trend. The sales force of a company may also be geared towards the satisfaction of operational considerations rather than marketing requirements. Salespeople may have territories assigned to them on the basis of geography, rather than type of customer, for example.1 Dibb and Stern (1995) identify some problems with the reliability of segmentation techniques. They consider the validity of segmentation as a marketing tool. They argue that the process of segmentation makes a number of assumptions which could be flawed. They identify three main problems: 1. The market and its boundary may be pre-defined by the marketer and this may not reflect reality (market definition). 2. Segments may not be stable with respect to time or competitor activity.

1

Danneels (1996) gives an explanation of why the ‘normative’ segmentation model presented in the textbooks and some articles may not actually be followed in practice. Dibb and Simkin (1994) also provide some explanations as to why marketers will face implementation problems with segmentation.

3. The process of segmentation itself may change the market’s response to the dimensions of the segmentation technique (market stability). There is an assumption that attitudinal responses correlate with behavioural activity (attitudinal reliability), so there may be problems with interpreting the output of cluster analysis. Moreover, can factor and cluster analysis be relied upon? There are also specific problems with geographic segmentation. None of the above methods will work if it is possible for customers to buy in one market and sell in another; this is also known as personal arbitrage. The ability of the British government to impose high taxes on sales of alcohol in the UK is being challenged by the ability of British drinkers to drive to France and buy relatively cheap drinks, which they bring back to the UK. But there are ways in which marketers can try to overcome individuals’ ability to undertake personal arbitrage. Geographic segmentation can be imposed where, for example, customers will buy a certain product by force of habit. In the UK the steering wheel is on the right-hand side of the car and it is on the left in continental Europe. Cars on the continent tend to be cheaper than those sold in the UK. There is nothing stopping British drivers buying a car on the continent and driving it in the UK. However, it is difficult to drive a left-hand car on British roads so people do not do this. Language can also help the marketer to keep geographic markets separate. In various European countries cigarettes must carry the health warning in the

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language of that country. This means that it is not possible for retailers to buy cigarettes in countries where they are cheap and sell them in more expensive countries. Finally, marketers can control their distribution networks (for example, by not offering warranties on products which have been bought in one country and then taken to another). In a study of segmentation Danneels found that the implementation of segmentation, targeting and positioning did not follow the normative model. He says: In the normative model, segmentation, targeting and retail mix development occur sequentially. It was found that the normative sequence – market segmentation, target selection and retail mix development – is not respected by the apparel retailers in this study. The interview data suggest that a cyclical, as opposed to a sequential, process of adjustment of the retail mix would more accurately reflect actual business practice. This suggests that, in practice, the stages of the sequence are rearranged and repeated. (Danneels, 1996, p. 42)

Process of market segmentation Marketers can go through a concrete sequence of steps in order to identify the major segments in a market: 1. survey stage 2. analysis stage 3. profiling stage. Since market segments change over time, marketers need to analyse their market periodically. It is possible for new competitors to enter a market if they can identify segments previously unrecognised by existing marketers. New segments may be developed by marketers if they recognise that some customers would be willing to pay for a hierarchy of product attributes (benefits) which are different to those offered by existing products. For example, while existing car manufacturers stress benefits of speed and comfort with less emphasis on safety, a marketer may perceive a market segment (parents of children) who would prefer to have safety. There are, however, requirements for effective segmentation. The market needs to be: • measurable • substantial • accessible • distinguishable • actionable. To enable the marketer to evaluate the size of the segment, it must be measurable. Using the example of safe cars, the marketer must be able to measure how many car drivers are also parents of small children. In order to ensure profitability, the segment needs to be large enough (substantial). Nevertheless, a large potential market is of no use if it cannot be reached (i.e. it must be accessible); therefore thought has to be given to the methods the marketer will use to promote and distribute the product. The segment must also be distinguishable from existing segments; otherwise it would be profitable to continue selling existing products to customers. Finally, the marketer should be able to carry out the segmentation exercise (i.e. it should be actionable).

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Market targeting Attractive segments will have the following characteristics: • measurability (easy to measure to determine size, location and content) • accessibility (through some marketing programme) • substantiality (large enough to invest in a marketing programme).

Evaluating market segments There are three main criteria which firms use to assess whether they should target specific market segments. Assessments of size and growth are relative to the size of the firm itself. A small firm may actually prefer a segment which is so small that it is referred to as a ‘niche’ market. However, all companies generally want segments which are growing. Structural attractiveness refers to the inherent long-run profit attractiveness of a market segment. There are a number of factors which influence this: threat of competitive rivalry, threat of new entrants, threat of substitute products, threat of growing bargaining power of buyers and threat of bargaining power of suppliers. Selection of market segments refers to decisions regarding the number of segments which the firm should serve: • single segment: the small car market • selective specialisation: a number of segments are chosen • product specialisation: the same product sells to different segments • market specialisation: different products are sold to the same segment • full market: all customer groups are sold all products they may require. Within full market coverage the firm can undertake undifferentiated marketing or differentiated marketing. The former refers to the same offer being made to all segments and the latter involves the marketer designing different offers for different segments. Mini-case 5.1: Identifying the right customer for Ford’s Ka in France Before Ford could develop a marketing strategy for Ka (a new small car) in France, they needed to determine the target market for the new product. The car industry had traditionally segmented the market into size tiers but Europe’s market for small cars was changing rapidly, prompting significant concerns about continuing with ‘traditional’ sizebased market segmentation. Ultimately the firm decided to target market segments they labelled as ‘freedom lovers’ and ‘attention seekers’. These were customers who were aged between 25 and 35, urban and with a strong inclination towards products and innovation. Once this segment had been identified, additional research showed that these people were heavy consumers of movies and magazines, but watched television much less often than the average consumer. This information had an impact on the choice of advertising strategy, with a focus on cinema advertising. Ford’s advertising agency felt that the market for Ka in France could be segmented on the basis of consumer lifestyles and behaviour. They had identified four attitudinal segments: 1. ‘Freedom lovers’ (described as being outgoing, social and active). 2. ‘Attention seekers’ (innovators, opinion leaders and flashy). 3. ‘Sensible classics’ (responsible, risk-averse traditionalists).

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4. ‘No-nonsense neutrals’ (brand wary, TV watchers, unenthusiastic consumers). The agency had then shown the level of interest each attitude segment had towards Ka. It became clear that ‘freedom lovers’ had the most Ka choosers, whereas the nononsense neutrals had the most Ka non-choosers. The agency felt that the first two groups would be the targets for Ka. ‘Ford Ka, The market research problem’, Cothier, G., M. Christen and D. Soberman (2003); INSEAD Case no. 503-084-1; http://www.ecch.cranfield.ac.uk

Positioning Market positioning is the process of establishing a position for a product relative to its competitors, using the different elements of the marketing mix. The position of a product will be defined by how consumers view it on important attributes. There are a number of different ways in which marketers can differentiate their offering from those of their competitors: product, services, personnel, image. It becomes easier for marketers to promote their differences to customers if these differences are: important to the customers; distinctive; superior to those of competitors; communicable; pre-emptive; affordable; and profitable. In order to see the range of different positioning options open to marketers, consider the washing powder market. You will note that some are sold on the basis of price (they are cheap), others are sold on the basis of performance (they wash whiter), yet others because of their ability to wash at low temperatures (performance). All of these are benefits that customers want. However, because different market segments attach different priorities to whiteness, cheapness and low temperature, manufacturers are able to take advantage of this by offering different products for each segment. So far as cars are concerned, manufacturers offer different models in order to cater for different segments that place varying emphasis on luxury, fuel economy, passenger capacity, speed and a number of other benefits. You should note that in both of the examples above we have said that customers attach different levels of importance to benefits. This means that just because someone attaches importance to luxury does not necessarily mean to say that all the other benefits are now redundant – they just come lower in the list of priorities. As a concept for marketers, positioning is important because it takes for granted that there are other products that people can buy, as well as ours. Looking at the alternatives from the customers’ point of view we need to appreciate that customers will see the alternatives as occupying different ‘positions’, in terms of what they can do, how much they cost and what image they present, for example.

Summary In this chapter we have described the normative approach to segmentation, targeting and positioning and explained the generally defined advantages of this approach to marketers. However, we have also seen that there have been a number of criticisms levelled at STP. We have investigated the nature of these criticisms and the reasons why they may be valid. We concluded that STP may conceptually be a useful tool and

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indeed it may provide managers with some answers to an important problem. However, managers need to recognise the shortcomings inherent in this approach.

A reminder of your learning outcomes By the end of this chapter and the relevant reading, you should be able to: • understand the possible usefulness of segmentation, targeting and positioning to marketing managers • explain the STP process • critically evaluate the arguments in favour of STP and the criticisms levelled against it.

Sample examination questions

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1a.What segmentation variables are most commonly used in consumer marketing? (10 marks)

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If a question was allocated 25 marks in the examination, the weighting for the two parts would be similar to this.

b. How in target marketing would you decide which types of variable are most suitable for segmenting your market? (15 marks) 2a.Explain what you consider to be the advantages of undertaking segmentation. (10 marks) b. Using examples, discuss the problems that firms may face in undertaking segmentation. (15 marks) 3a.Explain the importance of segmentation in marketing. (10 marks) b. In recent times many marketers have found it advantageous to divide markets into smaller and more numerous segments than in the past. What are the factors that are driving this change? (15 marks)

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Chapter 6: Organisational buyer behaviour

Chapter 6: Organisational buyer behaviour Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapter 7. Mitchell, V-W. ‘Buy-phase and buy-class effects on organisational risk perception and reduction in purchasing professional services’, Journal of Business and Industrial Marketing 13(6) 1998, pp. 461–78. Wilson, D.F. ‘Why divide consumer and organisational buyer behaviour?’, European Journal of Marketing 34(7) 2000, pp. 780–96.

Further reading Bauer, R.A. ‘Consumer behaviour as risk taking’ in Cox. D. (ed.) Risk taking and information handling. (Boston: Division of Research, Graduate School of Business Administration, Harvard University, 1967), pp. 22–33. Ben Porath, Y. ‘The F connection: families, friends and firms and the organisation of exchange’, Population and Review 6 (1980), pp. 1–30. Bettman, J.R. ‘Perceived risk and its components: a model and empirical test’, Journal of Marketing Research 10 (1973), pp. 184–90. Boze, B.V. ‘Selection of legal services: an investigation of perceived risk’, Journal of Professional Services Marketing 3(1) 1987, pp. 287–97. Cox, D.F. ‘Risk taking and information handling in consumer behaviour – an intensive study of two cases’ in Cox, D. (ed.) Risk taking and information handling. (Boston, Mass.: Harvard University Press, 1967), pp. 82–108. Derbaix, C. ‘Perceived risk and risk relievers: an empirical investigation’, Journal of Economic Psychology 3 (1983), pp. 19–38. Guseman, D.S. ‘Risk perception and risk reduction in consumer services’, in Donelly, J.H. and W.R. George (eds) Proceedings of American Marketing Association. (Chicago, IL: 1981), pp. 200–204. Hirschman, A. ‘Rival interpretations of market society: civilizing, destructive, or feeble?’, Journal of Economic Literature 20 (1982): 1463–84. Johanson, J. and L.G. Mattson ‘Interorganisational relations in industrial systems: a network approach compared to a transaction approach’, International Studies of Management and Organisation 27(1) 1987, pp. 34–38. Ring, P.S. and Van de Ven, A.H. ‘Structuring co-operative relationships between organisations’, Strategic Management Journal 13 (1992), pp. 483–98. Webster, F.E. and Y. Wind ‘A general model for understanding organisational buyer behaviour’, in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston: Allyn and Bacon, 1991) [ISBN 0205129242]. Williamson, O. ‘The economics of organisation: the transaction cost approach’, American Journal of Sociology 87(3) 1985, pp. 548–77. Williamson, O.E. ‘Transaction cost economics: the governance of contractual relations’, Journal of Law and Economics (1979), pp. 233–61.

Aims of the chapter The aims of this chapter are to: • introduce you to the major topics in business buyer behaviour • explain the notion of risk and how it arises for business buyers • explain the traditionally defined distinctions between business and consumer buyer behaviour and critically examine the validity of these distinctions.

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Learning objectives By the end of this chapter and the relevant reading, you should be able to: • explain the differences between consumer and business buyer behaviour and critically assess the extent to which they are valid • explain the notion of risk for purchasers and how it can arise • describe the different stages of the business buyer process model, the factors that influence the buying process and the individuals who take part in the buying process.

Introduction This topic deals with the purchasing of services and products by businesses and public-sector bodies. Business buying is an increasingly important market. Many companies buy a growing proportion of their product from third parties. Canon, for example, supply printers to a number of computer manufacturers who sell the printers under their own brand name. A number of car manufacturers buy a large proportion of components from independent manufacturers. In this chapter the key differences between consumer and industrial marketing are explained and we then examine the validity of some of these distinctions. This chapter then examines some important aspects of business buyer behaviour, for example, the types of purchases that business buyers can make, the types of people who take part in business purchasing and the major influences on business buyers. For most of this coverage we simply summarise the issues as explained by the main textbook used in this course. However, when we consider the major influences on business buyers, we look at one issue, that of risk, in much more detail. We consider different types of risk and how these influence buyers – we also consider how these arise and how these can be managed. In our discussion of risk we consider concepts that are not covered in Kotler and Armstrong, but are nevertheless very important and examinable. You should also note that they help to set the background for our consideration of customer relationship management, which will be covered in a subsequent chapter. This is because one of the reasons why customers (whether consumers or business buyers) may want to establish long-term relationships with suppliers is because they perceive risk in making a purchase and they feel that a long-term trust-based relationship can help to manage such risk. There is also an article by Mitchell that accompanies our coverage of risk and you should read that in order to help your understanding of the topic. We conclude this chapter by looking at non-commercial types of business buying.

Characteristics of business markets The following are the characteristics of business markets often identified in marketing texts as distinguishing business markets from consumer markets. We will look at each of them in turn and then consider some of the points made by Wilson (in the essential reading) which question some of these distinctions.

Additional needs Industrial organisations’ buying differs from that of consumers because

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they have additional needs, for example, the making of profits and legal obligations to their customers.

Different decision-making procedures There are also more people involved in purchasing decisions and within the organisation there may be formal policies and procedures which are to be followed.1 There is also administrative paperwork associated with the purchasing activity, such as order forms and purchase contracts. It should be remembered, however, that the procedures in any two organisations are unlikely to be the same.

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Webster and Wind (1991) see organisational buying as a decision-making process carried out by individuals interacting with other people in a formal organisation.

Derived demand In industrial markets, demand for goods is ultimately derived, in that it depends on the demand for what the buyers are producing. This means that marketers need to pay attention to the markets served by their customers. Are these markets growing? If they are falling, could this mean a reduction in demand for their own goods and services? Marketers of industrial products can play a proactive role in stimulating derived demand by advertising their product directly to final consumers. For example, the British glass manufacturer, Pilkington, sells the benefits of its high-technology glass to householders. As a result impulse buying is less common and objective criteria are more likely to be used when making purchases. Since demand depends on the health of the customer’s business, it is liable to fluctuate more than is the case in consumer markets. However, demand is also more inelastic (i.e. its cost is often a small proportion of the purchaser’s total cost); for these reasons demand may be insensitive to the product’s price.

Professional buyers Because of the relative high dollar costs of purchasing, the number of people who are affected by the purchases and the technical nature of the purchases made by organisations, the actual purchase process may involve a number of people. As a result of this it will usually take more time than consumer purchasing and involve negotiation and bargaining. Business buying is usually undertaken by professionals who have access to more information than do consumers.

Are the distinctions valid? Wilson (1998) questions the validity of distinguishing between consumer and organisational buyer behaviour. He argues that while the distinction can help with teaching and planning, it limits the development of a generic theory of buyer behaviour. Wilson draws attention to the distinction between organisational and consumer buying on the basis that the former is more rational than the latter. He argues that the differences are more likely to be that of degree, with for example, organisational buyer behaviour being more rational than its consumer buying counterpart. This is in contrast to commonly taught ideas that organisational buyer behaviour is rational and consumer buyer behaviour is not. Moreover, developments in information technology, competition between suppliers and communications have meant that the extent to which consumers can be rational has increased. Wilson says that consumers do not only buy for themselves, where they respond primarily to

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their own perceptions and wishes, but they also buy on behalf of others. He also argues that societal influences on consumers are the corollary of organisational influences on business buyers. Moreover, the distinction is usually made between consumer purchases of impulse goods and organisational purchases of expensive or strategic goods (which would involve many members of the organisation). Between these two types of purchases there are clearly substantial differences in terms of information gathering, for example. However, there will clearly be much less difference between what is for consumers a significant purchase and what is a routine purchase for an organisation. In the routine type of purchase you would expect their behaviour to be more similar. An important question raised by Wilson (2000, p. 782) is ‘why people assume that individuals should behave differently when embedded in the context of one form of organisation (professional) as compared to another (social)’. Other important assumptions regarding organisational buyer behaviour which can be questioned are as follows. Organisational buyer behaviour theories are based on research undertaken in large manufacturing organisations. The practice in other industries, types of organisations (e.g. not for profit) and in different national contexts may well be different. Webster and Wind (1972), for example, developed models that presented the buying process as a series of compartmentalised phases (a linear model), the result of which was a purchase which was satisfactory for both parties. It is argued that these results of empirically driven research were not surprising given the make-up of the respondents not only in terms of the types of organisations that they represented, but also in terms of the individuals who responded, who were professionals and schooled in working within bureaucratic organisations. They were, therefore, more likely to say that their purchasing for their organisations followed a linear and rational path.

Business buyer behaviour In Kotler and Armstrong you will find the following categorisation of different types of business purchase. The simplest is the straight rebuy, which is the routine repurchase of a product which a customer has bought before. A modified rebuy occurs when the purchaser wants to repurchase but with changes to the original specifications (these may include changing the original supplier). A new task occurs when a customer wants to buy a product or service for the first time. The number of people involved in the decision-making will depend on the cost and the complexity of the purchase being made. In an attempt to simplify the purchasing process, buyers may use systems buying, which involves the buying of all of the components needed to perform a particular activity together. This method has obvious benefits for marketers who can sell to customers not just single products, but a complete range of goods. For example, computer manufacturers can undertake initial consultancy work to specify what hardware a customer needs, provide the hardware, undertake the installation and also provide training for the customer’s staff.

Participants in the business buying process For marketers interested in making sales to business organisations, it can be important to understand who it is in the organisation who is

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responsible for making purchases. However, the issue is not that simple and the list below shows the different types of people who can be involved and the roles that they play. People who are involved in the buying process can be described as: • Users – the people who actually use the product or service. • Influencers – people who, because of their expertise, set the specifications of what is to be bought. They may also play an important role because of their political power. • Deciders – people who make the actual buying decision. How important this person is in the buying company’s hierarchy will depend on the importance of the purchase being made. • Gatekeepers – people who control the flow of information within the organisation. These may include secretaries, personal assistants and technical personnel. While they may not be responsible for decision-making, many sales training manuals pay a great deal of attention to the need to build co-operative relations with these important people. • Buyers – people who actually process the purchase orders. Who is involved and to what extent will depend on the purchase being made. For marketers the challenge is to understand the people who comprise the buying centre for their products. It should be noted that in industrial buying, emotional factors can play a role in the purchasing decision. The marketer of corporate jets may seek to appeal to the chairman’s ego as well as the chief pilot’s safety concerns.

Major influences on business buyers Buyer behaviour can be influenced by the economic environment, environmental factors, organisational factors, interpersonal factors and characteristics of the individual. The economic environment plays an important role in industrial purchasing since the outlook for a business’s sales will determine whether or not it should invest in new stock or plant. Organisational factors comprise corporate objectives, policies and procedures. Interpersonal factors are also important and the marketer may not be aware of the internal power structures within the buying organisation. Individuals can bring their own habits and personalities to the buying situation. They may, for example, have a strong interest in technical detail and require a large amount of specifications. Another important factor that has an influence on buyers’ behaviour is the level of risk that they perceive in the purchase.

What is risk? ‘The bearing of risk by an individual is defined as: a situation which may lead to negative consequences and the individual is not able to control the occurrence of such consequences’ (Bauer, 1967). The degree of risk in an exchange depends on the size of the negative consequences of making a purchase and the extent to which the purchaser can control those consequences (also referred to as the probability of something going wrong). The size of the negative consequences can be financial (in terms of the money the purchaser stands to lose) if the purchase goes wrong. However, losses can also be in terms of the time that is wasted and also negative reputational effects. In the context of consumers such reputational effects

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are in terms of what friends and relatives may think of the purchaser if they make a wrong purchase. In the context of organisational buying such reputational effects will be in terms of the impact on the brand if the company buys in products and services that do not perform as expected and thereby have a negative impact on the purchaser’s brand. For example, a risk that Singapore Airlines faced when buying the A380 aircraft was that it would not be delivered on time. The possible losses to Singapore Airlines were in terms of the lost ticket sales and also in terms of the impact on its reputation when passengers would be told that they could not fly when they were expecting to. Correctly assessing that the airline was exposed to these risks meant that the company could draw up a contract at the start of the process which would involve compensation being paid to the airline should the aircraft not be delivered on time. In the area of buyer behaviour, what matters is perceived risk and we will now consider the difference between this and actual risk. Figure 6.1 shows the links between the different types of risk.

Perceived risk

Outcome risk

Consequent risk

Inherent risk (product class level)

Handled risk (brand level)

Factors that contribute to customer perceived risk Asset specificity Intangibility Variation of quality

Figure 6.1: Types of risk

Actual risk and perceived risk Perceived risk is important to marketers since this is what influences customers’ actions. Perceived risk is what the purchaser experiences and this is regardless of the actual level of risk. The issue that arises is whether there is a type of risk other than perceived risk. Of course there may well be an objective, real level of risk, which may be made up of what a customer really has at stake when they make a purchase; and the real ‘scientific/actuarial’ probability of something going wrong. Activity Can you think of examples where perceived risk may have increased regardless of the level of actual risk? Answer When the first poultry with bird flu were found in France, a number of countries stopped imports of French chickens. Their perception of the risks of buying such chickens had gone up, even though the level of actual risk may not necessarily have risen. Perceived risk is risk perceived by the customer and as such directly influences their behaviour. However, perceived risk can be different to the

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actual risk in purchasing a product or service (i.e. customers may perceive more risk than actually exists or they may perceive less). Reducing actual risk is neither a necessary nor a sufficient condition for reducing perceived risk. Neither, in fact, does it follow that reducing perceived risk will only be obtained by reducing actual risk.

Linking perceived risk to other forms of risk Perceived risk is the risk that customers think exists in a transaction. This contrasts with actual risk, which is the real, objective level of risk that exists. Figure 6.1 shows how perceived risk can be linked to other forms of risk. The diagram should be read starting with the box entitled ‘inherent risk’. This section will explain the relationship of inherent, handled, outcome and consequent risk to perceived risk. The relevance of the bottom box will be explained later when we consider the factors which contribute to the amount of risk in a purchase. Inherent risk and handled risk Inherent risk is the level of risk customers perceive at the level of the product class (i.e. some product classes are perceived to be riskier than others). Inherent risk is the latent risk a product class holds for a consumer, the innate degree of conflict the product class is able to arouse (Bettman, 1973, p. 184). Handled risk within a product class will depend on the specific brands being bought: customers will perceive different degrees of risk between different brands (Bettman, 1973, p. 184). Mitchell (1998, p. 463) explains these concepts in the following terms related to the purchase of professional services by organisational buyers: Bettman’s (1973) notion of inherent and handled risk is also important in this context. Inherent risk concerns a person’s risk disposition towards a certain product category (e.g. consultants); while handled risk relates to the level of risk engendered by the employment of a specific consultant. As the purchaser becomes more involved, so inherent risk will be replaced by handled risk as the prime concern and motivator of risk-reduction activity.

When a purchaser makes a purchase, the risk they perceive will depend on two variables: the product class (inherent risk) and the brand within the product class (handled risk). The relationship between handled and inherent risk is as follows: where a customer has no information, handled risk and inherent risk should be the same. Handled risk should rise as inherent risk rises, but should fall as customers’ information about the product class rises and they become better informed about different brands. Other variables which reduce handled risk are the usefulness of the information a customer has about a brand and the confidence with which it is held. Consequent risk and outcome risk As shown in Figure 6.1, there is an alternative means of conceptualising inherent and handled risk. Inherent risk will be the same across all brands within a product class. Similarly, the amount the customer has to lose as a result of making a wrong purchase will also be the same across all brands. However, this will not always be the case and marketers can try to reduce the amount a customer stands to lose as a result of buying their brand. The activity below explains this in more detail. Outcome

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risk is what the customer has at stake. Consequent risk is the probability of something going wrong; this is effectively the same as handled risk and for this reason a line is shown joining the two concepts. Since both inherent risk and outcome risk apply at the product class level, the diagram shows a direct relationship between them. In terms of the options customers have for mitigating outcome risk, they can reduce what they have at stake and in order to mitigate consequent risk they can acquire information in order to reduce the probability of making the wrong decision (Cox, 1967). Thus far customer perceived risk has been shown to operate at two different levels, the product class and the brand; inherent and handled risk, respectively. It has also been shown that risk can be decomposed into two different forms: outcome and consequent. Activity How can firms reduce the level of consequent and outcome risk for their customers? Answer Consequent risk refers to the level of risk at the brand level. A firm can reduce this by, for example, making its products more reliable. This reduces the probability of something going wrong. However, firms can try to reduce what the customer has at stake. This can be undertaken by, for example, offering warranties and guarantees. So if something does go wrong the customer stands to lose a lot less than they otherwise would.

Factors contributing to the degree of handled and inherent risk The discussion of risk thus far has only considered how any specific degree of risk may be represented; we have not considered per se the factors which directly influence the degree of risk. This section deals with the box at the bottom of Figure 6.1: we identify and explain why specific factors can contribute to either inherent risk and/or handled risk. Both an economic perspective and subsequently a marketing perspective are used in the explanation. The value of using the economics-oriented approach lies in its explanation of the relationship between information and risk, and product homogeneity and risk. In Figure 6.1 these factors are listed as: asset specificity, intangibility, variation of quality. The following section seeks to identify why these factors contribute to the level of customer perceived risk (CPR).

Economic approach In order for there to be no risk in exchange, one must adhere to the neoclassical assumptions of the market, namely: • Agents have perfect information and perfect foresight. • Decision-making is rational. • There are large numbers of price-taking anonymous buyers and sellers. (Hirschman, 1982) • There are no carry-over effects from one time period to another of a specific transaction between two parties in the market. (Johanson and Mattson, 1987; Ben Porath, 1980, p. 4) Derbaix refers to this situation as ‘market transparency’ and it leads to: the cognitive capacity of knowing and comparing everything (Derbaix, 1983, p. 1). Social relations either do not exist or, if they do, they are atomised and

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irrelevant (Williamson, 1985, p. 69; Ring and Van de Ven, 1992). If the above assumptions are relaxed, individuals have ‘bounded rationality’: they have a limited ability to acquire and process information. This is one of the reasons why risk will exist for parties to an exchange. The notion of bounded rationality is a handicap to economic agents due to the existence of opportunism. Because of opportunism, agents will disclose incomplete or distorted information to others (Williamson, 1985, p. 47). Asset specificity Where customers make investments which are specific to one supplier (i.e. they cannot be used with another supplier), they are said to be making ‘asset-specific’ investments. Investments can include the training needed to learn how to use certain equipment. If the same skills can be used for different suppliers, then they are not asset-specific. For example, when airlines invest in training for their pilots to be able to fly the aircraft built by a specific manufacturer, they cannot use those skills for flying planes built by another manufacturer – to that extent they have made an asset-specific investment. According to Williamson (1979), it is here that the possibility for opportunism is greatest. Since both parties may be locked into each other, if one of them is opportunistic it will try and expropriate as much as possible from the other party without forcing them to quit from the exchange. This contributes to the level of risk for the customer because should the relationship with the supplier not work, then they will have lost the value of their investment. If assets are not specific then the risk associated with a failed relationship is less, because the same assets can be used with other suppliers. Activity Can you think of examples where you have made asset-specific investments? Answer The purchase of certain types of printer can involve asset-specific investments, where toner cartridges have to be those made by the same manufacturer. This adds to perceived risk, because that manufacturer may charge very high prices for their branded cartridges.

