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Lecture Notes Ch. 6 Innovation and New Product Development All companies need to grow their revenue over time by developing new products and expanding into new markets. If we believe in the product life cycle concept and we believe that most firms are interested in growth, the need for innovation and new product development is essential to long term success. Nothing lasts forever. This is true for very large organizations and small businesses. It is true for products or services. For some firms, their dominant marketing strategy evolves around product innovation. A good example is the 3M Company. 3M makes more than 50,000 products, including sandpaper, adhesives, optical films, and fiber-optic connectors. It invests more than 1 billion annually in research and development, with a staff of more than 6,000 scientists worldwide, and launches scores of new products every year. In 2013, 3M generated 18 Billion in sales. The companys policy of allowing all employees to spend up to 15 percent of their time working on projects of personal interest helped to produce Post-it notes, masking tape, and 3Ms micro-replication technology. At the same time, 3M carefully monitors the commercialization potential for new-product candidates, making sure scientists and marketers collaborate early in the process and invests additional resources, as needed, behind the likely winners. 3Ms Golden Step Award program honors 3M employees and team members who have developed significant new products, product lines, or markets, and successfully generated at least 10 million in annual global sales within three years of product introduction. Clearly, 3M has developed the culture and processes necessary to be considered a leader in new product development. Booz, Allen Hamilton Innovation Classifications A survey of the new product development practices of 700 U.S. corporations conducted by the consulting firm Booz, Allen Hamilton found that the products introduced by those firms over a five year period were not all equally new. A classification of new product strategic alternatives used by marketers, as discussed in the textbook, was developed based on the Booz, Allen Hamilton study and included the percentage of new entries falling in each category during a five-year study period New-to-the world products. True innovations that are new to the firm and create an entirely new market and product category. (10 percent) New product lines. A product category that is new for the company introducing it, but not new to customers in the target market because of the existence already of one or more competitive brands (20 percent). Additions to existing product lines (Product Line Extensions). New items that supplement a firms established product line. These items may be moderately new to both the firm and the customers in its established product-markets. They also may serve to broaden the market appeal of the product line (26 percent). Improvements in or revisions of existing products. Items providing improved performance or greater perceived value brought out to replace existing products. These may present moderately new marketing and production challenges to the firm, but unless they represent a technologically new generation of products, customers are likely to perceive them as similar to the products they replace (26 percent) Repositioning. Existing products that are modified and targeted at new applications or new market segments (7 percent). Cost reductions. Product modifications with the specific purpose of providing similar performance at lower cost. In todays weak economy where demand for many products is lower, many firms are focusing on cost cutting by making changes to their current products (11 percent). These new product development strategies could be implemented through acquisition or development. The acquisition route can take three forms. A firm can buy other companies, it can acquire patents from other companies, or it can buy a license or franchise from other companies. Notice that each of these strategies could be used to pursue one or more of the corporate growth strategies discussed previously in week 1. For example, improvements in or revisions of existing products would primarily support a product development growth strategy. Totally new innovation and new products never offered by the firm before could be supporting either a product development or diversification growth strategy of some type depending upon whether the new, innovative product will be directed to an existing product market that you already compete in or if you will be competing in a totally new market. Market Entry Strategies Is it better to be a pioneer or a follower when introducing new products or new product enhancements With products such as Word, Excel, and PowerPoint, Microsoft holds a leading share of most office application software categories. But in most of those categories, Microsoft was NOT the pioneer. Lotus 1-2-3 was the leading spreadsheet for many years, and WordPerfect and other programs led the word processing category. But as a follower Microsoft developed improved product designs offering better performance, and it had superior financial resources to aggressively promote its products. Microsofts Windows also held a commanding share of the operating systems market, a position the firm leveraged to convince personal computer manufacturers to bundle its applications software with their machines. The competitive importance of growth via the introduction of new products is not in question by following one or more of the new product development strategies describe above. However, another important strategic question is whether it always makes sense to go first Or do both pioneer and follower market entry strategies have some particular advantages under different conditions Pioneer Strategy Conventional wisdom holds that although pioneers take the greatest risks and probably experience more failures than their more conservative competitors, successful pioneers are handsomely rewarded. It is assumed competitive advantages inherent in being the first to enter a new product-market can be sustained through the growth stage and into the maturity stage of the product life cycle, resulting in a strong share position and substantial returns. Some of the potential sources of competitive advantage include First choice of market segments and positions. The pioneer has the opportunity to develop a product or service offering with attributes most important to the largest segment of customers or to promote the importance of attributes that favor its brand. Thus, the pioneers brand can become the standard of reference customers use to evaluate other brands as they are introduced. This can make it more difficult for followers with me-too products to