Professional Documents
Culture Documents
1
Principles of marketing
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
2
Chapter 1: A general introduction to the subject guide
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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Principles of marketing
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].
4
Chapter 1: A general introduction to the subject guide
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 post-
purchase 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
7
Principles of marketing
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
8
Chapter 1: A general introduction to the subject guide
9
Chapter 2: An overview of marketing: history and theory
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.
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.
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
11
Principles of marketing
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
Joseph Schumpeter (1883–1950)
was a well-known economist who
A brief history of marketing theory developed and popularised a version
You may wonder why a history of marketing is of interest in the context of of business cycle theory based on
punctuated spurts of technological
more recent developments. To paraphrase Joseph Schumpeter
advances that is now accepted by
(1883–1950),1 in order to be a well-grounded social scientist, one needs a economists of the evolutionary
school of economics.
12
Chapter 2: An overview of marketing: history and theory
13
Principles of marketing
14
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).
P Supply=MC
AC
p=MR=Demand
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
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?
16
Chapter 2: An overview of marketing: history and theory
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.
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Principles of marketing
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.
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Chapter 2: An overview of marketing: history and theory
19
Chapter 3: The marketing environment and a game theory perspective on competition
Further reading
Axelrod, R. The evolution of co-operation. (London: Penguin Books, 1990)
[ISBN 0140124950].
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.
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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Principles of marketing
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 1
Those of you who studied
Principles of sociology should
The microenvironment consists of five major factors:
recall the coverage of ‘Elements of
1. The marketer’s ‘internal environment’ (i.e. its own management organisations’. That topic considered
structure). the role of ‘missions and goals’;
these are an important element of
2. The ‘marketing channel’ used by the firm (for example, its suppliers). the internal environment for an
organisation. For example, the
3. The markets in which the firm may be selling (these may be consumer,
mission of an organisation explains
producer, reseller, government or international markets). what the organisation is about and
4. The firm’s competitors (also contained in the ‘internal environment’). what different stakeholders can
expect from it.
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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Chapter 3: The marketing environment and a game theory perspective on competition
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
23
Principles of marketing
2
Technology2 Those of you who have studied
Principles of sociology will recall
Technological developments offer marketers both opportunities and threats.
the argument between modernists
While firms can offer customers a wider array of advanced products, changes and post-modernists. The latter
in technology also mean that there may be more than one technical solution argue that the information explosion
to a customer’s needs. Where a market converges towards one technological of recent years has not led to
standard, there can be problems for marketers who had promoted an increasing conformity, as the
modernists have argued, but it has
alternative standard. An example of such a situation was illustrated by the
led to an increase in diversity and
fight between two alternative video formats: VHS (promoted by JVC) and choice. This highlights the issue that
Betamax (promoted by Sony). While Sony’s technology was considered there can be considerable debate
superior, most other manufacturers adopted the VHS format and ultimately about the impact of changes in
Sony stopped selling Betamax video recorders and switched to making those technology on society.
using the VHS format. Today there is a similar struggle between suppliers of
different types of hi-fi equipment.
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, long-
term 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 3
Those of you who have studied
Marketers are influenced by the regulatory environment. This has Principles of sociology will
recall the points made about the
implications for their obligations to customers and the wider public.
size of transnational corporations
Customers are increasingly able to seek redress for faulty products and those and the impact that they can
who live near manufacturing plants are able to claim compensation for have on people. Indeed, some
pollution. The political environment around the world has recently favoured are argued to be more powerful
the privatisation of public companies. Such companies have also been able to than some nation states.