Marketing approach The Williamson conceptualisation of risk was stated in abstract terms above. For example, there is asset specificity. The following discussion seeks to state the existence of risk in terms which can be related to actual management practice. This will enable conceptual definitions to be stated in more operational terms. Variation of quality Customer-perceived variation of quality within a particular business sector can contribute to the perception of risk. Boze (1987) found that there was a relationship between perceived variation in the quality of attorneys and perceived risk. People perceive more risk the greater the variation among lawyers. Bettman (1973) says that, for a particular product class, the greater the number of brands which fall into an acceptable level of quality, the lower the perceived risk associated with that product class.

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Intangibility If perceived risk is determined by the amount that is at stake and the certainty with which consumers can regard the outcome of the purchase as a favourable one, then it ought to be possible to consider different products and services by these criteria. Purchases which are tangible – that can be seen, felt, even used before purchase – ought to have limited outcome risk. On the other hand, with intangible purchases, the customers do not know what they will get until they have made the purchase; consequently, the degree of outcome risk is high. There are other factors which distinguish services and products and which force customers to rely on personal sources of information. For instance, there is no transfer of ownership in the sale of a service; the buyer is dependent on the participation of the seller for consumption to take place. Their ‘in-being nature’ means that services cannot be inventoried. Furthermore, performance standards are more difficult to attain in the production of services. Guseman (1981) has found that services were perceived as having more risk than products and consumers use ‘riskrelievers’ (actions used to allay perceived risk) in different proportions for services.

The business buying process The process of decision-making by buyers is as follows. In the first instance there has to be a recognition by the organisation that a purchase has to be made. Then the need is described, which leads to product specification and ultimately the search for a supplier. Proposals are then solicited and on the bases of these, suppliers are selected. Once the purchase has been made, the performance of the supplier is reviewed. Activity The above is a simple, linear model of business purchasing. Identify some of the reasons why it may not actually work in practice. Answer The individual stages of the buying process may be more relevant to some types of purchases than others. This type of behaviour may also be more applicable to certain types of organisations (large commercial ones) than others. This behaviour may also be more culturally appropriate in some countries than others.

Institutional and government markets The institutional market includes schools, hospitals and prisons. Buying by government departments and the public sector differs from commercial purchasing for the following reasons: their financial resources will be different (usually lower than that of a comparable private organisation); they will be answerable to the government to a higher degree than private-sector organisations. For this reason they may require suppliers to comply with more regulations and complete larger amounts of resulting paperwork than commercial buyers. Usually government buyers require competitive tenders for contracts, so that they can award the contracts to the lowest bidder. However, their choice of supplier may entail employment and other economic considerations as well as price. Political reasons may also mean that governments buy within the country rather than import products.

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Summary In this chapter we have looked at some of the important features of organisational buyer behaviour. We have considered the factors that influence this behaviour and we have looked at the stages that buyers go through when they make their purchases. What we have also done is to enumerate the orthodox distinctions that are drawn between organisational buyer behaviour and consumer buyer behaviour. However, we have emphasised the criticisms that have been put forward against a simplistic assessment of this difference and have shown that the difference can often be one of degree. We have also given some emphasis to the notion of risk, how it arises and how it can affect purchasers. This is an important concept that we will revisit when we consider relationship marketing, since it is one of the major motivations for customers to enter into long-term relationships, particularly those involving trust.

A reminder of your learning outcomes By the end of the chapter and the relevant readings, you should be able to: • explain the differences between consumer and business buyer behaviour and critically assess the extent to which they are valid • explain the notion of risk for purchasers and how it can arise • describe the different stages of the business buyer process model, the factors that influence the buying process and the individuals who take part in the buying process.

Sample examination questions 1. Explain the difference between inherent and handled risk. Why is an understanding of this important for business marketers? 2. What are considered to be the major differences between consumer and business markets? Why is it argued that these differences can be overstated? 3. Identify and describe the situations where business buying can be very similar to consumer buying. Critically assess the differences between these situations and those where business and consumer buying are likely to be very different from each other.

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Chapter 7: Customer relationship marketing (CRM)

Chapter 7: Customer relationship marketing (CRM) Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapters 13 and 14. Ring, P.S. and A.H. Van de Ven ‘Structuring co-operative relationships between organisations’, Strategic Management Journal 13 (1992), pp. 483–98.

Further reading Holmstrom, B. and J. Roberts ‘The boundaries of the firm revisited’, Journal of Economic Perspectives, Volume 12(4) 1998, pp. 73–94. Kotler, P., S.H. Ang, S.M. Leong and C.T. Tan Marketing management – an Asian perspective. (Singapore: Prentice Hall, 1996) [ISBN 0132548976]. Simon, J.L. ‘Optimal allocation of space in retail advertisements and mail-order catalogues: theory and first-approximation decision rule’, International Journal of Advertising 2 (1983), pp. 123–129 (with Vithala Rao).

Aims of the chapter The aims of this chapter are to: • demonstrate the importance of customer relationship marketing (CRM) • highlight four different ways in which transactions can be undertaken • describe the characteristics of each of these and explain when they may be relevant for marketers to use • explain the key account management method as an example of CRM.

Learning objectives By the end of this chapter and the relevant reading, you should be able to: • distinguish between discrete market transactions, hierarchical managerial transactions, recurrent contracting transactions and relational contracting transactions • describe the bases of the differences between the above types of transactions and in particular the different assumptions regarding the marketplace • explain the role of risk and trust in determining the suitability of the different methods of undertaking transactions in different situations • identify which of the above methods of undertaking transactions will be most effective in different situations • apply these concepts to actual marketing situations in order to understand business practice.

Introduction The traditional ‘Four P’ model of marketing (product, place, price and promotion) was developed in the United States post-war era of the 1950s and 1960s where there had been a boom in the manufacture and sales of consumer goods. The underlying assumption of the marketing models

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developed at that time was that firms’ efforts needed to focus on acquiring customers. Limited attention was paid to keeping them. Since that time the level of competition has increased and firms have realised that it can be far more effective to keep existing customers than to expend all their efforts on acquiring new ones. There have been a number of ways that recognition of this has influenced marketing practice. For example, there has been increased emphasis on issues such as segmentation (the recognition that different groups of customers have different needs and therefore require different products). There has also been recognition that corporate success will require not just one-off sales to customers but long-term relationships with them. This is also the reason presented by Kotler and Armstrong (2004) as to why customer relationship marketing (CRM) has become more popular in recent years. The study of relationships needs to take into account that they can exist not just between firms and their consumers (consumer marketing), but also between firms (business-to-business or industrial marketing). As will be seen through the course of this chapter, the nature of relationships will vary significantly depending on who they are with. Relationships between organisations can emerge from their role as buyers or sellers in a business-to-business marketing context, or through strategic partnerships and alliances specifically established to enhance the offering to customers. Most organisations are part of a complex network of relationships – whether they intend to be or not – and relationships may develop through third-party introductions and ‘networking’. In this chapter we will look at the issue of customer relationship management from two different perspectives. First of all we will look at the issues as presented by Kotler and Armstrong – these take a managerial perspective and focus on the methods that marketers can use in order to develop relationships. Although we talk about CRM as one overarching activity, it does in fact cover a range of different activities which vary in terms of the ‘depth’ or intensity to which a relationship is sustained. Therefore we need to distinguish between different ‘types’ of relationships. In the next section we do so in terms of recurrent contracting and relational contracting. Once you have noted the Customer relationship marketing

Relational exchanges Joint ventures Alliances

Recurrent exchanges

Key account management

Figure 7.1: Key concepts difference we will look at a specific technique that can be used in business-to-business CRM, which is referred to as key account management (KAM). This approach to building relationships takes place in stages and you will see how such relationships can start off on a transactions basis and over time become recurrent and then relational.

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So for the purposes of clarity the overall topic of this chapter is customer relationship marketing (CRM). However, within this one of the techniques that firms can use in a business-to-business context is key account management. Under the umbrella of CRM are two major types of relationship: recurrent contracting and relational contracting. Key account management has a number of stages and some of these have characteristics of recurrent exchange, while others have characteristics of relational exchange. We have just seen some of the common arguments as to why CRM has become more popular in recent years. We will then focus on a specific aspect of this explanation. Our focus will be on the concept of risk and the fact that using trust-based relationships becomes more important where risk exists for both customers and suppliers. We will explain how trust can overcome risk and will end with a discussion of how different types of relationships may be required for different marketing situations. Central to the discussion of the latter topic is the seminal article by Ring and Van de Ven (1992), which is highly recommended for this chapter.

Attracting, retaining and growing customers Kotler and Armstrong (2004, p. 16) define customer relationship management in the following terms: ‘overall process of building and maintaining profitable customer relationships by delivering superior customer value and satisfaction’. According to them, developing relationships requires certain building blocks and these are identified as customer value and customer satisfaction. The notion of value is an important one in marketing. It takes into account not only the benefits that a customer enjoys as a result of making a purchase, but also that in making the purchase the customer will have incurred both money and non-money costs – for example, the time and effort that it takes to go out and make the purchase. Value is the difference between the total costs of making a purchase and the total benefits received. For marketers this concept is an important one because they can consider how they can offer customers ‘value’. Some marketers will, for example, add additional features to a product so that it delivers more benefits. If the increase in value is considerably more than that offered by competitors, the marketer may be able to charge a higher price and thereby improve profit margins. Figure 7.2 shows how product, place and promotion can be used to deliver value to customers and marketers can extract profit from the last ‘p’ of the Four P model; price. Activity Write down the ways in which firms can bring value to their customers through product, place and promotion. Product can be used to add value to the marketer’s value proposition by offering a higher level of benefits. Place can be used to add value by, for example, offering more convenience, and promotion can be used to offer value by raising the customer’s perceptions of value (for example, by raising the image of prestige that a product has through presenting adverts featuring well-known actors and actresses) (see Figure 7.2). Prior to making a purchase, customers have expectations about what they are going to buy. These expectations will depend on, among other factors, the marketers’ advertising, that of competitors, as well as the customer’s previous experience of making that purchase. If the purchase meets

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Marketer Product Promotion

Value enhanced via benefits etc

Place Value delivered through e.g. greater convenience

Enhance cutomers’ perception of value

Value

Price Customer Figure 7.2: Deliver value and extract profit expectations, the customer will be satisfied and in marketing terms feel that they have made a quality buy. Satisfaction is important because it can lead to customers trusting the brand that they have just bought and being encouraged to buy it on future occasions. If the purchase does not meet expectations, then the customer will be dissatisfied and may buy another brand next time. This concept is also important in terms of the implications for marketers – they need to ensure that the promises made by their marketing communications can actually be met by their products and services. This argument can be helpful for understanding the concept of quality, which we discuss in Chapter 9. Kotler and Armstrong (2004) also argue that successful companies try to increase their share of the customer – this refers to encouraging existing customers to spend more with them.

Building customer relationships and customer equity Kotler and Armstrong (2004) focus on the idea that developing relationships is a long-term proposition. In this respect they argue that firms should develop high levels of customer equity. This reflects the combined customer lifetime values of all of the company’s customers – hence the more loyal they are, the higher customer equity will be. Kotler and Armstrong recognise that relationships can be maintained at a number of different levels; they range from basic relationships to full partnerships. The principle underlying the concept of different levels of relationships is that firms do not need or want to spend the same amount of time, effort and money developing relationships with all their customers – some customers are more important than others. Similarly, some types of customers will want deeper relationships with their suppliers than other customers. This is a very important issue and we will consider this in far more depth later in this chapter.

Planning marketing: partnering to build customer relationships In order to undertake CRM firms need to practise partner relationship management. This involves working with other company departments and other companies in the marketing system. Within an organisation each department can be seen as a link in a ‘value chain’.

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In addition to looking at the internal value chain, organisations can also benefit from analysing their value chain in terms of the contributions made by other firms with whom they do business. For example, if a firm’s supplier can reduce costs then that can help reduce the purchasers’ costs and make them more competitive.

Using relationships instead of markets or hierarchies Although the discussion so far gives some insights into what CRM is, we do not have a basis for understanding when it should be used and when alternative methods of undertaking transactions may be more effective. In this section we will explore the latter issue in more detail. Williamson puts forward arguments as to why some transactions are undertaken using markets (between independent firms) and others take place in hierarchies (within organisations). If Singapore Airlines has its own in-house catering operation this would be an example of a hierarchical exchange. In a market-based exchange the above example would change to Singapore Airlines buying meals for passengers from a range of independent suppliers. In recent years, however, researchers such as Peter Ring have presented arguments as to why transactions need not just take place in either markets or hierarchies, but using other modes of exchange, such as recurrent or relational contracting, involving networks of firms. These alternatives are characterised by co-operative agreements between firms, where there are repeated transactions between the same buyer and seller. In this respect transaction cost economics is argued to be deficient since it does not take adequate account of such issues as trust and equity in the relationships that firms have with each other. In order to understand the arguments surrounding the decision of whether to use markets, hierarchies or networks it is important to be aware of some important concepts. There are two important behavioural concepts – bounded rationality and opportunism – and two principles of organisational design – asset specificity and externality. Bounded rationality refers to managers acting as economic agents being intentionally rational but only to a limited extent. This is because they are limited by the availability of information and their capacity to process it. This assumption is important because it shows the limits in the ability of an organisation to write contracts that fully protect its interests. Opportunism is defined by Williamson as ‘self-interest with guile’. In an organisation, opportunism can refer to the practice of managers making decisions in pursuit of objectives that are inconsistent with the aims of the organisation. As a result opportunism may increase the cost of transactions carried out within the organisation. Activity The concept of opportunism is important, as it explains one element of cost associated with internalisation of transactions, that is, carrying them out within an organisation. Can you identify examples of opportunism that you have come across? Asset specificity. The issue of transaction-specific investments is an important one. You will find examples in many large organisations where they prefer to undertake those exchanges in-house for which they have to make specific investments. For example, a college may invest in its own classrooms and lecture theatres since these are specific to the business of teaching and cannot be used for anything else.

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Externality describes the pursuit of private goals by an agent. For example, retailers (agents) may have business objectives that are different to those of the brand owners (principals) whose products they stock. There have recently been cases of supermarkets wanting to sell branded fashion goods at high levels of price discount, which the brand owners have opposed since it would compromise the image of the brand. The problem arises because of the difficulty in writing a contract that adequately protects the interests of the supplier. The characteristics of market-based transactions are as follows. The buyer will be interested only in price since it is also assumed that suppliers sell goods that are homogeneous (the same as each other). Buying from a supplier in one time period is no guarantee that Singapore Airlines will go back to the supplier in future time periods. So such exchanges are described as being a relatively short-term, bargaining relationship between highly autonomous buyers and sellers. The contracts are described as being ‘sharp in and sharp out’. This means that it is clear to both parties what the costs and benefits of the exchange will be in money terms. Also when the deal finishes, that is the end of the matter; there are no further obligations of either party to the other. There are no social relations between parties and the state enforces contracts. If there are disputes these are resolved within the organisation. Before we deal with recurrent and relational contracts we’ll briefly look at the advantages of markets versus hierarchies. This will also help to highlight the advantages of relationship marketing. Because of bounded rationality, many contracts with external suppliers, under market governance, may be sub-optimal. It is impossible to write long-term contracts that still properly reflect the interests of both parties – we simply cannot cover the range of possibilities that far ahead. This is particularly true for organisations operating in a rapidly changing environment. Exclusivity clauses or minimum purchase requirements in distributor contracts are examples of marketing contracts that can easily become unfair if marketing conditions change. Under circumstances of uncertainty, hierarchical governance (i.e. carrying out activities in-house) may offer an organisation greater protection and control than reliance on the market. Most organisations choose to do certain activities in-house even if it may be possible, at times, to purchase the good or service more cheaply from outside. This is particularly likely if the activity is vital or of strategic value to the organisation, and if the consequential cost of non-availability or poor quality would be high. Where a transaction involves a high level of asset specificity, the risks are likely to be lower under hierarchical governance. Most organisations want to keep their most skilled and experienced staff on their payroll rather than contract for these skills or experience from outside firms. It is unlikely, for example, that a research-based chemical company would be prepared to rely on the market to supply PhD chemists on a contract basis. Externality is a particular risk in the area of distribution and reliance on market governance can lead to loss of control. You can probably see examples when you go shopping where the interests of the shop owners are different to those of the brand owners whose products they are selling. There are costs associated with hierarchical governance. You may be familiar with situations where large organisations are criticised for their

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‘bureaucracy’, and issues such as motivation and incentive can also become a problem. You should note though that concepts such as ‘internal marketing’ have also been developed in order to address these problems; these will be discussed briefly in Chapter 9. In this section we present the idea that customer relationship marketing is a concept that fits in a wider discussion that distinguishes between transactions being undertaken in markets, within hierarchies or using some form of relationship, either relational or recurrent. This distinction between markets, hierarchies and relationships is important because it identifies the important assumptions underlying each mode of exchange and helps provide an understanding of when the different types of exchange will be more suitable than others. This is an important issue because sometimes students can gain the impression that ‘relationship marketing’ is ‘superior’ to other modes of transacting and should be preferred at all times. This is not the case. Reading the Ring and Van de Ven (1992) article is essential for this part of the chapter; we highlight the key arguments, but you will find their detailed explanations useful. Ring and Van de Ven (1992) argue that there has been a tendency to emphasise that exchanges will take place in either markets or hierarchies. They deal with what they refer to as ‘recurrent’ and ‘relational’ contracting. Both of these types of exchange are alternatives to markets and hierarchies and they make use of trust, which is useful where risk exists in transactions. Recurrent contracts are described as repeated exchanges of assets that have ‘moderate degrees of asset specificity’; this means that there is a limited extent to which the assets are specific to that particular exchange – for the marketer this means that they can be used in exchanges with other customers. Relational contracts tend to involve long-term investments. The property, products and service may be jointly developed and exchanged and these will involve asset-specific investments. Also the nature of the exchange may be impossible to specify or control in advance. Disputes are resolved through internal negotiation in order to ensure that equity and efficiency outcomes are recognised. You should note that Ring and Van de Ven often refer to the type of contract law that would be applicable in different types of exchange – that discussion is beyond the scope of our interest and you should not study it in detail. Activity Identify some situations where you believe the following are observed: • market-based transactions • hierarchical transactions • recurrent transactions • relational transactions. Explain the reason for your choices. The sale of petrol at a motorway service station is an example of a market-based transaction. The product to be sold is fairly homogeneous, the two parties to the transaction are unlikely to see each other again, and the price is similar to that charged by other retailers and transparent. Once the transaction is completed there is nothing tying the two parties together.

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Ring and Van de Ven (1992) make some important assumptions regarding the role of risk and trust. Organisations face the following types of risk. Commercial risk refers to the probabilities of finding commercial niches in the marketplace. Technological risk refers to the probability of bringing technology to the market. Engineering risks refer to the probabilities of whether or not a technology will work. Ring and Van de Ven (1992) assume that risk will rise proportionately as time, information and control decrease. As far as trust is concerned, they say that some element of trust will be required for any transaction. Furthermore, trust is likely to be built up over time as firms and people develop reputations for their conduct. The relationship between risk and type of relationship can be summarised in the following way: 1. Where risk of a deal is low and there is low reliance on trust firms will use market-based transactions. 2. Where risk of a deal is high and there is high reliance on trust firms will use relational exchanges. 3. Where risk of a deal is high and there is low reliance on trust firms will use hierarchical exchanges 4. Where risk of a deal is low and there is high reliance on trust firms will use recurrent exchanges. In summary, in market-based transactions, levels of risk are likely to be low and as such the need to trust the other party is likely to be less. The notion of control, or power, is explained in more detail in Chapter 12 of this subject guide. Activity Think about the previous activity and in particular consider whether the market-based transaction undertaken by the petrol company could be changed by the petrol company in order to make the business more profitable. You should consider real-life examples to illustrate your answer. Some of the ways in which firms have sought to overcome the homogeneity of petrol is to use additives and market the offering as something superior to ordinary petrol and thereby worthy of the premium charged for it. Thus they have made a homogeneous product heterogeneous and as a result sought to make customers more loyal – i.e. make their custom ‘recurrent’. Another method used by retailers has been to introduce loyalty cards; here customers have an incentive to keep coming back to the same retailer because they are given points with each purchase. The more points they have, the more they can spend on special gifts. Such activity has also encouraged ‘recurrent’ buyer behaviour. In this instance customers also have a certain level of ‘sunk investment’ in the relationship, since a few points on the loyalty card may be useless and more have to be collected in order to be redeemable. Market-based transactions are shown as those where there is a low amount of risk and a low amount of trust. This is because there are a number of different suppliers from whom the customer can make their purchase. Trust is not so important because the courts of law will be adequate to resolve any problems. Nevertheless, firms can establish trust in such transactions by not behaving in an opportunistic manner. Where risk is high but levels of trust are low, firms will use hierarchical modes of undertaking exchange. Here firms will perform the risky tasks themselves. Other ways of achieving the same results as a hierarchy are

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through acquisitions and mergers and the creation of joint ventures. The need for trust in exchange partners is reduced since the firm will either undertake the exchange in-house, or it will develop a business structure that enables the exchange to be undertaken in-house to some degree. Where the risks of the deal are low, but the reliance on trust is high, it is argued that recurrent transactions will be used. Such transactions allow both parties to build up trust in each other by demonstrating the extent to which they will reciprocate and how equitable they are willing to be in their transactions. There are situations where the risks of the deal are high and the reliance on trust is also high. Such situations will have high levels of asset specificity and uncertainty. It is argued that instead of using hierarchy in such situations, as transaction cost economics suggests, firms can instead use informal, socially embedded personal relationships. Such relationships will produce stable relations of trust, obligation and custom amongst firms that are formally independent. It is also pointed out that given the high levels of risk that exist in such transactions, high levels of trust are necessary. Moreover, firms will need to develop safeguards between themselves by which they will mutually abide, because they see their interests as converging. Ring and Van de Ven (1992) also point out that this reliance on trust also means that firms need not worry if any contracts between them do not cover all eventualities. Relational contracting is particularly suited to situations where firms use their resources to undertake joint research and development or product development. There are lots of examples of contracting from around the world which have characteristics of recurrent and relational contracting. • In Japan, manufacturing firms traditionally use contractors to carry out activities even where highly specific assets are involved. These practices feature long-term, close relationships with a limited number of independent suppliers that seem to mix elements of market and hierarchy. Long-term relationships substitute for ownership in protecting specific assets. This pattern, which is at odds with transaction cost theory, is enabled by the long-term, repeated nature of the interactions. • Alliances can be an attractive source of governance in some industries. In the airline industry several airline ‘blocs’ are emerging. These offer scale economies in reservations, route management and support operations. Integration (hierarchical governance through takeover) is generally not feasible because of regulations and anti-trust objections, and alliances therefore present an alternative. (Source: based on Holmstrom and Roberts, 1998) • Guanxi (good relations or connections) are used in Chinese society in order to underpin business relationships and refer to family-like links that individuals can have with each other. Such trust-based links can be very useful in environments where there is a lack of rule of law and transparency in rules and regulations. (Kotler et al., 1996)

Key account management (KAM) In recent years, key (or strategic) account management has become increasingly important for many companies. A variation of the Pareto principle is relevant here because it is argued that 80 per cent of current or potential revenues come from 20 per cent of customers; as a result,

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firms may need to focus on that 20 per cent in order to improve performance. As a result of mergers and acquisitions in a number of different industries, the final customer is becoming larger for many suppliers. Production and distribution processes that rely on ‘just-in-time’ management, where goods arrive at the customers’ facilities at the time they are needed and not before, has also required purchasers to develop long-term relationships with a smaller group of suppliers. The key account management (KAM) concept shows how firms can develop relationships over time. At the company level the firm will have to define the criteria it uses to identify strategically important customers and it will need to identify existing and potential accounts that fulfil these criteria now and in the future. At the individual level the seller will need to identify the people holding the power to continue or terminate the relationship and the persons listened to by the key decision-makers. Activity What criteria do you think a firm should use to identify key accounts? Answer The criteria are: sales volume, use of strategic resources, age of the relationship, the supplier’s share of the customer’s purchases and profitability of the customer to the supplier. Also important are the growth rate of the customer’s market and the buyer’s relative share of the customer’s purchases.

Complex

SynergisticKAM PartnershipKAM Mid-KAM

Simple

Level of involvement with customers

The stages that firms can go through in order to implement KAM are shown in Figure 7.3.

EarlyKAM

Collaborative

Transactional Pre-KAM

Nature of customer relationship

Figure 7.3: Developing key accounts • Pre-KAM. No interaction between the seller and the buyer, but the seller identifies the buyer as being a good prospect. • Early-KAM. Transactions established, but the seller is one of many. The number of contacts between the two companies is limited and trust has not developed yet. • Mid-KAM. Trust has developed and commitment has increased. The selling company has become a preferred supplier. The selling organisation’s ability to meet key account needs can be developed by

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adjusting the organisational structure to correspond with the key accounts’ global and local needs. • Partnership-KAM. The buyer and seller will be sharing highly sensitive information and will work jointly to solve problems for mutual gain. • Synergistic-KAM. ‘You cannot see the join’: borders between the companies have become blurred and quasi-integration is evident. These are some of the factors that firms need to take into account when considering the attractiveness of KAM. Information technology used in just-in-time production and distribution channels increases the possibility of customising the offering in consumer markets as well. Information exchange is particularly important in KAM as an important relationship specific task is to search, filter, judge and store information about the organisations, strategies, goals, potentials and problems of the partners. Human capabilities are also important and the right people need to be selected as key account managers and allowed to develop the right set of skills. They need to consider the size of the partner, the potential to them in terms of profit margins, the extent to which the relationship and sales can grow and finally the risk the organisation runs when it develops the relationship. Amongst the risk factors are, for example, the extent to which the organisation will become dependent on a single customer and the extent to which investments sunk into the relationship could be used with other customers. The higher the extent of the latter, the less risk the organisation is running. Mini-case 7.1: Introducing KAM at some other company (Soco) Soco is a major multinational company in the data processing and computer equipment field. Soco has three divisions which are centred on specific business activities. Each division is represented in the countries in which Soco operates. Soco realises that it serves a number of companies across a number of different countries as well as having more than one division cater to their needs. For this reason Soco is considering establishing global key account management. The customers that would qualify as key accounts would represent 50 per cent of total turnover. Four, threeperson teams co-ordinated by the key account director would become responsible for a total of 40 accounts. Each team would be responsible for 10 accounts and the basis on which the accounts are divided would be according to broad groupings of financial services and banking, general manufacturing industry, hi-tech industry and other. Key account managers will liaise with people within each division as well as representatives from Soco country offices. These people may be hierarchically above them and perhaps located in another part of the company with different objectives and motivations. For historical reasons, in some countries some of Soco’s products have been distributed by locally based distributors. They have had privileged relationships with customer units, and they have tended to jealously guard information. As part of the move towards KAM, Soco intends to drop the use of distributors, indeed the company hopes that the adoption of KAM will allow it to penetrate markets better than was previously the case. One of the companies which will qualify as a key account is Delta, which is a major firm in the international aerospace market. The company designs projects and the actual production is sub-contracted to other specialised firms in the industry. For reasons of image Delta has to demonstrate that it is at the leading edge of technology in all its

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fields; these considerations outweigh those of price in purchasing decisions. Soco supplies Delta’s international subsidiaries. It was originally appointed on the basis of its technological prowess in integrated systems. But Delta found that having bought a new type of system from Soco, it had problems both at start-up and subsequently during operations. Delta international subsidiaries have very good relationships with Soco’s distributors in a number of different countries. While in terms of turnover Delta will be one of the smallest key accounts in Soco’s KAM portfolio, it is critical that it serves as a test-bed for new product try-outs and has considerable reference value. Recently relations have become strained, with several promises not having been kept by Soco. There is virtually no contact between Soco and Delta’s head of projects. Soco has therefore no idea of factors influencing its behaviour regarding neither computer material nor its present equipment. Activity Read Mini-case 7.1. What benefits could accrue to Soco as a result of this move? Where vendors initiate a global account programme for strategic reasons, their motivation is to increase their share of the customer’s business (for example, by penetrating country markets where their share of the customer’s business has been low because of local factors). As well as savings in operational costs there can be savings via collaborative development and R&D cost sharing. This is particularly the case for companies with a high level of investment in development, long development cycles and markets with short product life cycles. Soco can beta-test new products or services in real life and on a larger scale than their own facilities permit. Transactions cost analysis arguments • Bounded rationality – there is only a limited extent to which customers can know and understand the nature of the work that they do with Soco. A KAM relationship built on trust will help to overcome the problem of bounded rationality. • Uncertainty – asset specificity: the nature of the business means that asset-specific skills and resources are developed by both organisations. Therefore it pays for them both to try to develop long-term relationships with each other. • Externality – a KAM relationship would also mean that the ability of any one party to act opportunistically would be reduced. What problems would Soco encounter if this move is undertaken? Soco risks upsetting the distributors that it currently uses and thereby it risks losing the access to the market that they provide. If it continues to work with the distributors then it may need to pay commissions twice over. In the case of Soco’s relationship with Delta, we know that there has been a problem with delivery up to now, so Delta may be sceptical about a KAMtype relationship. Also, starting a relationship given the problems that exist could be difficult. For Delta developing a deeper relationship with Soco may mean cutting off links with local distributors, and managers responsible for those ties may not like this. If the relationship reaches a large proportion of Soco’s turnover, there may be an issue of dependence. For buying companies such as Delta the risks are that there could be an increase in cost (from effort duplication and/or substitution of cash for activity by having the supplier add some of the value that the customer could have added themselves).