convince existing customers that their new brands are superior to the older and more familiar pioneer. The pioneer defines the rules of the game. The pioneers actions on such variables as product quality, price, distribution, warranties, post sale service, and promotional appeals and budgets set standards that subsequent competitors must meet or beat. Distribution advantages. The pioneer has the most options in designing a distribution channel to bring the new product to market. Especially for industrial goods, this can exclude later entrants from some markets. Distributors are often reluctant to take on second or third brands. For consumer goods, it is more difficult to slow the entry of later competitors by preempting distribution alternatives. However, the pioneer still has the advantage attaining more shelf-facings at the outset of the growth stage. Economies of scale and experience. Being first means the pioneer can gain accumulated volume and experience and thereby lower per unit costs at a faster rate than followers. This advantage is particularly pronounced when the product is technically sophisticated and involves high development costs or when its life cycle is likely to be short with sales increasing rapidly during the introduction and early growth stages. High switching costs for early adopters. Customers who are early to adopt a pioneers new product may be reluctant to change suppliers when competitive products appear. This is particularly true for industrial goods where the costs of switching suppliers can be high. Some pioneers clearly fail. They either abandon the product category, go out of business, or get acquired before their industry matures. Thus, while a pioneer may have some potential competitive advantages, not all pioneers are successful at capitalizing on them. Some fail during the introductory or shakeout stage of their industry life cycle. And those that survive may lack the resources to keep up with rapid growth or the competencies needed to maintain their early lead in the face of onslaughts by stronger followers. This is especially true with smaller businesses. Follower Strategy In many cases a firm becomes a follower by default. It is simply beaten to a new product-market by a quicker competitor. However, even when a firm has the capability of being the first mover, the above observations suggest there may be some advantages to letting other firms go first as a strategic decision. Let the pioneer shoulder the initial risks while the followers observe their shortcomings and mistakes. Some of the possible advantages of such a follower strategy include Ability to take advantage of the pioneers positioning mistakes. If the pioneer misjudges the preferences and purchase criteria of the mass-market segment or attempts to satisfy two or more segments at once, it is vulnerable to the introduction of more precisely positioned products by a follower that does a better job of tailoring its offerings to each distinct segment. Ability to take advantage of the pioneers product mistakes. If the pioneers initial product has technical limitations or design flaws, the follower can benefit by overcoming these weaknesses. Even when the pioneering product is technically satisfactory, a follower may gain an advantage through product enhancements. Ability to take advantage of the pioneers marketing mistakes. If the pioneer makes any marketing mistakes in introducing a new entry, it opens opportunities for later entrants. A follower can observe these mistakes, design a marketing program to overcome them, and successfully compete head-to-head with the pioneer. Ability to take advantage of the latest technology. In industries characterized by rapid technological advances, followers can possibly introduce products based on a superior, advanced-generation technology and thereby gain an advantage over the pioneer. Ability to take advantage of pioneers limited resources. If the pioneer has limited resources for production facilities or marketing programs, or fails to commit sufficient resources to its new entry, followers willing and able to outspend the pioneer experience few enduring constraints. Successful fast followers and market challengers often come into the market with greater resources available than the pioneer and/or leapfrog the pioneer with superior product technology, product quality, or customer service. Successful late entrants tend to focus on peripheral target markets or niches. Thus, a key strategic decision involves not only what type of product development strategies you want and are able to pursue, but also whether you want to be a pioneer or follower, if you have the choice. There are many large, well known corporations that have been successful by always using their vast resources to only pursue a follower strategy. However, sometimes being a pioneer makes more sense. The text also talks briefly about the product development process. You should have covered this in your introductory marketing course and you should understand the steps. They are almost universal in nature and the effectiveness of your new product development processes is almost as important as the new product itself. Finally, I selected an article on innovation and new product development for developing or under-developed markets. We tend to focus on competitive strategies in developed markets. However, there are substantial opportunities in under-developed markets too. Often success in these markets requires a little different approach. The article is available online under Week 4 content. Pricing Strategies Did you know that price is the one element of the marketing mix that produces revenue All the other elements produce costs Prices are perhaps the easiest but perhaps most dangerous element of the marketing program to adjust product features, channels, and even promotion take more time. Price also communicates to the market the companys intended value positioning of its product or brand. A well-designed and marketed product can command a price premium and reap big profits. Consider the following example regarding Whirlpool. Washers and dryers traditionally were seen as utilitarian products that could never justify a high price. In 2001, Whirlpool introduced the Duet, a front-loading washer-dryer combo that retailed at 2,300 nearly four times the price of comparative models. How did Whirlpool do it The Duet was a truly unique offering that promised performance and efficiency without compromise. Its huge capacities could wash and dry big loads, yet it used much less water and electricity than competitors. It also washed all types of clothing from silks and lace to sleeping bags and comforters. Duet also could claim an emotional benefit for users bigger loads meant fewer loads and therefore more time and freedom to do other things. The Duet pricing plan was the