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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Chapter 3: The marketing environment and a game theory perspective on competition
Culture4 4
Those of you who have studied
Principles of sociology will
People’s opinions and tastes are shaped by the society in which they live.
recall the discussion about
It should be noted that societies are not made up of homogeneous globalisation. One of the
populations. They contain sub-cultures, which are beliefs and values definitions put forward in that
shared by smaller groups of people. Such groups may arise out of a course highlighted that as a result
common race, religion, social activity or hobby. Sub-cultures are important of globalisation the constraints of
to marketers insofar as they may have different consumption habits from geography on culture recede and
people act accordingly. Following
the rest of the population.
that argument, if globalisation is
The following are some aspects of culture which influence people’s taking place, it will have an impact
consumption: the ‘core’ culture is that set of values which is handed down on the cultural environment. You
should also recall the coverage
from generation to generation and which is reinforced by social
given to ‘religion’ and how this can
institutions such as schools and places of worship. Core values are likely influence behaviour. Specifically,
to be strongly held and it may be difficult for marketers to promote a the course mentioned that
message which runs counter to them. More susceptible to change are substantive definitions of religion
secondary values, as people’s opinions are influenced by the media, are based on religious beliefs – in
role models and changing tastes. Chapter 5 of Kotler and Armstrong terms of a marketing context such
beliefs can drive consumption
(2004) ends with a discussion of how marketers can respond to the
behaviour.
marketing environment. That is an important issue which is significant for
examination purposes and you should pay attention to it.
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
customers competitors
Economics management
Culture
External strategies & Internal public
Environment objectives Environment
Nature
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
25
Principles of marketing
consumption: it is not heavily spiced and it often features familiar ingredients," comments 5
John Band, consumer markets
Band.’5 analyst at Datamonitor.
26
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 co-
operate 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.
27
Principles of marketing
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 zero-
sum 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 non-
zero-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.
28
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-zero-
sum 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
29
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:
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Chapter 3: The marketing environment and a game theory perspective on competition
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.
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Chapter 4: An introduction to consumer behaviour
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.) Post-
Keynesian 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)].
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.
33
Principles of marketing
Introduction
In a sense, everything an organisation does (whether it is a private for-
profit 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 1
Those of you who have studied
on consumer behaviour will tend to provide a more accurate portrayal of Elements of social and applied
why consumers make the purchase decisions they do.1 psychology will recall that Stockdale
(2005) deals with ‘attitudes’. This is an
It is not our intention in this brief introduction to explain each of the important topic in marketing,
factors affecting consumer behaviour in great detail, as the Kotler and specifically in terms of consumer
Armstrong text does a very good job of this already. Rather (as we did in behaviour and also for understanding
Chapter 2 with the theory of perfect competition) we will start by the differences between consumers in
presenting a relatively stylised economic interpretation of consumer different countries; indeed the link
between attitudes and culture is
behaviour and then we’ll see what implications this has for the marketing
discussed in more depth in Section 9.8
decisions of an organisation. We will then contrast this economic version of Stockdale. The uni-dimensional
with the social and psychological approaches. model described by Stockdale (2005)
refers to attitude as: ‘a general
enduring positive or negative feeling
about a person, object or issue’.
34
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.
Indifference curve
Budget line
Y
35
Principles of marketing
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?
36
Chapter 4: An introduction to consumer behaviour
37
Principles of marketing
Activity
What implications does the above view of consumer behaviour have for former non-
market 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.
38
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 Anglo-
Americans 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
WD US Figure 4.2b:
Same preferences; different ‘prices’
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.
39
Principles of marketing
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
6
opportunity cost of time. For example, the authors – using UPC code6 data UPC stands for universal price
that uniquely identifies a good – find that middle-aged households (with high code, which is simply the number
wages and lots of family commitments) pay 16 per cent higher prices for the and barcode that identifies an
individual consumer product.
same goods and services than 24-year-olds and 8 per cent higher prices than
40
Chapter 4: An introduction to consumer behaviour
41
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.
42
Chapter 4: An introduction to consumer behaviour
attributions
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
43
Principles of marketing
attributions
44
Chapter 4: An introduction to consumer behaviour
Involvement
Differences in brand High Low
Significant differences Complex buying Variety-seeking buying
between brands behaviour behaviour (primarily behavioural
(cognitive process) with some cognitive)
Few differences Dissonance-reducing Habitual buying behaviour
between brands buying behaviour (behavioural process)
(primarily cognitive with
some behavioural)
45
Principles of marketing
46
Chapter 4: An introduction to consumer behaviour
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 Cognitive advertising with
with some informative substantial informative
content content
Low Behavioural persuasive Cognitive persuasive
advertising advertising
47
Principles of marketing
48
Chapter 5: Introduction to market segmentation
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.