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Sales commissions can also increase as Soco has to pay commissions to both global account teams and local sales teams.

Summary In this chapter we have seen that relationship marketing can take different forms and this distinction is important to appreciate because firms in different situations have differing needs. We have also seen that relationship marketing exchanges are alternatives to market-based transactions and hierarchies. We have also seen that the relevance of each mode of exchange depends on the assumptions that are made about the marketplace. Central to the role and importance of relationship marketing exchanges (recurrent and relational) is the role of personal relationships and the use of interpersonal trust. These two important features play a much more limited role in market-based exchanges and hierarchies.

A reminder of your learning outcomes By the end of this chapter and the relevant reading, you should be able to: • distinguish between discrete market transactions, hierarchical managerial transactions, recurrent contracting transactions and relational contracting transactions • describe the bases of the differences between the above types of transactions and in particular the different assumptions regarding the marketplace • explain the role of risk and trust in determining the suitability of the different methods of undertaking transactions in different situations • identify which of the above methods of undertaking transactions will be most effective in different situations • apply these concepts to actual marketing situations in order to understand business practice.

Sample examination questions 1. ‘Relational contracting is the ultimate form of relationship marketing; it is the goal towards which all firms should aspire.’ Critically discuss this statement. 2. Explain, using examples, the differences between relational and recurrent transactions. Critically assess why they may be used in different situations. 3. A computer manufacturer is investigating the possible use of relationship marketing. Using the concepts from the subject, explain the different ways in which relationship marketing could be used with both consumers and business customers. 4. Critically examine the differences between market-based transactions and recurrent transactions and explain why market-based transactions may actually be preferred in some situations.

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Chapter 8: Introduction to promotion and advertising

Chapter 8: Introduction to promotion and advertising Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapters 15 and 16.

Further reading Adman, R. Morris Hite’s methods for winning the ad game. (Dallas, Tex.: E-Heart Press, 1988) [ISBN 0935014128]. Black, M. and D. Greer ‘Concentration and non-price competition in the recording industry’, Review of Industrial Organisation 3 (1987), pp. 13–37. Jagpal, P. Marketing under uncertainty. (Oxford: Oxford University Press, 1999) [ISBN 0195125738]. Levinson, J.C. Guerrilla advertising: cost-effective techniques for small-business success. (Boston: Houghton, 1994) [ISBN 0395687187]. Simon, J.L. ‘Optimal allocation of space in retail advertisements and mail-order catalogues: theory and first-approximation decision rule’, International Journal of Advertising 2(1983), pp. 123–129 (with Vithala Rao).

Aims of the chapter The aims of this chapter are to: • present you with a fuller treatment of promotion beyond the obvious forms such as commercial advertising • make you aware of the importance in distinguishing the prevalence of advertising and its effectiveness in motivating consumers to buy or to switch brands.

Learning objectives By the end of this chapter and the relevant reading, you should be able to: • discuss what is meant by promotion and the promotional mix • describe the various types of promotional techniques and tools • explain how firm advertising expenditures are affected by variables such as market concentration and the price elasticity of demand.

Useful web sites http://www.marshallmcluhan.com/marchand.html A web site dedicated to the influential communications professor, Herbert Marshall McLuhan (1911–1980), and his observations and theories of media and advertising.

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Introduction In this chapter we will examine what is often considered by outsiders to be the concept most often associated with marketing – promotion. Promotion in turn is also synonymous with a single term – advertising. But in fact, as we have learned already, promotion is but one part of the firm’s overall marketing mix and advertising is but one component of a firm’s promotional mix (or what Kotler and Armstrong (2004) sometimes refer to as the communications mix). Promotion only occurs in a society in which the act of production is separated from the act of consumption. A Robinson Crusoe-style economy (i.e. one full of self-sufficient producer consumers) does not need advertising. Why? Because either the producer or the consumer is the same person, or, if it is a barter economy, every act of production has to produce a reciprocal act of consumption, that is, by definition you must trade what you produce with someone else. Thinking of more primitive market societies where everyone is a producer/consumer, it is easy to see that every act of production necessitates an act of consumption. The economic circuit is not broken and supply creates its own demand. But once we separate acts of production from consumption, and suddenly some people have capital to start a business and other people are paid a wage, promotion has to step in to ensure that we are buying goods that are produced by someone else. The purpose of promotion could be just to provide information about where to buy goods, their quality and attributes. Or, as is often the case, promotion could be there to persuade us to buy something we otherwise would not. This chapter will not attempt to replicate or distil the Kotler and Armstrong approach, which is focused on the design of a proper marketing communications mix for the firm. Instead this chapter will attempt to explain some important phenomena observed in the field regarding the promotional and advertising behaviour of firms. It will end with a discussion of how firms have tried to counter the decline in the effectiveness of formal promotional techniques with new strategies and media (e.g. guerrilla marketing).

What is promotion?

1

Advertising is salesmanship mass produced. No one would bother to use advertising if he could talk to all his prospects [potential customers] face-to-face. But he can’t. (Morris Hite, quoted in Adman, 1988 p. 203).

We can answer the question above in a negative way, by stating what promotion is not. It is not advertising, as advertising is but one form of the promotional mix. Other promotional mix tools include sales, public relations, personal selling and direct marketing. These are explained and defined in greater detail in Kotler and Armstrong (2004, p. 467). The term ‘mass marketing’, which one often hears used in the popular press, is again a bit of a misnomer because it refers only to mass promotion or communications, which typically involves the promotional tools of advertising, public relations and sales. The key to making the promotional mix effective is the implementation of an integrated marketing communications strategy, whereby a ‘firm carefully integrates and co-ordinates its many communication channels to deliver a

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1

Those of you who have studied Elements of social and applied social psychology will recall that Chapter 12 deals with attitude change and persuasive communications. Some of the broad principles covered in that chapter can clearly help with an understanding of marketers’ choice of marketing communications. Although this course does not presume that you have a detailed knowledge of the models presented in that course, the material in Chapter 12 has some important links with the coverage of marketing communications in this course.

Chapter 8: Introduction to promotion and advertising

clear, consistent, and compelling message about the organisation and its product’ (Kotler and Armstrong, 2004, p. 469). The purpose of promotion can vary from the most basic case of informing consumers of a product’s availability to overt persuasion in the case of an aggressive sales force. In fact there are four clear purposes associated with promotion: 1. Informational promotion: designed to inform buyers. 2. Persuasive promotion: designed to translate minor ‘wants’ into major ‘needs’. 3. Reminder promotion: maintaining top-of-mind awareness in the consumer’s mind. 4. Anti-competitive: designed to create a barrier to entry for potential new entrants. Often the purpose of advertising varies according to which promotional mix tool is used. Advertising, for example, is often associated with persuasive and anti-competitive purposes. Another factor affecting the message of a promotional campaign is the medium, to use a term made popular in the 1970s by a University of Toronto professor of communications named Marshall McLuhan (1911–1980). The medium refers to the form (or technology) used when communicating with a target audience. For example, using a print medium to communicate with your customer is often good when you have something detailed to say. In an electronic medium such as television, a firm has only 15 seconds or less to make an impression on the audience, and hence the message is usually an abbreviated one, which is heavy on visuals and emotional reactions rather than on complicated content. Each category of the promotional mix, therefore, has its own specific tools and medium. In advertising, which we will be examining in greater detail below, we have the following tools or media available: • electronic media: radio, television, Internet • print media: newspapers, magazines, flyers • visual media: billboards, signs, aircraft signs, plans to advertise in space • guerrilla media: ‘culture jamming’ (originally an anti-advertising movement and also part of the environmental movement Greenpeace). Despite the growing cost of advertising and much evidence that the effectiveness of mass promotional marketing tools such as television ads are declining in today’s fragmented consumer markets (Kotler and Armstrong, 2004, p. 467), the study of advertising is an important concept in its own right, especially because we as consumers are surrounded by mass advertising.

Advertising: some theory and evidence We try to keep a very high share of ‘voice’ in the marketplace to maintain the ability to charge a price that is higher than competition because most of our products sell at a higher price than competition. (August A. Busch III, CEO, Anheiser-Busch, Inc.)

Recall that in the first chapter we spoke about the context in which ‘general marketing policies’ operate. We argued that perfectly competitive

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market structures leave little or no scope for any ‘marketing mix policies’ (e.g. pricing policy, promotion, distribution). For example, if all consumers consider all brands of a product as perfect substitutes, the optimal advertising budget is zero for any given brand. There is of course one exception to the above conclusion. The exception is the case where all firms in an industry advertise collectively to increase demand. This type of advertising is said to increase primary demand. This occurs in the case of the milk industry, where milk producers pool their resources and decide to advertise collectively (see Mini-case 8.1). According to a recent study, this activity is highly beneficial to the industry. Mini-case 8.1: Milk industry advertising works to make dairy farms strong and healthy Milk may do the body good, but generic milk advertising keeps dairy farms healthy by beefing up the bottom line. ‘It’s clear that dairy farmers benefit from the presence of the National Dairy Promotion and Research Board (NDPRB). Generic advertising of milk impacts on farm prices and producer revenue in a positive way,’ said Harry M. Kaiser, Cornell Associate Professor of agricultural economics. ‘Taxpayers also benefit because government purchases of dairy products are significantly lower.’ Kaiser’s study, ‘An Analysis of Generic Dairy Promotion in the United States,’ was funded and published by the National Institute for Commodity Promotion Research and Evaluation (NICPRE). Kaiser is co-director of NICPRE. There are many generic milk campaigns sponsored by the NDPRB; for example, their new ‘Milk, Help Yourself’ campaign replaced ‘Milk. It Does the Body Good.’ The board also helps to sponsor the dancing snacks – showing up on evening television as they suggest, ‘Let’s go out to the kitchen…’ Dairy farmers are receiving a relatively high return on their investment from advertising, Kaiser learned. He also found that dairy producers could earn more money by investing more in fluid milk advertising and less in dairy product advertising. ‘The reason for this is dairy farmers receive a higher price for milk made into fluid products, rather than for milk made into manufactured products,’ he said. For every 100 pounds of milk marketed in the United States, dairy farmers pay a mandatory 15 cents to finance a demand-expansion programme. These assessments – which can top $200 million annually – are guided by the Dairy and Tobacco Adjustment Act of 1983. Its purpose: drive up milk demand, improve dairy farmer income and reduce the surplus milk purchased by the federal government. So far, that strategy has worked. Kaiser’s economic models show that between 1984 and 1993, the presence of the NDPRB resulted in a 1.2 per cent increase in fluid milk demand and a 14.3 per cent increase in the retail fluid milk price. Generic milk advertising also showed positive impacts on other dairy products. For example, butter’s demand rose 1.4 per cent and there was a 3.8 per cent higher retail price. While Kaiser’s analysis showed a reduction in government purchases of butter and cheese, there were no increases in wholesale prices of butter and cheese due to the NDPRB. Of all the dairy products available to be promoted, fluid milk is the one that moves the most when it is directly connected with advertising. ‘It had the highest response to generic advertising of any of the other dairy products,’ said Kaiser. The prices of other dairy products also rose when generic advertising generates consumer interest, but the increases are not as dramatic as fluid milk. In contrast, prices for retail frozen dairy products increased by a meagre 2 per cent, cheese by 4 per cent and butter by 2.8 per cent. When a firm or brand manager advertises to increase demand for his/her brand by differentiating that brand from other brands, the purpose of this advertising strategy is to increase secondary demand. Since we live in a world of monopoly and imperfect competition is the norm (see Chapter 11 for more detail), we will focus on this latter form of demand and advertising strategy.

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The link between advertising and sales What is the relationship between advertising and sales? That is an important question since ultimately a firm only allocates resources to advertising in the hope that it will generate sufficient revenue to compensate for the expenditure. The answer to the above question begins with the following argument. Assume that the firm has already made its pricing decision (see Chapter 11) and now has to decide how much to spend on advertising. Most formal advertising is used for low-involvement products (see Chapter 4). Given that consumers have a low involvement to begin with, they are passively awaiting advertising signals from the firm. Advertising in this instance has a ‘threshold effect’ with respect to sales. The threshold effect is that unless a consumer is exposed to an advertising message with a minimum frequency, the message does not get stored in the consumer’s long-term memory and advertising is virtually useless. Activity Consider the case where advertising works subliminally or unconsciously. Does this change the implications above? If advertising expenditure exceeds the threshold level, then advertising becomes productive and marginal returns to advertising increase (e.g. each additional dollar of advertising adds more to sales volume than the previous dollar). This is sometimes represented by the advertising elasticity formula: Advertising elasticity

=

% Change in sales % Change in advertising budget

When the elasticity of advertising is greater than 1, the marginal return to advertising is positive and firms continue spending money on advertising. As advertising increases beyond some point, diminishing returns set in and the advertising elasticity falls. This is because the firm has already reached the most attractive segments of the consuming public (i.e. those with a greater likelihood of purchasing the product), and so the firm begins to target less attractive segments. Also, if the firm targets the same consumers over and over again with increasing frequency this has little marginal effect on sales. Indeed one can even envisage a ‘negative oversaturation’ effect (e.g. existing consumers stop buying the brand and the sales–advertising relationship may actually turn negative). The advertising–sales relationship under these conditions is as shown in Figure 8.1. Sales volume Backlash

Advertising expenditure Threshold

Figure 8.1: The relationship between advertising and sales

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In summary, our simple discussion of advertising has thus far yielded the following implications: 1. Under conditions of perfect competition, the industry as a whole may still find it attractive to advertise to increase primary demand. 2. Firms in a monopolistic setting advertise to differentiate their brands and so focus on building secondary demand. 3. The advertising–sales relationship is highly non-linear because of threshold effects (a certain amount of advertising expenditure will never penetrate the market immediately) and varying marginal returns to advertising.

How much should firms spend on advertising? In the above discussion we assumed that pricing and advertising decisions were made separately and that the pricing decision occurred first. For various reasons such hierarchical or sequential decision-making can lead to serious errors. Both price cuts and advertising are designed to increase demand, but their effect on consumers differs. But let us suppose that the firm chooses pricing and advertising decisions optimally. The so-called Dorfman–Steiner (D–S) theorem states that the following relationship between advertising expenditure and sales revenue holds: Advertising expenditure Sales revenue

= advertising elasticity |price elasticity of demand|

The formula states that advertising expenditure, relative to sales revenue, is equal to advertising elasticity over the absolute value of the price elasticity of demand. In other words, if advertising elasticity is equal to 2, then for a given price–advertising combination, sales volume will increase by 2 per cent if advertising expenditure increases by 1 per cent. The same applies for the price elasticity, only that the elasticity is reversed; a price elasticity of 2 means that sales volume increases by 2 per cent following a 1 per cent decrease in price. Thus, the D–S theorem shows that price sensitivity depends on advertising and advertising sensitivity depends on price. Firms obviously want price sensitivity to be low but advertising elasticity to be high. Three implications arise from this simple model. The first and most important implication of the above model is that the advertising-to-sales ratio is positively related to the advertising elasticity (intuitively, the more productive advertising is, the more that is spent on it relative to sales revenue). The second important implication is that the advertising-to-sales ratio is inversely related to price elasticity. This also makes sense (see Chapter 11) as the more elastic price is with respect to demand, the less likely advertising is to be effective as there are likely many substitutes for the product. A third implication of the model relates to new products (see Chapter 9). For new products, there are likely to be fewer competitors and hence price sensitivity should be low. Given the non-linear advertising-to-sales relationship, advertising should be effective because consumers are learning about the new product. Both effects – that is, the lack of competition leading to low price elasticity and high advertising elasticity – reinforce each other and so the ratio of advertising expenditure to sales revenue is high. As the brand progresses over time, however, the market becomes more and more saturated as potential substitutes increase, so

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price sensitivity increases as well. Also, advertising media become ‘noisy’ as many other brands compete for advertising space. So advertising elasticity becomes low. Consequently, we expect that the advertising-tosales ratio will fall over the life cycle of a brand (see more about product life-cycle theory in Chapter 10). Activity For a new brand introduction, price sensitivity should be low (due to the lack of competitors). a) Does this necessarily imply that a firm should ‘exploit’ this low price elasticity by choosing an initial price that is very high? b) What kind of advertising message should accompany a new product introduction and how should it interact with the pricing decision?

The link between advertising and sales in a dynamic setting In the previous examples we implicitly assumed a one-period advertising–sales relationship in that consumers did not have a memory of advertising. Consumers either have seen an advertisement or not, and once they see it they quickly forget. Nerlove and Arrow developed a model (N–A) based on the observation that advertising has carry-over effects, because of the advertising goodwill or, in modern parlance, the brand equity (see Chapter 9) created by the exposure to a brand image. The model can be easily represented using some simple algebra. Let G denote the advertising goodwill (brand equity) at time t, price p, and advertising expenditure A. Let D be the demand at time t, so that demand is a function, f, of goodwill and price D = f(G,p) and G0 denotes the advertising goodwill at time 0. Assume that demand D increases with goodwill and that the returns to goodwill are strictly diminishing (meaning that they fall smoothly with time). . The rate of change of goodwill G is the sum of two effects (again because of current advertising and a loss caused by the decay in goodwill): . G = A – ΩG, where Ω is the constant proportional rate at which goodwill depreciates over time. For additional information see Jagpal (1999, p. 153). The point of the N–A model is the following: it shows that the D–S theorem holds even if advertising has a carryover effect. If goodwill is too low, the firm increases advertising as rapidly as possible in order to attain an optimal level. If advertising goodwill is too high, the firm advertises as little as possible until the optimum goodwill is reached. In the special case of a new product (G = 0) with no goodwill, N–A implies that advertising should be very high during the introductory phase of the life cycle. Once the optimal goodwill is reached, only maintenance advertising is required. Activity These models, though interesting, do not tell a brand manager/firm about when they should stop or start advertising. Can you cite examples of where firms got the timing wrong, either advertising for too long, stopping too soon, or waiting too long to begin recouping goodwill? In a variant of the above approach, the so-called pulsating model of optimal advertising timing, the question is whether advertising expenditures should be evenly distributed over a given time period or concentrated in limited bursts. The latter policy is known as pulsing

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(see Simon, 1983). One form of pulsing is the following: spend £100 in period 1 on advertising; £150 in period 2; and then £0 in period 3. The rationale for this approach is that advertising steadily without discontinuities may move consumers to the point of message saturation too quickly (as seen in Figure 8.1) and hence by pulsing, advertising can take advantage of accumulated goodwill and also remain on the most productive portion of the advertising-to-sales curve for longer. The assumption underlying the pulsation strategy is that advertising has a much stronger dynamic carryover effect amongst consumers and therefore does not require constant investment in advertising. Activity There are a number of other rationales (mainly psychological) for why pulsating may be more effective than a continuous model of advertising expenditures. Can you think of any?

Strategic promotion: how advertising can affect competitive balance in the marketplace We saw above that advertising can be profitable because it can enlarge sales volume or permit price increases. But we also saw that advertising costs money, hence each firm had to answer the question of how much to spend on advertising relative to its sales in order to maximise profits. A simple theoretical answer assumed that there was an optimal advertising to sales ratio based on advertising and price elasticities: Advertising expenditure = advertising elasticity Sales revenue

|price elasticity of demand|

Advertising-to-sales ratio

Let’s look closer at the lower term on the right-hand side. That is known as the price elasticity of demand, which is actually made up of another fraction (% ΔQ) / (% ΔP). The greater the price elasticity, the lower the firm’s advertising outlay relative to sales. The converse also applies. Because a firm’s price elasticity of demand is a positive function of how much market share2 it has, this discovery leads to a simple theory connecting market concentration to advertising intensity at market-wide

Non-linear hypothesis

B Linear hypothesis

Perfect competition

Oligopoly

Monopoly

Concentration in an industry Figure 8.2: The relation between advertising and market concentration

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2

The percentage of total sales in an industry accounted for by a firm in that industry.

Chapter 8: Introduction to promotion and advertising

levels. As a firm’s market share rises, its demand curve becomes more and more like the market-wide demand curve and thereby becomes less and less elastic. Hence rising market share might be associated with rising advertising expenditures for the market as a whole. And rising market concentration might likewise be associated with rising advertising–sales. Think of the extreme case of perfect competition discussed in Chapter 2: with the price elasticity being infinitely high, advertising expenditure relative to sales will be driven to zero. This yields the ‘linear’ hypothesis, with advertising intensity and market concentration positively related throughout their range (see Figure 8.2). But there are many empirical examples of where this relationship does not hold up. And just looking at the assumptions there are problems: managers often do not have precise estimates of the effect of advertising and price variation on sales. Moreover, the unstated assumption that rival firms maintain a constant advertising expenditure is not realistic. What one firm does will affect the behaviour of others, in advertising as well as in price. This interaction is illustrated by the estimate that, on average, a 1 per cent increase in tobacco advertising provokes a 1.12 per cent increase in advertising of competitors.

Advertising and concentration: the non-linear hypothesis A non-linear relation between advertising with respect to sales and market concentration seems more tenable. The implication is that advertising in relation to sales will not be highest where concentration is highest (i.e. monopoly), but rather where concentration is moderately high, such as point B in Figure 8.2. To see how the non-linear association between market concentration and advertising expenditure can occur, let us examine each range of the curve. • The positive range: Apart from falling individual firm price elasticity, there may be a trade-off between price and non-price competition as concentration rises. At low levels of concentration, price competition seems pre-eminent. However, at moderate levels of concentration, firms begin to see the financial dangers in price rivalry. A shift to non-price competition through promotion occurs. The reason is simple: price collusion is much easier to monitor than non-price collusion. • The negative range: When concentration reaches high levels we expect advertising to fall for two reasons. Ever higher concentration makes tacit or explicit collusion (in non-price activities) more and more feasible. Higher price levels implied by higher concentration starts to raise the industry’s price elasticity of demand and lower the advertising-to-sales ratio (see Mini-case 8.2). Mini-case 8.2: Lever Brothers dirty dealing in the soap industry An excellent historical example of the collusive effect of concentration on advertising resides in the British soap industry at the turn of the nineteenth century. At the time, the Lever Brothers Company had 20 per cent of the market for soap. Firms in the industry were spending an inordinate amount on advertising to compete with each other. So in 1906 William Lever (1851–1925) openly tried to organise a cartel, arguing ‘that some measures must be adopted by the leading soap-makers to allay the fierce competition that has arisen…to terminate the frenzied competitive advertising which was daily becoming more intolerable’. This had an inadvertent effect on newspapers, who after

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receiving their first advertising contract cancellations, began attacking the ‘soap trust’ in their editorials and the companies were forced to stop. William Lever, however, soon alleviated his frustration by acquiring one competitor after another in the soap industry so that by 1920 his company had 71 per cent of the industry. Advertising expenditures declined concurrently.

Advertising as a partial cause of concentration The case above shows how concentration can affect the advertising outlays of firms in an industry. But sometimes even when firms achieve a dominant position in the marketplace, they still advertise highly. This is what we referred to before as anti-competitive advertising. Advertising expenditure is meant to create a barrier to entry to thwart rivals from entering the market. Most barriers to entry are of the ‘static’ variety, such as large economies of scale (see Chapter 11) because if you can overcome upfront start-up costs then you can compete in an industry (e.g. Airbus entering the market once dominated by Boeing; it could do this because of huge start-up financing by the European Union). But how does a potential new entrant overcome a competitor’s brand equity or stock of advertising goodwill? These are called dynamic barriers to entry, so-called because they take time to build up, and are often harder to quantify and overcome than static barriers. Studies in the United Kingdom of the new entry reactions in consumer goods markets find significant advertising escalations in response to new entries in those markets by the incumbent firms. Another interesting fact is that sharp advertising outlays often occur more frequently in stagnant markets than in rapidly growing ones. And dominant firms (those with market shares over 30 per cent) were much more likely to react aggressively than others. This helps explain why high concentration is associated with relatively low frequencies of successful new entries by incumbent/challenger firms.

Techniques other than advertising that follow the same non-linear profile Variations in differentiation effort other than advertising follow a nonlinear pattern as well. Complete non-linear patterns have been found in: • services (in the United States private healthcare industry – the number of nurses per patient’s bed) • excess capacity (which could be a proxy for speed of service, but which may also reflect entry deterring efforts) • product proliferation (when you produce many differentiated versions of the same product such as in cereals or cars). The last of these patterns is the most interesting. Two excellent examples are: • food products: product proliferation reaches a peak at concentration levels of 60–70 per cent in the food industry with cereals, alcoholic beverages and pet foods among the top product launchers • music industry (see Mini-case 8.3). Mini-case 8.3: Product proliferation in the music industry In the late 1940s and the 1950s, the dominant companies such as CBS and RCA Records released serious and rather sedate music. The rise of rock’n’roll music in the 1950s was left to small independents such as Sun Records and Atlantic, which

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introduced artists such as Elvis Presley, Jerry Lee Lewis and Ray Charles. The independents were successful and by the early 1960s concentration in the record industry had fallen markedly (measured by the share of chartered hits accounted for by the big-four leading firms). The major companies reacted by ‘covering’ or copying successful ‘indie’ records with their own artists, and eventually innovating on their own. Thus the lower concentration ratios and increased competition resulted in much more product diversity for consumers. In particular there was a greater number of different records reaching the weekly top ten of Billboard during 1962, 1963 and the other years of lower concentration. However, once the major labels beat out the ‘indie’ labels and recovered their dominance during the 1970s and early 1980s, concentration climbed, and new record releases by the industry fell substantially, down 45 per cent for LPs and 18 per cent for cassettes. In short, other marketing activities of the firm often follow the same pattern as that of formal advertising, in that marketing efforts appear to peak under oligopolistic market structures. Activity What other cause(s), drawn from demand analysis or segmentation analysis, can we give for the rise and fall of independent label market power?

How do firms attempt to counter the declining effectiveness of traditional advertising? As pointed out by Kotler and Armstrong (2004, p. 498), ‘Good advertising messages are specially important in today’s costly and cluttered advertising environment…One expert estimates that the average person…is exposed to about 5,000 ads a day.’ So how do firms cut through the clutter? One-way is to use unconventional methods of promotion such as guerrilla marketing.

Guerrilla marketing: history, definition and examples Guerrilla marketing can be broadly defined as unconventional promotion intended to get maximum results from minimal resources. This type of marketing uses highly unorthodox, and sometimes barely legal, strategies for reaching precisely targeted prospects. It can be used to promote not only products, but also concepts and values. Coined by Jay Conrad Levinson, guerrilla marketing is more about matching wits than matching budgets. Guerrilla marketing can be as different from traditional marketing as guerrilla warfare is from traditional warfare. Rather than marching their marketing dollars forth like infantry divisions, guerrilla marketers snipe away with their marketing resources for maximum impact. What is important to note is that what we perceive as conventional today was at one time unconventional and, similarly, what is unconventional today becomes conventional somewhere else. If we take the case of the formal advertising and graphic visual ads, the use of sexually or emotionally charged imagery to sell goods and services is commonplace today. But at one point, this type of advertising represented a break from the past and in a sense was guerrilla-like in that it was unconventional. If we examine advertising in the nineteenth century, it was very informational and heavy on content. It was also mostly designed in-house, meaning that no external advertising agency3 was involved. However, by the early twentieth century, companies had begun to purchase the services of advertising agencies, which in turn

3

A firm that specialises in promotion for many external clients and assists companies in planning, preparing, implementing and evaluating all or portions of their advertising programmes.