result of a broader shift in Whirlpools pricing strategy to reduce the frequency of costly and potentially confusing discounts. It wanted to find the optimal prices for its products, in this case premium pricing for a premium product. Many marketers, however, neglect their pricing strategies one survey found that marketing managers spent less than 5 percent of their time on pricing considerations. Pricing decisions are clearly complex and difficult. They are one of the most significant factors that contribute to the success or failure of a product. In some companies price plays a dominant role in marketing strategy, whereas, in other situations, price may perform a more passive role. For example, price may play a key factor in marketing tablet computers whereas with marketing paper clips it probably will not. There are two key situations where pricing strategies and decisions are necessary. The first is when you introduce a new product. This is where strategy is most important. Once you select a pricing strategy for a new product or service and establish initial prices, it is often very difficult to change. You can change the actual prices or discounts frequently but changing the overall strategy is more difficult. The second situation is when firms initiate price changes or react to price changes of other competitors. This is obviously the most common situation and tends to deal with more tactical decisions. The text does a pretty good job of framing the pricing decision process so I will simply summarize, clarify, and expand upon their framework. Setting Pricing Objectives The clearer a firms objectives, the easier it is to set pricing policies. A company can typically pursue any of five major objectives through pricing Survival Companies pursue survival as their major objective if they are plagued with overcapacity, intense competition, changing consumer wants, or if they are struggling financially. Survival is a short-run objective. In the long run, the firm must learn how to add value or face extinction. Obviously, in the current recession, many firms are focusing on survival strategies until conditions improve. Maximum current profit Many companies try to set a price that will maximize current profits. They estimate the demand and costs associated with alternative prices and choose the price that produces maximum current profit, cash flow or rate of return on investment. This strategy assumes that the firm has knowledge of its demand and cost functions. In reality, these are often difficult to estimate accurately. Maximum market share Some companies want to maximize their market share. They believe that a higher sales volume will lead to lower unit costs and higher long-run profits. They set the lowest price, assuming the market is price sensitive. Often this objective is obtained by following what is known as market-penetration pricing. Maximum market skimming Companies that introduce a new technology or a truly new product form favor setting high prices to skim the maximum amount of revenue from the various segments of the market. Often this objective is obtained by following what is known as market-skimming pricing. Product-Quality Leadership A company might aim to be the quality-product leader in the market by combining quality, luxury, and premium pricing vs. competition if brand loyalty is high. This is just an example of the most common type of objectives. There are others, especially for non-profits and certain industries, that dont fit the above. The textbook lists some others. For example, a nonprofit hospital may aim for full cost recovery in its pricing a nonprofit theater company may price its productions to fill the maximum number of theater seats or a university might aim for partial cost recovery, knowing that it must rely on private gifts or public funding to cover the remaining costs. Analyze the Pricing Situation The text talks about evaluating customer price sensitivity, costs, and competitors before making strategic or tactical pricing decisions. For customer price sensitivity this often involves, at minimum, estimating elasticity of demand where you estimate quantity demanded at different prices. For costs, this usually involves looking at total cost, average cost, experience curve effects, and break-even analysis. Finally, within the range of possible prices determined by market demand and company costs, the firm must take competitors costs, prices, and possible price reactions into account. Most of this type of analyses are critical when introducing a new product but is also important on an ongoing basis before changing actual prices. Some of these types of analyses are covered in an introductory marketing course or in a marketing management course. You wont be expected to actually do this since this is more of a marketing strategy course. Just recognize that in the area of pricing, it requires the most mathematical and financial analysis compared to most other areas of marketing. Select pricing strategies New Product/Market Entry Pricing Strategies Base pricing strategies usually dont change much as the product passes through its life cycle. However, the introductory stage is especially challenging. Companies bringing out a new product face the challenge of setting prices for the first time. There are five basic strategy alternatives that are often followed especially if you are introducing a single product. If you are introducing a new product into an existing product line, there are five other supplemental strategy alternatives that might also be appropriate. Market-Skimming Pricing Many firms that invent new products set high initial prices to skim revenue from early adopters. Did you know that HDTV first was introduced by Sony in the Japanese market back in 1990 The initial price was 43,000 Since that time prices have obviously fallen to probably about 900 as an average price for an HDTV. This strategy is common for introducing truly new products, especially new technology. Market skimming makes sense only under certain conditions. First, the products quality and image must support its higher price, and enough buyers must want the product at that price. Second, the costs of producing a smaller volume cannot be so high that they cancel the advantage of charging more. Finally, competitors should not be able to enter the market easily and undercut the high price. Often with market skimming, it is anticipated that prices will continue to fall over time as more competitors enter the market. Market-Penetration Pricing Rather than setting a high initial price to skim off small but profitable market segments, like early adopters, some companies use market-penetration pricing. They set a low initial price in order to penetrate the market quickly and build a large market share. This strategy makes sense if the market is highly