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.
49
Principles of marketing
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.
Assumptions regarding Customers are not Customers are not They need to be pushed into
buyer behaviour concerned about product aware of the possibilities buying.
quality or variety. for the product class.
Situations when When customers have a When marketers come Where focus on selling leads
ineffective choice – they will want to regard themselves marketers to sell whatever
quality and variety. in the business of making they have rather than consider
a particular product and customers’ wants.
not fulfilling a particular
want.
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Chapter 5: Introduction to market segmentation
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 As well as products which satisfy needs and wants
if you take into account needs and wants. should also consider wider issues
– in their own right.
Customers prefer products which cater Customers will buy from marketers with concerns
for their needs and wants and if this for wider environmental issues. This will also
is done they may come back. Will need less win favour with government.
sales effort.
Where customers have a choice Where there is pressure to look after the
and will prefer those products environment and other social issues.
which cater most closely to their needs.
Where customers are unable to identify Where there is no pressure from customers/
their needs and wants. Where there is a government and no long-term benefits
lack of production capability and and the costs outweigh the benefits.
customers will buy anything.
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Principles of marketing
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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Chapter 5: Introduction to market segmentation
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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Chapter 5: Introduction to market segmentation
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Principles of marketing
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:
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Chapter 5: Introduction to market segmentation
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).
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Principles of marketing
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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Chapter 5: Introduction to market segmentation
2 2
Sample examination questions If a question was allocated
25 marks in the examination,
1a.What segmentation variables are most commonly used in consumer the weighting for the two
marketing? (10 marks) 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
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.
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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.
Additional needs
Industrial organisations’ buying differs from that of consumers because
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Chapter 6: Organisational buyer behaviour
they have additional needs, for example, the making of profits and legal
obligations to their customers.
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.
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Principles of marketing
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.
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Chapter 6: Organisational buyer behaviour
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.
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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Principles of marketing
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
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.
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Chapter 6: Organisational buyer behaviour
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Principles of marketing
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.
Economic approach
In order for there to be no risk in exchange, one must adhere to the neo-
classical 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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Chapter 6: Organisational buyer behaviour
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 ‘risk-
relievers’ (actions used to allay perceived risk) in different proportions for
services.
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.
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Chapter 6: Organisational buyer behaviour
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.
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Chapter 7: Customer relationship marketing (CRM)
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).
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
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Chapter 7: Customer relationship marketing (CRM)
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.
Activity
Write down the ways in which firms can bring value to their customers through product,
place and promotion.
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Principles of marketing
Marketer
Product
Promotion Value enhanced via benefits etc Place
Enhance Value delivered
cutomers’ through e.g.
perception greater
of value convenience
Value
Price
Customer
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Chapter 7: Customer relationship marketing (CRM)
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?
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Chapter 7: Customer relationship marketing (CRM)
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.
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Principles of marketing
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.
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Chapter 7: Customer relationship marketing (CRM)
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)
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Principles of marketing
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.
The stages that firms can go through in order to implement KAM are
shown in Figure 7.3.
Complex
Level of involvement with
customers
Synergistic-
KAM
Partnership-
KAM
Mid-KAM
Simple
Early-
KAM
Transactional Collaborative
Pre-KAM
Nature of customer relationship
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Principles of marketing
Activity
Read Mini-case 7.1. What benefits could accrue to Soco as a result of this move?
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Chapter 7: Customer relationship marketing (CRM)
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.
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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).
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.
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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 1
Those of you who have studied
Elements of social and applied
Advertising is salesmanship mass produced. No one would social psychology will recall that
bother to use advertising if he could talk to all his prospects Chapter 12 deals with attitude
[potential customers] face-to-face. But he can’t. (Morris Hite, change and persuasive
communications. Some of the broad
quoted in Adman, 1988 p. 203).
principles covered in that chapter
We can answer the question above in a negative way, by stating what can clearly help with an
promotion is not. It is not advertising, as advertising is but one form of understanding of marketers’ choice
the promotional mix. Other promotional mix tools include sales, public of marketing communications.