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used talented visual artists to come up with attention-grabbing advertisements to cut through the clutter of life. And it worked. An advert for Coca Cola in 1920s’ America pictured a young attractive woman in hair curlers. Of course we are no longer shocked at the sight of a woman in hair curlers, blushing and drinking Coca Cola. But remember the context when it appeared (1920s America). Today, of course, guerrilla marketing techniques are much more extreme than a mildly suggestive advertisement. The pioneering work in modern guerrilla marketing was done not by an advertising agency or a private company, but by a group of environmentalists in the 1970s who were concerned about what was happening to the environment. The group was Greenpeace and it was they, rather than the advertising industry, that began to use unconventional techniques to generate attention and promote their agenda of animal rights and a safe and healthy environment. Greenpeace began by attempting to shift the attention of the news media to their causes by staging dramatic public events and inviting the news media to come and watch. In some cases they would try to board fishing boats and whaling ships in the Atlantic Ocean with a small rubber raft. At other times they would try and stop seal hunters from killing baby seals by first spraying the seals with non-toxic paint so as to make their fur useless on the market. In every case, they generated free publicity for their cause by inviting the media along to film their activities. Were these guerrilla techniques a success? Judging by the fact that they are now the most powerful non-governmental organisation (NGO) in the world, the results speak for themselves.

A reminder of your learning outcomes By the end of this chapter and relevant readings, you should be able to: • discuss what is meant by promotion and the promotional mix • describe the various types of promotional techniques and tools • explain how firm advertising expenditures are affected by variables such as market concentration and the price elasticity of demand.

Sample examination questions 1. Explain why it is important for firms to have an integrated promotional/communications campaign. 2. What does the term ‘guerrilla marketing’ mean? 3. Why is it necessary to use unconventional promotional techniques in today’s marketplace? 4. Should every firm spend huge amounts on advertising and promotion? Explain your answer.

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Chapter 9: Branding and product development

Chapter 9: Branding and product development Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapters 9 and 10.

Further reading Berry, L.L. ‘In services, what’s in a name?’ , Harvard Business Review, September/October 1988, pp. 28–30. Berry, L.L. ‘Services marketing is different’ in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston, Mass.: Allyn and Bacon, 1991) [ISBN 0205129242]. Berry, L.L. and A. Parasuraman Marketing services. (New York: The Free Press, 1991) [ISBN 002903079X]. Davis, H.L. ‘Service characteristics, consumer search and the classification of retail services’, Journal of Retailing 55(3) Fall 1979. Durgee, J.F., G.C. O’Connor and R.W. Veryzer ‘Observations: translating values into product wants’, Journal of Advertising Research Nov/Dec 1996, pp. 90–9. Ghobadian, A., S. Speller and M. Jones ‘Service quality: concepts and models’, International Journal of Quality & Reliability Management, 11(9)(1994), pp. 43–66. Guseman, D.S. ‘Risk perception and risk reduction in consumer services’, in Donelly, J.H. and W.R. George (eds) Proceedings of the American Marketing Association (Chicago, IL.: 1981), pp. 200–204. Halstead, D., C. Droge and M.B. Cooper ‘Product warranties and post-purchase service’, Journal of Services Marketing 7(1) 1993, pp. 33–40. McDougall, G.H.G. ‘The intangibility of services: measurement and competitive perspectives’, Journal of Services Marketing 4(4) Fall 1990. Olson, J.C. ‘Cue utilisation in the quality perceptions process’ in Venkatesan, M. (ed.) Third Annual Conference of the Association for Consumer Research. (Chicago: Association for Consumer Research, 1972), pp. 167–79. Rokeach, M. The nature of human values. (New York: The Free Press, 1973) [ISBN 0029267501]. Shimp, T.A. and W.O. Bearden ‘Warranty and other extrinsic cue effects on consumers’ risk perceptions’, Journal of Consumer Research 9(1) 1982, pp. 38–46.

Aims of the chapter The aims of this chapter are to: • explain the role of quality in marketing • highlight the importance of branding; the role of values within branding and the branding decision • distinguish between branding decisions and those to do with managing the product line • describe the new product development process • explain service characteristics and why these may not fully distinguish services from products • identify some of the issues surrounding managing services.

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Learning objectives By the end of this chapter and the relevant reading, you should be able to: • describe the meaning of the term ‘product’ and the elements associated with it • explain the importance of quality for products and how it can be assessed • critically assess the conceptual problems associated with managing product lines and brands • describe the new product development process • distinguish products from services and the problems associated with doing this • explain problems faced by marketers in managing services and how these problems can be addressed.

Introduction In this chapter we will focus on some of the issues linked to the recommended reading. The reading in Kotler and Armstrong is generally selfexplanatory and does not require additional discussion; for that reason we will focus on specific issues that do require additional explanation and discussion. The specific issues that we will consider in more depth in this chapter are as follows (you should note, however, that all of the topics in Kotler and Armstrong (2004) in the essential reading are examinable). First, we will consider in more detail the notion of ‘quality’ as it is applied to products. Then we will consider the different meanings the term can have and why an understanding of quality is important to marketers. We will then move on to consider what we argue are the related issues of product line management and brand management. This discussion touches upon the issue of launching new products and we will develop this theme further in the next topic, which deals with new products. The final topic in this chapter deals with services marketing. We will start that discussion with the distinction between products and services; again you will note that Kotler and Armstrong present this in a straightforward manner, but once the issues are examined in more detail they are clearly not as simple as they may appear at first. The final topic that we will consider will be the management of services and the methods that marketers can use in order to achieve this.

Quality in marketing The reasons for the importance of quality in marketing can be traced back to our previous discussion about expectations and satisfaction, which we saw were crucial for marketers being able to develop long-term relationships with customers. As we shall see below, quality can mean ‘conforming to requirements’ (i.e. meeting expectations and for that reason if marketers can develop and sell quality products and services they may be better able to meet expectations and thereby develop relationships with customers). Perceived product quality is defined as the perceived ability of a product to provide satisfaction relative to the available alternatives. Customers’ perceived quality of a brand depends on the perceived quality of competing brands. Perceived quality depends on, for example, personal factors such as involvement, prior knowledge and the individual’s level of education. This

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is an important point because it highlights the idea that for the same product two different people may perceive different levels of quality and the reason for the difference could be their ‘prior knowledge’, which could include such factors as the extent to which they had been exposed to competing products in the past. Figure 9.1 shows the relationships between quality, expectations and satisfaction; some of these issues have been considered in more detail in Chapter 7.

Past Experience

Exposure to marketing mix

Satisfaction: It was a Quality purchase

Customer’s Expectations

Purchase Experience

Exposure to competitors’ marketing

Dissatisfaction: It was not a Quality purchase

Figure 9.1: Quality: a customer view Activity Take a minute to think about the word ‘quality’. Write down what you understand it to mean. What we have asked you to do is, in effect, to come up with a working definition of the word ‘quality’. It would be particularly interesting to compare what each of the many people undertaking this activity has written. Each person will probably have written something slightly different. However, it is likely that your definition falls into one of the following categories. Perceived This approach is based on a view of quality as innate excellence. Quality is ‘something that you know when you see it’. So a Rolls Royce can be recognised as a quality car. Similarly, Wedgwood is perceived to be quality pottery, and a Rolex is a quality watch. Such superior quality can be identified by its look, its touch, its feel and so on. Where a service is involved, judging quality may rely on even more ethereal criteria, like the atmosphere in a restaurant. Product-based This approach views quality in terms of superior product attributes that can be designed and precisely measured. Quality is seen as a measurable set of characteristics. Thus the quality of a car can be determined by its performance as measured by its top speed, its acceleration, its fuel consumption and so on.

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User-based This approach sees quality as fitness for use from the customer’s perspective. Thus this is based on a marketing view that customers ultimately decide what quality means. However, particularly in mass markets there can be a danger that an individual customer’s view may run counter to any collective view obtained by aggregating all customer views. Operations-based This approach sees quality in terms of conformance to a specification of a product or service. In this way, quality is achieved if all activities are carried out right first time and error-free. Thus any product can be considered to be a quality product if it conforms to its specification. Value-based This approach modifies the user-based approach by introducing the notion of cost or price into the consideration of quality. Quality is thus considered to be the best value for money for a given purpose. Different customers may be prepared to accept a product offering with a lower specification if the price is low. The success of budget airlines, like Easy Jet or Ryanair, stems from the fact that many travellers are quite happy to forgo the higher levels of service provided by traditional airlines. Being able to afford to travel to their desired destinations is far more important to them than complimentary food and drink, in-flight entertainment, executive lounges and so on. The categories of quality, above, are based on Ghobadian et al. (1994). Activity Which of these approaches to quality would you expect to find in a marketing-oriented company? And what are the limitations associated with each of them? The product-led approach would probably be associated with a productoriented organisation and the process-led approach with a production-led organisation. A marketing-oriented company would probably follow the customer-led approach to quality.

Intrinsic and extrinsic cues To conclude this discussion of quality, we should also consider the ways in which consumers assess the levels of quality in different products and services. How does a customer tell whether they have bought a ‘quality’ product? Physical product characteristics are referred to as intrinsic cues; they cannot be changed without changing the physical product itself. Nonphysical product characteristics are referred to as extrinsic cues (e.g. price and warranties, brand name, country of origin, store name). Extrinsic cues are particularly important when a product’s intrinsic cues have low confidence and predictive values (i.e. in the case of intangible products/services where customers cannot tell how the product/service will perform, they will tend to depend on price/warranty and other cues (Olson, 1972)). For utilitarian products (everyday items which are not bought for image or fashion purposes) intrinsic cues are more important; for image products, extrinsic cues are more important. So for fashionwear stores, their image plays an important role. An extrinsic cue available to marketers is warranties. Warranties can help reduce customers’ perception of risk by offering them the possibility of redress when the product/service does not perform to expectations. This

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may be particularly important where the inherent risk is great (Shimp and Bearden, 1982). However, it has been said that warranties can lead to expectations of greater product/service quality, increased value and enhanced post-purchase service (Halstead et al., 1993).

Branding There are a number of different ways in which brands can be identified, from a name to a symbol. The reason why branding is used is to enable the marketer to differentiate their product from the competition. In order to understand the role of branding, you should consider the difference between an unbranded product and a branded one. With the former there are no means of knowing who made it, and if you want to buy the product again you do not know who you could go back to. When a product is branded the marketer is explicitly identifying itself. Because of this, branding enables promises to be made by the marketer, for them to be fulfilled, and for trust/loyalty to be established. Once this happens the marketer can benefit from repeat sales. So branding is the foundation for relationship marketing. As part of the differentiation of its brand from those of competitors, marketers can make use of the fact that brands can communicate values and personality to the customer. The notion of ‘values’ used here is very important and we will now examine it in more detail. First of all we will look at a definition of the term ‘value’, but from a wider social science perspective. A value is an enduring belief that a specific mode of conduct or end-state of existence is personally or socially preferable to an opposite or converse mode of conduct or end state of existence. (Rokeach, 1973)

What this definition is saying is that if we believe that a specific mode of conduct or end-date is preferable to the opposite and that belief lasts for a long time, then it is a ‘value’ that we hold. For example, we may believe that the importance of education is preferable to the opposite (valuing leisure time) and this may be a long-term belief. As a result, we could describe it as a value. For marketers it can be important to understand the values of their customers. In societies where the values emphasise the importance of education, the marketing of educational services and products will be relatively more successful than in societies where such values are held less highly. Brand values are guiding principles (i.e. what the brand believes in) but they will only distinguish a brand from competitors if they are unique. This discussion highlights the fact that the concept of values is not specific to brands, but to consumers and to whole societies. Individual brands therefore need to make sure that their values are consonant with those of the societies in which they are being sold. We will develop this idea below when we consider core and peripheral values. Brand values are important because they can be considered by consumers to reflect their own, personal values. According to Durgee et al. (1996, p. 90), ‘Marketers are interested in values because they are thought to influence behaviour.’ Research has been undertaken, for example, into whether Ford owners had more conservative values than Chevrolet owners. Recent approaches by researchers have sought to ask consumers about import product attributes and then consumers are probed (for example, by asking why those attributes are important) until the researcher finds out the values the consumer associates with that product.1

1

Those of you who have studied Elements of social and applied psychology will recall that Stockdale et al. (82:2005) discuss the ‘functions of the self’. This topic has an important link with marketing, because as Stockdale points out, ‘beliefs about the ideal self reflect a person’s hopes or wishes as to how they might or could be’. In social psychology one of the purposes for understanding the function of the self is to assess the impact on individuals of differences between the actual self and the ideal self. A possible result of such differences can be social anxiety. In marketing, the reason for understanding the function of the self is to see how it impacts on individuals’ consumption of brands, for example.

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Added values augment an offering from a commodity to a brand and differentiate the brand from competitors. For example, the British aircraft engine manufacturer Rolls Royce says on its web site that its brand values are ‘reliability, integrity and innovation’. Added values can be emotional and/or functional. Rolls Royce’s added values are ‘24 hour services support’ (which is a functional value) and the confidence that it inspires in customers (which is an emotional value). See Figure 9.3. You should note that an organisation can have core and peripheral values (see Figure 9.2). The former remain constant while peripheral values are susceptible to change, depending on changes in the marketing environment. Hewlett Packard’s core value of providing customers with technically superior products and services has remained unchanged, whereas its peripheral value of sharing success with its staff had to adapt when the organisation moved into the computer market and needed to recruit specialist staff externally rather than promoting from within.

Figure 9.2: Core and peripheral values Our definition of a brand talks about relevant added values. This repeats the importance of being marketing oriented (i.e. the added values should be relevant to customers and not necessarily to marketing managers). Values also need to be sustainable, but it has become increasingly difficult to sustain for a significant amount of time the uniqueness of a brand’s functional added values (Figure 9.3). The airline market provides a good example of the problem of sustaining functionalism. For example, an airline launches more comfortable beds, only for another to follow suit soon afterwards. In contrast, it is more difficult to copy a brand’s emotional added values. While there are many high-quality academic institutions, the emotional added values associated with the brands ‘Oxford University’ or ‘Cambridge University’ are much more difficult to copy. This is partly because of their long history and consistent reputation over that time.

Figure 9.3: Values and branding

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Branding decisions One of the branding decisions marketers need to make is the extent to which they use the same brand name across different products.

Existing New

Brand Name

Brands enjoy customers’ trust. The further that trust can be stretched, potentially the more profitable this can be for the company. However, there are limits to which customers will accept such ‘brand extensions’. Brand extensions work on the principle of ‘stimulus generalisation’. Customers make the same response to slightly different stimuli. Success depends on relevance of the new product to the marketplace image of the brand name. The greater the similarity between the primary product and the brand extension, the greater the transfer of positive evaluations to the new product. We are more likely to trust finance company HSBC’s brand name when it is extended to new financial services than if it were extended to a new clothing range.

Line Extension

Brand Extension

Multibrands

New Brands

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New

Product Category Figure 9.4: Brand strategies Figure 9.4 shows the different strategies that a firm can pursue in order to grow the business in terms of how it manages the brand and/or the product categories in which it competes. These two variables are the focus of analysis in this model. The first option that we will consider, a line extension, is the top lefthand quadrant. Here the firm is using an existing brand name and launching a product within an existing product category (i.e. a product category in which it has previous experience). One of the ways in which we can consider the attractiveness of the different options is in terms of their ‘riskiness’ and that is what we will do here. This option is argued to be relatively less risky than the others for the following reasons. The firm knows what customer reaction is to the brand name; it knows the amount of trust the brand name enjoys and also how competitors react to it. In short, the firm has a lot of information about how the brand name ‘works’ in the marketplace. In addition, the firm knows the product category into which the new product is to be launched, it knows the customers and competitors and it knows how to manage the elements of the marketing mix. Assuming a stable marketing environment, given all these ‘knowns’ regarding the brand name and the product category this option is considered to be relatively less risky than the others. Of course the potential for sales and profits may be limited for other reasons, such as the fact that the new offering may be so similar to existing products that the firm sells that any sales of the new product are

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at the expense of the firm losing sales of existing products, also referred to as ‘cannibalisation’. Activity Based on the previous discussion, how would you assess the riskiness of the ‘new brand’ option in Figure 9.4? When a firm launches a new brand name in a new product category (one in which it has not previously made sales), it has launched a ‘new brand’. This is a relatively risky option because the category is new to the marketer, as is the brand name. The firm has no previous experience in selling in this new category nor does it know whether the new brand name will be popular with customers. The firm and its managers therefore have two important areas which are totally new to them, and the chances of making a mistake are correspondingly high; that is the reason why this option is considered to be relatively risky compared with the other three options.

Existing

Market penetration

Product Development

New

Market

Looking at the options the marketers face in terms of their riskiness is useful because, as we shall see, a similar analysis can be undertaken with another model widely used in marketing when considering firm growth strategies. The product/market expansion grid, or Ansoff matrix, is usually associated with marketing strategy, but we refer to it here because it helps to emphasise the importance of considering risk, trust and information when considering strategies for growth.

Market development

Diversification

Existing

New

Product Figure 9.5: Product market expansion grid Figure 9.5 shows the Ansoff matrix. This model shows that a firm can grow by either innovating its products and/or the markets that it serves. As with the branding model, the top left-hand quadrant has the option where both variables (product and market) remain the same – the company carries on doing what it has done before and this option has relatively low levels of risk because the firm focuses on what it knows (where it has information). In contrast, the ‘diversification’ option is relatively higher risk because both options (product and market) are new and the firm may not have experience in either of them. Of course with both models what greatly influences the riskiness of each option is the marketing environment. For example, if there are strong competitors entering an industry, a strategy of innovating may be less risky than one where nothing at all is done. Having looked at the conceptual similarities in both models we can also

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draw attention to common weaknesses. These weaknesses are centred on the definitions that are used for the terms in each model. In the brand strategies model, how do you define ‘product category’? If we take extreme examples to illustrate the model, the ‘problem’ does not appear to be a significant one. For example, when the computer manufacturer Apple launched an mp3 player this was clearly a new category for the company, since its experience was in manufacturing personal computers. Moreover, the brand name ‘iPod’ was clearly different from the Macintosh range of computers that Apple sells. A case could therefore be made that this was an example of a ‘new brand’. However, when Singapore Airlines launched a new budget airline with a new name DragonAir, could that also be described as a new brand? The situation here is not as clear. Clearly the brand name is new; DragonAir is different from Singapore Airlines. However, is the product category, ‘budget airline’, really that different to a full-fare airline? Can it really be described as a new category or simply a development on an existing one? This is where a model such as this one has limitations, since the categories which it identifies do not always appear to be mutually exclusive. Also in the real world it is possible to find examples that do not neatly fit into the four quadrants. So what does this discussion tell us? It shows that the models that have been developed are limited in terms of usefulness. This also has important conceptual implications for students since it highlights the importance of understanding why some examples are more applicable than others and it also shows the importance of understanding the reasons why. This issue also highlights why your example for illustrating individual concepts should be carefully made, since you should try to exemplify the concept with an example where there are no ambiguities. As we will see in the discussion regarding the distinction between products and services, often the ‘labels’ that textbooks use can be arbitrary, but what is important are the bases for the differences. So far we have presented the argument for one of the key topics to be discussed in this chapter. In the next section the broad subject matter of managing the product/brand will continue but we will examine the issue of how two seemingly different models relate to each other. This is an important topic because, as a result of the discussion, we will see how two different perspectives on a specific issue give two different insights. We will now move on to the related issue of managing the product line. As we’ve mentioned, Kotler and Armstrong (2004) deal with this topic separately to the brand management topic, though some of the issues overlap. With the brand management model that we have seen earlier, the issue is how a firm manages new/existing brands when it launches products in new/existing categories. The focus of that model is to highlight the options facing the firm. What we have also seen is that the model can be used to understand the different types of risks that the firm faces with the different options open to it.

Branding and managing the product line In the brand strategies model we saw how growth for the firm was considered in terms of whether it should enter into new product categories and/or use new brand names. Kotler and Armstrong present another model in the same chapter that deals with managing the product line. A product line is defined by Kotler and Armstrong (2004, p. 288) as, ‘a group of products that are closely related because they function in a

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similar manner, are sold to the same customer groups, are marketed through the same types of outlets, or fall within given price ranges’. The argument is that within an individual product line marketers can make decisions regarding its length by either ‘stretching’ or ‘filling’ it. Kotler and Armstrong present the advantages and costs of the different options that marketers face, and you should read about these in the set text. What we want to do here is to draw your attention to the idea that decisions to do with the product line length are similar but subtly different to decisions in the brand strategies model dealing with line extensions – where within an existing product category a firm was working with a new brand name. In the brand strategies model the multi-brand option made no reference to whether or not the new brand was more or less prestigious compared with existing brands. In the product line model there is an emphasis on prestige, with a downward stretch being considered to be a move downmarket and an upward stretch considered to be a move upmarket. Product-mix decisions are to do with the range of different product lines that an organisation has on offer. The ‘width’ of a product mix refers to the number of different lines that an organisation carries. There are also decisions related to the product line depth. The focus of analysis with product mix decisions is to do with consistency, and how closely related the product lines are in terms of production requirements, distribution channels and so on. The major point of distinction with the brand strategy model is that the latter emphasises reputational issues and whether or not consumers will appreciate a high-fashion brand such as Gucci being applied to a range of different consumer goods. So what’s the benefit of this discussion? What should be clear is that there are two separate models in the same chapter of Kotler and Armstrong and they deal with similar issues. However, the problems that they address are subtly different and for that reason the choice of model becomes important when faced with a marketing problem.

New product development For the marketing-orientated firm the marketing department plays a key role in the development of new products. There are two ways that a firm can offer new products to its customers. It can either acquire the products from other companies or it can develop them itself. There are different degrees to which new products are innovative: they can be original, improved, or modified. The categorisation used by Booz Allen is: • new-to-the-world • new product lines • additions to existing product lines • improvements in revisions to existing products • repositionings • cost reductions. Only 10 per cent of new products are new-to-the-world. The remainder are essentially developments of existing products. One of the reasons for this relatively low level of innovation is the high failure rate of new products. Companies develop new products to maintain their competitiveness with developments made by other companies or in some

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cases to remain one step ahead. Given the problems associated with effective new product development and marketing, researchers have studied the ways in which management can improve the successfulness of their new product development activities. We firstly outline the common factors which hinder product development. Subsequently attention is paid to the methods used by companies to overcome some of these problems.

Reasons for product failure The reasons for product failure are as follows: • persistence with an idea despite adverse response to market research information • overestimation of the market size • ineffective use of the marketing mix for a product which has sales potential • the development of other, better products by the competition. Development may also be hindered by factors such as social and governmental constraints, capital shortage and costliness of the new product development process. For example, the costliness of development of new types of aircraft has limited the numbers developed.

Approaches to product development The traditional approach to product development has been the use of sequential product development, where bright ideas start with the R&D department and end with the sales team who are responsible for ensuring the marketing success of the innovation. The problem with this approach is that the people who interact with the customer, indeed the customers themselves, are the last to know about the innovation. Thus it is at the very end of the development process that the firm realises that changes may need to be made to the product to ensure market acceptance. If by that time the product has already developed a bad reputation it may be too late to salvage it. To overcome this problem firms are using simultaneous product development. This method requires teamwork between the different functions within the company. Furthermore, it is the marketing department which leads the development process. Market research is used to ascertain customer needs and their opinions are used to drive the whole innovation process. A particularly effective system for product innovation is referred to as the stage-gate system (pioneered by 3M). This system divides the innovation process into a series of distinct stages. At the end of each stage is a ‘gate’, manned by a senior manager who requires the team responsible for each new product project to have achieved a set of goals before the project can progress to the next stage.

The stages of new product development The development of new ideas requires the fulfilment of eight stages (these are explained in more detail below): 1. Idea generation 2. Screening 3. Concept development and testing

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4. Marketing strategy 5. Business analysis 6. Product development 7. Market testing 8. Commercialisation. Idea generation The search for ideas needs to have certain guidelines which are set by senior management. Such parameters can be in terms of the products and markets in which the firm wants a presence. The new product objectives also need to be set. According to the marketing concept, the source of new product ideas should be the customer. For technical products, companies can learn from their ‘lead users’. These are customers who make the most advanced use of the company’s products and who can recognise necessary improvements before other customers. The company’s employees who have closest contact with customers – the salespeople – are also a good source of ideas. Companies can also find ideas for product development by asking customers for their perceptions of existing offerings. Similarly, employees can be asked for their opinions. A third source of ideas is competitors and their products. This allows firms to follow a strategy of product imitation and improvement rather than innovation. While ideas can abound, whether or not they succeed can depend on their being promoted within a company by a ‘product champion’. Screening Once ideas have been generated, they need to be screened. The company’s objective is to consider any further only those ideas which are practicable. There are two types of errors which firms can make at this stage. They can make ‘drop errors’ and ‘go errors’. Drop errors involve dropping a good idea and a go error means that a poor idea is supported. Rating devices can be used to assess new product ideas. Concept development A product idea is a possible idea that a company might offer the market. A product concept is an elaborated version of the idea expressed in terms that can be understood by the consumer. A product image is the picture that consumers have of the actual or potential product. Any product idea can be turned into any number of product concepts. Groups of such concepts are referred to as category concepts – the idea is positioned within a category. It is the category which defines the competitors of a product. A product positioning map can then be used to show the relationship between the new product and the competition. The axes of the map are drawn according to the type of product being considered. For example, a new breakfast drink could be analysed against competitors according to preparation time and cost. A map enables the marketer to compare and contrast the new product against its competitors. The next stage is to turn the product concept into a brand concept. In order to do this a brand positioning map can be used. This enables marketers to analyse how their offering will compete against existing brands.

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Concept testing Once concepts have been developed they can be tested with target groups of customers. The testing can be done with descriptions or images. The more concrete or realistic the image, the more reliable the results will be. Respondents are then asked about their opinions. Marketing strategy development The first stage of the marketing strategy describes the size, structure and behaviour of the target market, the planned product positioning, sales and market share. The second stage outlines the product’s planned price, distribution strategy and marketing budget. The third stage of the marketing strategy describes the long-run sales and profit goals. Business analysis In order for a product to move from the concept to the development stage, management needs to evaluate the product’s projected financial performance to see whether it is in line with company objectives. The first part of this process is to see whether sales will be high enough to generate a satisfactory profit. This will depend on the frequency of purchase and will determine the life cycle of the product. In particular, the company will need to estimate first-time sales, replacement sales and repeat sales. Product development This involves the product concept being turned into a physical product. Such a product should have the required functional and psychological characteristics. Such prototypes have to be tested. While the designs thus far have been developed according to customer needs, the product soon has to be passed to the manufacturing department to ensure that it is capable of being produced in sufficient quantities for the right cost. A compromise between customer needs and manufacturability is referred to as design for manufacturability and assembly (DFMA). Market testing Market testing differs from product testing since it involves not only testing the product but also the testing which accompanies it. Firms use market testing to learn how customers and members of the distribution channel handle, use and repurchase the product. There are a number of ways in which market testing can take place; one of these is test marketing. Test marketing subjects a product to a launch which resembles a full-scale product launch. This allows the marketer to identify any problems which may occur when the product is launched for real. The testing enables a firm to test the product, the branding, the pricing, packaging, distribution and so on. The degree and length of test marketing which is needed will depend on the complexity of what is being sold and the other development costs associated with it. Commercialisation This term refers to the introduction of a new product into the marketplace. This may require investment in new production plants and considerable expense in advertising and marketing. There are four key decisions to be made when products are commercialised; when, where, to whom and how?

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Introduction to services marketing As the marketing discipline has matured over the past 30 years, so practitioners and academics have realised that concepts which are effective for understanding the situation facing some marketers are unsuitable for addressing the needs of others. While marketing originally addressed the needs of marketers selling consumer products, there was a subsequent development in industrial marketing dealing specifically with the marketing needs of those who sell to other business organisations. In recent years there has also been growing interest in the marketing needs of those firms which sell services. This has given rise to a host of concepts and models which can help service marketers understand the situation they face and address the problems involved. Consumer marketing led to the development of notions such as the ‘four Ps’ (product, place, price and promotion). It will become readily apparent, however, that the four Ps alone are not suited to the marketing of something which is intangible (i.e. something which cannot be seen, felt or heard). In recent years the need to develop marketing concepts for intangibles has grown as the importance of the service sector has increased within industrialised economies. Principles which are adequate for products will not suffice for services. However, it has increasingly become the case that marketing principles can be used for services, people, ideas and organisations. Indeed, wherever there are customers with needs, marketing can play a role.

Characteristics of services A service is any activity or benefit that one party can offer to another that is essentially intangible and does not result in the ownership of anything. These issues are considered in more detail below.