price sensitive so that a low price produces more market growth, if production and distribution costs fall as volume increases, and/or if it helps to keep out the competition. Dell initially followed this type of pricing strategy. Through its focus on low production and distribution costs, Dell has retained its price advantage and established itself as the industrys number one PC maker, although HP has now surpassed Dell. Long Term Premium Pricing (Prestige pricing) While penetration and skimming are often considered the two general approaches to entry pricing, premium pricing is a specific approach to launch high early prices you intend to maintain. This coincides with a high-end or premium product and service offering that you believe has a large enough market to sustain your business over time. Luxury fashion retailers, for example, typically charge premium prices because their customers are more concerned with quality and the service experience. They expect a high price to match now and in the future. Long Term Discount Strategy (Value Pricing or EDLP) In recent years a real trend is toward discount pricing strategies, especially in retailing. The firm wins loyal customers by charging a fairly low price for a high-quality offerings throughout the product life cycle. They provide value by consistently offering discount prices. Among the best examples of firms that follow value-based pricing are IKEA and Southwest Airlines, at least in the past. Value pricing is not a matter of simply setting initial lower prices like penetration pricing it is a matter of reengineering the companys operations to become a low-cost producer without sacrificing quality, and lowering prices significantly to attract a larger number of value-conscious customers. Two examples of value pricing are everyday low prices (EDLP), which takes place at the retail level or high-low pricing where the retailer charges higher prices on an everyday basis but then runs frequent promotions in which prices are temporarily lowered below EDLP. Market-Parity Pricing If a firm is introducing a new product but it is not first to market in that category, the pricing of products that have entered the market first will have an impact on new product pricing. Although opportunities for skimming or penetration pricing might still be possible, often pricing has to be close to what has already been established, unless strong product differentiation exists. In essence, a firm might price slightly above or below the existing competitors but the pricing flexibility is greatly diminished once a market has been established. The strategy for setting a new products price, in addition to one of the above basic strategies, may also include additional supplemental strategy considerations when the product is part of a product mix or product line. In this case, the firm often looks for a set of prices that maximizes the profits on the total product offerings. Sometimes pricing strategies become more complex because the different products have different demand curves and costs and perhaps face different degrees of competition. Here are just a few examples of some of the more common additional and/or alternative approaches to new product pricing Product Line Pricing Firms often offer product lines rather than single products. For example, Snapper makes many different lawn mowers, ranging from simple walk-behind versions starting at 349 to elaborate lawn tractors priced at 2,200 or more. In product line pricing, the firm must decide on the price steps to set between the various products in a line. Optional-Product Pricing - This is a strategy where along with a main product the firm also markets optional or accessory products. For example, refrigerators may come with optional ice makers. There seems to be a trend away from a lot of options like the automobile manufacturers have evolved to. Captive Product Pricing Companies that make products that must be used along with a main product are using captive product pricing. Examples of captive products are razor blade cartridges, printer cartridges, video games, etc. Often the main product is priced to have low profit margins and the captive products are priced to have very high profit margins. The company really makes it profits on the on-gong stream of higher margin add on sales. By-Product Pricing In producing processed meats, petroleum and agricultural products, chemicals, and etc., there are often by-products. If the by-products have no value and getting rid of them is costly, this will affect the pricing of the main product. Using by-product pricing, the firm will seek a market for these by-products and will accept any price that covers more than the cost. Sometimes, firms dont realize how valuable their by-products are and often they can actually turn out to be profitable. Product Bundle Pricing Using this strategy, sellers often combine several of their products and offer the bundle often at a reduced overall price. Comcast and other cable companies bundle cable service, phone service, and high-speed internet connections at a lower, combined price. Bundle pricing strategies seem to be growing in popularity. This strategy is also used for many grocery products through packaging options. Evian might offer a 1 ml. bottle of water for 2.19 each and use bundle pricing by offer a package of six bottles for only 9.98. Determining Specific Prices and Policies Selecting a Pricing Method Regardless of the strategies followed and given knowledge of the customers demand schedule, the cost function, and competitors prices, the firm is now ready to select a price. Before an actual price can be set, a firm must select a pricing method. Some of the most common methods include Markup pricing The most elementary pricing method is to add a standard markup to the products cost. Construction companies and lawyers typically price by adding a standard markup on their time and costs. Often this is used because it is easy but does it make logical sense Any pricing method that ignores current demand, perceived value, and competition is not likely to lead to the OPTIMAL price. Target-return pricing In target-return pricing, the firm determines the price that would yield its target rate of return on investment (ROI). For example, target pricing is used by General Motors, which prices its automobiles to achieve a 15-20 percent ROI. Perceived value pricing An increasing number of companies now base their price on the customers perceived value. Caterpillar uses perceived value to set prices on its construction equipment. It might price its tractor at 100,000, although a similar competitors tractor might be priced at 90,000. When a prospective customer asks a Caterpillar dealer why he should pay 10,000 more, the dealer is able to demonstrate why Caterpillars tractor delivers more value than