Although this course does not
relations, personal selling and direct marketing. These are
presume that you have a detailed
explained and defined in greater detail in Kotler and Armstrong (2004, knowledge of the models presented
p. 467). in that course, the material in
The term ‘mass marketing’, which one often hears used in the popular Chapter 12 has some important
links with the coverage of
press, is again a bit of a misnomer because it refers only to mass
marketing communications in this
promotion or communications, which typically involves the promotional course.
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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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.
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Principles of marketing
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.
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Chapter 8: Introduction to promotion and advertising
Activity
Consider the case where advertising works subliminally or unconsciously. Does this
change the implications above?
Sales volume
Backlash
Advertising expenditure
Threshold
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Principles of marketing
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.
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Chapter 8: Introduction to promotion and advertising
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?
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?
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Principles of marketing
(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?
Non-linear hypothesis
B
Linear hypothesis
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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.
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Principles of marketing
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.
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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?
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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.
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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 self-
explanatory 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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Chapter 9: Branding and product development
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 Exposure
to to
marketing Customer’s competitors’
mix Expectations marketing
Activity
Take a minute to think about the word ‘quality’. Write down what you understand it to
mean.
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?
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Chapter 9: Branding and product development
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.
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Chapter 9: Branding and product development
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.
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.
Existing
Brand
Brand Name
Line Extension
Extension
New
Existing 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 left-
hand 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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Principles of marketing
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.
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.
Existing
Market Product
penetration Development
Market
Market
New
Diversification
development
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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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.
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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.
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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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.
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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.
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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).
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Table 9.1: Services marketing – the link between management issues and service characteristics
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:
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?
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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.
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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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.
Sales
1 2 3 4 5 What happens next?
Time
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Sales
LP
CD
45s
Tapes
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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.
Time
Time
Sales Low-learning product with a
long shelf-life
Time
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Chapter 10: Product life-cycle (PLC) theory
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?
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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.
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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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.
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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 fourth-
largest 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.)
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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/
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.
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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.
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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 Wal-
Mart’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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Costs per
unit
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Costs
per unit
$10
$9
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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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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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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.
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.
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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.
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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.
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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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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.
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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.
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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.
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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, cost-
reduction 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.
1
• Globalisation of brands and the growth of franchising based on brand power. E-tailing refers to retailing over the
internet. Thus an e-tailer is a B2C
• Developments in technologies of information, control and command by business that executes a transaction
application of IT. with the final consumer. E-tailers can
1 be pure play businesses like
• Development of e-tailing and direct marketing reflecting technological and social
Amazon.com or businesses that have
changes.
evolved from a legacy business, e.g.
Tesco.com. E-tailing is a subset of e-
commerce. Source:
www.capcomarketing.com/mediakit/
Marketing_Glossary/
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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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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.
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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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 1
Broadly defined as the space between
behaviour of firms and see how firms respond. We will also examine the the state and private organisations on the
question of which firms are more likely than others to adopt corporate one hand, and the individual on the
other. Normally we think of civil society
socially responsible behaviour and what factors may be responsible for
as being synonymous with the voluntary
the switch to corporate socially responsible ways of behaving. sector, but also included are religious
groups, informal associations and labour
organisations.
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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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 media-
saturated 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.
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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 consumer-
oriented 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.
3
In 2000 Enron was the largest
So where does South Korea’s future lie? energy company in the world,
Having chosen consumption-led growth as the path to get out of the economic malaise until it went bankrupt as a result
of the late 1990s, South Korea is now faced with the prospect of the hollowing out of its of unethical business practices,
financial impropriety and phoney
own industry and an increased dependence on exports. Exports accounted for 98.2 per
accounting.
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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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?
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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.
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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 4
Blog – online personal website
larger number of potential consumers. set up with little or no cost or
technical expertise required.
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’ one-
fifth 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?
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Appendix 1: Sample examination paper
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