Intangibility versus tangibility Tangibility refers to whether something can be seen, tasted, felt, heard or smelled prior to purchase. This means that customers are uncertain about the outcome of their purchase; they do not know whether a service will meet their expectations. In contrast, they can see a product prior to purchase and can ascertain whether it is what they really want. In order to overcome the intangibility of services, individuals use cues to determine service quality. These can be such factors as the quality and cleanliness of the premises which are used by the marketer. Potential purchasers can also rely on word of mouth: the opinions of friends and associates can be very important in the purchase of services. This is particularly the case because research has shown that people trust word of mouth more than they do other forms of communication. In purchasing, the greater the degree of customer-perceived risk, the greater the customer’s reliance on sources of information which can be trusted. Furthermore, other cues can be used, such as price: high prices may indicate high quality. While customers may use cues and sources of information to overcome intangibility, the marketer can also try to overcome customer fears by making an otherwise intangible service more tangible. The marketer can use physical evidence such as the customers’ environmental surroundings (the waiting and consulting rooms of health practitioners, for example); attention can also be paid to the quality of brochures.

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Inseparability One factor which distinguishes services from products is that the former are ‘inseparable’. Goods can be produced and sold at some later date; they can be stocked. Services cannot be stocked; they must be consumed wherever they are produced. Indeed, customers are likely to be present in the production of services. This places a great deal of importance on the personnel used by the company to deliver the service. Because of inseparability, capacity also becomes an issue. Only limited numbers of customers can be served by the service provider, unless more staff are hired. This means that service providers need to consider capacity levels for their business. They also need to consider ways in which the same number of employees can offer services to larger numbers of customers, perhaps without compromising service quality. They may also need to consider how training may be offered to new employees. Products can come off a production line, so quality can be relatively easy to maintain. However, since each instance of the delivery of a service is a new encounter between provider and customer, the maintenance of quality becomes more difficult. In order to maintain consistent service quality, firms can place an emphasis on staff training. Incentives can also be provided to employees so as to encourage their commitment. Customer satisfaction can be monitored through the use of surveys. This can ensure that the company knows as soon as possible whether quality levels are being maintained. The provision of guarantees also helps ensure that customers are not aggrieved if they do not receive adequate service.

Perishability Unlike products, services cannot be stored: they are perishable. If customers do not show up for appointments, then the service provider cannot offer that time to other people. The service provider will therefore need to consider whether customers should be charged penalties for such things as missed appointments or whether other mechanisms should be used, such as overbooking. The latter is an option where customers may not want to pay for missed appointments and past experience shows that a certain percentage of customers on any given day will not come in. Because of perishability, service firms need to be able to match supply to demand. The following are some ways this can be done: • They can charge more for peak times, for example, as is the case with theatres and cinemas. • They can also reduce prices for off-peak services to encourage a better spread of usage. • Where there is significant non-usage of services at certain times, new services can be developed which make use of that time. • Excess demand can be overcome through the use of part-time employees and through the shifting of task performance onto customers themselves.

The differences between products and services: real or imagined? In this analysis we will refer to some of the concepts regarding risk that were first explained in Chapter 6. If perceived risk is determined by the amount that is at stake and the certainty with which consumers can regard the outcome of the purchase as favourable, then it should be possible to

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consider different products and services by these criteria. Purchases which are tangible, which can be seen, felt, even used before purchase, ought to have limited outcome risk. On the other hand, with intangible purchases, the customers do not know what they will get until they have made the purchase; consequently, the degree of outcome risk is high. With tangible products/services therefore, there is little need for there to be trust between seller and buyer. The purchaser of a tangible good is not placing herself in any position of vulnerability to the seller. With intangibles, however, the customer is vulnerable to the quality of promises made by the seller and so trust does need to exist to facilitate exchange. Davis (1979) discusses other factors which distinguish services and products and which force customers to rely on personal sources of information. For instance, there is no transfer of ownership in the sale of a service; the buyer is dependent on the participation of the seller for consumption to take place. Their ‘in-being nature’ means that services cannot be inventoried. Furthermore, performance standards are more difficult to attain in the production of services. Guseman (1981) has found that services were perceived as having more risk than products and consumers use risk relievers (actions used to allay perceived risk) in different proportions for services. It is possible to derive a risk continuum from tangible to intangible (McDougall, 1990). At the tangible end one finds products like salt, with a progression towards the more intangible: from soft drinks to clothes to bank loans to teaching, and medical diagnosis (see Figure 9.6). However, this tangibility scale provides some interesting comparisons. A fast-food lunch (service) is perceived to be more tangible than buying a used car (product). A movie (service) is perceived as being more tangible than a sweatshirt (product).

Mainly products

Mainly services

Very tangible

Very intangible Perceived risk rising

Figure 9.6: Product service continuum

Internal marketing and interactive marketing The special characteristics of services indicate that employees have a greater degree of interaction with customers than is the case with product marketers. For this reason employees need to be constantly motivated and informed about the benefits the company offers. A marketer cannot make promises to its customers unless the employees know what those promises are and understand the importance of meeting them. Many companies develop a company philosophy that includes a system of values and beliefs with which to motivate employees. Where employees can identify with their company’s value system they will be better able to fulfil its objectives.

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Interactive marketing refers to the notion that the quality customers perceive in a service depends on the quality of their interaction with the marketer’s personnel. So it is not just the technical quality which matters (the excellence of the food) but also the functional quality. For example, was the waiter attentive and interested in the customers? Taking all the above factors into account, for marketers there are three important issues when competing with other service providers. They need to be able to increase competitive differentiation, service quality and productivity.

Managing differentiation This involves the marketer differentiating between what is offered to the customer, what is delivered and also the image of what is sold. The offer can include innovative features which are different from those of competitors. It should be noted, however, that service innovations can be easily copied. There are three ways in which service delivery can be improved: through the physical environment used, through the people who deliver the service and through the process of service delivery. The physical environment in which service delivery takes place can be made conducive to customer expectations. For example, the waiting rooms and surgery of a doctor may have to have the clinical cleanliness which customers expect. Indeed, the doctor may need to look fit. For another example, the employees of the company might be more professional than those used by competitors. The image which others have of a service provider may also be manipulated through symbols and branding. Symbols in corporate logos may include animals that signify particular characteristics in specific cultures (e.g. in many cultures the eagle signifies strength and power).

Managing service quality The key to developing a reputation for service quality lies in the management of customers’ expectations. Management of expectations means that companies can only promise to the customer what they know they can deliver. This will generate customer expectations. Secondly, they should try to deliver more than they have promised. Where customer expectations are exceeded, customers will perceive that they have received quality service. Where customers perceive that the quality of service they have received is greater than they were expecting, they will probably use that service provider again. An inherent characteristic of service delivery is that mistakes will happen and they will not be rectified before the customer has received the service. Inevitably there will be customers who are dissatisfied. However, research has shown that the ways in which a marketer overcomes a problem can result in the customer actually appreciating even more the service provided by the marketer. This is called ‘service recovery’. Service recovery can take place only where employees are empowered to make decisions and undertake initiatives which can help the customer, even though such initiatives may not be included in that employee’s job specification. Employees must also be motivated enough to care about the customers in their charge to take the initiative. As well as the front-line staff having a high regard for customers, senior management need to pay as much attention to service quality and

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Characteristics/ Management issues

DIFFERENTIATION

QUALITY

PRODUCTIVITY

INTANGIBILITY

Because it is not possible to see, touch or taste services, it becomes more difficult to differentiate between competitors’ offerings.

Quality is difficult to assess due to the intangibility of services.

Staff productivity is difficult to measure because of intangibility.

Managing consistent quality is more difficult for service marketers because the output usually has to be produced close to the time it will be consumed.

Because services cannot be stored this limits the productivity of the organisation.

PERISHABILITY

VARIABILITY

Since output within an organisation can be of variable quality, this makes it more difficult to differentiate it from the output of competitors.

INSEPARABILITY

This is difficult to maintain because service quality is variable between employees of the same organisation and also the same employee may offer different service quality at different times. Quality is hard to maintain because output is inseparable from the person delivering the service.

Because the delivery of services is inseparable from employees, this affects the quantity of services which can be delivered per employee, or at any one time.

Table 9.1: Services marketing – the link between management issues and service characteristics customer satisfaction as they do to the financial performance of the business. Thus marketers can set targets for the percentage of customers who rate their service at an excellent standard. Marketers may also need to set specific targets for their service provision. For example, in the case of a telephone company, quality targets may be expressed in terms of the amount of time it takes for faults to be rectified on a telephone line. The importance of motivated employees for a service firm means that the management also needs to satisfy employees. For this, good employee relations are important.

Managing productivity Productivity of service companies can be improved through the training of employees. The working environment can be industrialised, which means the greater use of machines with which to carry out work or help to shift functions to the service client, as with banks’ automatic cash dispensers.

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Activity When you next purchase from a service business, try and make notes for the following features: Service Provider (A)

Service Provider (B)

Physical evidence Process People The list you have drawn up could be used as part of your revision notes, when you are asked about examples of physical evidence. Do differences in the four Ps affect your overall perception of the service provider and your satisfaction with the services received?

A reminder of your learning outcomes By the end of this chapter and the relevant reading, you should be able to: • describe the meaning of the term ‘product’ and the elements associated with it • explain the importance of quality for products and how it can be assessed • critically assess the conceptual problems associated with managing product lines and brands • describe the new product development process • distinguish products from services and the problems associated with doing this • explain problems faced by marketers in managing services and how these problems can be addressed.

Sample examination questions 1. With respect to a service business, discuss the problems of any strategies for managing differentiation, quality and productivity. Illustrate your answer with appropriate examples. 2. In a service business, why may internal marketing be especially important? 3. Assume you are responsible for recruitment and training in a major international airline. In what respects would marketing be important to your responsibilities?

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Chapter 10: Product life-cycle (PLC) theory: fads, fashions and why some products succeed while others fail Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapter 10.

Further reading Bikhchandani, S., D. Hirshleifer, and I. Welch ‘Learning from the behaviour of others: conformity, fads, and informational cascades’, Journal of Economic Perspectives 12(3) Summer 1998, pp. 151–70. ‘Console wars’, The Economist, 20 June 2002; http://www.economist.com/ To view this article, you will probably need to subscribe to the Economist. Gale, D. ‘What have we learned from social learning?’, European Economic Review 40(3–5) April 1996, pp. 617–28. Hanson, W.A. and D.S. Putler ‘Hits and misses: herd behavior and online product popularity’, Marketing Letters 7(4) 1996, pp. 297–305. Lambin, J. Market driven management: strategic and operational marketing. (Basingstoke: Macmillan, 2000) [ISBN 0333793188; 0333793196 (pbk)]. Liebenstein, H. ‘Bandwagon, snob and Veblen effects’, Quarterly Journal of Economics 62 (1948), pp. 165–201.

Aims of the chapter The aims of this chapter are to: • make clear to you that the PLC is both a useful model and a useful tool for firms in designing appropriate marketing strategies • reinforce the view that marketing models can explain seemingly irrational consumer choice behaviour, like following the herd, and show that they actually have a rational basis.

Learning objectives By the end of this chapter and relevant reading, you should be able to: • discuss what the product life-cycle model (PLC) represents and describe the five stages involved in it • describe the various types of PLCs that are possible • explain how a firm’s responses or behaviours differ at each stage of the product life cycle • explain the various theories of why some products have more successful PLCs than other comparable products.

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Useful web sites http://welch.econ.brown.edu/cascades/ Provides a listing of all papers related to informational cascades titled ‘Informational cascades and rational herding: an annotated bibliography and resource reference’.

Introduction In Chapter 9 we learned about the management of individual brands and the development of new products. New products and brand development, as noted by Kotler and Armstrong (2004, p. 313), are the ‘lifeblood of an organisation’. However, differentiating your product from competitors and investing in new products and service development can be risky for a firm, as the majority of new products fail. Often two products are introduced which are otherwise identical, yet one succeeds and the other fails. At other times a product has an extremely quick success in the market on entry and then fades from view as quickly as it has arrived. Why? In this chapter we will explore questions of why products succeed or fail by using a tool known as the product life cycle (PLC). We will examine how every product or service has a PLC that is unique to it, but that also follows several predetermined stages. We shall also see how firms can anticipate changes in a product’s life cycle and therefore devise polices which can adapt to, or alter, the PLC. We will then present a few concepts, such as cascade theory and the bandwagon effect model, which try to explain why some products generate popularity and others do not. We shall see that firms have a number of policies that can stimulate sales and which take advantage of certain features of the PLC, consumer behaviour and the marketplace.

What is a product life cycle? A useful tool for understanding a product’s success or failure is the PLC. It is usually represented in a diagram that relates time on the horizontal axis to some measure of product success (such as sales) on the vertical axis. In Figure 10.1, the diagram shows five stages in a product’s PLC. We shall see in a moment that as product markets grow, mature and decline over time, a firm’s marketing strategy must evolve to the changes in a buyer’s behaviour and the changing competitive environment. Because a PLC is dynamic and involves two variables (time and sales) it is best shown graphically.

Sales

1

2

3

Time Figure 10.1: The product life cycle

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What happens next?

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The five stages of the typical PLC are as follows: 1. Introduction: The uptake of a new product is often slow. There are several reasons for this. Technology is new and uncertain. Distributors still have contracts with older products. Buyers are still unaware of the new product or are uncertain of its benefits. Competition from other brands and products is low at this stage. For example, in the initial stages of the home personal computer, companies like Olivetti were major players while giants like IBM were more concerned with large mainframe and institutional computers. 2. Growth phase: Growth of sales occurs at an accelerating rate. The causes of growth can be varied but one can surmise that if first users are satisfied they then pass on favourable word-of-mouth for the product. Wider distribution and more visibility increase sales. More competitors enter but actually expand the market. For example, the growth of car technology in the early twentieth century allowed over 200 domestic car companies to exist in the United States in 1905 versus only three domestic car manufacturers today. 3. Shake-out phase: Demand is still increasing but at a slower rate. The weakest competitors are leaving the market. Concentration and merger activity begin. Airlines and passenger air travel witnessed numerous mergers and failures since the terrorist attacks on 11 September 2001, which lowered passenger travel. 4. Maturity: Market penetration is now very high. Most consumers have bought the product. Technology has stabilised and only minor modifications are possible. There is not much room for growth but neither is there much decline. 5. Decline: New, more technologically advanced products make their appearance and substitute for the product. Changes in the consumers’ needs or external changes (perhaps in complementary technology) could make products obsolete. For example, if the price of petrol increases, this may make obsolete the internal combustion engine and cause permanent declines in car sales. In most cases the PLC’s fifth stage is shown with sales declining to zero. But what happens after a product begins to decline, however, is not predestined. Indeed, as we shall see in a moment, firms can do much to relaunch or forestall a product’s decline in this last stage.

Firm strategies at each stage of the PLC Kotler and Armstrong (2004, pp. 332–36) detail the various stages of the PLC, and show how firms can develop appropriate marketing strategies for each of these different stages. Rather than repeat their entire text, we will endeavour to show by way of examples some stage one generalisations that can lead firms to adopt a certain mix of marketing strategies.

PLC regularities in stage one and how sellers respond • Consumer uncertainty is usually high, even for products that are clearly better. In the case of passenger jet travel this meant that the first passenger jet planes were not successful. Why? Early crashes of jet aircraft like the Comet meant that even until the 1960s people were still taking propeller planes and even large cruisers such as the Queen Elizabeth II to cross the Atlantic because of safety concerns (even though the latter was a five- to seven-day trip).

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• Distributor reluctance and failure to build long-term relationships may hamper the take-off of a product. This has direct implications for the new information economy as many producers can exploit the growth of direct distribution on the Internet. For example, many academic authors with new ideas – normally rejected by traditional print journals, which can be slow to respond – have spawned the growth of online publications. • Competition in stage one is usually not very large in the narrow product market1 definition. But although there may be no direct competition in the product market, there is perhaps big competition in the solution market.2 For example, in the narrow product market of electronic gaming, there are only three major players left: Nintendo Game Cube, Microsoft X-Box and Sony Playstation. However, in the entertainment solution market there are many other competitors, from recorded music to films (although Sony and Microsoft now increasingly own a piece of this entire solution market as well). See Table 10.1. DVD Sales Music Sales (CDs, downloads) Games Software Cinema Box Office

$33 Billion $32 Billion $18.5 Billion $17 Billion

Table 10.1 Games software sales in comparison with other entertainment purchases, in $USbn (worldwide sales in 2004)

Real-world application(s) of the PLC Another important feature to note about the PLC is that despite its name, it can also be used to account for what happens to a specific technology, or what happens in an entire industry or market segment over time. As an example, examine Figure 10.2 to see what has happened to the global market for recorded music since the 1970s. Sales

LP CD

45s

Tapes 1970

1975

1980

1985

1990

1995

2000

2005

Time Graph created using data from Lambin (2000, p.284).

Figure 10.2: An example of PLC behaviour in the audio market There are several important points of interest in Figure 10.2. Notice, for example, how tapes were given a ‘second life’ when CDs were introduced. Why? The answer is simple. Blank tape cassettes (before the advent of digital downloading and mp3 technology) were complementary to CDs. This was not the case with record LPs and 45s. These were substitutes and overtaken by CDs.

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A product market is where a specific customer (‘who’), is seeking a specific solution/function (‘what’), based on a single technology/product (‘how’’).

2

A solution market is where a specific customer (‘who’), is seeking a specific solution (‘what’), based on all the possible technologies/products to perform these functions (‘how’).

Chapter 10: Product life-cycle (PLC) theory

But what is missing from this PLC diagram for the recorded music industry? Looking at Figure 10.2, it would appear that recorded music has reached its decline stage and will disappear. Perhaps people have stopped listening to music? But is this really the case, or rather, have consumers simply begun switching to a new technology in order to sample recorded music? The answer, of course, is that digital technology in the form of the mp3 and digital downloading has made listening to music more convenient and cheaper than the old format as represented by the CD. So the answer is not that the recorded music industry is dying, but that the old way of listening to music has changed and has been replaced by a new form.

Are other PLC profiles possible? One question is whether the PLC seen in Figure 10.1, with its neat and scripted five stages, is true for every product and service. The answer is no. There are many varieties of PLC profiles not described by the typical PLC. Below we describe three possible PLC profiles, and in keeping with our recorded music theme, describe a musical genre and artist that fit with each of the profiles in Figure 10.3. Sales

High-learning product

Time

A fad: low-learning product with a short shelf-life

Sales

Time Sales

Low-learning product with a long shelf-life

Time

Figure 10.3: Example PLC profiles

Applying PLC profiles to music genres and artists A high-learning product may be very new to the market and has many attributes and features that are hard to observe. In the case of a product like software or an epic novel, it may be complex and involve a large commitment in effort and time to appreciate its value. This means that consumers have to take time to learn about the product and sample it before purchasing. Sometimes the typical consumer of such a product is older than average. In terms of music, what genre is emblematic of this type of PLC profile? Typically we associate classical music with complexity and subtlety that requires a listener to exert patience and time to appreciate fully.

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Classical music, a form of music developed in Western Europe several centuries ago, is still listened to by fans today. Wolfgang Amadeus Mozart (1715–1774), even had a burst of popularity almost two centuries after his death when the film Amadeus became a huge success in 1984. Although sales of classical music are not comparable to those of more recent popular bands like U2, the music sells consistently. Typically, the buyer of classical music is older, again reflecting possibly the difficulty in immediately grasping all the subtlety and complexity of classical music. A fad is a product with a quick take-off and an equally quick decline in sales. It is known as a fad because of its properties of being purchased almost blindly without regard to real intrinsic needs on the part of the consumer or because of attributes that are not truly needed or innovative. A product with a quick take-off and equally quick decline also typically has attributes that are easy to sample, see and inspect and so consumers do not have to learn much about it before purchasing. What kind of musical genre or performer conforms to this kind of profile? Typically the music that appeals to a very young audience has this faddish PLC profile. Many artists that cater to younger audiences with a less well-developed appreciation for musical complexity often have brief careers. Do any of you remember the biggest hit of 2003? It was a song called ‘Not gonna get us’ by a Russian duo named tATu. Still don’t remember? Well, that is the nature of a faddish good – it’s here today and gone tomorrow. Finally, a low-learning product with a long shelf life describes a product that has attributes of a fad, in that it does not take the consumer long to start buying the product, but it also has a staying power in the market of the kind seen with a high-learning product. Which band in recent history has had this kind of profile? In the autumn of 2000, a band called the Beatles had the number one album in the world with their collection of number 1 hits. What makes this interesting, of course, is that the Beatles first appeared 40 years earlier with their hit ‘I wanna hold your hand’. The Beatles at the time of their first hit single had the appearance of a fad, but their music has continued to sell long after the first fans purchased their music. The headline below was typical of many articles written at the time:

Beatles album is Number One around world…in 2000! ‘Beatlemania’ was back 30 years after the group broke up – their greatesthits album topped the charts in 30 countries around the world in the autumn and winter of 2000. Just five weeks after being released, the album of their 27 chart hits sold 12 million copies in the United States alone. Billboard magazine said: ‘Decades after their original releases, these songs still resonate with a potency and vibrancy that simply doesn’t exist in a lot of today’s pop music. Truly the best from the best.’ How did this happen? According to Howard Goodall, a composer and musicologist from Britain, the reason for the long shelf life of Beatles’ recordings is that their music combined elements of popular forms (which have easy-to-like melodies and arrangements) with more complicated musical structures of the classical tradition. It was this unique combination that makes Beatles’ music popular year after year. Goodall argues that classical composition lost its way in the years leading up to the Beatles’ popularity, by breaking with the traditional ‘language’ of Western music that listeners understood. The Beatles, he says, threw music a lifeline by building on foundations abandoned by the modernists (see web site: www.howardgoodall.co.uk/).

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Activity Next time there is a concert in your town or city, examine the crowd and attempt to form a profile of the typical audience member. Does it conform to the type of music being played?

Why do some products have more successful PLCs than others? In 1995, two management professors, Treacy and Wiersema, secretly purchased 50,000 copies of their own business strategy book The discipline of market leaders (1997) from stores across the United States. Similar accounts of attempting to control the process of social influence occur elsewhere: • In ancient Rome professional mourners were hired to follow a funeral procession. • Claque is a group of people hired to clap or heckle at a performance. • In 1996, at a time when the place was full of drugs and criminal activity, Disney invested in New York Times Square: many other entertainment companies followed. • Hennessey Cognac Co. hired professional models to order their product at fashionable bistros in New York. The reasons for these types of activity are varied. The two most intuitive answers are: • Informational effects of learning from others (i.e. when we see others doing something we may learn and partake in that activity as well). • Preference effects (i.e. wanting to fit in). Seeing others purchasing a product or doing something makes us want to do it as well. But these arguments can’t really explain why two very similar products that emerge at the same time often have distinct PLC profiles. There are therefore more thorough arguments that can be made to explain why some products generate excess demand or a queue and others do not.

Network externalities and bandwagon theory Positive network externalities are the benefits accrued to a consumer from being part of a network of users who consume the same good or service. Maybe you buy a book or go to see a film not because it has an intrinsic quality, but because you want or need to talk about it with others. This is different from just wanting to fit in; externalities imply that there are real or perceived benefits from being part of a large network. This in turn explains the need for firms to move quickly and be the first to launch a product (so-called first-mover advantage) and why we observe different outcomes for seemingly similar Hollywood films. For example, why did Saving Private Ryan (a film from 1998 about the Second World War) do so well and a similar film released not long after, The Thin Red Line (1998), do relatively poorly? Bandwagon effects (positive network externalities) A bandwagon effect is defined as a positive network externality in which an individual demands a good in part because many other people have the good as well. It can occur for two reasons. First, it can occur when people consume a good/service if they get positive benefits from knowing

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that others have consumed it as well. This refers to the ‘sociological’ need to be in style, to have a good because almost everyone else has it, or to indulge in a fad. The bandwagon effect is associated with fads and fashions, but a positive network externality can arise for other reasons. The ‘intrinsic’ value of some goods to their owners is greater, the greater the number of other people who own the goods. The case of ‘the stock purchase’ is an obvious one. My stock is worth more when others purchase it as well. But it is also true in consumer goods: if I am the only person to own a CD player, it will not be economical for companies to produce CDs, and without CDs, the CD player will be of little value to me. The more people who own CD players, the more CDs that will be produced and so on, so companies may want to lower prices, or give initial stock away to initial customers, so as to induce a bandwagon effect. Snob goods (negative network externalities) The ‘snob effect’ is another similar application of network externalities, except in this case it works the other way. The network externalities are negative. The quantity demanded of a snob good is higher, the fewer the perceived number of people who purchase the same good. This is perhaps a reason why Britain’s now infamous Millennium Dome3 failed, because people thought it was going to be too full and popular, and hence ‘un-cool’. There can be more obvious negative network channels at work for a product’s failure. The effect of congestion is one. There were reports that transportation to the Dome was very poor, and initially when the crowds were heavy, people had a hard time getting around. Stocks also face ‘congestion problems’. How? With the growth of online investing and direct broker hotlines, purchase orders sometimes take half a day or more to process. Hence, a popular stock may vary in price wildly in a day, leaving the initial purchase order out of date and leaving the investor dissatisfied.

Informational cascades There is a theory known as informational cascades that may also offer an explanation for why some products take off and others drown. Let us begin hypothetically with three people: Aaron, Barbara and Clarence. Each decides in sequence to adopt a certain action. The action is adopted with information drawn from a signal (which is either high or low). Aaron chooses action V, based on a high signal. Barbara now has two pieces of information upon which to base a decision, the private signal and the signal inferred from Aaron. We know that Aaron would not have chosen action V if the signal had been low. So Barbara now has to decide on the basis of her private information and the decision of Aaron. So if she receives a high signal about action V, then it’s two pieces of high (H) information and her decision is easy. However, if she receives a low (L) private signal, then she has one H and one L piece of information. Presumably, she would flip a coin to decide, and in this case it is H. Now it is the turn of Clarence, and he has three possibilities to deal with: both predecessors adopted, both rejected or one adopted and the other rejected. In the first case, where both are adopted, he adopts (two H signals outweigh even one private L signal). Clarence’s decision provides no new information to anyone coming after. So, now a fourth person, Donna, adopts regardless of her own private signal. Everyone after and including Clarence is said to be in an informational cascade and following the herd. In this case, the cascade was up because the first and second person chose action V (namely to purchase the good).

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The Millennium Dome was one of Britain’s famously expensive millennium projects. Unlike other millennium projects, for example the building of the new Tate Modern gallery on the bank of the Thames, the Dome was perceived almost to be a failure from the start.

Chapter 10: Product life-cycle (PLC) theory

What the model basically states is that rather than go through a costly process of searching to try to find out whether a product is of high quality or not, it may make sense instead to observe what others do in the market and follow their behaviour. This is especially true if the information about whether the decision is correct or not is costly to obtain and the consumer believes that others are more informed about the decision. There are in fact four conditions under which the cascade model works very well to explain why some products succeed in generating huge sales and cascade-type behaviour. 1. The type of product/service/adoption or investment decision • Any decision which is taken infrequently and where the outcome is uncertain, that is, ‘an experiential decision’. • For the purchase decision of products or services in which quality is hard to judge before purchase and that you consume infrequently. These goods are called experience goods. • There is also another, similar class of goods and services, for which this theory works even better. These goods are known as credence goods, and these are goods in which even after purchase, a typical consumer requires expert opinion to determine quality (e.g. financial investments, medical operation, car mechanic repair). 2. The type of market setting • Paradoxically, when faced with too much choice, persons are more likely to follow external cues of quality and thereby be more likely to queue behind an existing standard. • The implication is that if you give people a bit less choice, they’ll rely on their own sampling history and won’t have to queue up for as long. 3. The individualistic/collective nature of a society • The more individualistic and less tied to social constraints consumers are, the less social conformity will be present, but the more ‘herding’ will occur via the cascade effect. 4. The type of consumer • The more informed and knowledgeable consumers are, the less likely it is that a cascade effect will occur. There are several important implications of the cascade model for marketers. Differing information precision and fashion leaders The importance (and in some cases drawback) of leading off with the best informed has not been lost. Why, for example, do judges in the United States Army vote in an inverse order of seniority? This is a convention designed to reduce the natural influence of older judges on the choices of junior judges. There is also a danger of a bad or duplicitous ‘fashion leader’ causing people to fall into a negative informational cascade. Jack Grubman, a telecommunications analyst for Salomon Smith Barney, who misled clients and Wall Street Journal readers on which shares to buy, and in part caused the famous Worldcom and Global Crossing scandals (see Mini-case 10.1), is an example of where following others’ actions and recommendations is dangerous.