the competitors. Although the customer is asked to pay a 10,000 premium, he comes to believe he is actually getting 20,000 extra value. He chooses the Caterpillar because he is convinced that its lifetime operating costs will be lower. This is always a classic story used to demonstrate perceived value pricing. Going rate Pricing The firm bases its pricing largely on competitors prices. In oligopolistic industries that sell a commodity such as steel, paper, or fertilizer, competitors usually charge close to the same price. Also, where costs are difficult to measure or competitive response is uncertain, firms feel that the going price is a good solution because it is thought to reflect the industrys collective wisdom. Auction-type pricing. Auction-type pricing is growing more popular, especially with the growth of the internet. There are over 5,000 electronic marketplaces selling everything from pigs to used vehicles to cargo to chemicals. One major purpose of auctions is to dispose of excess inventories or used goods. E-bay is certainly a vehicle for accommodating auction-type pricing. Price Change Strategies Pricing decisions are never ending. After a new product is initially launched, marketers must often make price changes. Changing prices might only be considered annually when doing marketing planning for the next year, or it might require price changes at various times during the year, and it might even involve making price changes on a daily basis somewhat like the airlines often do with dynamic pricing. Price changes might be required due to changes in product costs or supply and demand may change suggesting price changes. When the demand for hotel rooms is unusually high for a special event in town, what happens to prices Often hotel room rates are raised substantially. Perhaps competition has introduced something new and different making your product outdated and suggesting a need to lower your prices. If the economy begins to head into a recession, often the price of many products or services are reduced. There are many factors that could suggest an opportunity or threat to the sales of your product or service if you make a price change. If you are competing in a competitive market, recognize that the price change by one competitor can greatly influence the action of others. In any case, making pricing change decisions for established products and services is a critical, ongoing responsibility for marketing management. There are four basic price change strategies that firms follow Initiate a Price Increase In a competitive market with multiple competitors, you make the decision to initiate a price increase. Someone has to be first. However, unless others raise their prices too, you could find yourself losing sales due to your price increase. Initiate a Price Decrease In a competitive market with multiple competitors, you make the decision to cut your prices in hopes of attracting more business. This may work if your competitors dont follow suit or delay reducing prices. However, if they lower their prices too, the only effect it might have is to reduce the profit margins for everyone. Price Follower Some companies follow the strategy of never initiating price changes and simply consider price changes when other competitors have initiated changes in price and you feel that sales might be lost or threatened if not following suit. Price maintenance Regardless of what competitors do with regards to price changes, you elect not to just follow suit but instead just maintain your current prices. At the end of all of this consideration and strategy selection, an actual base price or MSRP for the product must still be determined. It is important to select prices that fit within the guidelines of your pricing strategies. It is only the final price in dollars and cents that really matters. All the rest of this has simply been a path to follow to lead to a final pricing decision. Even that decision has some psychological considerations. For example, if you want to charge 50.00 for a product, most firms, especially retailers, will charge 49.99 instead. Experts insist that psychologically 49.99 sounds much less than 50.00. Price Adaptation Strategies Firms usually do not set a single price, but rather design a pricing structure that often reflects variations in geographical demand and costs, market segmentation requirements, purchase timing, order levels, delivery frequency, guarantees, service contracts, and other factors. As a result of discounts, allowances, and promotional support, a firm rarely realizes the same profit from each unit of a product that it sells. A firm might consider using one or probably more of these adaptation strategies. These adjustments to price are also a critical part of developing a complete pricing program. The following represent just an example of some of the most common price adaptation strategy alternatives that could be considered Price Discounts and Allowances Most firms will adjust their list price and give discounts and allowances for early payment, volume purchases, and off-season buying. Cash discounts, quantity discounts and seasonal discounts have become very common. In addition to discounts to end users, functional discounts and allowances are often provided to middlemen for providing various functions. For example, it is common for Proctor Gamble to provide a promotional allowance to retailers like Vons for participating in advertising and sales support programs. Promotional Pricing Firms, both manufacturer and retailers, will often implement promotional pricing programs to stimulate early purchase. Unlike price discounts, allowances, and geographical pricing that are a permanent part of a pricing program, most promotional pricing efforts are only temporary in nature. As a result, these probably should be considered as sales promotion efforts rather than being part of the pricing program. However, I have included them because they do affect price and they have become so common. Some examples of promotional pricing are loss-leader pricing, special-event pricing, cash rebates, low-interest financing, and etc. Promotional pricing could be used for individual products or bundled products. Differentiated Pricing (or segmented pricing) - Firms often adjust their base price to accommodate differences in customers, products, locations and so on. For example, museums often charge a lower admission fee to students and senior citizens. Utilities vary energy rates to commercial users by time of day and weekend vs. weekday. I recently bought some pure maple syrup at Vons in Claremont which was price .60 more than the same product at Vons in Rancho Cucamonga. Might it be due to the different economic backgrounds of the respective customer bases in these two different locations Dynamic and Internet Pricing Throughout early