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The importance of the first decision Social psychologists consistently find that people defer to and imitate the actions of those who appear to have expertise. This probably underlies the success of product endorsements in which athletes are seen to use a particular brand of athletic shoes or tennis racket (e.g. the famous Michael Jordan association with Nike). Differing preferences and pay-offs Above we saw the impact of someone observed to have expertise endorsing a product (Michael Jordan and Nike shoes) leading to a bandwagon effect. What if you can’t observe the type of first mover? Trying to understand that initial decision is hard – and perhaps even harder for the person undertaking the initial decision. Indeed, do you have a clear understanding of yourself? Why do you choose one action over another? Take the case of a software programmer who may commit to a programming language. This decision may be because he/she: • is optimistic about the software’s prospects (favourable signal) • is tolerant of the risks (heterogeneous preferences) • thinks the firm’s profits will be high if the programming language catches on (heterogeneous pay-offs) • made a mistake (imperfect rationality). An individual making a decision after the first mover cannot be sure why they adopted the software and this makes the decision ‘noisy’. Cascades can still form under these conditions but the point is that they may take longer when we have unobserved preferences and pay-offs. Costly information and network externalities In our first example with Aaron, etc., we assumed that private information was costless. But what if private information is costly? Then in our example, cascades can start immediately. In other words, Barbara would have followed Aaron’s action without looking at her own private information if doing her own homework was too costly for her. An interesting and very pertinent application of the above is the case of the financial sector. Many times investors lack information and rely on independent analysts to make buying or selling decisions. Mini-case 10.1 shows how cascades are dependent on costly information and the influence of a few important fashion leaders, who may or may not be right. The case should serve as a warning to those who believe that share prices always reflect the best information of the market at every point in time. Mini-case 10.1: Playing follow the leader can be risky business Should investors do their own homework, spending hours researching firms or should they rely on specialised analysts in the financial field to make recommendations about what to buy and sell? Based on the theory of cascades and what you’re about to read, you may think twice about playing follow the leader with your investments. What makes some stocks more valued than others may be the result of a few influential ‘fashion’ leaders, whose credibility is often suspect. In the late 1990s, telecommunications stocks enjoyed a terrific rise in their value. But when the boom turned to bust between 2000 and 2002, the investment dollars lost were extreme: more than half a trillion dollars (US) in market value were lost in less than two years. The telecommunications overexpansion and abrupt contraction reverberated across the entire US economy.

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As Salomon Smith Barney's telecom analyst, Jack Grubman was at the heart of the telecom stock market meltdown. He earned about $20 million a year, making him Wall Street's highest-paid analyst ever. In the years leading up to the telecom boom and bust, he forged a reputation for penetrating analysis. He developed relationships with all the key players in the sector and had access to the best information. He had influence over companies and money managers and came to be seen as the authority of all that was going on in global telecom. His judgments could make a stock fall or be successful. If Jack said it was good, it had to be good. Indeed, his investment column in the Wall Street Journal also persuaded hundreds of thousands of ordinary readers to follow his investment advice for the sector. And his advice as a supposedly dispassionate analyst usually was the same: buy! But Grubman wasn’t just any analyst, especially given his distinctive role in the industry's rise and fall. His stature helped vault Salomon Smith Barney into a powerful position in telecommunications just as it was taking off. Behind the scenes, he also advised CEOs on takeovers. When Grubman was ever quizzed about his closeness to the firms he was analysing, he would always respond that what used to be viewed as a conflict was now a synergy. His definition of the word ‘objective’ was simply another word for being uninformed. Investors hung on his every utterance. Salomon Smith Barney’s army of nearly 13,000 brokers shared his picks with clients. When Grubman’s email updates hit the news wires, they were picked up on television stations such as CNN and CNBC. And when he spoke, stocks moved. According to Elliot Dorbian – a former broker at Salomon who is now president of AJ Investment Advisors – Grubman’s wonderful words about a company were like ‘a narcotic’ in that everybody wanted to hear them. In one case, after Grubman raised his price target on fibre-optic networker Level 3, its stock rose 12 per cent, increasing its market value by $4.9 billion in only one day. Grubman continued to champion the highly risky telecommunications sector even after it began to plummet. In spring 2001 he issued a report titled ‘Grubman’s state of the union: does he ever stop talking?’ that proclaimed, ‘Over the next 12 to 18 months, investors will look back at current prices of the leading players and wish that they had bought stock at these prices.’ Of the 10 companies he picked, five now trade below $1 a share. Three of those – Global Crossing, McLeodUSA and Winstar Communications – filed for bankruptcy. Perhaps no telecommunications company is more emblematic of the industry’s collapse, and Grubman’s role, better than Global Crossing. It was founded in 1997, it had the grandiose plan of laying all the fibre-optic pipes over which data would be sent worldwide. In 1998 Salomon Smith Barney helped take the firm from a small private company to a public one trading in stocks, jointly raising $397 million. Grubman’s ties to the firm were tight. He advised it on successful buyouts of other firms in the industry. From September 1998 through June 2001, Grubman issued at least 16 buy recommendations on the stock. At first the stock soared, hitting a high of $61.38 in 1999. At that point the stock was trading at 33 times the company’s sales, but Grubman wasn't worried. In early 2000, when the stock began to slip, he continued to recommend buying the stock. In April 2001 he recommended it again, this time in a report entitled ‘Don't panic: emerging telecom model is still valid.’ A month later, he reiterated his buy rating, calling Global Crossing one of ‘the new breed’ and ‘well funded’. The reality of Global Crossing’s finances, for those that cared to look and do their own research, was quite different. In October 2001, when the stock had collapsed to around $1 and the firm was on its fifth CEO in four years, Grubman finally cut his rating from buy to neutral. On 28 January 2002 Global Crossing filed for bankruptcy, the fourthlargest Chapter 11 filing ever. In total, more than $55 billion in paper wealth had evaporated. The day after the bankruptcy filing, Grubman issued a short note saying that he had discontinued coverage of the stock.

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Who’s ultimately to blame? Of course, investors must accept their share of the blame. Kent Womack, a professor of finance at Dartmouth, who studies analysts’ conflicts of interest has his opinion. He believes that when consumers watch a television commercial for a consumer product, they usually are aware that companies are putting the most positive spin on their products possible. Consumers, in other words, are naturally sceptical. Professor Womack’s point is that investment research should be no different, consumers need to be as sceptical or even more so of the investment advice provided by people like Grubman and the institutions they work for. In short, consumers should do their own homework and stop following the leader whenever important investment decisions are at stake. (Case study created using data from various news stories in MoneyWeek magazine, The New York Times and Time.)

A reminder of your learning outcomes By the end of this chapter and relevant reading, you should be able to: • describe what the product life-cycle model (PLC) represents and describe the five stages involved in it • describe the various types of PLCs that are possible • explain how a firm’s responses or behaviours differ at each stage of the product life cycle • describe the various theories regarding why some products have more successful PLCs than other comparable products.

Sample examination questions 1. Pick any product or service and describe what stage of the product life cycle the product is currently in. Using information on the regularities associated with most PLCs, comment on what the company manufacturing the product or delivering the service must do to adapt to (or forestall) the next stage. 2. Can you think of examples of any product which has not followed the traditional PLC profile? 3. How does one explain the behaviour of Treacy and Wiersema, who secretly purchased 50,000 copies of their own business strategy book The discipline of market leaders (1997) from stores across the United States? Explain your thinking behind the answer. 4. Can a product be revived after its PLC profile suggests it is in the decline stage?

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Chapter 11: Introduction to pricing strategy Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapters 11 and 12.

Further reading Coase, R. ‘The lighthouse in economics’, Journal of Law and Economics, 17 (1974), pp. 357–76. Fishman, C. ‘The Wal-Mart you don’t know’, FastCompany Magazine 77, December 2003; www.fastcompany.com/magazine/77/walmart.html Nagle, T. and R.K. Holden The strategy and tactics of pricing: a guide to growing more profitably. (Upper Saddle River, NJ: Prentice Hall, 2006) fourth edition [ISBN 0131856774]. Salkever, A. ‘Byte of the apple’, Business Week, 21 April 2004. Samuelson, P.A. Economics: an introductory analysis. (New York: McGraw-Hill, 1994) [ISBN 0070747415]. Varian, H. ‘Differential pricing and efficiency’, First Monday: The Internet Peer Reviewed Magazine 2 (1996); www.firstmonday.dk/issues/issue2/different/

Aims of the chapter The aims of this chapter are to: • demonstrate how the marketing practice of pricing differs slightly from economic pricing theories • make you aware of the range of choices that firms have over pricing, and how each pricing decision actually entails its own costs and benefits • show how firms can often use their pricing strategies (e.g. very low prices on selected items) to define their brand image.

Learning objectives By the end of this chapter and relevant reading, you should be able to: • explain the importance of pricing • identify what factors, both internal and external to the firm, determine the pricing decisions of firms • describe what is meant by terms such as ‘economies of scale’ and the ‘learning curve’ • explain how consumer heterogeneity can influence the pricing decisions of firms.

Useful web sites http://www.pricingsociety.com The Professional Pricing Society’s web site includes pricing information resources and sample case studies. www.mywiseowl.com/articles/Pricing This web site provides articles and terminology on pricing.

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Introduction Price can be broadly defined as the value of what is exchanged in terms of a customer’s utility, which either comes from tangible (e.g. functional) or intangible (e.g. prestige) factors. More narrowly, price is simply defined as the amount of money charged for a product or service. Despite the association made between marketing and other parts of the marketing mix such as advertising, price is still one of the most important marketing tools available. As pointed out by Kotler and Armstrong (2004, p. 363), price is the only part of the marketing mix that produces revenue directly, as all other marketing mix elements, such as promotion, represent costs. The purpose of this chapter is to briefly outline some of the theory and practice of pricing policy and strategy. Hence, the theoretical (mostly economic) approach to pricing policy will be emphasised first, followed by the marketing pricing practices and strategies that are applicable to business reality. We will begin by examining why pricing is so important, which factors are related to the pricing decisions of firms, and the strategies that firms employ in order to make the most profitable pricing decisions possible.

Why is pricing so important? Pricing is often treated as the last stage in the marketing mix, which means that all the investment in product development, positioning and distribution that precedes it hinges on getting the pricing decision right. Marketing practitioners often say that for the firm to profit from the value it creates it must price properly, for a bad pricing strategy can ‘leave money on the table’ or kill a product. Take the case of Apple computers, which only recently has re-emerged as a major and profitable player in the computer and high-technology market. In the 1990s, however, Apple was nearly bankrupt, in part because it failed to charge prices that were comparable with its close substitutes in the personal computer (PC) market. Apple’s design and software were years ahead of Microsoft and most PC makers for many years, until 1993 when Microsoft launched its Windows operating software and licensed its use to every hardware manufacturer on the planet – except Apple. This lowered PC prices tremendously and with Windows’ new user-friendly software, it also offered a close substitute to the Apple Macintosh at a fraction of the price. The impact on Apple’s market share and viability as a company was dramatic. The company even had to admit that it lost too much of its market share when it announced a promotional campaign in 2000 called the ‘switch campaign’, which encouraged PC users to switch to Apple. They even established a dedicated web site, www.apple.com/switch/ that still delivers the message of the advantages of switching to an Apple computer. Despite Apple’s recent switch campaign and the sales success the company has enjoyed with the iPod music player and its digital downloading service iTunes, the company’s computer sales have been lagging. The problem according to many market analysts is still the same old one of pricing its product too high.

Have you thought about switching to Apple today? According to Business Week reporter Alex Salkever (2004): Apple managed to increase it by only 5 per cent for the quarter, year-over-year. Worldwide PC shipments in the first quarter of

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Chapter 11: Introduction to pricing strategy 2004 grew 13.4 per cent, according to technology consultancy Gartner. That means in relative terms Apple is falling behind by growing more slowly than its rivals…So while it’s great that Apple seems to be winning the digital-music race, a little perspective is in order. Mac sales really need a lift, and there’s a simple way to do this: cut prices. Consumers still see Macs as the most expensive PCs around. And so far, the G5 has been a sales disappointment. Apple needs to learn that price is determined by market demand and not its own perception of what products are worth. Its prospects look brighter now than at any point in recent memory, and it still boasts some of the fattest margins – if not the fattest – in the business for its PCs. Jobs & Co. has the tools to really turn Apple into a mainstream player if they can boost computers sales by dropping prices.

The case of Apple is illustrative of a more general point: when firms have some degree of brand identity and monopoly power, they have choices with regards to how to price their good and/or services. Their pricing choices also have to take account of rival behaviour. Recall that in the case of a perfectly competitive industry, where all products are the same (or perceived to be the same by consumers), no firm can set a price lower or higher than its rivals. Why? The answer is simple. In perfect competition firms are making normal profits and hence if they lower price, they are pricing below cost and going out of business. If they raise price, they lose all their sales to their competitors and hence go out of business. So there is only one real price that firms can charge and that is the market-wide price that is equal to marginal cost. This is illustrative of how market structure – the degree of competition and whether one is in a monopoly or a perfectly competitive market – can affect a firm’s pricing decisions. Below we highlight the factors, including market structure and rival pricing behaviour, which firms must take into account before making their pricing decisions.

Factors affecting firm pricing decisions The factors that affect a firm’s pricing decisions and strategy can be both internal and external. By internal factors we mean factors inside the firm (such as marketing mix strategy or organisational goals) that affect the prices charged by a firm for its goods and services. External factors are factors that lie outside of the direct control of the firms such as market structure seen above, the price actions of rivals or the demand elasticity of consumers. Although recognising that in pricing decisions, the external factors are more often than not the biggest determinants of a firm’s pricing strategy, we will deal with each set of factors in turn.

Internal factors affecting a firm’s pricing decisions There are several internal factors that influence pricing behaviour, such as the firm’s marketing objectives, marketing mix strategy and cost structure. The last of these, however, is often a function of external factors to the firm and so we will treat cost structure as a sub-set of the external market structure. Let us start with overall marketing objectives and see how they may influence pricing decisions. Take the case of a firm that wishes to establish a ‘beachhead’ in the marketplace and therefore wants to acquire market share as its primary goal. In such a case, the firm may want to adopt an aggressive pricing structure that emphasises low prices above all

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else. If in turn it has sufficient scale and a distribution marketing mix that is efficient, which facilitates this price strategy, it may be able to build its brand reputation on providing the lowest prices on all goods and services all the time. A company that has done this successfully, amidst much controversy, is Wal-Mart, the American retailer giant that is now the world’s largest single private sector employer in the world (see Mini-case 11.1). Mini-case 11.1: For Wal-Mart, low prices is how you keep customers happy and suppliers and retail competitors mad! Wal-Mart is not just the world’s largest retailer. It’s the world’s largest company – bigger than ExxonMobil, General Motors and General Electric. The scale can be hard to absorb. Wal-Mart sold $244.5 billion worth of goods last year. It sells in three months what America’s number-two retailer Home Depot sells in a year. And in its own category of general merchandise and groceries, Wal-Mart no longer has any real rivals. In the United States, the largest single consumer market in the world, it does more business than Target, Sears, K-mart, J.C. Penney, Safeway and Kroger combined. How has Wal-Mart achieved this stunning success? The answer, according to its executives, is through Wal-Mart’s pricing philosophy, which is very simple: offer the lowest price on all goods 365 days of the year. Rather than focus on targeted discounts and costly promotions, Wal-Mart builds simple stores which are very large, and sells at very low prices. The pricing philosophy is also, in many respects, its organisational philosophy and certainly underlies its marketing mix strategy. The overall goal of offering the lowest price of any retailer for well-known branded items is what determines WalMart’s distribution and channel decisions as well. It has become the largest importer of Chinese goods in the world (bigger than any nation in fact!). One of the most illustrative examples of what this commitment to everyday low prices has had on well-known brands is the effect Wal-Mart had on the Vlasic Pickle Company. Wal-Mart priced a 12-gallon (approx. 30 litres) jar of Vlasic pickles at $2.97 – that’s a year’s supply of pickles for less than $3! ‘They were using it as a “statement” item,’ says one retail observer, ‘Wal-Mart was putting the jar before consumers, saying, “This represents what Wal-Mart’s about. You can buy a stinkin’ gallon of pickles for $2.97. And it’s the nation’s number-one brand.”’ According to journalist Charles Fishman (2003), ‘Therein lies the basic problem of doing business with the world’s largest retailer. By selling a gallon of kosher dills for less than most grocers sell a small jar, Wal-Mart may have provided a service for its customers. But what did it do for Vlasic? The pickle maker had spent decades convincing customers that they should pay a premium for its brand. Now Wal-Mart was practically giving them away. And the fevered buying spree that resulted distorted every aspect of Vlasic’s operations, from farm field to factory to financial statement.’ Indeed, as many companies including Vlasic have discovered, the real story of Wal-Mart that often never gets told is the story of the pressure the biggest retailer in the world relentlessly applies to its suppliers and retail competitors in the name of bringing consumers everyday low prices. It’s the story of what that pressure does to the companies Wal-Mart does business with, to United States manufacturing, and to the economy as a whole. That story, according to Fishman, ‘can be found floating in a gallon jar of pickles at Wal-Mart’. Activity Is it too simplistic to state that Wal-Mart is beneficial to consumers and so we shouldn’t care about what it does to its competitors, suppliers and even the rest of the economy? Other internal marketing mix decisions may affect pricing. For example, a company may decide that it wants to associate its product or service with a ‘premium’ or ‘high-quality’ image. If the company’s pricing decisions are

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not co-ordinated with this promotional or market positioning decision, the firm may confuse consumers and lessen the impact of its positioning strategy. In particular, if the company prices its product below what consumers associate with quality, it can lead to a major loss of potential sales as the product will dissuade cost-conscious consumers with the premium price image, and alienate premium image consumers with the low-quality price. It is often the case that consumers associate quality with price and hence a firm wishing to target a certain market niche must take this into account.

External factors affecting a firm’s pricing decisions There are four main external criteria according to which a firm sets a price: 1. Cost structure of the industry 2. Market structure 3. Consumer demand (or the desired level of price discrimination) 4. Macroeconomic environment, principally inflation. We will begin with cost considerations and deal with each of the other three items in turn. 1. Cost structure considerations Although cost is a factor that firms deal with internally, the type of industry a firm is located in often determines the prevailing cost structure present and hence the typical costs of production for firms in that industry. For example, in many industries with large start-up and fixed or sunk costs1 of production, such as steel and aviation, the costs per unit decline as the scale of operation increases (see Figure 11.1). Figure 11.1 depicts the case of a firm in which the long-run average cost curve (LRAC) falls as output increases from 1,000 to 3,000 units. This is because the large scale of the production process favours larger-scale output. However, this is only true up to a point. After producing 4,000 units, the production plant’s cost per unit begins to increase as the firm encounters what is known as diseconomies of scale – too many workers and machines slowing things down and putting upward pressure on costs.

1

Costs that do not vary with output or sales level.

Costs per unit

1,000

2,000 3,000 Quantity produced per day

4,000

Figure 11.1: Cost per unit at different levels of production In other words, industries with high fixed costs favour large consolidated companies and often only have a few competitors. The case of commercial ‘aircraft production’ is illustrative of this as there are now only two major players in the industry, Boeing and Airbus. Firms in these industries are said to have large economies of scale2 and low marginal costs of production, which would make pricing according to the

2

Declines in costs per unit as scale or output increases.

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traditional rule, of price equal to marginal cost, not profitable. On the other hand, when economies of scale are small, this favours many small firms and much more competition. In this situation we revert back to our simple cost-pricing rule, where prices approach marginal cost. A firm’s costs might also be affected by accumulated production, that is, the accumulation of daily experience in producing a good or offering a service will cause costs to fall as the firm and its employees learn how to produce better. This drop in the average per unit cost of production is sometimes referred to as the experience or learning curve as depicted in Figure 11.2. The figure shows that the average cost of production for the first 1,000 units is $10, but falls to $9 when the firm has produced 2,000 units. This drop in average costs with accumulated production or service delivery experience is called the experience or learning curve (depicted in Figure 11.2). Costs per unit $10 $9

1,000

2,000

3,000

Accumulated production

Figure 11.2: The experience curve A final type of cost consideration that affects firm prices are industries with high fixed or sunk costs and economies of scale at relatively low output levels. This means that if price were to equal cost, it would be equivalent to pricing close to zero. One prominent example of this phenomenon is found with information goods: the incremental cost of stamping out another CD or printing another book is on the order of a dollar. The incremental cost of downloading a purely digital good, such as a song or movie, is on the order of a few cents at most. In these cases, efficient pricing of such goods would require that users with a very low value for such goods pay a very low price. One might think that it is rare to observe information goods selling for virtually nothing, but on reflection, this is not so uncommon. As highlighted by the economist Hal Varian (1996) in his paper on differential pricing (see also Box 11.1 which is taken from Varian (1996)): many information goods are supported by advertising and sell for prices close to their marginal cost of production and delivery: newspapers and magazines are obvious examples. Books sell for a high price as hardbacks, and much lower prices when reissued as paperbacks. Remaindered books sell for very little. And all sorts of printed material – books, magazines, newspapers, etc. – are available in libraries at effectively zero cost to the users. In addition, there are thousands of shareware computer programs that sell for extremely low prices – in the order of a few dollars.

The implication of this is that in industries where there are large fixed costs but low average and marginal costs, there will be lots of price differentiation for the same goods and services.

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Box 11.1: Evidence of price differentiation for firms in industries with high sunk costs The evidence shows that differential pricing is common in industries that exhibit large fixed or shared costs. This is true both for industries that are highly concentrated or industries that are highly competitive. Airlines: The airline industry is highly competitive in many ways, yet it is common to see differential pricing practised in a variety of forms. As we have seen, airlines offer different types of consumers different fares (senior citizen discounts, major corporations, conference delegates, etc.); they offer different classes of service (first class, business class, tourist class); they offer different sorts of restricted fares (advanced purchase, weekend stays, etc.) Telecommunications: The long-distance telecommunications market in the US involves many different forms of differential pricing. Firms give quantity discounts to both large and small customers; charge business and individuals different rates; and offer calling plans that offer discounted rates based on individual characteristics and usage patterns. Publishing: As mentioned above, a book that sells for $40 can be produced at a marginal cost of $2. This gap between price and marginal cost has led to a variety of forms of differential pricing. Book clubs, hardback and paperback editions, and remaindered books are all examples of the ways that the product characteristics are adjusted to support differential pricing. Lighthouses: This example is rather interesting from a historical perspective. Economists have often used lighthouses as an example of a good that would be best provided as a public utility due to the difficulty of recovering costs. For our purposes, their interesting feature is that the cost of servicing incremental users is negligible. As Samuelson (1964) once put it, ‘...it costs society zero extra costs to let one extra ship use the service; hence any ships discouraged from those waters…will represent a social economic loss’. Ronald Coase (1974) examined the historical record and found that privately financed lighthouses were provided in England for hundreds of years. Even more remarkably, the pricing arrangement they used was quite efficient: they charged on a sliding scale based on the number of voyages a trip took per year. After six to 10 trips per year, the incremental price for the services of the lighthouse was zero, just as efficiency requires. (Source: Hal R. Varian ‘Differential pricing and efficiency’, First Monday 1(2) 1996 – permission granted by the author; ww.firstmonday.org/issues/issue2/different/index.html) 2. Market structure Economists generally define two major types of market structures – perfect competition and imperfect competition. Within imperfect competition there are usually three main market structures – oligopoly, duopoly and monopoly. However, under each of the imperfectly competitive market structures there is much more variety in terms of what the resulting pricing policies may be dependent upon. A. Perfect competition: the market consists of many sellers trading in a homogeneous product with no single buyer or seller having much of an effect on the going market price. B. Imperfect competition B.1 Oligopoly: The market consists of a few sellers who interact with each other in terms of pricing in ways that can be co-operative or non-co-operative. The oil industry exhibits some of this behaviour, in that petrol stations owned by several different major branded oil companies rarely vary their price significantly within a given geographic region. B.2 Duopoly: The market consists of two sellers who, as above, can interact with each other in terms of pricing in ways that can be

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co-operative or non-co-operative. In the case of Pepsi and Coca-Cola, the companies operate a co-operative price duopoly and engage in non-price competition through other marketing-mix policies (i.e. advertising and placement). B.3 Monopoly: The market consists of one seller and the monopoly may be static or dynamic. Static monopolies usually occur because of high barriers to entry and the impracticality of two or more firms competing in the same market (i.e. two public transportation operators in one city). Dynamic monopolies are shaped not by high fixed costs or the impracticality of having one supplier, but because the firm is acting in ways that thwart new firms from entering. These actions may be related to pricing low to keep competitors out or to new innovations, which make the firm a market leader. With regards to pricing in monopoly, in each of the static and dynamic cases, the monopolist has options for uniform or differential pricing. If we take the case of public transportation systems, in some cities like Madrid the prices are uniform for a standard ride. In other cities, most notably London with its six zones, prices vary by the distance travelled. In both cases, the city has one public transport body, but there is scope for differential or uniform pricing. Activity The case of Microsoft Windows, which has nearly 95 per cent of the global operating system software, is often alleged by Bill Gates (the founder and CEO of the company) to be an example of a dynamic monopoly. Do you agree? If not, what other factors may be related to Microsoft’s success? Within the term ‘market structure’ we can also define more generally a description of the firms’ behaviour in a given industry or market. The factors that determine firms’ pricing behaviour include precise specifications of: • the number of firms in the industry, along with the extent of barriers to the entry of new firms • the actions available to each firm • firms’ expectations about the actions/reactions available to competing firms • firms’ expectations about the number of firms in a given industry or market and the potential entry of new firms. 3. Consumer demand In 1991 before Pentium chips were available, the Intel Corporation announced the introduction of its 486 processor. Intel began with a fully functioning 486DX processor, and then proceeded to disable the maths co-processor, to produce a chip (the 486SX) that was strictly inferior to the 486DX but more expensive to produce. So which processor was priced more expensively to consumers? In 1991 the 486DX sold for $588 while the 486SX sold for $333. This was almost half of the price of the chip that was actually less expensive to produce. So the question is, why would a firm consciously sell and announce to the world that it is selling an inferior good that cost more to produce and then proceed to sell it at a lower price? The quick answer is that it depends on consumer demand, specifically demand that differs considerably between well-defined consumer segments.

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Suppose in a hypothetical representation of the Intel chip price decision above, that consumers are not homogeneous and have a different willingness to pay for a specific product such as a computer chip (i.e. some desire the product more and are willing to pay more to get it). Now suppose that the Intel Corporation has identified or thinks that there are two types of buyers of equal numbers for its DX and SX chips. No consumer wants to own both varieties simultaneously. Production costs for the DX are $5 and the SX $10. The two groups of consumers are: • Consumer type 1 (‘techno geeks’): values the high-quality DX processor at $130 and the low-quality version at $60. • Consumer type 2 (‘techno grannies’): values the high quality at $65 and low quality at $50. The intuition here is that if the DX chip was sold for $130 or less, Consumer 1 will buy it over an SX that is $60 or less. If the SX chip is sold for $50 or less, Consumer 2 will buy it over a DX chip priced at $65 or less. What is the profit-maximising strategy? Where profits = total revenue – total costs Intel chip

Willingness to pay for Consumer 1

Willingness to pay for Consumer 2

DX

$130

$65

SX

$60

$50

What is the optimal price strategy if there were two consumers? The answer is to price the SX at $50 and the DX at $130. This will generate profits of $180 – $15 = $165. No other pricing strategy maximises profit. What this case demonstrates is that firms may be able to differentiate on price and product attributes when consumers are sufficiently different from each other in their willingness to pay for a product. This is sometimes referred to as consumer heterogeneity. Consumer heterogeneity, often in combination with low marginal costs, opens up the door to marginal benefit pricing. This is where firms charge different prices to consumers for the same good based on the benefit that each consumer derives from consuming the product. Often, as in the case above, the product is slightly altered or the choice set is changed. For example, in the airline industry a ticket for the same destination is often priced differently depending on when the ticket is purchased. This is often an indirect tool designed to discriminate between different types of travellers with different willingness to pay schedules. For example, the retired tourist is price-sensitive and books early, and hence prices are lower for tickets booked ahead of time, whereas tickets booked at the last minute are often bought by business travellers who have to make an important last-minute business call, so these tickets are the most expensive. Closely related to this concept of willingness to pay is price elasticity, which is a measure of how responsive consumer demand is to a change in price. The price elasticity of demand is given by the following formula: Price elasticity of demand = % Change on quantity demanded % Change in price To understand what this relation means, suppose that a seller raises its price by 2 per cent and demand falls by 10 per cent. The price elasticity of demand is therefore –5 (the inverse relation of price and demand is captured by the negative sign) and the demand in this case is elastic and

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total revenues fall since a 2 per cent increase in price caused prices to fall by more than 2 per cent. If demand had fallen by 2 per cent, the seller’s total revenue stays the same and hence the elasticity is said to be unitary elastic. If, however, demand had fallen by only 1 per cent when price was increased by 2 per cent, then elasticity was –1/2, less than 1, and hence known as inelastic. The less elastic is demand, the higher the willingness to pay, and hence the more it pays the seller to raise the price to that consumer segment. Activity Visit online shopping sites of major retailers in two different countries and compare prices of identical branded goods. How different are the prices and to what do you attribute the price differences? 4. Macroeconomic environment There are a whole host of macroeconomic factors that firms need to consider when making their pricing decisions, the most important of which is the inflation rate – the rate of increase in the overall price level of an economy. The existence of high inflation often provides firms with a cover for inefficient (costly) production practices and pricing decision errors. In other words, firms find it much easier to pass along price increases when inflation is high. However, in the last few years many countries have witnessed the phenomenon of low inflation (and in the case of a country such as Japan, disinflation) caused by production overcapacity, intensified global competition and better central bank policies. In this context, firms need to carefully rethink their pricing policies and be aware of the effect on consumer demand caused by much more noticeable price changes. Examples of marketing-mix responses necessitated by low inflation are the following: • reduce discounts and promote everyday low prices • accelerate new product development • redesign products for ease and speed of manufacture • strip away costly features customers don’t want • forge closer links with customers (i.e. relationship marketing) • invest in information technology.

Pricing policies and strategy There are four main types of pricing policies. These will be discussed as well as their implications for profitability.

Uniform pricing With this approach the firm charges the same price for every unit of product. This relies on aggregate measures, such as the aggregate demand curve, and for this reason it has low market information requirements. On the other hand, the main shortcoming of uniform pricing is that the ‘inframarginal’ buyers – those who would have been willing to pay more for the product – enjoy a considerable consumer surplus, and this results in an economically inefficient quantity of sales.

Perfect price discrimination (dynamic pricing) Here the firm sets prices to earn different incremental margins on various units of the same or a similar product. In this way the two shortcomings

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of uniform pricing are resolved. First, by pricing each unit at the buyer’s benefit, it extracts the entire consumer surplus. Second, it establishes opportunities for additional profit from increased sales, since it provides the economically sufficient quantity. This is the most profitable pricing strategy for firms if every consumer’s willingness to pay is known ahead of time and resale can be prevented.

Direct segment discrimination With this pricing policy a firm sets different incremental margins to each identifiable segment. For this policy, the firm must be able to directly identify the various segments. In this way, it applies the rules of the uniform pricing in the context of each market segment. For instance, identifiable market segments could be men and women, or children and adults. The necessary conditions for the direct market segment are that there has to be a fixed and identifiable consumer characteristic that segments the market, and that there are no arbitrage (i.e. resale) opportunities among the segmented markets. The direct market segmentation in terms of profitability falls between complete price discrimination and uniform pricing, since it applies the rules of uniform pricing but in each segment’s context, thus reducing uniform pricing’s shortfalls. Moreover, since the buyers within a segment are usually nonidentical, this form of price discrimination does not extract consumer surplus and does not provide economically sufficient quantities, as does the complete price discrimination.

Indirect price discrimination The firm structures a choice for consumers so as to earn different incremental margins within each segment. The main reason for a firm to apply this type of pricing policy is because it cannot directly identify customers. In this case, there are two necessary conditions. First, the firm must have some control over some variable to which buyers in the various segments are differentially sensitive, in order to structure a set of possible choices that will discriminate among the segments. Second, the consumers must not be able to circumvent the discriminating variable. One of the most widespread methods of indirect segment discrimination is the so-called bundling method, where the firm offers a combination of two or more products in one package at a single price. In terms of profitability, this type of price discrimination falls between direct market segmentation and uniform pricing. It provides an enhanced alternative to uniform pricing through effective market segmentation based on consumers’ own preferences. However, when compared with direct price discrimination it is of lower profitability because it involves higher costs, relies on the self-identification of the market segments through structured choice, and it uses product attributes as discrimination criteria, thus marginally exploiting the consumer’s surplus. Summarising, uniform pricing is the simplest way to set price, mainly because of the low information requirement. For this reason, uniform pricing is the least costly but also potentially the least profitable pricing policy. If the costs of gathering information were zero, the most profitable pricing policy would be complete price discrimination, where each unit is priced at the benefit that the unit provides to its buyer. However, in order for this policy to be implemented, the firm must have complete information on each potential buyer’s individual demand curve and be able to set different prices for every unit of product. In the presence of information costs, a profitable pricing policy is direct segment

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discrimination. Finally, another profitable pricing policy when personal information is costly to obtain is that of indirect segment discrimination, according to which the firm structures a set of choices around some variable to which the various segments are differentially sensitive.

Pricing policy in the real world Determining pricing policies in the real world of marketing is a less theoretical and a far more intuitive process. The major difference between the theoretically (economic) and the on-the-ground marketing approach is that the profit-maximisation objective of pricing policy adopted in the economics textbooks is considered to be vague and incomplete. Alternatively, there are other, less tangible, types of pricing objectives, which have to be in line with the general organisational strategic objectives, such as: • price to achieve profit, but with the sense of satisfactory, rather than optimal, profit • price to gain market share, when the firm’s target is to increase or maintain market share • price to obtain cash flow: to recover cash as fast as possible, especially with products with short product life cycles (see Chapter 10) • pricing for survival: accept short-term losses necessary for long-run survival • price to maintain the status quo: applicable primarily in cases where non-price competition is more important (i.e. soft drink industry where Pepsi and Coke do not compete on price), when firms need to establish certain labels • pricing to forestall new entry and limit competition. Given the aforementioned goals there are many specific types of pricing policies that can achieve them. For example, some of the most commonly used specific pricing policies are the following: • Prestige pricing: a disproportionate price is used as a measure of quality. A firm charges the highest price possible that buyers who most desire the product will pay. The target group are consumers having inelastic demand since they are more interested in quality, status and the unique features of the product. • Price skimming: this is similar to the prestige pricing policy but is used in new products (e.g. innovative electronic devices). In this way, a firm can rapidly generate initial cash flow and cover high R&D costs. • Odd–even pricing: end prices with a certain odd number in order to give a false impression of accuracy, e.g. £99.95 sounds cheaper than £100. Unlikely as it may seem, people perceive a big difference between a .99 price and a rounded price. Also, pricing with .05 at the end induces a feeling in the consumer that the firm has calculated the exact cost of the good and is not ‘exploiting’ or extracting more consumer surplus. • Price bundling: aggregation of product, options and customer services in one price. It is prevalent in the PC market, where there is one price for the whole set of hardware, software, accessories, installation and support.

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Summary In this chapter we explored the internal and external factors that a firm has to consider (or is affected by) when undertaking its pricing decisions. We examined some general approaches to setting prices and finished the chapter with a brief look at pricing strategies. You may be tempted after having read this chapter, given the examples of how Apple lost market share with its premium pricing strategy and how Wal-Mart’s success is due to its low price strategy, to assume that price strategy today is synonymous with low price. This is not true, as good pricing really is about differentiating and giving value to customers, some of whom are willing to pay more or less for any given product or service.

A reminder of your learning outcomes By the end of this chapter and relevant reading, you should be able to: • explain the importance of pricing • identify what factors, both internal and external to the firm, determine the pricing decisions of firms • explain what is meant by terms such as ‘economies of scale’ and the ‘learning curve’ • explain how consumer heterogeneity can influence the pricing decisions of firms.

Sample examination questions 1. Discuss the extent to which the growth of the Internet and greater general consumer awareness of prices across a broad spectrum of retailers has influenced the pricing policies and functioning of firms. 2. Discount airline companies, such as Ryanair and Easy Jet, sometimes price their airline tickets for £1.00 on certain flights, yet these airlines have been hugely profitable. How do you think Michael O’Leary, chief executive of Ryanair, justifies this pricing tactic?

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Chapter 12: Introduction to placement and distribution analysis

Chapter 12: Introduction to placement and distribution analysis Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapters 13 and 14.

Further reading Blau, P.M. Exchange and power in social life. (New York: John Wiley, 1964). Bourantas, D. ‘Avoiding dependence on suppliers and distributors’, Long Range Planning 22(3) 1989, pp. 140–49. Dahl, R.A. ‘The concept of power’, Behavioral Science 2, July 1957, pp. 201–15. El-Ansary, A.I. and L.W. Stern ‘Power measurement in the distribution channel’, Journal of Marketing Research 9, February 1972, pp. 47–52. Emerson, R.M. ‘Power dependence relations’, American Sociological Review 27(1962), pp. 31–40. Frazier, G.L., J.D. Gill and S.H. Kale ‘Dealer dependence and reciprocal actions in a channel of distribution in a developing country’, Journal of Marketing 53, January 1989, pp. 50–69. Friedman, L. and T.R. Furey The channel advantage. (Oxford: Butterworth Heinemann, 1999) [ISBN 0750640987]. Gaski, J.F. ‘The theory of power and conflict in channel of distribution’, Journal of Marketing 48, Summer 1984, pp. 9–29. Heide, J.B. and G. John ‘The role of dependence balancing in safeguarding transaction-specific assets in conventional channels’, Journal of Marketing 52(1), January 1988, pp. 20–35. Joshi, A.W. and S.J. Arnold ‘The impact of buyer dependence on buyer opportunism in buyer-supplier relationships: the moderating role of relational norms’, Psychology and Marketing 14(8), December 1997, pp. 823–45. Narus, J.A. and J.C. Anderson ‘Turn your industrial distributors into partners’ in Kotler, P. and K. Cox (eds) Marketing management and strategy, a reader. (Upper Saddle River, NJ: Prentice Hall International, 1988) [ISBN 013557653]. Puttnam, D. Movies and money. (New York: Knopf, 1998) [ISBN 067976741X (pbk); 0679446648]. Spekman, R.E. and D. Strauss ‘An exploratory investigation of a buyer’s concern for factors affecting more co-operative buyer-seller relationships’, Industrial Marketing and Purchasing 1(3) 1986, pp. 26–43. Stern, L.W. and T. Reve ‘Distribution channels as political economies: a framework for comparative analysis’ in Enis, B.M. and K.K. Cox (eds) Marketing classics. (Boston, Mass.: Allyn and Bacon, 1991) [ISBN 0205129242 (pbk)]. Van de Ven, A. ‘On the nature, formation, and maintenance of relations among organisations’, Administrative Science Quarterly 21, December 1976, pp. 598–621. Williamson, O.E. Markets and hierarchies: analysis and antitrust implications. (New York: Free Press, 1975) [ISBN 0029347807 (pbk); 0029353602].

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Aims of the chapter The aims of this chapter are to introduce you to: • the functions of distribution channels • the factors that marketers need to take into account when establishing distribution channels • the role of power in determining channel member relationships.

Learning objectives By the end of this chapter and the relevant reading, you should be able to: • identify the functions of distribution channels and how marketers’ need for these will vary depending on the types of products and services that they are selling • describe and critically assess the key issues in the design and management of marketing channels • explain the factors that can influence the power relationships between channel members.

Introduction Most marketers do not sell their product or service directly to the end user. In order to reach their target customers, they sell or distribute via intermediaries. Such intermediaries are referred to as ‘marketing channels’. The choice of channel is important since it affects such variables as the pricing of the product and the level of service that the producer can offer. Furthermore, the choice of a channel can affect a firm’s long-term relations with other firms. In this chapter we look at the functions of distribution channels and we also consider the fundamental role that power plays in the relationships between channel members. Marketing channels are sets of interdependent organisations involved in the process of making a product or service available for use or consumption. Producers use other firms’ members of their marketing channel in order to reach the final consumer. Such firms can be wholesalers, retailers or distributors. Producers benefit from intermediaries’ use of their own capital to buy retail outlets and showrooms; indeed, even the largest manufacturers would find it difficult to purchase an entire dealer network. Furthermore, most manufacturers would not find it economic to have retail outlets selling only their own products. However, the use of intermediaries does involve giving control of some marketing activities to other companies. To a large extent the ways in which a product is promoted within a store will depend on the store owner. Manufacturers therefore trade control for gaining a wider distribution of their goods. Members of a marketing channel perform a number of functions. These include the collection and dissemination of marketing information, the promotion of products and accepting some of the risks in distributing the product. Each person within a channel who brings the product closer to the final consumer constitutes a channel level. Direct marketing is an example of a ‘zero-level’ channel; the marketer contacts the final user directly by mail, for example, and the customer places an order directly with the producer. The challenge facing firms is their choice of channel design. Which types

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of intermediaries should they have, how many and what should their terms and responsibilities be? The channel alternatives can be evaluated on the grounds of economic criteria, control criteria and adaptive criteria. Economic criteria deal with the costs and revenues associated with different channels. Control criteria refer to the extent to which a firm can influence the actions of other firms in the marketing channel. Such influence may be limited where such firms are independent businesses which can decide how they want to promote the manufacturer’s goods. Adaptive criteria are important since they deal with the ability of the marketing channel to adapt to a changing marketplace. This is affected by contracts between channel members. Once the decisions have been made regarding the design, individual channel members (i.e. actual firms) need to be chosen to distribute and retail the products. Firms need to pay attention to the factors that can cause conflict between channel members. Conflict can arise when their goals are incompatible. For example, the manufacturer may want a high market share through low prices, whereas the distributor may want to maintain a high profit margin. There may also be differences in perception. For example, the distributor may feel that the economic outlook is buoyant and merits a more aggressive marketing stance, while the producer may be more pessimistic. In this chapter we will pay specific attention to the functions performed by channel members and we will also consider the role of power in determining the relationships between channel members. This chapter accompanies Chapter 13 of Kotler and Armstrong (2004). All parts of that chapter are important; however, you do not need to read the sections dealing with public policy and distribution decisions and nor do you need to read the section dealing with marketing logistics and supply chain management.

The functions performed by marketing channel members Before we look at specific decisions related to the design and management of marketing channels, we will consider in more detail the functions that marketing channels can fulfil. Between the manufacturer and the end user lies the distribution channel or channel intermediaries. These people are in businesses in much the same way as the manufacturer and they are also motivated by making profits. Just like the manufacturer, they try to provide customers with benefits the customers want and are willing to pay for. The benefits that channel intermediaries provide are, for example, the convenience of a local neighbourhood shop or the cost savings of a supermarket or the selection of quality products in a delicatessen. Marketing channels can vary from direct to indirect. The functions in a channel cannot be replaced, though individual institutions can be. Someone will have to undertake the following functions: stock carrying; selling; providing after-sales service; extending credit to customers. According to channel-structure theory, consumers prefer to deal with marketing channels which provide higher levels of service outputs. These outputs can be considered in terms of: • spatial convenience (going to a shop nearer to you rather than further away)

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• lot size (people preferring to buy 250g of coffee, rather than a 5kg bag) • waiting time • product variety. The greater the level of these service inputs required by the consumer, the more intermediaries there will be. The organisation of marketing channels is geared towards providing benefits or utility for consumers (end users). The greater the level of utility the marketer provides to the customer, the greater the level of profits channel intermediaries can generate; channel intermediaries are people such as wholesalers and retailers. However, providing additional benefits to customers can also involve handling risk. Channel intermediaries can try to reduce the level of risk in their activities, and/or they can pass it on to other channel intermediaries or even take on more risk themselves. The reason they may want to take on more risk themselves is because they may usually make more profits as a result. The functions performed by channel members are as listed below.

Efficiency Efficiency within a marketing channel is improved if exchange is centralised rather than decentralised. You find it more efficient to visit a supermarket to buy products from a range of manufacturers than to visit each one of them individually. Similarly, channel members find it more efficient to reach you via a supermarket rather than visit you. The extent to which exchange is centralised is limited due to costs of communications, the effectiveness/efficiency of institutions and the quality of contact. If there are too many layers in the distribution channel, the level of noise will increase. In this instance ‘noise’ refers to the idea that information received by retailers (for example, about consumer tastes) will not be understood by manufacturers because it has to pass through a number of layers of intermediaries who may distort the message.

Adjusting discrepancy of assortments Among the functions performed by intermediaries such as wholesalers and retailers are the sorting of goods in order to bridge the discrepancy between goods made by producers and those that consumers demand. The discrepancy arises because each manufacturer (e.g. Heinz) produces a large quantity of a limited variety of goods and each consumer demands a small quantity of a wide variety of goods. Intermediaries also undertake sorting; this refers to the grading of the products retailers receive from manufacturers – especially important in the sale of fresh produce. They also bring together similar stocks from a number of sources; this is referred to as ‘accumulation’. The ‘allocation’ function performed by channel members refers to goods being bought in truck loads being sold in case lots – again this is an important source of utility for consumers. This is also an activity that distinguishes convenience stores from hypermarkets. The latter may charge lower prices, in return for consumers taking on the inconvenience of buying in large quantities – which the consumers will have to store at home. ‘Assorting’ refers to retailers building assortments of goods for consumers. For example, retailers will bring together a variety of different fruit from different countries. Each of the above is more commonly found in some markets rather than others. Because of the above issues there is a limit on the degree of

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vertical integration that can take place. Vertical integration refers to firms within a distribution channel, for example the manufacturer, the wholesaler and the retailer being owned by the same company.

Routinisation of transactions Costs can be reduced by increasing the extent to which transactions are ‘routinised’ (i.e. the same transaction takes place week after week). In contrast, the greater the extent to which bargaining takes place, the greater the costs – because every time the transaction takes place you have to work out the price to be charged. Routinisation is an important aspect of exchange; it leads to standardisation of goods and services, for example automatic reordering.

Postponement–speculation and channel structure Efficiency in channel structure is achieved by postponing (delaying) changes in the form and identity of a product to the latest possible point in the marketing process and inventory location to the latest possible point in time. This reduces risk and the costs associated with uncertainty. The more differentiated the product (the greater the number of models of a range of cars or flavours for crisps), the greater the risk. The cost of physical distribution is reduced by sorting products in large lots in undifferentiated states. So it is cheaper to hold parts and only manufacture when there are confirmed orders for particular specifications. By postponing, channel members can also shift risks to other channel members. So retailers only buy from wholesalers who offer fast delivery – this means they can delay placing an order to the last possible moment. The wholesaler will need to carry enough stocks to supply product at the last possible time. The opposite of postponement is speculation, which involves reducing risk rather than shifting it. The earlier that changes and movement takes place, the greater the reduction in costs of the marketing system. Speculation involves reducing costs by achieving economies of scale; reducing large numbers of small orders; and reducing stockouts.

The importance of power in channel member relationships The following definition of power is given by Dahl (1957, pp. 202–3): A has power over B to the extent that he can get B to do something that B would otherwise not do.

The key feature of power then is the ability to cause someone to do something he/she would not have done otherwise (Gaski, 1984). In marketing the notion of power is an important one when considering distribution channels because channel relationships can involve the exercise of power by one party over another. When we consider vertical marketing systems below, we will see how power can be applied in a practical context. In this section, however, we will consider the factors that contribute to power; this will clarify in conceptual terms how power can be exercised and managed by different members of a marketing channel. The reason why an organisation has power over another is because of the existence of the related concept of ‘dependence’. Emerson (1962) argued that the relative dependence between two actors in an exchange

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relationship determines their relative power. Not being dependent, a state of independence, refers to the concept of autonomy. Dependence poses constraints in the freedom of choice of actions. A company becomes vulnerable when it loses control over resources to its exchange partners and finds itself dependent on its partner (Spekman and Strauss, 1986). With increased dependence also comes strategic vulnerability (Van de Ven, 1976). Frazier et al. (1989) define dependence as the degree to which a party needs to maintain its relationship with another party in order to achieve the desired goals. Dependence on an exchange partner is often connected to the costs associated with terminating the relationship and switching to an alternative exchange partner (Heide and John, 1988; Joshi and Arnold, 1997). Dependency increases the organisation’s vulnerability by creating problems of uncertainty or unpredictability; it reduces the organisation’s autonomy and the degree of strategic freedom, and allows the direct transfer of benefits and profits from the dependent on the dominant organisation (Bourantas, 1989). El-Ansary and Stern (1972) viewed dependency as a function of: • the percentage of a channel member’s business which they contract with another member and the size of the contribution which that business makes to their profits • the commitment of a channel member to another member in terms of the relative importance of the latter’s marketing policies • the difficulty in effort and cost faced by a channel member in attempting to replace another member as a source of supply or as a customer.

Channel behaviour and organisation We will not cover this topic in detail here, but you should read about it in Kotler and Armstrong (2004). In particular, you should pay attention to the coverage of vertical and horizontal marketing systems. You should also consider multi-channel systems. Activity What are the advantages of vertical marketing systems (VMS)? Explain the reasons for the increase in the use of systems of this type. Suggested answer The advantages are in terms of common channel design criteria relating to economic, control and adaptive needs. Hence VMS can be expected to offer, in particular, costreduction advantages and superior management of conflict within the channel: • The growth of powerful retailers able to dominate the distribution process, itself perhaps reflecting the growth of self-service retailing, shopping by car, etc. • Globalisation of brands and the growth of franchising based on brand power. • Developments in technologies of information, control and command by application of IT. 1

• Development of e-tailing and direct marketing reflecting technological and social changes.

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E-tailing refers to retailing over the internet. Thus an e-tailer is a B2C business that executes a transaction with the final consumer. E-tailers can be pure play businesses like Amazon.com or businesses that have evolved from a legacy business, e.g. Tesco.com. E-tailing is a subset of ecommerce. Source: www.capcomarketing.com/mediakit/ Marketing_Glossary/

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Channel design and management decisions Kotler and Armstrong (2004) deal with channel design issues in terms of a sequence of stages that organisations may need to follow in order to design their marketing channels. The textbook highlights the different options that marketers face and the advantages and disadvantages associated with each. Once the company has established the channel design, it will need to consider how the channel ought to be managed and this is also covered in terms of the selection of channel members, managing, motivating and evaluating them. Mini-case 2.1: Disintermediation in the movie industry2 Major film studios dominate the distribution channels for films around the world. They have achieved this by owning film, video and television distribution companies. The importance of video and television is underlined by the fact that 80 per cent of movie revenues come from the video and television markets. A recent development has been video-on-demand (VOD). This would involve movies being delivered to the audience, for example, via the Internet. Consumers would be able to download movies on their computer hard drive (for a fee). However, this would only be for a limited period of time and the movie could not be copied or transferred to another device.

2

For further information on the movie industry and distribution channels, see: Puttnam, D. Movies and money. (New York: Alfred A. Knopf, 1997); Friedman, L. and T.R. Furey The channel advantage. (Oxford: Butterworth Heinemann, 1999).

One of the factors driving this move to VOD has been the success of Napster (a music file-sharing service) that has been accused by the music industry for facilitating the illegal distribution of songs by individuals. Film industry executives have been fearful that a similar unlicensed service could be established and would thereby have an impact on the sale of movie DVDs and perhaps cinema tickets. Another factor encouraging the development of VOD has been the fact that the Internet is a distribution channel which allows firms to establish relationships directly with the final consumer – this is unlike traditional distribution channels where there has usually been an intermediary between the movie studio and the film watcher. Moreover, this new distribution channel allows the movie studio unprecedented ability to gain information about their consumers and engage in a dialogue with them. Such information could be particularly useful for undertaking direct marketing campaigns and developing offers specifically suited to particular market segments. Of course there are also clear economic benefits to using a distribution channel which offers such low costs to the movie studios. Studios will effectively be in the movie rental business, except that when the consumer pays their $2.50 to rent the movie instead of some of it going to the rental store – the studio will be able to keep all of the proceeds. Activity What are the factors that are encouraging disintermediation in the movie industry?

Summary In this chapter we have looked at the functions that distribution channels can perform and this has set the scene for considering how marketers may need to alter the design of distribution channels based on the functions that they would like the channel to perform. We have also considered the role of power in determining channel relationships and this has provided a backdrop to the coverage of channel design issues in Kotler and Armstrong (2004).

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A reminder of your learning outcomes By the end of the chapter and the relevant reading, you should be able to: • identify the functions of distribution channels and how marketers’ need for these will vary depending on the types of products and services that they are selling • describe and critically assess the key issues in the design and management of marketing channels • explain the factors that can influence the power relationships between channel members.

Sample examination questions 1. ‘Reducing the level of dependence that an organisation has on other channel intermediaries is an important goal for an organisation.’ Critically discuss this statement. 2. Discuss the different ways in which vertical marketing systems can enable an organisation to manage the power relationships between itself and channel intermediaries. 3. Explain the difference between direct and indirect distribution. Assess the advantages and disadvantages of each and explain why direct distribution has become popular in recent years.

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Chapter 13: Corporate social responsibility (CSR) and marketing

Chapter 13: Corporate social responsibility (CSR) and marketing: ethical and social implications of marketing behaviour Essential reading Kotler, P. and G. Armstrong Principles of marketing. (Upper Saddle River, NJ: Pearson, Prentice Hall, 2004) tenth international edition [ISBN 0131212761], Chapter 20.

Further reading Benioff, M. and K. Southwick Compassionate capitalism: how corporations can make doing good an integral part of doing well. (Franklin Lakes, NJ: Career Press, 2004) [ISBN 1564147142]. Frank, R. Luxury fever: money and happiness in an era of excess. (Princeton, NJ: Princeton University Press, 2000) [ISBN 0691070113]. Galbraith, K. The affluent society. (London: Penguin, 1999) [ISBN 0140285199]. Klein, N. No logo: no space, no choice, no jobs: taking aim at the brand bullies. (Toronto: A.A. Knopf Canada, 2000) [ISBN 067697130X]. Veblen, T. The theory of the leisure class. (New York: Random House, 1899, 2001) Modern Library Classics edition [ISBN 0375757872]. ‘Corporate social responsibility: two-faced capitalism’, The Economist, 22 January 2004. ‘Survey: corporate social responsibility’, The Economist, 20 January 2005.

Aims of the chapter The aims of the chapter are to: • make clear the growing importance of ethical marketing and explain the reasons why it’s more important today than ever before • emphasise how the rise in the global telecommunications industry makes inappropriate corporate behaviour much less localised • demonstrate that firms engage in socially responsible behaviour for both normative reasons (i.e. because it’s good) and for profit-oriented reasons (i.e. acting ethically can also be good for the bottom line).

Learning objectives By the end of this chapter and relevant reading, you should be able to: • identify some of the common and more radical criticisms of marketing • explain what is meant by the term ‘corporate social responsibility’ and its origins in the early Industrial Revolution • describe the history of ethical marketing practices and the impact of the environmental and other social movements on fostering modern ethical behaviour on the part of firms.

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Useful web sites http://www.csr.gov.uk The United Kingdom government’s web site on corporate social responsibility. http://www.bsr.org Business for Social Responsibility (BSR) offers a large collection of online tools and guidelines on responsible business practices. www.christianaid.org.uk/indepth/0401csr/index.htm The Christian Aid web site contains a detailed report entitled ‘Behind the mask: the real face of corporate social responsibility.’

Introduction Although often relegated to the final chapter of most marketing textbooks, including this one, the topic of social responsibility and ethical behaviour is of paramount importance in marketing. The term corporate social responsibility (CSR) is a rather new one applied to all aspects of ethical corporate behaviour, from the environmental practices of a firm to the way in which management treats its employees. Before we explore this ethical approach to marketing and deal with the question of why it may have arisen, it may be helpful to outline why marketing may generate ethical and social problems to begin with. We shall then move on to discuss the responses of consumers and civil society1 to the marketing behaviour of firms and see how firms respond. We will also examine the question of which firms are more likely than others to adopt corporate socially responsible behaviour and what factors may be responsible for the switch to corporate socially responsible ways of behaving.

What ethical and social problems is marketing accused of causing? There is a long list of social and environmental ills of which marketing is often accused of causing. Many of these negative effects are outlined in great detail by Kotler and Armstrong (2004, pp. 630–36) and include: • high prices • deceiving consumers • high-pressure selling • shoddy or unsafe products • waste/environmental damage • planned obsolescence.

Impacts on consumers The list above affects individual consumers directly and although the list looks negative, there are in fact reasons or rationales that vindicate the marketing framework in each of the points above. For example, high prices are often alleged to be the result of the marketing system, with its emphasis on high promotional costs and complicated distribution channels. A more centrally planned system, with fewer intermediaries and less scope for promotion, could, in theory, lower costs for consumers.

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Broadly defined as the space between the state and private organisations on the one hand, and the individual on the other. Normally we think of civil society as being synonymous with the voluntary sector, but also included are religious groups, informal associations and labour organisations.