history most prices were set by negotiations between buyers and sellers. Today most pricing involves fixed price policies for the base price or suggested retail prices. However, due to the internet there is a growing interest in dynamic pricing where prices are adjusted continually to meet the characteristics and needs of different customers and situations. For example, airlines and hotels often change prices on the fly according to changes in demand or cost, perhaps on a day-to-day basis or even hour-by-hour basis. Geographical Pricing In geographical pricing the firm decides how to price its products to different customers in different locations and countries. It makes sense that there would be differences by country but geographical pricing applies locally as well. Often this is used to compensate for say higher transportation costs to different geographical locations. This is especially true for industrial goods or durable goods that involve high weight. Approaches like zone pricing or FOB-origin pricing or freight-absorption pricing become important decision areas for certain products. In conclusion, developing pricing strategies and making pricing decisions is critical to the success or failure of many products. It is not an easy task and most marketers dont do a good job. Thus, they dont get the sales desired or they dont maximize their profit opportunities. Marketing Channel Strategy (Supply Chain Strategy) Most firms do not sell their goods directly to the final user. Normally there are a variety of intermediaries performing a variety of functions. Marketing channel or distribution channel decisions is not the glamorous part of marketing decision-making but it can be very critical to success. The text does a good job of describing the major strategic alternatives but I want to add some clarification and stress a few other factors. The text titles this chapter, Supply Chain Strategy, but that can involve a much wider set of strategies beyond marketing. Marketing Channel Strategy is only a subset of supply chain strategies from the manufacturer to the end customer so, to me, Marketing channel strategy is a more appropriate title. Marketing Channels focus on the path through which goods and services travel from the producer to the customer or the path payments for those products and services travel from the customer back to the producer. It reflects how the exchange process can occur for a specific product or service. A marketing channel can be as short as a direct transaction from the producer to the customer or may include several interconnected intermediaries along the way such as wholesalers, distributors, agents or retailers or online retailers. A Multi Channel Marketing strategy is when a business distributes its products or services through more than one channel. Especially with the advent of the internet, this has become the most common channel strategy used. The motive for using a multi- channel strategy is generally to reach the same customers in different buying situations and provide different opportunities to buy or to reach multiple market segments using different channel strategies. For example, if you are a chewing gum manufacturer, how will customers be able to purchase your product Most likely it would be through purchase at retail locations and your channel strategy would probably be indirect and focus on an intensive distribution strategy where your gum would be sold in as many retail locations like grocery stores, convenience stores, movie theaters, and etc. as possible. In addition, perhaps your gum could be made available for purchase through vending machines. This would represent an additional channel of distribution. Thus, your target market would have the opportunity to purchase your gum at multiple retail locations and vending machines. If you are Lands End, they send out catalogues and offer an online website. Customers can actually place orders by returning an order form in the catalogue, calling in an order on an 800 telephone number or going online and placing an order on their website. This would involve a direct channel strategy where Lands End sells directly to the customer and provides three different ways for them to make an actual purchase. In addition, Lands End clothing is also offered through Sears store locations. Thus, the customer can purchase at Sears. This would involve an indirect channel strategy through a retail store serving as an intermediary. Thus, the channel strategy being used by Lands End is a Multi-Channel Marketing Strategy. NCR, as one of their product lines, sells ATM machines to financial institutions. Due to the complexities of the sales and often the cost and volume involved, the financial institutions have the opportunity to purchase only through an NCR sales representative. This NCR salesperson will also call on the financial institution to sell other types of equipment made by NCR for financial institutions. Thus, they follow a direct channel strategy by employing their own salespeople but not a multi-channel strategy. So, when thinking about marketing channels, if you start with identifying the different ways you want your customers to be able to actually make a purchase that makes sense for the type of product or service you are selling, it will make developing your marketing channel strategy so much easier. First, marketing channel decisions are most critical when introducing a new product. However, it is probably more common and more important to recognize that the need for modifying your channel strategies often becomes necessary when the channels are not working as planned, customer buying patterns change, the market expands, new competition arises, innovative distribution channels emerge, and a product moves into later stages in the product life cycle. For example, a new firm may start as a local operation selling in a limited market, using existing intermediaries. The number of such intermediaries is apt to be limited a few manufacturers sales agents, a few wholesalers, several established retailers. Deciding on the best channels might not be a problem the problem might be to convince the available intermediaries to handle the firms line as an unknown entity. If the firm is successful, it might branch into new markets and use different channels in different markets. In smaller markets, the firm might sell directly to retailers in larger markets, it might sell through distributors. In rural areas, it might work with general-goods merchants in urban areas, with limited-line merchants. In one part of the country, it might grant exclusive franchises in another, it might sell through all outlets willing to handle the merchandise. In one country it might use international sales agents in another, it might partner with a local firm. In short, the channel system evolves in response to changing opportunities and conditions. This is why channel decisions, as part of the marketing mix, are often found in most annual marketing planning decisions. Lets step through the major decisions that must be made when developing or modifying channel strategies. Prior to making strategy decisions, it is critical to first clearly determine which channel functions are required. The text addresses this very briefly on pp 170 - 172. In essence, who is going to conduct the buying or selling activities Are assembly, transportation, and/or processing and storage of goods involved Who is going to do the advertising and sales promotion, the manufacturer or an intermediary Who sets the price Who assumes the risk and/or offers risk reducing benefits Is personal selling required and who will do that best What about service or repair needs or other value-added channel-related services that might be needed Answers to each of these types of questions then help guide your strategic and tactical decision making. For example, if your product requires personal selling to be successfully sold, often the case with industrial products, is it better and more cost effective for the manufacturer to do their own personal selling or to give that task to intermediaries Then do we use outside salespeople, national accounts management, telemarketing, the internet, dealers and value added resellers, retail stores, and etc. to perform these personal selling functions This is just one small part of developing and implementing a channel strategy. Key Strategic Decision 1 Direct or Indirect Do we follow a direct channel strategy and do it all ourselves Do we use intermediaries to perform all the needed functions Do we use a combination of 1 and 2 above Start-up and smaller businesses often use indirect channels because they cant afford doing everything direct. Because of the rapid rise of e-commerce this is changing since many small firms simply sell direct online. Even larger firms that could afford to use direct channels have tended to pursue a combination of direct and indirect. This is especially true in business to business markets. Firms such as IBM, NCR, Xerox and etc all used to do everything themselves as the manufacturer. Now, each of these Fortune 500 firms has evolved to both direct and indirect channel strategies. For some industries channel strategies and structures are well defined. Take, for example grocery products. If you manufacture grocery products you usually go through wholesalers who sell to retailers who sell your product to the public. It just isnt feasible for even the largest manufacturers, like Procter Gamble, to have their own sales reps calling on every grocery outlet in the world. Thus, the use of intermediaries is essential but for some key accounts, like Wal-Mart, Safeway/Vons, Kroger, etc. I suspect PG has national account managers that service these chains direct. Thus, even with fairly defined channel structures there are still a lot of alternative decisions possible depending upon your size, resources, and market coverage. Key Strategy Decision 2 Alternative types of channels Do you use conventional channels Do you participate in some type of Vertical Marketing System Do you consider using some type of Horizontal Marketing System A conventional marketing channel is comprised of independent producers, wholesalers, and retailers. Each are separate businesses seeking to maximize their own profits. No channel member has complete or substantial control over other members. Most food products typically use conventional marketing channels and intensive distribution strategies. I would suspect that Sony with its line of e-book readers probably uses selective distribution strategies and conventional marketing channels like Fryes or Best Buy. Fryes is very independent. Sony has no ownership control, with Fryes carrying so many products there probably is no contractual arrangements, and Sony has little informal influence or power over Fryes. A vertical marketing system comprises the producer, wholesaler(s), and retailer(s) acting as a unified system. One channel member, the channel captain, owns the others (corporate VMS), or has contractual control (contractual VMS, or has so much power or leadership ability that they all cooperate (administrative VMS). For example, to combat its lowly 3.4 percent share of the U.S. personal computer market, Apple opened more than 75 retail locations since 2001. The stores sell Apple products exclusively and target tech-savvy customers with in-store product presentations and workshops a full line of Apple products, software, and accessories and a Genius Bar staffed by an Apple specialist. Although the move upset existing retailers, Apple explained that since Apple generated over 25 percent of its own sales, its own retail chain was a natural modification of its channel arrangements. This is an example of moving toward a corporate vertical marketing system owned by Apple as well as using conventional channels as part of its overall channel strategies. A corporate VMS provides the most control and power because one of the channel members actually owns the distribution channels. A corporate VMS may be the result of pursuing a backward or forward integration growth strategy. Sherwin-Williams, a paint manufacturer also owns all of its own retail paint stores which is one example of a corporate VMS. What is the most common type of contractual VMS Franchising The franchisor is usually the channel captain and has organized control over the distribution channels through contractual arrangements. Coca-Cola, for example, licenses bottlers in various markets who buy its syrup concentrate and then carbonate, bottle, and sell it to retailers in local markets. And almost any franchise from McDonalds to Cold Stone Creamery all are based on strict contractual arrangements and control. An administered VMS coordinates successive stages of production and distribution through the size and power of one of the members, not through ownership or contractual arrangements. If you are a small manufacturer of a product and your primary customer is Wal-Mart who do you think has power and control This is another example of an administered VMS where any member of the marketing channel might have the informal power, either the manufacturer or the reseller. Sometimes a firm will follow multiple strategies, usually involving corporate and contractual VMSs. For example, Starbucks runs a number of its own retail outlets but also uses contractual arrangements extensively both in terms of franchising and licensing agreements. It is usually easier to understand corporate and contractual VMSs. Often it is more difficult for students to determine whether they should use a conventional channel arrangement or an administered VMS. The key is whether you have a