Chapter 13: Corporate social responsibility (CSR) and marketing

But is such a system ‘better’ than the one we currently have? The disastrous examples of centrally planned economies notwithstanding, there may be a reason why consumers willingly pay more for a certain product than they would otherwise if they lacked the sophisticated distribution and promotional techniques that the marketing system provides. This is because price mark-ups often reflect product or service attributes that consumers want, such as convenience and choice. Having a less costly distribution system with only one location where goods and services can be bought may lower the direct cost of the product, but these savings will be offset by greater indirect costs associated with the purchase such as increases in transportation costs and search time. Likewise, heavy advertising expenditures may increase the cost of a product, but advertising may also inform millions of consumers about a product or service’s availability and its attributes. Promotional and branding efforts may create distinctions among products that otherwise do not exist (e.g. how different is bottled Evian water from Volvic?), but these may also be useful for consumers as symbols of quality in an uncertain world filled with many choices. On balance it is difficult to make a claim that marketing harms or helps consumers since there are equally compelling reasons for each view. As is often the case, the question of whether marketing activity is good or bad for consumers is an empirical or a practical one. That is, we have to ask whether, in the real world, the benefits of such market activities as advertising (e.g. information) outweigh the costs (e.g. higher prices).

Impacts on society A potentially greater and more damaging allegation against the marketing system is the effect that it has on the attitudes and values of citizens, or if you will, on society as a whole. No less an authority than the famous Harvard economist John Kenneth Galbraith (1908–2006) called the behaviour induced by marketing efforts a ‘hedonic treadmill’. Galbraith in his book The affluent society (first published in 1958) specifically argued that one of the most powerful dimensions of marketing, the promotional side, was responsible for the creation of artificial needs. If wants emerge before the production process, such as the need for lodging while travelling (which produces a hotel industry), then these can be said to be genuine wants that require satisfying. However, if wants emerge with the production process itself, then the urgency of these wants can no longer be used to defend the urgency of production. For example, why do I need a special holder for my mobile phone in my car, if in point of fact I don’t need to speak while I am driving and have never needed this before the invention of the mobile phone? According to Galbraith, when production begins to fill a void that it has itself created, then this is proof that the need is artificial and the satisfaction that it will bring can only be insignificant and temporary (like the example of the hamster who tries to keep ahead of the treadmill that is propelled by his own efforts). But is there any empirical evidence in support of the ‘hedonic treadmill’? Early theories of consumption behaviour showed that there was a very close positive association between income and consumption, but that this only worked in one direction, up. When personal income fell, consumption, instead of falling with it, would remain relatively constant. Some economists claimed that this was proof of a hedonic treadmill or ‘keeping up with the Jones’s phenomenon.

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More recently, Robert Frank in his book Luxury fever (2000) studied conspicuous consumption, a term first used by a famous economist in the early part of the twentieth century named Thorstein Veblen (1857–1929). Strange as it may seem to students who have to work out whether they can afford this month’s rent and still have money for holiday gifts, there are those in society capable of spending large amounts of money on a watch, having plastic surgery at 20 years of age and paying several hundreds of thousands for a Ferrari. You might say, well that’s fine because those are private acts. If our society allows people to make that sort of money, then how and why should we stop them from spending it? However, from an economy-wide perspective this type of consumer behaviour, according to Frank, ‘has a disastrous knock-on effect in less privileged sectors of society’. In the US, by far the most unequal and mediasaturated economy, luxury spending during the 1990s and early 2000s was rising four times as fast as on ordinary items. Personal savings, on the other hand, were (and are) still in steep decline not only in the US, but also in previously high-savings societies like South Korea (see Mini-case 13.1). And despite the US economic miracle of the late 1990s, personal bankruptcies remained at an all-time high as well. What happens, according to Frank (2000), is that in a society as inundated with spending signals and income inequality as the United States, there is a spending cascade effect that induces higher (unaffordable) purchases by all segments of society. We, as citizens, often make judgments of our social standing and personal success by comparing ourselves with our nearest neighbour. But on what basis can we compare ourselves with our neighbours? Often we don’t speak with our neighbours directly and we often have no clue as to what they do, so we look at their outward signals of status and power to make comparisons. Things like houses and cars affect how we perceive someone and in return, how we measure our own standing in society. In the case of spending by the super-rich, most people are not affected. But the very rich, who compare themselves with the super-rich, do respond to these spending signals, and this in turn affects their spending patterns and those of their nearest neighbours, the near rich, and so on down the line. The spending cascade eventually affects all segments of society.

More radical critiques of marketing According to Naomi Klein, author of the best-selling book No logo (2000), and academics such as Sut Jahally,2 advertising does not create wants and needs; in fact it does the opposite, it taps into all our wants and needs (no matter how damaging or reckless). It is just that the marketing process takes those wants and desires, transforms them, and sells them back to consumers in a distorted and inauthentic form. For example, the need for a return to ‘small town’ life in America is taken away by suburban reality, and then it is sold back to people in the form of ‘Main Street USA’ at Disney World and the Mall of America in Minnesota. The only difference is that you need to pay an admission fee to walk down the high street at Disney World. Certain points that Sut Jahally and other radical critics of marketing make include: • Happiness surveys across countries show that there is no correlation between happiness and national income. • Quality-of-life surveys show that the things we value can be divided

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up into social values (love, family, friends) and material values (economic security and success), but that the former outranks the latter in terms of importance. • The irony in the marketing system is that the marketing approach is good at providing the things that can be bought and sold, but the real sources of happiness are beyond marketing’s capability. • The advertising industry exhibits the above fact. Examinations of advertising at the end of the nineteenth century reveal a lot of information about the properties of the commodities sold. But starting in the 1920s, advertising shifts to discussions of social life. So the falsity of promotion and the marketing approach, according to these more radical critics, is not in the appeals that it makes (which are very real) but in the answers it provides. People say they want love and friendship, and marketing points the way to these things of value through the acquisition of products and services, which they cannot in themselves provide. Mini-case 13.1: Has South Korea become consumption and credit crazy? Has marketing and the attention placed on the alleged economic benefits of a consumeroriented society turned a nation of savers into out-of-control ‘spendaholics’? That’s the question many commentators are asking of South Korea, one of the most successful countries, economically, in South East Asia. For many years South Koreans were known for their thriftiness and high savings rates. The country’s huge reservoir of personal savings kept interest rates low, fuelled real investments by governments and businesses, held inflation at bay and kept economic growth rates high from the 1960s all the way through to the late 1990s. Then something began to change. Partly induced by the speculative bubble of the late 1990s and the Asian currency crisis of 1998, South Korea has now emerged as one of the highest per capita spenders in the world. Much of the blame has been laid on new consumer society inventions like non-secured credit and the aggressive promotional campaigns designed to get consumers to spend following the last economic downturn. Growth was maintained during the last Asia crisis because the government boosted private consumption by aggressively promoting credit card use. It did this by, among other things, introducing tax deductions for purchases made by credit card. The result was a credit card debt explosion. The total amount of credit card spending rose from $53 billion in 1998 to $519 billion in 2002; household debt soared from 18 per cent of GDP in 1999 to 62 per cent in 2001. Not surprisingly, delinquency rates began rising sharply in 2002. As reported by the Korea Economic Institute, ‘credit card excesses…created spiralling social problems [including] increasing numbers of suicides, violent crime, kidnappings, and prostitution.’ Frightened by the possibility that personal bankruptcies could undermine the country’s financial system, the government finally took steps to limit credit card use in early 2003. Its success produced a sharp contraction in private consumption, which triggered a decline in business investment, and a recession in 2004. So where does South Korea’s future lie? Having chosen consumption-led growth as the path to get out of the economic malaise of the late 1990s, South Korea is now faced with the prospect of the hollowing out of its own industry and an increased dependence on exports. Exports accounted for 98.2 per cent of the country’s growth in 2003, while investment in new equipment for production inside of South Korea, which regularly exceeded 20 per cent during the economic expansion days prior to 1998, has been zero or negative since 1999.

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In 2000 Enron was the largest energy company in the world, until it went bankrupt as a result of unethical business practices, financial impropriety and phoney accounting.

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Activity Can you find evidence of how much consumers spend in your country, relative to national income? Has this changed over time? Is it greater than or less than other countries? What might explain the changes over time and the differences across countries?

But is it marketing’s fault that we care so much about consumption spending and public displays of wealth? The basis on which good repute in any highly organised industrial community ultimately rests is pecuniary strength; and the means of showing pecuniary strength, and so of gaining or retaining a good name, are leisure and a conspicuous consumption of goods. (Thorstein Veblen, Theory of the leisure class (1899), 2001 edition)

People seem generally to interpret ‘conspicuous consumption’ as ‘a vulgar display of wealth’ or, in cases of leering glances and long low whistles at expensive cars, for example, as ‘a display of wealth which I admiringly acknowledge’. Another understanding of Veblen’s message is that ‘conspicuous consumption’ is more complex and important in social organisation. It is often found along with ‘conspicuous leisure’ and is a way of signalling social power, of intimidating onlookers and gaining their submission, thereby retaining, and perhaps augmenting, one’s social power. Veblen, in this respect, has a very modern evolutionary psychology story to tell about why we consume and display our wealth. The ‘warrior’ in pre-industrial society would, for example, wear golden armbands and lie around all day. This tells onlookers two things: the warrior didn’t mine the gold himself, and he’s got it. Inferentially, he took it. Therefore, be wary of dealing with him, because he is visibly powerful. This applies to some extent in our society today although the signals being sent by public displays of wealth are more varied. People stop to look at stretch limousines and behave deferentially toward the occupants. Nike trainers are a marvellous example of conspicuous consumption – they are desired because they are known to be expensive. If conventional pricing and economic theory worked in this case, they would cost almost nothing, because they cost almost nothing to produce, and Nike could underprice its rivals if market competition were the main factor in pricing. But Nike shoes, apart from satisfying the generic need for protective footwear, give status to their wearer. The person wearing them either got the shoes or successfully stole them. This applies equally to such items as designer clothes, perfumes, expensive cars – they are all imbued with powerful social signals that irrespective of marketing’s existence are always present. Since pre-industrial times, we have inched forward in our social views and no longer blatantly defer to powerful people whether or not they are rich. Our deference to the wealthy, when it does occur, is often explained as admiration for their ‘hard work’. But in social fact, somebody who works hard and shows up in greasy pants and a shirt, with his fingernails dirty, is not likely to impress us as much as an immaculately dressed person with clean fingernails. The latter appearance signals higher social rank – basically, the ability to get more money without strenuous physical activity – in other words, we still recognise conspicuous consumption and conspicuous leisure as symbols of real power. Given that this is so, it may be argued that the worst that marketing does is accentuate these perplexing tendencies at the expense of others in our social make-up.

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Definitions and a brief history of corporate social responsibility (CSR) Should businesses have to consider the economic, social and environmental impacts of their activities, wherever they operate in the world? According to many social activists, policy-makers, marketers and even economists, the answer is a resounding yes. Corporate social responsibility (CSR) is about how business takes account of its economic, social and environmental impacts in the way it operates – maximising the benefits and minimising the disadvantages. CSR can be described as the voluntary actions that business can take, over and above compliance with minimum legal requirements, to address both its own competitive interests and the interests of wider society. The British government is such an advocate of CSR that it has even created a ministerial post devoted to the fostering and study of CSR, and the World Bank has issued an official definition and is helping governments encourage this behaviour amongst their firms: Corporate Social Responsibility is the commitment of business to contribute to sustainable economic development – working with employees, their families, the local community and society at large to improve the quality of life, in ways that are both good for business and good for development. (World Bank, 2004)

But is all this effort worth it? The biggest detractors of CSR are those who claim that it is yet another corporate fad or buzzword. The well-known and influential Economist magazine in particular has been very critical. Like the stakeholder society before it, which argued that corporations are beholden to all those who have a stake in the company (employees, consumers, residents) and not just shareholders, the critics claim that CSR is an unwarranted intrusion on what should otherwise be the corporate prerogatives to make profits and add value for the owners of an enterprise, who are typically shareholders. But this view of CSR negates the long-term concern that many industrialists and business leaders have had with social welfare and the role firms could play in fostering it.

CSR principles have a long history The idea of corporate social responsibility has its roots in the writings and work of three early writers, the so-called utopian socialists of the eighteenth and nineteenth centuries – Charles Fourier (1772–1837), Robert Owen (1771–1858) and Henri de Saint-Simon (1760–1825). Although they differed from one another in a number of fundamental ways, they had enough in common to justify talking about them collectively. They all lived at approximately the same time: only 12 years separated the oldest (SaintSimon) from the youngest (Fourier). All were alive between 1770 and 1825 and they all did their most influential work during the first quarter of the nineteenth century. Although it was Karl Marx (1818–1883) and Friedrich Engels (1820–1895) who eventually labelled these socialists as utopian, they were not utopian in the traditional sense of the word. The Utopian Socialists believed that their ideal societies could be established in the immediate future. The label utopian has been accepted but not necessarily because historians have agreed with the judgment of Marx and Engels. The real reason why Saint-Simon, Fourier and Owen are Utopian Socialists is because their thoughts closely resemble those of a religious sectarian, the recent convert, the visionary and the romantic. It might also be added that for the modern reader, the ideas of the Utopian Socialist also appear to have been formulated by social activists rather than commentators.

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Robert Owen, to modern eyes, is the closest to purveying some of the elements of what we might call modern CSR. He was at first just a benevolent factory owner who made paternalistic improvements in the lives of his employees. He spoke a language that seemed to hark back to a preindustrial moral economy and a near rejection of modern commercial civilisation. For this reason, Owen attracted the attention of the rural gentry and those politicians whose ideas were conservative and decidedly antimodern. Owen’s reputation grew after 1800 through his operation of a textile factory in New Lanark, Scotland. Owen had introduced such improvements as shorter working hours, healthier and safer working conditions, afterhours recreation, schools for children and adults, moral education, renovated housing, an end to child labour and insurance plans financed by payroll deduction. This may seem standard today, but one must remember that this was happening during the early Industrial Revolution when few if any government regulations existed to protect workers. What was also remarkable about New Lanark was that Owen not only improved the lot of his employees, he also managed to make profits. Before long, New Lanark became a tourist attraction where visitors came to stare openly at Owen’s social experiment in efficient production. Although his experiment did not last long, between 1805 and 1815, 15,000 visitors came to New Lanark and his ideal factory continued to show profits, but the idea did not spread. One reason why New Lanark did not work anywhere else was due to its location. New Lanark was dependent on water power rather than steam and was filled with workers who had to be imported into the area. New Lanark was operating under conditions that were typical of the initial stages of textile production, conditions that were being quickly overcome by the rapidly advancing Industrial Revolution. Eventually, however, some of his ideas were to become pillars of later industrialist reformers. Twentieth-century industrialists such as Andrew Carnegie (1835–1919) and others carried on some of Robert Owen’s interests in industry benefiting society. Carnegie, founder of US Steel, articulated two social responsibility principles he believed were necessary for capitalism to work. First, the charity principle required more fortunate members of society to assist the less fortunate members, including the unemployed, the disabled, the sick and the elderly. These ‘have-nots’ could be assisted either directly or indirectly, through such institutions as churches, settlement houses and other community groups. Second, the stewardship principle required businesses and wealthy individuals to see themselves as the stewards, or caretakers, of their property. Carnegie’s view was that the rich hold their money ‘in trust’ for the rest of society. Holding it in trust for society as a whole, they can use it for any purpose society deems legitimate. However, it is also a function of business to multiply society’s wealth by increasing its own through prudent investments of the resources that it is caretaking. These ideas gained wide acceptance over the years. Coupled with the threat of government intervention and regulation, they helped form the expectation that corporations add social needs and concerns to their economic purpose. But fulfilling the economic purpose was seen as the primary task of the corporation. This began to change in the middle to latter part of the twentieth century in many Western countries, as governments began to increase their role in the economy in what has come to be known as the era of the welfare state (1945–80). The state now began to overtake the large corporation

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as provider of many social goods (like health insurance) and also to act as guardians of the environment and regulator of business. Business, in turn, refocused its energies primarily on the task of generating profits for shareholders. In the early 1980s, however, there grew powerful attacks on the welfare state, and in many countries, the state retreated from functions it had once occupied. In England this was known as Thatcherism, named after Margaret Thatcher (1925– ), the Tory architect of privatisation and deregulation. In America it was also known as the era of Reaganomics, so named after Ronald Reagan (1911–2004), President of the United States for two terms. The gap left behind by governments who had retrenched from many of the social interventions of the post-welfare state era once again left open space for private actors, such as large corporations, to fill. In many cases, through deregulation and globalisation, the corporation’s size and scope necessitated policies or principles which took account of the social effects of their actions. Although the growth in the size of the corporation and the retreat of government from the economic and social landscape were important factors, the resurgence of corporate social responsibility has many other causes, some of which are detailed below.

Which firms adopt CSR and why? Corporate social responsibility has taken on more prominence in recent years because it has been adopted by well-known globally branded companies such as the Body Shop, Starbucks and even the most ubiquitous brand in the world, McDonalds. This is important since these are obvious examples of large, globally branded companies. Even oil companies, which were once stigmatised by environmental and human rights groups such as Amnesty International, are now some of the biggest proponents of CSR (see Mini-case 13.2). To understand why, there are several points to consider in the context of companies that are branding internationally. First, branding has a danger in that external ‘shocks’ or accidents (like selling a defective product) have a stronger and more immediate effect on sales for branded goods than no-name goods. Among branded goods, the strength and transmission of these shocks are an increasing function of how much brand equity a particular firm has. Therefore to protect itself, a company often has to be prepared to defend its actions to the public. CSR is one way to achieve such protection in the marketplace. Moreover, it is the large globally branded company that often has the means to adopt costly CSR provisions such as buying only environmentally compliant products from suppliers. Second, large globally branded companies are also often companies that sell shares to the public as well as to large institutional investors. These investors often worry about the safety of their investment and do not want to witness an Enron-style scandal3 that can ruin their investments. They pressure firms to adopt codes of conduct that, in turn, encourage more CSR-type behaviour. Finally, there is the growth of public pressure to improve corporate behaviour via consumer actions, and pressure from non-governmental organisations such as Greenpeace (or what Kotler and Armstrong refer to as consumerism and the impact of environmentalism). Consumers,

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moreover, are sometimes willing to pay more for goods and services if they feel that the companies are operating in a socially responsible manner. Consumers often have two very powerful mechanisms in the marketplace by which they can affect the corporate behaviour of large firms. As noted by Albert Hirschman, they can either exercise voice or exit if they disapprove of corporate actions. The exit option works when there is sufficient competition in the marketplace such that consumers can switch from one company to another if they disapprove of the actions of one company. Voice is exercised when there is less likelihood of switching behaviour because the company commands a large share of the marketplace. This is often the case with large globally branded companies, which explains why consumer boycott campaigns often target these large companies and not smaller, less well-known (but perhaps more egregious) violators of whatever standard consumers are hoping to improve. Both the voice and exit options have been given more power recently via the Internet and the increasing spread of communications technology. Whereas traditional awareness campaigns such as those created by Greenpeace in the late 1970s and early 1980s required many months of planning and investment in leaflets and a plethora of volunteers, today an email list, web site or online ‘blog’4 is able to reach a larger number of potential consumers. Mini-case 13.2: How global outrage changed corporate practices at Shell (or did it?) In the winter of 1995 the Royal Dutch Shell company (or Shell as the popular brand has come to be known) was in the news for all the wrong reasons. The company at the time had extensive holdings in Nigeria (e.g. Shell is currently still responsible for 40 per cent of Nigeria’s total oil output and 55 per cent of its onshore production). At the time there were three human-rights activists in Nigeria, most notably Ken Saro-Wiwa, who were raising international awareness of the deplorable living and working conditions of Nigerian citizens in and around the Brent Spar oil platforms run by Shell. The government at the time, fearing that this negative publicity could stir popular insurrection and hence cause foreign investment to desert the country, pre-emptively imprisoned and sentenced to death these three human-rights activists. The outside world was outraged and many critics of the regime blamed Shell for not intervening and even secretly condoning the silencing of these three human-rights activists. The Nigerian government, despite popular and international scorn, carried out their death sentences and this created a publicity nightmare for Shell. Critics from all walks of life were alarmed that the company, whose activities were the cause of the activists’ fight to begin with and the eventual reason for their deaths, had remained silent and never threatened to pull out its investments as a result of the Nigerian government’s actions to restrain individual human rights. Sensing that its corporate image could be irreparably damaged and noting the fall in its stock price brought about by jittery investors who were uncertain as to whether Shell could survive the publicity nightmare, the company took a bold step. It decided in early 1996 to embark on a major consultative exercise known as ‘Society’s changing expectations’. Largely prompted by public reaction to the Brent Spar incident and allegations of complicit involvement in other human-rights abuses in Nigeria, human rights emerged as one of the key concerns of the company’s goals. This led to a revision of the company’s business principles, which now explicitly commit Shell to ‘respect the human rights of its employees’ and ‘express support for fundamental human rights in line with the legitimate role of business’. In 1998, the company produced a management primer on business and human rights.

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Shell also engaged with a range of stakeholders such as Amnesty International and Human Rights Watch regarding the security aspects of their Nigerian operations starting in 1996. This led to a revision of Shell’s rules of engagement with the state security forces – the police and the military – to accommodate the United Nations Basic Principles on the Use of Force and Firearms and the UN Code of Conduct for Law Enforcement Officials. The experience in Nigeria has prompted a more broadly based review of security provision, and the development and adoption in 1998 of group-wide Use of Force Guidelines. Despite all the visible commitment to change its practices, in 2003 Shell was in the news once again (and again for all the wrong reasons) as the company faced multi-million dollar class-action suits brought by enraged investors, and five legal investigations including the United States Justice Department and Securities Exchange Commission, following the shock announcement earlier in the year that the company had ‘lost’ onefifth of its assets, leading to dramatic revisions of its global oil reserves. The honesty of directors on what assets the company actually had (there were four successive revisions of its oil reserves) called into question Shell’s ability to deliver on its corporate social responsibility commitments made after 1995 and even the veracity of its own accounts were now in doubt. Despite changes in the boardroom and a noticeable shift of tone towards a more contrite approach to admitting its mistakes, the company seemed to be engulfed in the same kind of identity crisis it faced in 1995. The new Shell Chair Ron Oxburgh, whose appointment followed the departure of three senior managers including the former Chair Sir Philip Watts, was not even sure that Shell should be in the oil business anymore: ‘No one can be comfortable at the prospect of continuing to pump out the amounts of carbon dioxide that we are pumping out at present…with consequences that we really can’t predict but are probably not good,’ Oxburgh told The Guardian newspaper. The case of Shell illustrates the extent to which social and ethical factors in the external environment are inextricably linked to the fortunes of a company, which if it wishes to establish a global brand reputation must be prepared to defend it not only with the right commitments on paper, but through actions at the highest and lowest levels of the company. Activity Consult the Shell web site in your country (check their global web site to find your own country site via www.shell.com) and find its statements on human rights and the environment. Then do a literature search from local newspapers, journals, human rights and environmental agencies such as Amnesty International and Greenpeace to see if Shell’s rhetoric matches its behaviour in your country. Is there a big difference between the company’s rhetoric and its practice? If so (or not), can you explain why?

What do we mean by contagion effects for branded companies? Why do car companies prefer to settle a series of lawsuits and compensate individuals out of court for enormous sums of money before issuing recall in their products? The answer is that there are strong brand connotations in the car industry. A recall announcement for one model affects sales across every car type. People just assume a Ford is a Ford. If one model is defective then consumers assume that all the others are defective as well. This is called a contagion effect. Bad press in one area can spill over and affect a firm’s entire product line. Think of a bad neighbour who never cleans his garbage and holds a loud party every night; the whole neighbourhood’s property value begins to fall if he is allowed to continue unabated. Something similar has happened to several companies. In 1999

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Perrier had to recall all its worldwide production because it had a problem in a few of its stocks of bottled water. The rest were fine, but to protect the brand, all bottles were recalled. Nike is another company illustrative of the point above. Nike is a virtual company. It has a brand name and a headquarters that employs only a fraction of its worldwide labour force. The rest of the operation is conducted through a series of outsourced contracts with firms operating in Third World countries. This allows Nike to produce high-quality, lowcost shoes, and because of the strength of its brand equity, sell them at a huge premium. It turns out, however, according to labour rights activists, that the low-cost premium was derived from sweatshop labour in many instances. Once word of this began to spread, Nike became susceptible to corporate watchdogs and ethical marketing campaigns. In the mid to late 1990s, these campaigns forced Nike to change its practices (or at least to say that it would). In any event, there is no doubt that Nike has had to alter its public image, monitor to a greater extent its outsourcing activities and alter many of its procurement practices. If it hadn’t had such a prominent brand name it would have been much more difficult to mount a public awareness campaign outlining for consumers where or how Nike made its shoes. The bottom line is that if it wasn’t Nike, no one would have cared. However, if you have a strong brand name and adopt ethical and socially responsible practices before an unforeseen problem occurs, you are also potentially inoculated from the spread of contagion effects. In fact, you may actually increase sales at the expense of some other brand’s misfortune. Take the example of the fast-food industry, where an American company known as ‘Jack in the Box’ sold hamburgers with E. coli bacteria, in which 11 people died. Jack in the Box was even cheaper than McDonalds, and so when this shock hit Jack in the Box, people weren’t turned off the product (fast food) but they switched to McDonalds, which was seen as having a better and safer product.

Looking back at the marketing framework Let us end this chapter and guide by returning to the rather philosophical note struck in Chapter 2, when we asked what was the ultimate aim of marketing or of any form of production. The ultimate aim of production was seen not to reside in the production of more goods and services, nor the satisfaction of a narrow set of consumer preferences, but rather ‘the production of free human beings associated with one another in terms of equality’. This was Adam Smith’s (1723–1790) definition in the Wealth of nations (1776). We mention this again because the underlying marketing ethos or approach, for example of discovering and satisfying human wants and desires in the most economically efficient and socially responsible manner, is not incompatible with Adam Smith’s vision of freedom and equity. In fact, so long as society, through non-market institutions like the family and our systems of public education, can nurture or cultivate the right set of values and behaviours, marketing will respond by providing those citizens with the products and services necessary to make those values actualised. The subject of marketing and the practitioners who work in the field, because they deal with so many key aspects of organisational behaviour (pricing, promotion, distribution and product development) therefore have a huge responsibility. To the extent that certain practices of firms are harmful to the environment or to the living standards of workers, this

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prevents marketing activity from benefiting society as a whole. When marketers are aware of their potential side-effects, they can take actions which benefit both the organisations they work for and society as a whole. We saw how firms that care about socially conscious production may also be able to capture consumer segments with a higher willingness to pay, thereby benefiting society and the economy alike.

A reminder of your learning outcomes By the end of this chapter and relevant reading, you should be able to: • identify some of the common and more radical criticisms of marketing • explain what is meant by the term ‘corporate social responsibility’ and its origins in the early Industrial Revolution • describe the history of ethical marketing practices and the impact of the environmental and other social movements on fostering modern ethical behaviour on the part of firms.

Sample examination questions 1. Discuss the extent to which the growth of the Internet and consumer awareness campaigns have influenced the marketing policies and functioning of large corporations. 2. Evaluate the extent to which CSR can provide a more effective way of fixing social and environmental ills than direct government intervention. 3. Is CSR here to stay? Or are the critics correct and this is only a passing corporate public relations fad?

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Appendix 1: Sample examination paper Time allowed: three hours. Candidates should answer FOUR of the following EIGHT questions. All questions carry equal marks. 1. Explain what is meant by a consumer’s ‘life cycle’? What are the limits of the life-cycle model in explaining consumer behaviour? 2. You are responsible for setting pricing policy in a budget airline. Describe each of the following policies and explain which one you would choose for this business: a) uniform pricing b) perfect price discrimination (dynamic pricing) c) direct segment discrimination d) indirect price discrimination. 3. What are the major differences between the cognitive and behavioural approaches? Explain the four types of buying behaviour and show what role is played by the cognitive and behaviour approaches for each type. 4. ‘Expecting firms to use “corporate social responsibility” is idealistic and governments should intervene in all situations where corporate activity negatively influences communities and the environment.’ Critically discuss this statement. 5. Explain, using examples, the differences between market-mediated and recurrent transactions. Critically assess why they may be used in different situations. 6. In a distribution channel, why may firms seek to raise the level of dependence that other firms have on them? 7. Using examples, show why an understanding of the difference between outcome and consequent risk can be important for marketers and their choice of marketing strategies. 8. Explain the relationship between expectations, quality and satisfaction. What implications does this relationship have on marketers’ strategies?

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