SIGNIFICANT power advantage over other channel members AND the need to exercise control to some degree over how your product is marketed AND when there are only a few identified channel members involved. A horizontal marketing system is where two or more unrelated companies put together resources or programs to exploit an emerging marketing opportunity. For example, many supermarkets chains have arrangements with local banks to offer in-store banking. Maybe some of the banks you use have at least some of their branches in supermarkets Both are catering to the same customer base and combining services provides more one-stop-shopping convenience. In some ways this fits more into our discussion of strategic relationships but it could also be considered a type of channel strategy too. Digital Channels or internet based channels have become commonplace and continues to grow in significance and probably deserve to be considered as a separate, additional type of marketing channel. Conducting transactional activities on the web through websites, smart TVs, mobile apps, transactional e-mails may occur through physical channel members like on the ground retailers or distributors or manufacturers but in a growing number of cases both the buying and selling is all electronic and the physical entity is not very relevant. It is hard not to consider part of your channel strategy including some forms of digital channels. Key Strategy Decision 3 Intensity of Distribution Firms have to decide on the number of intermediaries to use at EACH channel level. Three strategy alternatives are typically available as discussed in the text Exclusive distribution Selective distribution Intensive distribution Exclusive distribution means severely limiting the number of intermediaries. It might be used if the producer wants to maintain control over the service level, selling activities, and other outputs offered by the resellers. Often, but not necessarily, it involves exclusive dealing arrangements. Small firms with limited resources and market objectives often use exclusive distribution. However, it isnt limited to small firms. For example, Disney Consumer Products and Wal-Mart signed a landmark pact in 2003 giving Wal-Mart a six-month exclusive on sales of toys and merchandise from Disneys new Kim Possible franchise. Almost always there is some type of contractual agreement. Selective distribution involves the use of more than a few but less than all of the intermediaries who are willing to carry a particular product. It is used both by established companies and by new companies seeking distributors. The company does not have to worry about too many outlets it can gain adequate market coverage with more control and less cost than intensive distribution. Sometimes I get student in class who work for Disney so lets use them for another example. Disney sells its videos through five main channels Movie rental services like Netflix the companys proprietary retail store, called Disney Stores (if they still own them retail stores like Best Buy online retailers like Amazon.com and Disneys own online Disney Stores the Disney catalog and other catalog sellers. These varied channels afford Disney maximum market coverage, and enable the company to offer its videos at a number of price points. Disney is following a selective distribution strategy since there are many more retailers and outlets that could sell Disney videos but dont or cant. Intensive distribution consists of the manufacturer placing the goods or services in as many outlets as possible. This strategy is generally selected for items such as tobacco products, soap, gum and many consumer products where the consumer requires a great deal of location convenience and selling an/or service functions are not a key factor. With intensive distribution the manufacturer has the least control over how a product is sold, pricing policy, conditions of sale, training or service support. So if customer service or personal selling is important, then it might not be wise to give us so much control. It could increase short term sales but at reduced prices and profitability and it could harm brand image and brand equity as a Calvin Klein experience illustrates In May 2000, designer Calvin Klein sued Warnaco Group, Inc. for selling his jeans to cut-rate, mass-market outlets without his permission. Warnaco, which had the license to make and distribute the jeans, was accused by Calvin Klein of making lower-quality jeans for these outlets, and therefore hurting his image. The suit was settled out of court in January 2001, and both sides said they looked forward to expanding jeans wear sales consistent with the image and prestige of Calvin Klein products. Warnaco would limit distributing jeans wear products to department and specialty stores only. Key Strategic Decision 4 Identifying the specific intermediaries Companies can choose from a wide variety of different types of channel members which determine the channel length, how many levels of intermediaries between the manufacturer and the customer and which specific type of intermediary should be used. We already alluded to the fact that different types of intermediaries include company sales forces, sales agents, manufacturing reps, distributors, wholesalers, dealers, retailers, direct mail, telemarketing, and the internet. Each channel type has unique strengths and weaknesses. Company sales forces can handle complex products and transactions, but they are expensive. The Internet is much less expensive, but it cannot handle complex products. Distributors can create sales, but the company loses direct contact with the customer. One of the best ways to define your channel strategy and the specific type of intermediaries that will be used is to create a Channel Map. Below is an example of a channel map for Kelloggs Cereals. In this example, Kelloggs uses a multi-channel strategy by using two different direct channels and one indirect channel through wholesalers. For some larger retail accounts they probably use their own salespeople to call on select retailers. However, for very large retailers who probably handle their own distribution of products to their stores, orders can be placed directly via computers with no sales person involvement. Finally, the bulk of their business probably is derived from independent channels where wholesalers sell and distribute Kelloggs products to a wide variety of smaller retail accounts. Managing marketing channels effectively is a major marketing management responsibility. Especially when multi-channels are used, which is becoming the norm, it is very easy to create channel conflicts. For example, about 25 years ago GE sold all of its appliances through separate GE appliance dealers. 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Solution: Facebook Case Presentation